Align Technology, Inc. — Q3 2010 Form 10-Q
Business context and period. Align designs, manufactures and sells Invisalign clear-aligner systems and related products. This unaudited quarterly filing covers the three and nine months ended September 30, 2010; comparisons are with the same 2009 periods unless noted. Financial statement amounts below are in millions of dollars, except per-share data.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net revenue | $95.9 | $79.3 | $294.2 | $225.7 |
| Gross profit / margin | $74.9 / 78.1% | $59.0 / 74.4% | $231.7 / 78.7% | $169.7 / 75.2% |
| Operating income (loss) | $21.9 | ($60.2) | $88.0 | ($48.7) |
| Net income (loss) | $16.8 | ($49.9) | $64.3 | ($42.8) |
| Diluted EPS | $0.22 | ($0.72) | $0.83 | ($0.64) |
| Operating cash flow | Not separately provided for Q3 | $97.0 | $39.9 |
- Revenue rose 20.9% in Q3 and 30.4% year to date. Invisalign case shipments increased 17.2% in Q3 and 23.7% for the nine months.
- Q3 North American Invisalign revenue grew 20.0%; international Invisalign revenue grew 25.4%. Year-to-date international revenue increased 28.3%, partly offset by unfavorable foreign exchange.
- Gross margin improved year over year, primarily from better fixed-cost absorption at higher production volumes. Year-to-date margin also benefited from a $14.3 million release of previously deferred Invisalign Teen replacement-aligner revenue.
- Q3 operating expenses included a $3.3 million Leiszler litigation charge. Prior-year operating results included a $69.7 million Ormco litigation charge; this materially affects the year-over-year profit comparison.
- Cash and cash equivalents were $264.9 million at September 30, 2010, versus $166.5 million at December 31, 2009. Cash plus marketable securities totaled $280.1 million. Current assets were $357.9 million and current liabilities $80.0 million.
- No revolver borrowings were outstanding. The company had a $25.0 million credit facility maturing December 31, 2010 and reported covenant compliance. Total liabilities were $85.8 million.
Material changes and unusual items
- In June 2010, Align released $14.3 million of deferred Invisalign Teen revenue based on estimated historical replacement-aligner usage. The release was recorded in the first half of 2010, not Q3, and increased nine-month revenue and gross margin. Align said it would continue monitoring usage and could revise the estimate.
- Align received an $8.7 million insurance settlement in June 2010 related to OrthoClear litigation.
- In October 2010, the company reached a memorandum of understanding to resolve the Leiszler matter. The proposed settlement contemplated about $7.5 million in escrow; Align recorded a $3.3 million Q3 estimated litigation charge. Court approval and a formal settlement agreement remained pending.
- Align eliminated North American minimum case-start requirements in April and annual continuing-education requirements in October, effectively ending its Proficiency Program. Management expected customer activity and case shipments to fluctuate as providers adjusted.
Outlook, management commentary and risks
- Management expected Q4 2010 case shipments to be lower than Q3, predominantly among general-practice dentists, citing reported lower dental visits and weaker demand for premium procedures. It expected Q4 operating expenses to rise due to international sales and marketing, Invisalign G3 commercialization and China pre-commercialization.
- Invisalign G3 launched in October 2010. Management expected the product features to support utilization and broader adoption, but results depended on customer uptake. Align announced regulatory approval to market Invisalign in China and expected a commercial launch in the second half of 2011.
- Align believed cash and existing borrowing capacity would fund operations for at least 12 months. It cautioned that additional financing, if needed, might not be available on acceptable terms.
- Principal risks include economic weakness and consumer spending, uncertainty after changes to provider requirements, seasonality and customer utilization, competition and pricing pressure, foreign exchange exposure, reliance on international manufacturing and single-source suppliers, operational or natural-disaster disruption, regulatory and product-liability exposure, and litigation.
- The filing reported a securities class action whose motion to dismiss had not yet been ruled on. Align said it believed the claims lacked merit and intended to defend itself. It also disclosed $10.4 million of unrecognized tax benefits at September 30, 2010 and uncertainty in the effective tax rate.
- Management stated disclosure controls were effective as of September 30, 2010 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Separate underlying revenue and shipment growth from the $14.3 million Teen deferred-revenue release and assess whether the estimated usage rate remains supportable.
- Track Q4 and subsequent case shipments, especially North American GP activity, provider participation and utilization after the Proficiency Program changes.
- Check whether the Leiszler settlement receives court approval and whether the recorded $3.3 million estimate is sufficient relative to the proposed escrow and related costs.
- Monitor gross margin, operating expenses and cash generation as Align invests in G3, international expansion and China launch preparations.
- Review the credit facility’s December 2010 maturity, tax exposures, unresolved securities litigation and key manufacturing, supplier and foreign-operation risks.