3D Systems Inc. CEO Abe Reichental had his first inkling in last year’s second quarter that the company’s financial reporting might be flawed.
The news couldn’t have come at a busier time for the provider of three-dimensional printing, prototypes, and manufacturing systems for a range of business lines. The headquarters were being moved from southern California to a new Rock Hill, South Carolina, facility. It was outsourcing its global logistics to UPS. And an Oracle Corp. enterprise resource planning system had gone on-stream in the second quarter.
As it turned out, the timing was no coincidence — it was the ERP implementation that was turning up longstanding problems. “I first heard about the problem in working sessions with our management team,” Reichental said in an interview in late January. The company had a new controller, Bill Tennison, “who immediately flagged the problem the moment it became even a mild concern.”
But the growing scope soon made it hard to miss. “We attempted to close the books on the second quarter of 2006, and we detected material weaknesses in our controls,” the CEO said. With difficulty, the quarterly results were reported. The audit committee, the full board, and external auditors BDO Seidman LLP were consulted. The initial reading by the chief executive was that “we may have had some innocent errors here, and some misapplications of certain accounting principles.”
A year later, the assessment about the errors being innocent still seems the same. But the problems have increased during the effort to restate. In February, CFO Fred R. Jones “stepped down by mutual agreement,” and was replaced as interim finance chief by Gerald J. Pribanic, a partner with executive services firm Tatum LLC. Then, a delay in filing the annual 10-K report led to a notice from Nasdaq that 3D Systems’ stock is subject to delisting, although 3D Systems continues to trade while it appeals the notice.
On April 5, the company announced that it would filed its annual 10-K report “as promptly as practicable.”
The CFO’s Role
Jones got involved early on with the process of preparing for the restatement, Reichental said in the January interview. The CFO’s first assignment was “organizing the team and the effort to carry out our investigation and analysis, and to attribute the appropriate adjustments to each period,” the CEO said. Jones also supervised various tests to determine which errors “rose to a level of materiality,” and thus had to be reported as material to the SEC, Reichental said. Consultants were engaged to help with these tasks.
“One of the challenges of a restatement is to make sure the rest of the business goes on uninterrupted,” he said. “For many of us this is uncharted territory. Also, you don’t want to siphon all your resources into the restatement.”
According to an August company news release announcing preliminary third-quarter numbers, 3D Systems “quickly began to experience unforeseen disruptions and delays in operating the system.” Other things were going wrong, too: supply-chain glitches, for example, complicated the entering and processing of customer orders. And in November, 3D Systems announced that it would restate the first two quarters of the year and delay filing its third-quarter 10-Q. Previously announced numbers shouldn’t be relied upon, it said, echoing the language of a Form 8-K that also was filed. Beginning a pattern that it continues to follow, the company followed 8-K filing and the news release with an analyst conference call featuring questions about the restatement plans.
Indeed, companies uncover errors in their books through a range of mechanisms — not all related to the internal controls audits mandated by the Sarbanes-Oxley Act. At 3D Systems, the ERP implementation led to disruptions that tipped the company off to its legacy accounting errors. At other companies, it can be the normal internal auditing process.
In December, the restatement widened, with the company adding 2004 and 2005 to the periods for which it anticipated a new filing, although it estimated that the effect of changes for the two years would be “less than $1 million of net income.”
As 3D Systems continued to work on the restatement, Reichental developed his own personal view of the process and its benefits. “If you move into an existing house, and the plumbing and electricity function, you’re not likely to go and rip out the sheet rock and try to expose the plumbing,” he said. “But in the event that you do need to renovate, you may discover that you had some fundamental problems in the infrastructure that might not be visible when you live in your house every day. In a way, that’s what happened to us.”
Eric Martinuzzi, an analyst with the firm of Craig-Hallum who follows 3D Systems, was impressed by the company’s early response — up to a point. “They’re doing the best they can, especially considering that it’s such a negative topic,” he said in January. Still, with last fall’s announcement of the 10-Q delay he believed that “they could have been a little more communicative, and said it was likely that ’04 and ’05 likely would have to be restated.” Specifically, CFO Jones sidestepped Martinuzzi’s question about prior years during the November 6 call, although he did provide examples of product-pricing errors that resulted from the problems that had been detected.
The company’s stock, which vacillated between $14 and $16 after a slide after that November conference call, began to rise again toward year-end, and in recent months has surged to above $22, despite the news about the CFO’s departure and the delayed 10-K filing.
Analyst Martinuzzi isn’t sure why the stock has risen, noting that Craig-Hallum is “certainly not comfortable recommending it as a buy stock without knowing what the material weaknesses are.”
Reichental didn’t answer questions about Jones’s replacement, or about what changes have occurred at the company since January.
In an April 5 news release, noting the latest Nasdaq delisting notice and the company’s intention to appeal it, Reichental said: “Our current inability to remain timely in our periodic filing requirements is a serious matter. While it is Nadaq’s customary practice to send notices such as this one to all Nasdaq-listed companies in similar circumstances, we plan to file our Form 10-K as promptly as practicable and are taking all remedial actions that are necessary to maintain our Nasdaq listing.”
In the January interview, however, he expressed certainty that the changes being made at 3D Systems during the restatement process will make it a better company. “Now, in a more disciplined ERP environment, we’ve hardwired checks and balances into the system. A more manual environment could allow for human errors.”
A Japanese Wake-Up Call
Another company that didn’t lose stock value after a restatement was Zygo Corp., which managed to restate its earnings within a few months of its initial announcement.
At the Massachusetts Institute of Technology’s CFO Forum in November, Walter Shephard, CFO of Middlefield, Connecticut-based Zygo, described the problem that the optical instrument supplier and electro-optical design company had reported in March. During an internal tax review, it found what Zygo’s filings described as “inadvertent accounting errors in the consolidation of its intercompany revenues from certain of its foreign operations.” The amount of net income from continuing operations covered by the restatement of the June 30, 2005, fiscal year, was $800,000 — out of annual net income of $10.2 million.
Still, chairman and CEO Bruce Robinson needed to be informed as soon as the company determined a restatement was necessary. That meant a call from Shephard to Robinson’s hotel in Japan, where he was traveling. “I had to wake him up in the middle of the night,” Shephard recalled.
“It’s a humbling experience when you have to go through this,” he said, noting the missed 10-Q filing and the notice from Nasdaq about a possible delisting. Zygo, which never was delisted, filed its delayed third-quarter report last June, along with the restatements. “Fortunately for us, we’d built good relations with Wall Street,” Shephard said, and analysts found positive news in the report of the restatement.
T-shirts seem to be a popular way to mark a successful restatement. At Flowserve Corp., whose case was featured in an April CFO article on restatements, relieved finance staffers got one that said “Looking to the Future,” marking the change in attitude that would be required when the corrected financials finally were filed. At Zygo, too, a shirt was customized for CFO Shephard to commemorate the moment.
On the front it says, “I Told the World I Screwed Up the Books.” And on the back, “But the Stock Price Went Up 30%.”