10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM 10-Q
____________________________
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2016
OR
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¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-32259
____________________________
ALIGN TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
____________________________
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| |
Delaware | 94-3267295 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
2560 Orchard Parkway
San Jose, California 95131
(Address of principal executive offices)
(408) 470-1000
(Registrant’s telephone number, including area code)
____________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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| | | |
Large accelerated filer | x | Accelerated filer | ¨ |
Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the registrant’s Common Stock, $0.0001 par value, as of April 29, 2016 was 80,184,259.
ALIGN TECHNOLOGY, INC.
INDEX
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PART I | | |
ITEM 1. | | |
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ITEM 2. | | |
ITEM 3. | | |
ITEM 4. | | |
PART II | | |
ITEM 1. | | |
ITEM 1A. | | |
ITEM 2. | | |
ITEM 3. | | |
ITEM 4. | | |
ITEM 5. | | |
ITEM 6. | | |
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Invisalign, Align, the Invisalign logo, ClinCheck, Invisalign Assist, Invisalign Teen, Vivera, SmartForce, SmartTrack, SmartStage, Power Ridge, iTero, iTero Element, Orthocad, iCast and iRecord, among others, are trademarks and/or service marks of Align Technology, Inc. or one of its subsidiaries or affiliated companies and may be registered in the United States and/or other countries.
PART I—FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
|
| | | | | | | | |
| Three Months Ended | |
| March 31, | |
| 2016 | | 2015 | |
Net revenues | $ | 238,720 |
| | $ | 198,086 |
| |
Cost of net revenues | 58,093 |
| | 46,996 |
| |
Gross profit | 180,627 |
| | 151,090 |
| |
Operating expenses: | | | | |
Selling, general and administrative | 112,210 |
| | 88,281 |
| |
Research and development | 15,083 |
| | 13,885 |
| |
Total operating expenses | 127,293 |
| | 102,166 |
| |
Income from operations | 53,334 |
| | 48,924 |
| |
Interest and other income (expenses), net | (427 | ) | | (1,452 | ) | |
Net income before provision for income taxes | 52,907 |
| | 47,472 |
| |
Provision for income taxes | 12,361 |
| | 11,295 |
| |
Net income | $ | 40,546 |
| | $ | 36,177 |
| |
| | | | |
Net income per share: | | | | |
Basic | $ | 0.51 |
| | $ | 0.45 |
| |
Diluted | $ | 0.50 |
| | $ | 0.44 |
| |
Shares used in computing net income per share: | | | | |
Basic | 79,831 |
| | 80,459 |
| |
Diluted | 81,320 |
| | 81,824 |
| |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
|
| | | | | | | | |
| Three Months Ended | |
| March 31, | |
| 2016 | | 2015 | |
Net income | $ | 40,546 |
| | $ | 36,177 |
| |
Net change in cumulative translation adjustment | (150 | ) | | (261 | ) | |
Change in unrealized gains (losses) on available-for-sale securities, net of tax | 1,152 |
| | 295 |
| |
Other comprehensive income (loss) | 1,002 |
| | 34 |
| |
Comprehensive income | $ | 41,548 |
| | $ | 36,211 |
| |
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| (unaudited) | | |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 154,418 |
| | $ | 167,714 |
|
Marketable securities, short-term | 393,660 |
| | 359,581 |
|
Accounts receivable, net of allowances for doubtful accounts and returns of $2,770 and $2,472, respectively | 178,000 |
| | 158,550 |
|
Inventories | 22,618 |
| | 19,465 |
|
Prepaid expenses and other current assets | 34,307 |
| | 26,700 |
|
Total current assets | 783,003 |
| | 732,010 |
|
Marketable securities, long-term | 132,690 |
| | 151,370 |
|
Property, plant and equipment, net | 148,029 |
| | 136,473 |
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Goodwill and intangible assets, net | 78,606 |
| | 79,162 |
|
Deferred tax assets | 57,527 |
| | 51,416 |
|
Other assets | 7,705 |
| | 8,202 |
|
Total assets | $ | 1,207,560 |
| | $ | 1,158,633 |
|
| | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current liabilities: | | | |
Accounts payable | $ | 36,258 |
| | $ | 34,354 |
|
Accrued liabilities | 92,723 |
| | 107,765 |
|
Deferred revenues | 145,769 |
| | 129,553 |
|
Total current liabilities | 274,750 |
| | 271,672 |
|
Income tax payable | 39,269 |
| | 37,512 |
|
Other long-term liabilities | 1,511 |
| | 1,523 |
|
Total liabilities | 315,530 |
| | 310,707 |
|
Commitments and contingencies (Note 6 and 7) |
| |
|
Stockholders’ equity: | | | |
Preferred stock, $0.0001 par value (5,000 shares authorized; none issued) | — |
| | — |
|
Common stock, $0.0001 par value (200,000 shares authorized; 80,175 and 79,500 issued and outstanding, respectively) | 8 |
| | 8 |
|
Additional paid-in capital | 824,063 |
| | 821,507 |
|
Accumulated other comprehensive income (loss), net | 22 |
| | (980 | ) |
Retained earnings | 67,937 |
| | 27,391 |
|
Total stockholders’ equity | 892,030 |
| | 847,926 |
|
Total liabilities and stockholders’ equity | $ | 1,207,560 |
| | $ | 1,158,633 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
|
| | | | | | | |
| Three Months Ended |
| March 31, |
| 2016 | | 2015 |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | |
Net income | $ | 40,546 |
| | $ | 36,177 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Deferred taxes | (6,113 | ) | | (4,488 | ) |
Depreciation and amortization | 4,792 |
| | 4,308 |
|
Stock-based compensation | 12,524 |
| | 11,648 |
|
Net tax benefits from stock-based awards | 7,220 |
| | 4,779 |
|
Excess tax benefit from share-based payment arrangements | (8,082 | ) | | (4,779 | ) |
Other non-cash operating activities | 3,754 |
| | 2,614 |
|
Changes in assets and liabilities: | | | |
Accounts receivable | (20,839 | ) | | (12,233 | ) |
Inventories | (3,155 | ) | | 1,334 |
|
Prepaid expenses and other assets | (618 | ) | | (10,527 | ) |
Accounts payable | 447 |
| | 1,871 |
|
Accrued and other long-term liabilities | (14,544 | ) | | (1,078 | ) |
Deferred revenues | 14,748 |
| | 6,019 |
|
Net cash provided by operating activities | 30,680 |
| | 35,645 |
|
CASH FLOWS FROM INVESTING ACTIVITIES: | | | |
Purchase of property, plant and equipment | (20,207 | ) | | (15,612 | ) |
Purchase of marketable securities | (143,926 | ) | | (113,508 | ) |
Proceeds from maturities of marketable securities | 128,524 |
| | 86,908 |
|
Proceeds from sales of marketable securities | 293 |
| | 5,505 |
|
Other investing activities | — |
| | 46 |
|
Net cash used in investing activities | (35,316 | ) | | (36,661 | ) |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | |
Proceeds from issuance of common stock | 5,384 |
| | 4,552 |
|
Common stock repurchases | — |
| | (1,781 | ) |
Excess tax benefit from share-based payment arrangements | 8,082 |
| | 4,779 |
|
Employees’ taxes paid upon the vesting of restricted stock units | (22,572 | ) | | (14,647 | ) |
Net cash used in financing activities | (9,106 | ) | | (7,097 | ) |
Effect of foreign exchange rate changes on cash and cash equivalents | 446 |
| | (1,780 | ) |
Net decrease in cash and cash equivalents | (13,296 | ) | | (9,893 | ) |
Cash and cash equivalents, beginning of the period | 167,714 |
| | 199,871 |
|
Cash and cash equivalents, end of the period | $ | 154,418 |
| | $ | 189,978 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ALIGN TECHNOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Summary of Significant Accounting Policies
Basis of presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared by Align Technology, Inc. (“we”, “our”, or “Align”) in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") and contain all adjustments, including normal recurring adjustments, necessary to present fairly our results of operations for the three months ended March 31, 2016 and 2015, our comprehensive income for the three months ended March 31, 2016 and 2015, our financial position as of March 31, 2016 and our cash flows for the three months ended March 31, 2016 and 2015. The Condensed Consolidated Balance Sheet as of December 31, 2015 was derived from the December 31, 2015 audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America.
