Align Technology, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. Align sells Invisalign clear aligners and iTero scanners and services.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $310.3 million | $238.7 million | +30.0% |
| Gross profit / margin | $235.6 million / 75.9% | $180.6 million / 75.7% | +30.5%; margin +0.2 points |
| Operating income / margin | $61.7 million / 19.9% | $53.3 million / 22.3% | +15.6%; margin -2.4 points |
| Net income | $69.4 million | $40.5 million | +71.2% |
| Diluted EPS | $0.85 | $0.50 | +70.0% |
| Cash from operations | $47.6 million | $30.7 million | +$16.9 million |
Revenue growth reflected higher case volumes across regions and products, increased non-case revenue, and stronger scanner sales. Clear Aligner revenue rose 28.5% to $282.4 million; Scanner revenue rose 46.8% to $27.9 million. Clear Aligner case volume increased 29.1% to 211,300 cases. International Clear Aligner revenue grew 42.5%; North America grew 21.5%.
Gross margin was broadly stable overall. Clear Aligner gross margin declined to 77.9% from 78.3%, reflecting more aligners per case, partly offset by production-volume absorption. Scanner gross margin improved to 56.1% from 45.0%, attributed to higher average selling prices, product mix and lower service costs. Operating margin fell as selling, general and administrative expense and R&D grew faster than revenue; SG&A increased $38.9 million and R&D increased $7.7 million.
The income-tax benefit was $7.2 million, versus tax expense of $12.4 million a year earlier. The 2017 effective tax rate was -11.4%, including $21.3 million of excess stock-compensation tax benefits recognized under newly adopted accounting guidance. This unusually favorable tax item materially contributed to net income growth.
Financial position and cash flow
- Cash, cash equivalents and short- and long-term marketable securities totaled $644.2 million at March 31, 2017, down from $700.0 million at December 31, 2016. Cash and cash equivalents alone were $261.0 million.
- Current assets were $918.2 million and current liabilities were $365.6 million. Total liabilities were $414.4 million; stockholders’ equity was $1.045 billion.
- No borrowings were outstanding on the $50 million revolving credit facility, extended to March 22, 2018. The company reported compliance with its conditions. The filing reports no interest-bearing liabilities.
- Operating cash flow was $47.6 million. Investing activities used $145.3 million, including $59.6 million of property and equipment purchases, $9.0 million for distributor acquisitions and an $8.0 million loan advance; financing activities used $33.0 million, mainly for taxes on vested restricted stock units.
- Capital expenditure guidance was $115 million to $125 million for the remainder of 2017, primarily for headquarters improvements and manufacturing capacity.
Changes, outlook and notable items
- Management expects operating expenses to increase in 2017, citing international expansion, manufacturing capacity, sales and support, legal costs and product development. It expects international Invisalign revenue to grow faster than North America for the foreseeable future and said the SmileDirectClub supply agreement is expected to contribute to 2017 revenue growth. No specific revenue or earnings guidance was provided.
- Total Invisalign utilization increased to 5.4 cases per doctor from 4.9; North American orthodontist utilization reached 12.6 from 10.4. The company trained 3,260 new Invisalign doctors in the quarter.
- Align completed the purchase of its new headquarters for $44.1 million and expected a further $29.7 million of building improvements during 2017. The filing’s $59.6 million first-quarter property and equipment spending included the headquarters purchase.
- Distributor acquisitions cost approximately $9.5 million, including cash acquired, and added preliminary goodwill and identifiable intangible assets. Align said the move toward direct sales could increase regional revenue through higher average selling prices.
- After quarter-end, Align paid $50 million for an accelerated share repurchase, with an initial delivery of approximately 0.3 million shares. The company also completed its prior $300 million 2014 repurchase program during the quarter and had authorized a separate $300 million 2016 program.
- Align owns a 17% equity interest in SmileDirectClub (SDC), carried at $43.9 million, and recorded $1.1 million of its share of investee losses. It had also advanced SDC $8.0 million under a $15.0 million secured loan facility.
Risks and contingencies
- Align depends heavily on Invisalign and faces potentially stronger competition as certain key U.S. patents begin expiring in 2017 and corresponding foreign patents begin expiring in 2018. Competition could pressure prices, volume, margins and market share.
- Foreign exchange is a material exposure: a 10% aggregate currency change relative to the U.S. dollar could materially affect results and financial position. International operations also expose Align to regulatory, political, operational and supply-chain risks.
- Management cited single-source suppliers and a third-party manufacturer for key scanner components, capacity and hiring needs, and the risk that facility expansion or demand changes could disrupt fulfillment or margins.
- Two longstanding shareholder matters related to alleged past goodwill impairment remained unresolved in the disclosed proceedings. Align could not estimate the likelihood or range of loss; it said other proceedings were not expected to materially affect its financial position, results or cash flows.
- Align was seeking renewal of Costa Rica tax incentives that begin expiring in 2017; failure to meet conditions or obtain renewal could increase taxes. Its Israeli subsidiary was under tax audit for 2006–2013.
- Management said liquidity was sufficient for at least 12 months and reported no material off-balance-sheet arrangements. Approximately $421.5 million of cash and investments was held by foreign subsidiaries and was intended to remain invested abroad.
Most important facts for investors to verify
- How much of earnings growth reflects recurring operating performance versus the $21.3 million stock-compensation tax benefit, and how the effective tax rate evolves.
- Whether Invisalign case growth and doctor utilization can continue as patent expirations bring additional competition and potential pricing pressure.
- Whether Clear Aligner margins stabilize as aligners per case, promotional discounts and product mix change, and whether Scanner margin improvement is sustainable.
- Execution and return on planned $115–$125 million remaining-2017 capital expenditures, international expansion and manufacturing capacity investments.
- Performance and risks of the SDC investment, supply relationship and loan, including potential investment impairment and customer response.
- Currency effects, renewal of Costa Rica tax incentives, and developments in the shareholder litigation and Israeli tax audit.