Align Technology, Inc. — Q3 2015 Form 10-Q
Business context and reporting period. Align designs, manufactures, and markets Invisalign clear aligners and iTero intraoral scanners and related services. This unaudited filing covers the quarter and nine months ended September 30, 2015; comparisons are with the same periods in 2014 unless noted.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $207.6 million | $189.9 million | $615.2 million | $563.1 million |
| Gross profit / margin | $157.6 million / 75.9% | $145.1 million / 76.4% | $467.3 million / 76.0% | $427.8 million / 76.0% |
| Operating income | $38.0 million | $51.5 million | $129.3 million | $142.1 million |
| Net income | $27.6 million | $38.2 million | $95.1 million | $106.3 million |
| Diluted EPS | $0.34 | $0.47 | $1.17 | $1.29 |
- Q3 revenue rose 9.3%, while operating income fell about 26% and net income fell about 28%. Higher SG&A and R&D spending, along with the new aligner policy, weighed on earnings.
- Clear Aligner revenue increased 11.3% in Q3 to $198.3 million. Invisalign case volume rose 23.3% to 147,500 cases. Scanner revenue declined 20.5% to $9.3 million; scanner gross margin fell to 14.7% from 33.5%.
- Q3 SG&A rose $21.1 million to $101.8 million, primarily due to higher compensation and headcount, ERP consulting, and clinical education. R&D rose $4.9 million to $17.8 million and included a $2.0 million charge for ending an obstructive sleep apnea development agreement.
- For the first nine months, operating cash flow was $158.6 million, compared with $155.3 million. Capital expenditures were $36.7 million. Cash and cash equivalents decreased to $174.0 million from $199.9 million at year-end 2014.
- Cash, cash equivalents, and marketable securities totaled $630.0 million at September 30, 2015. Total liabilities were $281.3 million. There were no borrowings under the $50 million revolving credit facility at quarter-end.
Material changes and management outlook
- In July, Align began providing eligible additional aligners at no charge and applied the policy to more than one million existing open cases. Management said the policy reduced Q3 Clear Aligner revenue by approximately $7 million and diluted EPS by $0.06. It expected a further $7–$8 million revenue impact in Q4 2015 and a $25–$30 million impact in 2016, with effects from grandfathered cases expected for at least two years. Management expects improved customer satisfaction and higher utilization over time.
- Management expected Invisalign volume to increase sequentially in Q4 2015, while noting normal regional seasonality. It also expects international revenue to grow faster than North American revenue over the foreseeable future.
- Align began shipping the iTero Element scanner in September and planned to ramp production over the following quarters. Scanner revenue had declined as customers awaited the new model and the prior-generation scanner faced permanent price reductions.
- Management forecast total 2015 capital expenditures of $55–$60 million, primarily for manufacturing capacity and infrastructure. It expected operating expenses to rise in 2015 as a result of sales-force expansion, ERP implementation, and product and market investment.
- Foreign exchange reduced international Clear Aligner revenue by $8.7 million in Q3 and $26.7 million for the first nine months. Align began using short-term foreign currency forwards in September; their reported impact was immaterial.
Risks, contingencies, and unusual items
- On September 30, Align was not in compliance with certain negative covenants in its revolving credit facility. On October 15, 2015, after the quarter-end, it received a waiver and amended the facility’s covenants. The facility matures March 22, 2016.
- Two shareholder matters remain unresolved: a securities class action appeal and a derivative lawsuit stayed pending the appeal. Align said it could not estimate the likelihood or range of loss. It does not believe other proceedings are likely to materially affect its financial position or results.
- Approximately $417.4 million of cash, cash equivalents, and marketable securities was held by foreign subsidiaries; repatriation costs would likely be material. Management intends to permanently reinvest foreign earnings.
- Key risks include reliance on Invisalign, currency movements, competition and pricing pressure, manufacturing capacity and ramp-up, single-source suppliers, international operating conditions, and execution of the ERP implementation. The company also cited potential exposure to litigation, regulation, and cybersecurity or patient-data incidents.
- Costa Rica tax incentives reduced income taxes by $24.6 million for the first nine months of 2015. Their continuation depends on meeting specified employment and investment conditions. Gross unrecognized tax benefits were $37.8 million, and Align was under California and Israeli tax audits.
- Management said disclosure controls were effective as of September 30, 2015 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the no-charge additional-aligner policy supports future case growth and customer retention enough to offset its disclosed revenue and EPS effects.
- Whether Invisalign utilization and case-volume growth can sustain revenue growth as foreign exchange, pricing, and promotional discounts affect average selling prices.
- Whether the iTero Element production ramp restores scanner revenue and segment margins, and whether manufacturing capacity investments meet demand without delays or excess-capacity costs.
- The status and terms of the amended credit facility, covenant compliance, and any refinancing or liquidity implications ahead of its March 2016 maturity.
- Progress on the shareholder litigation and tax audits, and any changes to potential exposures or tax incentives.