The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 or any other future period, and we make no representations related thereto. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A and 8, respectively, in our Annual Report on Form 10-K for the year ended December 31, 2015.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") in the United States of America (“U.S.”) requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, we evaluate our estimates, including those related to the fair values of financial instruments, long-lived assets and goodwill, useful lives of intangible assets and property and equipment, revenue recognition, stock-based compensation, income taxes, and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (" FASB") released Accounting Standards Update ("ASU") 2014-9 "Revenue from Contracts with Customers" to supersede nearly all existing revenue recognition guidance under GAAP. The core principle of the standard is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for the goods or services. The new standard defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
In August 2015, the FASB deferred the effective date of the update by one year, with early adoption on the original effective date permitted. We are required to adopt this standard starting in the first quarter of fiscal year 2018 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within the standard; or (ii) retrospective with the cumulative effect of initially applying the standard recognized at the date of initial application and providing certain additional disclosures as defined per the standard. We have not yet selected a transition method, and are in the process of determining the impact that the new standard will have on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases” (topic 842). The FASB issued this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption of the update is permitted. The Company is evaluating the impact of the adoption of this update on our consolidated financial statements and related disclosures.
In March 2016, the FASB issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting." This ASU affects entities that issue share-based payment awards to their employees. The ASU is designed to simplify several aspects of accounting for share-based payment award transactions, which include the income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows and forfeiture rate calculations. This ASU will become effective for the Company on January 1, 2017. Early adoption is permitted in any interim or annual period. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.
Note 2. Marketable Securities and Fair Value Measurements
As of March 31, 2016 and December 31, 2015, the estimated fair value of our short-term and long-term marketable securities, classified as available for sale, are as follows (in thousands):
Short-term
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| | | | | | | | | | | | | | | |
March 31, 2016 | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Commercial paper | $ | 55,972 |
| | $ | — |
| | $ | — |
| | $ | 55,972 |
|
Corporate bonds | 181,508 |
| | 79 |
| | (68 | ) | | 181,519 |
|
Municipal securities | 9,718 |
| | 11 |
| | (1 | ) | | 9,728 |
|
U.S. government agency bonds | 74,709 |
| | 17 |
| | (29 | ) | | 74,697 |
|
U.S. government treasury bonds | 71,213 |
| | 28 |
| | (11 | ) | | 71,230 |
|
U.S. dollar dominated foreign corporate bonds | 506 |
| | — |
| | — |
| | 506 |
|
Asset-backed securities | 8 |
| | — |
| | — |
| | 8 |
|
Total Marketable Securities, Short-Term | $ | 393,634 |
| | $ | 135 |
| | $ | (109 | ) | | $ | 393,660 |
|
Long-term |
| | | | | | | | | | | | | | | |
March 31, 2016 | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
|
U.S. government agency bonds | $ | 23,453 |
| | $ | 31 |
| | $ | (6 | ) | | $ | 23,478 |
|
Corporate bonds | 72,034 |
| | 221 |
| | (25 | ) | | 72,230 |
|
U.S. government treasury bonds | 29,086 |
| | 40 |
| | (6 | ) | | 29,120 |
|
Municipal securities | 3,958 |
| | 4 |
| | — |
| | 3,962 |
|
Certificates of deposit | 2,700 |
| | — |
| | — |
| | 2,700 |
