Velo3D: No Room For Error

seekingalpha04-02

Velo3D's stock has rebounded in recent weeks, but the company's balance sheet will make a successful turnaround difficult.While Velo3D has aggressively cut costs and is now generating orders again, ...

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Matveev_Aleksandr/iStock via Getty Images Velo3D's (NYSE:VLD) stock is up significantly off the lows of early 2024, although the merits of this move are questionable. I suggested in December that executive turnover and a strategic realignment were indicative of larger issues. I did not expect the business to come to a virtual standstill in the fourth quarter though. While the company is engaged in a turnaround effort, ongoing losses and a weak balance leave no room for error. Cost cutting efforts should help to reduce losses but there appears to be a demand problem and it is not clear that this is the result of macro conditions. Despite the precipitous fall in share price over the past few years, Velo3D's valuation is still fairly high given the company's fundamentals. The potential for an acquirer to step in could provide some support to the stock but unless Velo3D can reinvigorate demand, the share price is likely to remain under pressure. End Markets Velo3D is renewing its focus on space, defense and aerospace as its technology provides the most value to customers in these industries. This is largely based around the company's ability to produce metal parts with complex internal geometries. This is one of the puzzling elements of the company's current predicament though. Demand from space, defense and aerospace customers should have been fairly robust over the past few years, even as other industries have struggled with elevated interest rates and macro uncertainty. Velo3D believes that it is the additive manufacturing market leader in space, with the company’s technology helping to improve launch performance and reduce costs. Velo3D counts 9 North American launch companies as customers. With activity expected to ramp in coming years, Velo3D could see a significant increase in demand for its printers. This has certainly been the bull case since the company became public in 2021. Velo3D must survive to capitalize on this opportunity though. Figure 1: Rocket Lab Revenue (source: Created by author using data from Rocket Lab) Velo3D believes that its defense business has the most potential. Additive manufacturing is useful in areas like hypersonics and legacy part procurement. Velo3D has 9 defense customers, including Kratos Defense, Bechtel, Ohio Ordnance and Lockheed Martin. The recently approved 825 billion USD defense spending bill is expected to be a tailwind, with Velo3D already receiving a purchase order tied to this funding.   Figure 2: FY2023 System Revenue by End Market (source: Velo3D) Turnaround While results in the fourth quarter were extremely poor, Velo3D characterized this as a transition quarter. The company is trying to cut costs and reinvigorate demand, but this could be challenging considering that management commentary suggests customer satisfaction issues. In particular, Velo3D is shifting from a product to a customer driven model and aiming to improve manufacturing and reliability. Reliability concerns appear to be preventing some customers from scaling. Velo3D has a small cash runway in which to complete this turnaround though and its cost of capital is high. Figure 3: Velo3D Operational Improvement Plan (source: Velo3D) Little detail has been given on progress against its targets, but Velo3D has stated that it is happy with how things are progressing. As an example, Sapphire printer installation times have been reduced by 40% over the last 6 months. Velo3D is also expanding its field service organization to provide a higher touch service, this will increase costs though. The company is also trying to introduce processes that will enable it to identify and prevent field failures. Velo3D Business Updates Velo3D's current focus is on stabilizing the business and hence there hasn't been too many recent developments from a product perspective. The company is considering monetizing its Flow Developer software package though. Flow Developer allows customers to customize print parameters, potentially improving print quality and efficiency. This appears to be part of a broader effort to drive more recurring revenue, including from consumables. Velo3D also continues to invest in improving its Sapphire printer. Development appears to be focused on improving throughput and reducing cost, opening up the product to a broader customer base. Financial Analysis Velo3D's fourth quarter revenue was only 1.8 million USD, which was attributed to disruption caused by the company's shift in strategy. Only five orders were booked in the fourth quarter, with 80% of orders coming from existing customers. Velo3D's financial struggles could have caused customers to hold off on orders and this remains a risk going forward. Bookings and backlog have been falling for the past 18 months though, suggesting that there have been underlying problems brewing for some time. Most concerningly, consumable sales have fallen substantially in recent quarters, suggesting that utilization of printers in the field has been declining. Velo3D has also stated that some machines have been returned at the end of their lease term, potentially indicating a lack of customer interest. Velo3D has stated that its pipeline is now growing again, leading to a rebound in the company's backlog. Close rates are also reportedly beginning to improve. Since the middle of December, Velo3D has booked more than 15 million USD in orders. Velo3D expects 80-95 million USD revenue in FY2024, which would be roughly a 13% increase over 2023 at the midpoint. Figure 4: Velo3D Revenue (source: Created by author using data from Velo3D) While Velo3D has been trying to reduce its costs for a while now, fourth quarter losses were large due to the fact that the company generated little revenue. Figure 5: Velo3D Profits (source: Created by author using data from Velo3D) Velo3D's fourth quarter gross profit was driven by low volumes, along with a 27 million USD inventory charge. Field support has also reportedly been a drag on gross margins in recent quarters. Manufacturing cost reduction initiatives are beginning to have an impact though. This includes:  New suppliers New supply agreements Lower raw material costs Process improvements  Gross profits are still being hit by high inventory costs but the impact of this should be reduced going forward as lower cost inventory begins to flow through the income statement. The company wants to reduce Sapphire XC costs by more than 30% in 2024. A mix shift towards the higher priced Sapphire XC system should also be a tailwind. Improved monetization of maintenance and parts, along with an expanding consumables business should support margins as well. Gross margin is expected to be in the 20-30% range in 2024, ending the year at approximately 30%. This is an aggressive target that Velo3D has been pursuing for some time though and the company is not guaranteed of achieving it. Figure 6: Planned Gross Profit Margin Expansion (source: Velo3D) Velo3D has reduced headcount by 20% and has been consolidating facilities. It also has other cost cutting programs in place. The full benefit of this is not expected to hit until the first quarter though. Velo3D also incurred roughly 2 million USD of costs in the fourth quarter related to its realignment initiatives. While Velo3D's losses looked bad in the fourth quarter, the company has been making progress from a cash flow perspective. First quarter cash use is expected to be in the 13-17 million USD range. The company is targeting free cash flow breakeven excluding financing in the second half of the year. Figure 7: Velo3D Operating Cash Flows (source: Created by author using data from Velo3D) Velo3D ended the fourth quarter with only 31 million USD in cash and investments, even after raising 18 million USD through a registered direct offering of shares and warrants to an existing lender and new institutional investors. As a result, Velo3D will likely end the first quarter with only around 15 million USD cash, which may only be enough to finance the company until around the middle of the year, depending on demand and progress on reducing costs. This isn't an ideal situation for shareholders as the company's market capitalization means that any equity raise is likely to cause significant dilution. Conclusion Cost cutting efforts and a rebound in orders could see cash flows improve significantly going forward. Velo3D will have very little cash to work with after the first quarter though, raising the specter of further dilution for existing shareholders. Velo3D believes that it has a clear path to profitable growth, but the company has essentially been saying this for the last 12 months. If real progress isn't made in coming quarters, Velo3D will likely find it difficult to raise enough capital to remain a going concern. There could be acquirers waiting in the wings at the right price if this occurs though, like Nano Dimension (NNDM). This could help to limit downside in the near term, but after the recent increase in share price too much optimism may already be baked in. Figure 8: Velo3D Relative Valuation (source: Created by author using data from Seeking Alpha)  Editor's Note: This article covers one or more microcap stocks. 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