Stratasys' (SSYS +1.85%) second-quarter earnings were released last week and failed to impress investors. The once-beloved 3D printing maker reported anemic revenue growth of 2% year over year to $182.3 million, translating to a net loss of $0.55 per share, or an adjusted net profit of $0.15 per share.
Although its earnings fell in line with Wall Street expectations, the company withdrew its full-year guidance due to market uncertainty, and instead provided third-quarter guidance, which fell significantly below Street expectations. The combination of withdrawing guidance and providing weak third-quarter expectations prompted the stock to sell off as much as 16% following the release.
The conference call that management hosted along with its earnings release gave investors an opportunity to gain a greater understanding of the dynamics that are driving Stratasys' business. In total, there were four major takeaways.
1. Customers are digesting existing capacity
The biggest story from management during the call was that customers have far more 3D printing capacity than their current needs, and that's driving them to increase the utilization of their existing capacity before buying more 3D printers.
On the call, CEO David Reis highlighted this dynamic on several occasions:
We believe that our industry is now transforming through a period of slower growth as user digest the recent investment in 3D printing and expand capacity utilization. Despite these headwinds we are encouraged by areas of sequential improvement in our business and remain confident – sorry, remain convinced of our long-term potential over our industry.
Compared to the first quarter, total revenue increased by 5.3%. By segment, product revenue grew by about 6.2%, while services revenue expanded by nearly 3.7%.
2. MakerBot continues to drag on results
With revenue falling 57% year over year to $14.5 million, demand for MakerBot's 3D printers effectively nosedived in the second quarter. Overall, MakerBot represented nearly 8% of Stratasys' total revenue during the quarter, but its weak performance dragged heavily on its consumable revenue growth rate, which helps measure 3D printer usage trends.
Officially, consumable revenues increased by 6% year over year, down from 18% in the first quarter, but excluding MakerBot and a drag of 700 basis points from currency headwinds, Stratasys' consumable revenue growth would've been much stronger:
I would like to add to it that when – again just to repeat that if you take out the consumable part of MakerBot, the growth year-over-year in constant currency was 19%, which I think is impressive...
3. Underlying technology issues?
During the question-and-answer session, an analyst made a powerful observation that although Stratasys' existing customers may be digesting their recent 3D printer purchases, overall market penetration of 3D printing in manufacturing applications remains "minuscule." This led him to the question if there's an underlying issue with Stratasys' technology. After all, if there's such a large addressable market for 3D printing in manufacturing, why isn't Stratasys selling more 3D printers?
Reis agreed that for 3D printing manufacturing applications, penetration remains small, but rapid prototyping is the core driver of Stratasys' business:
Yes, I do agree with your statement that our penetration in this [manufacturing] market is very, very small.
I think this is [currently] a rapid prototyping market. We are dealing with some issues of capacity. We are dealing with issues of go-to-market and are extending our reach to new customers which did not experience hands-on the technology.
On the manufacturing side of it, I think the marketing – and we're doing a huge effort in this direction – is adopting the technology slowly and here technology breakthroughs will accelerate adoption. But it's mainly related to manufacturing; I don't think it's a true statement for rapid prototyping which is basically the core of our business for the last many, many years.
In other words, using 3D printing for manufacturing still represents a very small part of Stratasys' overall business, and the rate that manufacturers are embracing 3D printing is slow.
4. Unrealistic growth assumptions
On the call, Stratasys maintained two previous growth expectations that seem unrealistic in light of the company's slowdown. The first was when COO and CFO Erez Simha told investors that MakerBot will contribute to Stratasys' bottom line in 2016:
We expect a tough 2015 for MakerBot, meaning we do not expect MakerBot to contribute -- to gain benefit in 2015. And again, the plan is that as of 2016 MakerBot will come back to a higher growth than we saw in 2015 and will contribute to the bottom line of the company.
Considering MakerBot's initial fall from grace can be largely attributed to product reliability issues with its fifth-generation Replicator 3D printing platform, it remains unclear how management will successfully restore its brand image and grow the unit's revenue to the point that it positively contributes to earnings next year.
The second unrealistic assumption was when Reis highlighted that the company's investment initiatives are aimed at supporting potential annual revenue of $3 billion in 2020:
As mentioned earlier, we are committed to a strategic investment plan that we unveiled early this year, which is designed to support the future growth of our business and sustain our leadership position.
The multi-year investment plan focus on enhancing vertical industry solutions, expanding customer support services, building an enhanced sales and marketing infrastructure, and accelerating product development, all designed to support potential annual revenue of $3 billion in 2020.
For perspective, Wall Street expects Stratasys to generate $748 million in revenue this year and $852.5 million in 2016. Modeling off the former's 2016 forecast, Stratasys would have to grow sales by about 250% in four years, or by nearly 37% per year, compounded. Bear in mind that the 3D printing industry is forecasted to grow by over 31% per year between 2013 and 2020, according to Wohlers Associates.
While it's certainly not impossible for Stratasys to achieve this level of revenue growth, it seems like a very tall order to fill, given the company's recent underperformance.
Clouds of uncertainty
After Stratasys' second-quarter earnings call, it appears that customers have too much capacity on hand and it's hurting printer sales, MakerBot remains an ongoing challenge, manufacturers are slow to adopt 3D printing, and management hasn't reassessed what are likely unrealistic growth assumptions. Unfortunately, these dynamics are casting clouds of uncertainty around Stratasys' future growth prospects.