|
Asset-backed securities | 1,201 |
| | — |
| | (1 | ) | | 1,200 |
|
Total Marketable Securities, Long-Term | $ | 132,432 |
| | $ | 296 |
| | $ | (38 | ) | | $ | 132,690 |
|
Short-term
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| | | | | | | | | | | | | | | |
December 31, 2015 | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Commercial paper | $ | 38,537 |
| | $ | — |
| | $ | — |
| | $ | 38,537 |
|
Corporate bonds | 179,765 |
| | 6 |
| | (251 | ) | | 179,520 |
|
U.S. dollar dominated foreign corporate bonds | 510 |
| | — |
| | (2 | ) | | 508 |
|
Municipal securities | 14,209 |
| | 7 |
| | (2 | ) | | 14,214 |
|
U.S. government agency bonds | 75,172 |
| | — |
| | (53 | ) | | 75,119 |
|
U.S. government treasury bonds | 51,763 |
| | 1 |
| | (81 | ) | | 51,683 |
|
Total Marketable Securities, Short-Term | $ | 359,956 |
| | $ | 14 |
| | $ | (389 | ) | | $ | 359,581 |
|
Long-term
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| | | | | | | | | | | | | | | |
December 31, 2015 | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
U.S. government agency bonds | $ | 43,853 |
| | $ | — |
| | $ | (178 | ) | | $ | 43,675 |
|
Corporate bonds | 64,012 |
| | 9 |
| | (218 | ) | | 63,803 |
|
U.S. government treasury bonds | 37,673 |
| | — |
| | (107 | ) | | 37,566 |
|
Municipal securities | 3,993 |
| | — |
| | (2 | ) | | 3,991 |
|
Asset-backed securities | 2,338 |
| | — |
| | (3 | ) | | 2,335 |
|
Total Marketable Securities, Long-Term | $ | 151,869 |
| | $ | 9 |
| | $ | (508 | ) | | $ | 151,370 |
|
Cash and cash equivalents are not included in the table above as the gross unrealized gains and losses are not material. We have no material short-term or long-term investments that have been in a continuous unrealized loss position for greater than twelve months as of March 31, 2016 and December 31, 2015. Amounts reclassified to earnings from accumulated other comprehensive income related to unrealized gain or losses were immaterial for the three months ended March 31, 2016 and 2015. For the three months ended March 31, 2016 and 2015, realized gain or losses were immaterial.
Our fixed-income securities investment portfolio consists of commercial paper, corporate bonds, municipal securities, U.S. government agency bonds, U.S. government treasury bonds, U.S. dollar dominated foreign corporate bonds, certificates of deposits, and asset-backed securities that have a maximum maturity of 27 months. The securities that we invest in are generally deemed to be low risk based on their credit ratings from the major rating agencies. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As interest rates increase, those securities purchased at a lower yield show a mark-to-market unrealized loss. The unrealized losses are due primarily to changes in credit spreads and interest rates. We expect to realize the full value of these investments upon maturity or sale. The weighted average remaining duration of these securities was approximately and 9 months as of March 31, 2016 and December 31, 2015, respectively.
As the carrying value approximates the fair value for our short-term and long-term marketable securities shown in the tables above, the following table summarizes the fair value of our short-term and long-term marketable securities classified by maturity as of March 31, 2016 and December 31, 2015 (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Due in one year or less | $ | 393,660 |
| | $ | 359,581 |
|
Due in greater than one year | 132,690 |
| | 151,370 |
|
Total available for sale short-term and long-term marketable securities | $ | 526,350 |
| | $ | 510,951 |
|
Fair Value Measurements
We measure the fair value of our cash equivalents and marketable securities as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We use the GAAP fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value:
Level 1 — Quoted (unadjusted) prices in active markets for identical assets or liabilities.
Our Level 1 assets consist of money market funds and U.S. government treasury bonds. We did not hold any Level 1 liabilities as of March 31, 2016 and December 31, 2015.
