Stratasys, Ltd. (SSYS), 3D Systems Corporation (DDD): Earnings Going Forward

In the case of 3D Systems, which, after raising more than half a billion dollars in cash, has only $36.5 million of property and equipment on its balance sheet, you need to have some measure to gauge how successfully the company is making use of its intangible assets. Amortization sets a reasonable bar to help the average investor determine whether management is effectively employing the patents, licenses, technology, software and trade names of the companies it buys. Is enough income being generated to offset the decay of the intangible assets that drive the earnings power?Here’s a case in point: In its SEC filings, 3D Systems discloses that it has spent $89.6 million cumulatively on the acquisition of customer lists. Accounting for the portion that has already been amortized, that’s still $77.6 million, or nearly 8% of the entire asset base, that’s been attributed to customer acquisition. As a shareholder, you want to follow the amortization of this asset, and you want to see net income on the books even after the amortization is taken into account. In this way you’ll be comfortable that 3D Systems Corporation (NYSE:DDD) is using its customer lists in an efficient and profitable manner. In a global sense, because of the amortization of intangibles, 3D Systems has a much higher cost of sales (both operational and general/administrative) than one might realize from just looking at non-GAAP earnings.

Goodwill: not amortized, but significant
Goodwill presents a slightly different situation. In financial reporting, goodwill is a balance sheet account. When a corporation acquires another company for more than book value, it records the excess in this account. Companies are no longer required to amortize goodwill; rather, they test goodwill each year for “impairment.” Expense is recognized only if management determines that the value of the goodwill has declined.

For 3D Systems, which has grown primarily through acquisition and has a proportionately large goodwill account, reviewing GAAP earnings can help an investor discern whether the company is generating reasonable income from the acquired assets. While there is no recurring amortization bar as with intangible assets, prolonged GAAP losses are a potential flag that a company has overpaid for its acquisitions.

Earnings going forward
So far, 3D Systems Corporation (NYSE:DDD) has credibly delivered earnings on a GAAP basis: It’s shown a profit in each of the past three fiscal years since beginning its acquisition spree. Going forward, look for differences between unadjusted net income and non-GAAP earnings to decrease over time, as organic revenues replace acquired revenues, and net intangible assets decrease because of amortization. Increasing GAAP income will be a decent indicator of 3D Systems’ progress. But decreasing GAAP income in the future will serve as a cautionary flag — a reason to peel back the onion when reading through the company’s quarterly earnings, and reach comfort (or not) with the stock price, given the company’s typically high valuation.