Source: 3D Systems.
Last week, 3D Systems (DDD 3.31%) released its fourth-quarter and full-year 2014 earnings, which showed a business that continues to have trouble executing well across all of its segments. Along with the release, management provided additional color on the results during a conference call with analysts. Below are five key takeaways from the call.
1. North America's operating performance weighed on the company's overall organic growth rate.
In the fourth quarter, 3D Systems' North American operating performance "fell well short of expectations," as CEO Avi Reichental put it, and restricted the company's organic growth rate -- the rate of annual revenue growth that doesn't account for acquisitions less than a year old -- to 7% during the quarter.
During the call, Reichental offered some color on how the company plans to resolve this issue:
Specifically, we have reorganized and strengthened our North American senior leadership, we aligned our North American and APAC [Asia-Pacific] channel growth plans and incentives to closely mimic our successful EMEA [Europe, Middle East, and Africa] program, and we are investing in specific channel extension initiatives as well as productivity and training tools.
I fully expect us to deliver meaningful results from these corrective actions as the year progresses.
2. Management prefers that investors focus on the company's unit growth instead of its organic growth rate.
On the call, management said unit growth is a stronger indicator of the company's operating performance than organic growth.
After all, the company's unit growth in terms of 3D printers sold outpaced revenue growth by 3.5 times in the fourth quarter, and management believes growing its installed base lays the foundation for creating solid long-term recurring revenue-generating opportunities from the sale of high-margin consumables as its printers are used.
Chief Financial Officer Ted Hull elaborated:
Throughout 2014, we progressively increased printer units faster than printer revenues, underscoring a shift in mix and higher volume that is consistent with our plans to expand the reach of 3D printing from the factory floor to the desktop.
While in the short-term, this self-cannibalizing strategy understates our top-line [revenue] growth and pressures [gross] margin expansion, we firmly believe that it is key to our long-term recurring revenue momentum, and that printer unit's growth is the most relevant organic metric as we rapidly expand our installed base.
3. 3D Systems' gross profit margin should expand in 2015.
In the fourth quarter, 3D Systems' gross profit margin fell by 380 basis points year over year to 47.9%, as it continued to bear the up-front costs associated with a concentrated number of product launches and a manufacturing capacity build-out for its direct metal 3D printers.
However, according to Hull, not only are the underlying fundamentals of the business intact, but he also expects the company's gross profit margin will resume its expansion:
Looking beyond these transitional factors, we believe that the fundamentals of our business model remain intact, and we expect gross margin to resume its expansion by increasing materials, software and health care revenue contributions at higher gross profit margins, recovering product gross margins following a period of concentrated new products and [manufacturing] facilities transition, and continuing operational synergies and greater leverage from tighter integration and operational efficiencies.
4. The company is working to measurably improve its operational efficiency.
In recent years, 3D Systems' cash conversion cycle, which measures the amount of time it takes for cash to flow through the entire sales cycle, from sitting in the bank to buying inventory to selling inventory to collecting payment, has been rising:
DDD Cash Conversion Cycle (Quarterly) data by YCharts.
It's highly likely that 3D Systems' hyper-aggressive acquisition strategy has distracted from efficiently managing its inventory, paying its suppliers, and getting paid by customers.
Hull, though, emphasized that the company will work to improve its cash collection process; if successful, this would lead to an improved cash conversion cycle: "While we expect our DSO [days sales outstanding] to fluctuate a bit in the ordinary course [of business], we are taking decisive steps to improve our cash collection cycle and reduce DSO over time by another five days."
5. 3D Systems has not been experiencing pricing pressures.
3D printer manufacturers in general face the threat of increased competition, whether from expiring patents or new technologies that make previous technologies seem inferior. The fear is that increased competition could create pricing pressures that eat into profitability and undermine the investing thesis.
As 3D Systems' unit growth outpaced its revenue growth by 3.5 times during the quarter, the issue of pricing pressures came up during the Q&A session.
Reichental wasted no time in setting the record straight:
I want to be crystal clear that we have not experienced any change or any outlying behaviors in term of discounting. The simple answer is that ASP [average selling price] erosion is really not as wide in our results and specifically we did not experience any unusual discounting activities during the period.
Moments later, Reichental added:
This [focus on growing unit volume] is how we are going to accelerate market share and install base. We are doing it in the short-term in a way that is self-cannibalizing that substantially understates top-line [revenue] growth and pressures margins for a certain extent.
However, we continue to believe that this [focus on unit growth] is a key for [creating] long-term recurring revenue momentum, which again as I said earlier, on material [sales] alone, over a meaningful period, translates into at 24% CAGR [compounded annual growth rate] over the past two years.
The bottom line
Although 3D Systems' North American performance may have missed the mark in the fourth quarter, management has already begun implementing changes that should drive meaningful improvements to the segment's performance in future periods. Ultimately, a greater emphasis on operational effectiveness could also help 3D Systems establish that management is working to improve its execution across the board, which would certainly be a welcomed development for investors.
