Align Technology, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. Align sells Invisalign clear aligners and iTero intra-oral scanners and reports Clear Aligner and Scanner segments.
Financial performance
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Revenue | $278.6 million | $207.6 million | $786.7 million | $615.2 million |
| Gross profit / margin | $209.2 million / 75.1% | $157.6 million / 75.9% | $595.0 million / 75.6% | $467.3 million / 76.0% |
| Operating income | $62.1 million | $38.0 million | $180.5 million | $129.3 million |
| Net income | $51.4 million | $27.6 million | $142.1 million | $95.1 million |
| Diluted EPS | $0.63 | $0.34 | $1.74 | $1.17 |
- Q3 revenue rose 34.2%; nine-month revenue rose 27.9%. Q3 net income increased about 86% year over year.
- Q3 Clear Aligner revenue increased 22.9% to $243.7 million; Scanner revenue increased 273.7% to $34.9 million. Nine-month growth was 20.6% and 174.6%, respectively.
- Invisalign case volume rose 20.5% in Q3 to 177,800 cases, including 34.0% international growth. Management attributed Clear Aligner growth principally to volume; Scanner growth reflected shipments of the iTero Element.
- Q3 consolidated gross margin declined 0.8 percentage points. Clear Aligner margin fell to 77.7% from 78.8%, primarily due to more aligners per case; Scanner margin improved to 57.1% from 14.7% on product mix and lower unit costs.
- Q3 SG&A was $126.7 million, up $24.9 million, while R&D was $20.4 million, up $2.6 million. SG&A included higher compensation, marketing, equipment/material, and outside-services costs.
Cash, liquidity and capital
- At September 30, cash and cash equivalents were $419.9 million; short- and long-term marketable securities totaled $255.8 million. Combined cash and securities were $675.8 million, versus $678.7 million at year-end 2015.
- For the first nine months, operating cash flow was $166.7 million, compared with $158.6 million in 2015. Accounts receivable increased $93.1 million, partly offset in operating cash flow by a $46.5 million increase in deferred revenue.
- Investing cash flow was positive $142.9 million, reflecting $537.8 million of marketable-security maturities and sales, alongside purchases of property and equipment and the SDC investment. Financing cash outflow was $57.6 million, including $58.2 million of share repurchases.
- No borrowings were outstanding under the $50 million revolving credit facility; it matures March 22, 2017 and requires at least $50 million of unrestricted cash. The filing reports no interest-bearing debt outstanding.
- Management said available liquidity and operating cash flow should fund operations and planned repurchases for at least 12 months. Estimated 2016 capital expenditures were $76–$81 million, including manufacturing capacity, facilities and ERP investment.
Changes, outlook and notable items
- Management expects international Clear Aligner revenue to grow faster than North America for the foreseeable future, supported by market expansion and investment. It expects operating expenses to increase in 2016 for international expansion, sales/customer support and product development; no specific revenue or earnings guidance range is provided.
- Align invested $46.7 million for a 17% equity interest in SmileDirectClub (SDC) in July 2016 and entered a supply agreement, with aligner shipments beginning in October. Align expects the arrangement to add to revenue growth and earnings in 2017. A separate SDC loan facility of up to $15 million had no advances outstanding at quarter-end.
- A July 2016 international restructuring produced a $26.6 million tax expense from taxable gains in certain jurisdictions, while release of a valuation allowance on Israeli tax-loss carryforwards generated a $31.4 million tax benefit. The Q3 effective tax rate was 18.4%, versus 24.3% a year earlier; the nine-month rates were 21.6% and 24.8%.
- The “Additional Aligners at No Charge” policy affects revenue timing through increased deferrals; management says more revenue was deferred beginning in Q3 2015 and expects the policy to support customer satisfaction and utilization over time.
- Management reported total Invisalign utilization of 5.0 cases per doctor in Q3, up from 4.7; North American orthodontist utilization reached 11.1 from 9.9. It cautioned utilization may fluctuate with seasonality and product adoption.
- CFO David L. White announced retirement effective November 10, 2016; John F. Morici became CFO that date. Management noted transition uncertainty could affect execution or retention of key personnel.
Risks and contingencies
- Key risks include dependence on Invisalign, pricing and promotional discounts, foreign exchange exposure, competition (including the expiration of certain key patents beginning in 2017), and reliance on single-source suppliers and a contract manufacturer for scanner components.
- Growth and planned capacity investments create execution and forecasting risks; insufficient capacity may delay orders, while excess capacity or inventory could pressure margins. ERP implementation is ongoing, and management is monitoring for potential issues.
- Foreign operations, geopolitical conditions, natural disasters, product regulation, patient-data security, and changing tax rules may adversely affect operations or results. About $387.5 million of cash and securities was held by foreign subsidiaries; Align intends to reinvest foreign earnings and says repatriation costs could be material.
- A securities class action appeal had oral arguments in October 2016; a related derivative case remains stayed pending the appeal. Align could not estimate the likelihood or range of loss. The company said other claims and proceedings were not expected to materially affect its financial position, results or cash flows.
- The Costa Rica tax incentives begin expiring in various years from 2017; continued benefits depend on specified employment and investment conditions. The Israel tax subsidiary was under audit for 2006–2013.
Investor verification points
- Assess whether case-volume growth, international expansion and scanner shipments can continue, and how price, product mix and promotional activity affect average selling prices and margins.
- Check the sustainability and cash-flow effect of revenue deferrals under the additional-aligners policy, including deferred revenue and accounts-receivable trends.
- Monitor the SDC supply relationship, 2017 contribution expectations, equity-method losses, and any advances under the loan facility.
- Separate recurring tax performance from the restructuring-related tax expense and valuation-allowance release; verify tax-audit outcomes, Costa Rica incentive renewal and foreign-earnings plans.
- Track manufacturing capacity, capital spending, ERP implementation, supplier concentration and the CFO transition, as well as developments in the securities appeal and derivative litigation.