Align Technology, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Financial statements are unaudited. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data.
Business context
Align designs and sells Invisalign clear aligners and, following its April 29, 2011 acquisition of Cadent Holdings, iTero and iOC scanners and CAD/CAM services. Invisalign represented approximately 91% of third-quarter worldwide revenue; scanning products and services represented approximately 9%.
Financial results and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net revenue | $125.9 | $95.9 | $350.8 | $294.2 |
| Gross profit | $92.4 | $74.9 | $265.7 | $231.7 |
| Gross margin | 73.4% | 78.1% | 75.7% | 78.7% |
| Operating profit | $26.3 | $21.9 | $63.9 | $88.0 |
| Net profit | $19.3 | $16.8 | $46.3 | $64.3 |
| Diluted earnings per share | $0.24 | $0.22 | $0.58 | $0.83 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $88.5 | $97.0 |
Third-quarter revenue increased 31.3% year over year; nine-month revenue increased 19.2%. Nine-month 2010 revenue included a one-time $14.3 million release of previously deferred Invisalign Teen revenue. Nine-month operating and net profit fell year over year despite higher revenue; the comparison also includes an $8.7 million insurance settlement benefit in 2010 and a $3.3 million litigation charge in 2010.
At September 30, cash and cash equivalents were $202.2 million and marketable securities totaled $8.9 million, or $211.1 million combined, versus $312.4 million at December 31, 2010. Current assets were $327.1 million and current liabilities $120.2 million. The company had no borrowings under its $30 million revolving credit facility and reported compliance with its covenants. Total liabilities were $129.0 million.
Nine-month investing cash outflow was $199.3 million, chiefly reflecting the approximately $187 million Cadent acquisition and $21.0 million of property and equipment purchases. Capital expenditures and acquisition spending contributed to the $92.4 million decline in cash during the period.
Material changes and management commentary
- Cadent contributed approximately $18.1 million in revenue and a $6.2 million net loss from May through September. Its acquisition added $135.3 million of goodwill and approximately $50.2 million of net identifiable intangible assets at September 30; the purchase price allocation remained preliminary.
- Invisalign case volume rose 19.9% in Q3 and 15.0% for the nine-month period. Total utilization was 4.0 cases per doctor in Q3, unchanged from the prior-year quarter; North American orthodontist utilization increased to 7.1.
- Gross margin declined, principally because Cadent scanners and services carry lower margins than Invisalign, alongside acquired technology amortization. Operating expenses also rose, including acquisition integration, added personnel, marketing and product development costs.
- Management expected Q4 2011 gross margin to decrease slightly from Q3, citing Juarez manufacturing-capacity investments and higher training and product costs. It expected Q4 operating expenses to rise, primarily due to additional sales headcount. No specific revenue or earnings guidance was provided.
- Align announced a stock repurchase authorization of up to $150 million on October 27, 2011. It also planned to consolidate New Jersey operations by Q3 2012, with estimated severance costs of about $2 million and expected annualized net savings of about $4 million once complete.
Outlook, risks and contingencies
Management cited Invisalign G4 availability beginning November 14, 2011, expansion of international markets, and scanner/Invisalign integration as potential growth drivers, while cautioning that adoption is difficult to predict. It planned to train approximately 3,100 North American and 2,600 international doctors in 2011. The company expected sufficient cash and borrowing capacity for at least 12 months.
Key risks include reliance on Invisalign for most revenue; economic conditions, competition, discounts and pricing pressure; seasonal and quarterly demand fluctuations; execution and capacity risks in the Juarez facility expansion; Cadent integration and scanner adoption; dependence on international operations and suppliers; and regulatory, product-liability, cybersecurity and intellectual-property risks. The company disclosed a prior FDA Warning Letter concerning documentation of corrective actions and complaint/medical-device-reporting procedures, and said it was working with the FDA to resolve the matter.
A securities class action remained pending; Align said it believed the case was without merit and intended to defend it. Management stated it did not believe a loss was reasonably possible as of September 30, 2011. The company reported $14.0 million of unrecognized tax benefits and a $20.9 million valuation allowance on certain deferred tax assets. Disclosure controls were assessed as effective; Cadent was being integrated into internal controls and was to be excluded from the 2011 internal-control assessment as permitted by SEC guidance.
Important facts for investors to verify
- Whether revenue and case-volume growth continue, and whether Invisalign utilization improves beyond the reported 4.0 cases per doctor.
- Whether scanner sales and interoperability deliver expected strategic benefits, and how Cadent’s operating contribution and integration costs develop.
- Whether gross margins stabilize as scanner mix, product costs and capacity investment evolve; compare actual results with management’s qualitative Q4 outlook.
- How cash, working capital and capital spending change following the Cadent acquisition and the announced repurchase authorization.
- Progress on the Juarez facility, New Jersey consolidation, the FDA Warning Letter and the pending securities litigation.