Align Technology, Inc. — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2017; comparisons are with the third quarter and nine months ended September 30, 2016. Financial figures are in U.S. dollars; amounts below are in millions unless stated otherwise. Statements are unaudited.
Business context
Align sells Invisalign clear aligners and related products, as well as iTero intraoral scanners and services. Its reportable segments are Clear Aligner and Scanner. Management’s strategy centers on increasing Invisalign adoption and doctor utilization, expanding internationally, and growing scanner use through product development and regional operating investments.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $385.3 | $278.6 | $1,052.1 | $786.7 |
| Gross profit | $292.5 | $209.2 | $799.0 | $595.0 |
| Gross margin | 75.9% | 75.1% | 75.9% | 75.6% |
| Operating income | $98.8 | $62.1 | $244.0 | $180.5 |
| Operating margin | 25.6% | 22.3% | 23.2% | 23.0% |
| Net income | $82.6 | $51.4 | $221.2 | $142.1 |
| Diluted EPS | $1.01 | $0.63 | $2.71 | $1.74 |
- Q3 revenue increased 38.3%; nine-month revenue increased 33.7%. Net income grew approximately 60.7% and 55.7%, respectively.
- Q3 Clear Aligner revenue was $341.6 million, up 40.2%; Scanner revenue was $43.7 million, up 25.2%. Q3 clear-aligner case volume rose 43.6% to 255,400 cases. Total Invisalign utilization reached 5.5 cases per doctor, versus 5.0 a year earlier.
- Q3 gross margin improved year over year. Clear Aligner margin was 77.9% versus 77.7%; Scanner margin was 60.0% versus 57.1%. Nine-month Clear Aligner margin eased to 78.0% from 78.2%, while Scanner margin improved to 57.9% from 53.1%.
- Operating cash flow for the first nine months was $276.2 million, versus $166.7 million. Investing cash flow was negative $228.6 million and financing cash flow negative $79.0 million; cash and cash equivalents declined $26.7 million to $362.6 million.
- Cash, cash equivalents and short- and long-term marketable securities totaled $737.9 million at September 30, 2017, including $501.6 million held by foreign subsidiaries. Current assets were $1,101.0 million and current liabilities $461.4 million.
- No borrowings were outstanding under the $50 million revolving credit facility; the facility matures March 22, 2018. The filing reports no interest-bearing liabilities. Management said available liquidity and borrowing capacity should fund operations for at least 12 months.
Material changes and drivers
- Revenue growth reflected higher case volume across regions and products, increased non-case revenue, and scanner growth. International Clear Aligner revenue grew 50.2% in Q3; North America grew 34.8%.
- North American average selling price faced pressure from a mix shift toward lower-priced non-comprehensive products, including SmileDirectClub (SDC) sales, and higher promotions. In Q3, this reduced revenue by $19.6 million, partly offset by additional aligner revenue and price increases.
- Operating expenses rose with higher headcount, marketing, equipment and maintenance, and outside services. SG&A increased $42.8 million in Q3 and $123.2 million for the nine-month period; R&D increased $3.8 million and $17.3 million, respectively.
- Q3 results included $3.8 million of net interest and other income, mainly reflecting foreign-exchange gains as the euro strengthened against the U.S. dollar. The nine-month effective tax rate fell to 10.5% from 21.6%, principally due to recognition of stock-based compensation tax benefits and prior-year one-time international restructuring tax charges.
Outlook, risks and unusual items
- Management expected operating expenses to increase in 2017, citing international expansion, manufacturing capacity, sales and customer support, legal costs and product innovation. It expected SDC supply-agreement revenue to add to 2017 revenue growth, but provided no specific revenue or earnings guidance in the supplied filing text.
- Management expected to spend an additional $55–$60 million on capital expenditures during the remainder of 2017, primarily for manufacturing capacity supporting international expansion. It also reported a $26.1 million Costa Rica facility purchase, with a $5.2 million initial payment, and a $50 million software subscription commitment over three years beginning in 2018.
- Align’s SDC relationship expanded: it acquired an additional 2% interest for $12.8 million, bringing ownership to 19%, and increased the SDC loan facility limit to $30 million. At quarter-end, $17 million was advanced, and $12.7 million was due from SDC in accounts receivable. SDC’s supply agreement expires December 31, 2019.
- Key risks include intensifying clear-aligner competition as certain patents expire beginning in 2017 (with corresponding foreign patents beginning to expire in 2018), pricing and product-mix pressure, reliance on international facilities and suppliers, capacity constraints, foreign-exchange exposure, regulatory requirements, and information-security risks. Management stated that a 10% currency-rate change could materially affect results and financial position.
- The Costa Rica tax incentives were extended for 12 years, subject to employment and fixed-asset investment conditions; failure to meet them could result in higher tax expense. Approximately $46.1 million of gross unrecognized tax benefits remained at September 30, 2017, and an Israeli subsidiary was under tax audit for 2006–2013.
- A $1.9 million out-of-period adjustment was recorded in Q2 2017, reducing interest and other income and increasing accrued liabilities; management said it was not material to current or prior-period financial statements. The securities class action and related derivative action were dismissed; other claims and proceedings remained, which management did not expect to materially affect financial position, results or cash flows.
Important facts for investors to verify
- Whether strong case-volume growth can continue while monitoring North American ASP, promotions and lower-priced SDC mix.
- SDC’s revenue contribution, loan collectability, receivable balance and potential impact on Align’s strategic investment.
- Progress and costs of international capacity expansion, including planned remaining-2017 capital expenditures and facility commitments.
- Competitive effects of patent expirations, and the extent to which new products and doctor utilization can sustain growth and margins.
- Foreign-cash availability and repatriation costs, currency exposure, and continued eligibility for Costa Rica tax incentives.
- Timing and financial impact of adopting the revenue-recognition standard in 2018; the company said adoption may materially affect its financial statements and disclosures, but the impact was still being assessed.