3D Systems' (DDD +0.54%) second-quarter earnings may have missed Wall Street expectations, but that didn't stop the stock from soaring after the results. It seemed investors were relieved that the 3D printing maker didn't announce any new major negative developments -- an all too common occurrence in recent quarters.
The company also reported some signs of stabilization from its core business after two quarters of abrupt pause, which may have sent bears clamoring for the exits and prompted a classic short-covering rally. Prior to the release, nearly one-third of 3D Systems' shares outstanding were sold short.
The conference call that management hosted along with its earnings release highlighted the current state of 3D Systems' underlying business. In total, there were four major takeaways.
1. Previous problems weighed on organic growth.
Although 3D Systems didn't announce any new major problems during the quarter, several issues that developed in previous quarters persisted.
In his opening remarks, CEO Avi Reichental shed light on these ongoing problems and how they affected the company's organic growth rate, which helps investors measure the company's annual revenue growth outside acquisitions made within the last year:
Several factors besides currency adversely affected our revenue for the quarter including continued industry level challenges, macroeconomics weakness particularly in Asia-Pacific and remaining printer quality and performance issues related to specific nylon and metal applications that impeded our ability to sell additional printers during the quarter.
Altogether, these factors contributed to a 5% decline in organic revenue compared with the second quarter of 2014. At constant currency rate organic growth was 2% for the second quarter.
2. Mea culpa
During the call, Reichental finally admitted that the company's hyper-aggressive acquisition strategy of the last four years has hurt its operational performance.
While a period of high growth enabled us to acquire strategic assets and build critical expertise, our rapid expansion permitted certain operating inefficiencies that we are currently addressing.
Specifically we're enhancing the quality of our product and services, accelerating synergy and cost reduction measures, driving process improvement, and working closely with our channel partners to improve our sales operations in worldwide coverage.
3. About those printer problems...
According to Reichental, the ongoing performance issues that have been plaguing some of its nylon and metal 3D printers are a combination of inherent technological challenges and customers pushing the technologies into "uncharted territories."
Specifically, the nylon issue was related to temperature distribution, while its large-format metal 3D printer had issues with feeding the metal powders into the build chamber during builds that exceeded 40 hours:
We have one nylon model, one nylon machine that has had some performance related issues around primarily thermal distribution within the powder bed. This is not a new challenge with selective laser sintering or with nylon. It's a challenge that is inherent in that technology.
We have tried with this new generation of equipment to push the envelope further. And everything looked good until we got further down the line and discovered that we had a few more technological hurdles to overcome. We now believe that we have successfully remediated this issue...
...In direct metal printing, with the large-format machine, we had additional challenges that were related primarily to powder – consistent powder feeding and powder refresh, which created a symptom of starving taller builds of powder incrementally. So the word on the street was that the machine is challenged in building tall parts. That was the symptom.
The root cause of the problem had to do with consistent powder feed over very, very long builds that could exceed 40, 50 hours of build. We have now successfully understood it, we have solutions in place, and we are working with all of the affected customers one by one to get to satisfactory resolution, again standing behind our product.
4. A new approach
One of the biggest lies told by the 3D printing industry in recent years has been that consumers will soon adopt 3D printers en masse. This couldn't have been further from the truth, as the use cases explaining why an everyday consumer would benefit from owning a low-cost 3D printer have been severely lacking.
Reflecting the reality of the situation, 3D Systems' consumer revenue only represented 5.5% of its total revenue in the second quarter, and declined by 41% sequentially on lower demand. Consequently, Reichental highlighted that the company will now be shifting how it approaches the consumer segment:
We certainly see that within consumer at large, we are experiencing some softness but specifically within EDU [education] and the engineers' desktop, we see more immediate opportunities and so we're focusing our energies and resources on monetizing these opportunities while we push forward with those products. So we're not giving up on our product. We're not giving up on the potential to monetize them. But we're reprioritizing around where demand exists.
A long road ahead
As Reichental made clear, in order for the company to get a better handle on its inefficient operations, it has to improve quality controls, costs, processes, and become a better partner with its distributors. Ultimately, between the challenging industry environment and the internal improvements the company is working to make, it's likely that the company has a long road ahead before it can redeem itself.
