Align Technology, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are to the three months ended March 31, 2014 unless otherwise noted. Align designs, manufactures and markets Invisalign clear aligners and iTero intra-oral scanners and related services. Financial statements are unaudited.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $198.1 million | $180.6 million | +9.6% |
| Gross profit / margin | $151.1 million / 76.3% | $137.3 million / 76.0% | Margin +0.3 percentage points |
| Operating income | $48.9 million | $41.8 million | +17.0% |
| Net income | $36.2 million | $32.4 million | +11.5% |
| Diluted EPS | $0.44 | $0.39 | +12.8% |
| Operating cash flow | $35.6 million | $18.0 million | +$17.7 million |
Revenue mix: Clear Aligner revenue was $187.0 million, up 11.2%; Scanner and Services revenue was $11.1 million, down 10.5%. Clear Aligner gross margin held at 79.1%; Scanner gross margin fell to 28.3% from 33.6%. Total operating expenses rose to $102.2 million from $95.4 million. Net interest and other expense was $1.5 million, compared with $0.6 million of income, primarily reflecting higher foreign-exchange losses. The effective tax rate was 23.8%, versus 23.5%.
Growth drivers and geography: Invisalign case volume increased 16.6% to 130,800 cases: North America rose 11.9% and international rose 28.9%. Clear Aligner revenue increased in North America 10.1% and internationally 12.2%; reported international growth was affected by lower average selling prices, including currency translation. U.S. revenue was $139.7 million, Netherlands revenue $38.6 million and other international revenue $19.7 million.
Liquidity, cash flow and capital
- Cash and cash equivalents were $190.0 million at March 31, down from $199.9 million at year-end. Short- and long-term marketable securities totaled $423.0 million; combined cash and securities were $613.0 million, up from $602.6 million.
- Current assets were $657.3 million and current liabilities $200.6 million. Total liabilities were $234.9 million; the company reported no outstanding borrowings.
- Operating cash flow was $35.6 million. Investing used $36.7 million, including $15.6 million of capital spending; financing used $7.1 million. Cash declined $9.9 million during the quarter.
- Management expected 2015 capital expenditures of $65–75 million, primarily for manufacturing capacity and infrastructure, including the ERP implementation.
- A $50 million revolving credit facility, with a $10 million letter-of-credit sublimit, matures March 22, 2016. It was undrawn and the company was in compliance with its terms; it requires at least $50 million in unrestricted cash.
- About $363.9 million of cash and securities were held by foreign subsidiaries. Repatriation would likely incur material costs; management said it intended to permanently reinvest foreign earnings.
Material changes and management outlook
- Revenue growth was driven chiefly by higher Invisalign case volume. North American Clear Aligner volume gains were partly offset by lower average selling prices and promotional discounts. International volume gains were partly offset by lower average selling prices, including the effect of the weaker euro.
- Management expected operating expenses to increase in 2015, citing sales-force expansion, infrastructure and ERP investment, and product and market development. The company was adding about 50 North American sales team members in 2015, most in place by quarter-end.
- Management expected international revenue to grow faster than North American revenue over the foreseeable future, supported by market expansion investment and lower penetration. It also expected Invisalign utilization to improve over the long term, while cautioning that utilization may fluctuate.
- The company announced an approximately 3% price increase for Invisalign Full and Teen: $50 per treatment in North America effective April 1, 2015, and €50 internationally effective July 1, 2015. Prices for specified Express and Assist products were unchanged.
- New product developments included limited initial commercialization of Invisalign G6 in Q1, with broader international commercialization during 2015 and North American commercialization expected in early 2016; iTero Element availability was expected in the second half of 2015. These are expectations, not reported results.
- CEO Thomas M. Prescott announced retirement effective June 1, 2015; Joseph M. Hogan was to become CEO and a director on that date. Management cited potential transition-related uncertainty.
- After quarter-end, Align entered a $70 million accelerated share repurchase agreement on April 28, paid on April 29, and received an initial delivery of approximately 0.8 million shares. The transaction was expected to be completed by July 29. At quarter-end, $200 million remained under the $300 million repurchase authorization.
Risks, contingencies and unusual items
- Foreign exchange was a notable headwind: management said Q1 revenue was negatively affected by $4.2 million compared with Q4 2014, and net foreign-currency translation losses were $1.7 million. Further U.S. dollar strength could reduce reported revenue and income.
- The IRS approved a $6.8 million refund claim for medical device excise tax paid on aligners in 2013; Align recorded a receivable in current assets in Q1. Scanners remained subject to the tax. The Costa Rica tax incentives reduced Q1 income taxes by $8.2 million, or about $0.10 per diluted share; the incentives have conditions and begin expiring in various years starting in 2017.
- A securities class action related to alleged delayed goodwill impairment was dismissed without leave to amend in August 2014; the plaintiff appealed. A related derivative action remained 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.
- After quarter-end, California notified Align of examinations of its 2011 and 2012 income tax returns. The Israel subsidiary was also under local tax audit for 2006–2012. Gross unrecognized tax benefits were $34.4 million; the company did not expect significant changes within 12 months.
- Key risks include dependence on Invisalign for most revenue; competition, pricing and utilization; international currency and operating exposure; reliance on certain single-source suppliers and a contract manufacturer for scanners; regulatory and product-liability exposure; information-security and ERP implementation risks; and possible production disruptions or capacity constraints. Management stated there were no material off-balance-sheet arrangements.
Most important facts for investors to verify
- Whether Invisalign case-volume growth and utilization gains continue, and whether pricing and promotions constrain average selling prices and margins.
- Whether Scanner and Services revenue and gross margin stabilize after their year-over-year declines.
- Progress and costs of the sales-force expansion, ERP program and planned capital expenditures, and delivery and adoption of G6 and iTero Element.
- Actual foreign-exchange effects, tax-incentive eligibility and outcomes of the California and Israel tax matters.
- CEO transition execution, the final cost and share count under the $70 million ASR, and the company’s ability to maintain liquidity while funding repurchases and investment.
- Developments in the securities-action appeal and related derivative case; the filing provides no clear estimate of potential loss.