Align Technology, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. Financial statements are unaudited; dollar amounts below are in millions unless noted.
Business context
Align sells Invisalign clear aligners and related services through its Clear Aligner segment, and iTero intraoral scanners and services through its Scanner segment. Growth priorities include expanding product adoption, international markets, scanner sales, and regional treatment-planning and manufacturing capacity.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $505.3 | $385.3 | $1,432.5 | $1,052.1 |
| Gross profit | $371.8 | $292.5 | $1,064.8 | $799.0 |
| Gross margin | 73.6% | 75.9% | 74.3% | 75.9% |
| Operating income | $125.2 | $98.8 | $346.1 | $244.0 |
| Operating margin | 24.8% | 25.6% | 24.2% | 23.2% |
| Net income | $100.9 | $82.6 | $302.8 | $221.2 |
| Diluted EPS | $1.24 | $1.01 | $3.71 | $2.71 |
- Revenue rose 31.2% in Q3 and 36.2% for the nine-month period. Clear Aligner revenue grew 25.0% and 31.8%, respectively; Scanner revenue grew 79.1% and 74.4%.
- Q3 revenue growth reflected higher case and scanner volumes. Total clear-aligner case volume increased 31.0% in Q3; international volume increased 45.6%. Scanner growth was driven mainly by more scanners recognized and a larger installed base supporting services.
- Clear Aligner gross margin declined to 75.3% in Q3 from 77.9%, primarily due to manufacturing expansion spending and lower average selling prices. Scanner gross margin improved to 63.9% from 60.0%, reflecting manufacturing efficiencies.
- Q3 SG&A was $213.9 million, up $44.3 million, primarily from compensation, advertising and marketing, equipment/software, and legal and outside-service costs. R&D was $32.7 million, up $8.5 million.
- Q3 other expense was $0.8 million versus other income of $1.9 million a year earlier. The nine-month period recorded $7.8 million of other expense versus $4.1 million of income, mainly reflecting foreign-exchange losses, partly offset by forward-contract gains.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $313.4 million, compared with $276.2 million. Capital expenditures were $169.0 million; net cash used in investing activities was $24.0 million.
- Net cash used in financing activities was $315.2 million, including $250.0 million of share repurchases and $81.8 million of employee tax withholding on vested restricted stock units. Cash, cash equivalents and restricted cash decreased $28.7 million.
- At September 30, cash and cash equivalents were $420.9 million, and short- and long-term marketable securities totaled $192.4 million, for combined liquidity of $613.2 million. Current assets were $1,224.2 million and current liabilities $618.2 million.
- No borrowings were outstanding under the $200 million revolving credit facility, which matures in February 2021; the company reported compliance with its requirements. Management said available liquidity and borrowing capacity should fund operations for at least 12 months.
- Deferred revenue was $356.1 million current and $11.7 million long-term. Unfulfilled performance obligations were estimated at $380.7 million, generally expected to be fulfilled over one to five years.
Material changes and management outlook
- Management cited case-volume growth across regions and channels as the primary revenue driver. Q3 Americas Clear Aligner revenue grew 16.1%, while international Clear Aligner revenue grew 39.5%; international growth benefited from adoption and customer-base expansion.
- Management expects international revenue to grow faster than Americas revenue for the foreseeable future, while noting adoption rates can vary by region and channel. Total Invisalign utilization was 6.1 cases per doctor in Q3 versus 5.5 a year earlier.
- New offerings included an expanded Invisalign portfolio and Invisalign First in July, plus iTero Element 2 and Element Flex scanners. The company expected U.S. availability of Invisalign Teen with mandibular advancement beginning in November 2018, following FDA clearance in October.
- Management expected fiscal 2018 expenses to rise due to international expansion, product and technology development, capacity and facilities, intellectual-property protection, and sales, marketing and customer-support investment. It expected another $50–$55 million in capital expenditures during the remainder of 2018, primarily for manufacturing capacity.
- The May 2018 repurchase authorization had $550 million remaining at quarter-end. No specific revenue or earnings guidance was provided in the filing.
Risks, contingencies and unusual items
- Tax: Q3 effective tax rate was 19.4%, compared with 17.9%; nine-month rate was 10.2%, compared with 10.5%. IRS guidance on executive compensation deductions led to reversal of $20.2 million of previously recognized tax benefits, including a $14.7 million Q3 tax expense accrual. A statute-of-limitations expiration also resulted in recognition of approximately $29 million of previously unrecognized tax benefits and a reduction of accrued interest of approximately $2.9 million.
- SDC dispute: SmileDirectClub entities seek, among other relief, restrictions on Align’s Invisalign Experience locations and a right to repurchase Align’s SDC interests. A court denied a temporary injunction; arbitration was scheduled for December 2018. Align said it could not estimate the likelihood or amount of loss. The SDC supply agreement remained in force through December 2019, with a minimum-volume commitment.
- Patent litigation: Align’s lawsuits and ITC complaints accuse 3Shape of infringing Align patents; the complaints seek injunctive relief and, in district court, monetary damages. The filing does not state a quantified potential exposure.
- Supply and capacity: The company disclosed dependence on single-source suppliers for certain materials, equipment and scanner components. A supplier amendment increased minimum aligner-material purchases to approximately $425.9 million over five years.
- Currency and international exposure: Management said an aggregate 10% currency-rate change against the U.S. dollar could materially affect results and financial position. International operations also expose the company to political, regulatory, logistics, staffing and facility risks.
- Other key risks include competition and pricing pressure, patents expiring, consumer demand and utilization, product adoption, manufacturing execution, cybersecurity and patient-data privacy, regulatory compliance, and potential impairment of strategic investments. The filing reported no material off-balance-sheet arrangements and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue and case-volume growth, particularly international and scanner growth, persist and translate into durable margins.
- Whether promotional discounts, lower average selling prices, and manufacturing expansion continue to pressure Clear Aligner gross margin.
- The outcome and financial implications of the SDC arbitration and the 3Shape patent proceedings.
- Execution and cost of planned facilities and capacity expansion, including the stated remaining-2018 capital expenditure plan and supplier purchase commitments.
- How tax examinations, remaining Tax Cuts and Jobs Act estimates, and executive-compensation deduction rules affect future tax expense and cash taxes.
- Use of the remaining $550 million repurchase authorization relative to liquidity, investment needs, and operating cash flow.