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Our Level 2 assets consist of commercial paper, corporate bonds, certificates of deposits, U.S. government agency bonds, asset-backed securities, municipal securities, U.S. dollar dominated foreign corporate bonds and our Israeli funds that are mainly invested in insurance policies and foreign currency forward contracts. We obtain fair values for Level 2 investments from our asset manager for each of our portfolios. Our custody bank and asset managers independently use professional pricing services to gather pricing data which may include quoted market prices for identical or comparable financial instruments, or inputs other than quoted
prices that are observable either directly or indirectly, and we are ultimately responsible for these underlying estimates. The foreign currency forward contracts are valued using observable inputs such as quotations on forward foreign exchange rates.
Level 3 — Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.
We did not hold any Level 3 assets or liabilities as of March 31, 2016 or December 31, 2015.
The following tables summarize our financial assets measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 (in thousands):
|
| | | | | | | | | | | |
Description | Balance as of March 31, 2016 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) |
Cash equivalents: | | | | | |
Money market funds | $ | 67,608 |
| | $ | 67,608 |
| | $ | — |
|
Commercial paper | 26,453 |
| | — |
| | 26,453 |
|
Corporate bonds | 2,354 |
| | — |
| | 2,354 |
|
Short-term investments: | | | | | |
Commercial paper | 55,972 |
| | — |
| | 55,972 |
|
Corporate bonds | 181,519 |
| | — |
| | 181,519 |
|
Municipal securities | 9,728 |
| | — |
| | 9,728 |
|
U.S. government agency bonds | 74,697 |
| | — |
| | 74,697 |
|
U.S. government treasury bonds | 71,230 |
| | 71,230 |
| | — |
|
U.S. dollar dominated foreign corporate bonds | 506 |
| | — |
| | 506 |
|
Asset-backed securities | 8 |
| | — |
| | 8 |
|
Long-term investments: | | | | | |
U.S. government agency bonds | 23,478 |
| | — |
| | 23,478 |
|
Corporate bonds | 72,230 |
| | — |
| | 72,230 |
|
U.S. government treasury bonds | 29,120 |
| | 29,120 |
| | — |
|
Municipal securities | 3,962 |
| | — |
| | 3,962 |
|
Asset-backed securities | 1,200 |
| | — |
| | 1,200 |
|
Certificates of deposits | 2,700 |
| | — |
| | 2,700 |
|
Prepaid expenses and other current assets:
| | | | | |
Israeli funds | 2,455 |
| | — |
| | 2,455 |
|
| $ | 625,220 |
| | $ | 167,958 |
| | $ | 457,262 |
|
|
| | | | | | | | | | | |
Description | Balance as of December 31, 2015 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) |
Cash equivalents: | | | | | |
Money market funds | $ | 70,148 |
| | $ | 70,148 |
| | $ | — |
|
Commercial paper | 36,887 |
| | — |
| | 36,887 |
|
U.S. government Agency bonds | 3,599 |
| | — |
| | 3,599 |
|
Corporate bonds | 625 |
| | — |
| | 625 |
|
Short-term investments: | | | | | |
Commercial paper | 38,537 |
| | — |
| | 38,537 |
|
Corporate bonds | 179,520 |
| | — |
| | 179,520 |
|
U.S. dollar denominated foreign corporate bonds | 508 |
| | — |
| | 508 |
|
Municipal securities | 14,214 |
| | — |
| | 14,214 |
|
U.S. government agency bonds | 75,119 |
| | — |
| | 75,119 |
|
U.S. government treasury bonds | 51,683 |
| | 51,683 |
| | — |
|
Long-term investments: | | | | | |
U.S. government agency bonds | 43,675 |
| | — |
| | 43,675 |
|
Corporate bonds | 63,803 |
| | — |
| | 63,803 |
|
U.S. government treasury bonds | 37,566 |
| | 37,566 |
| | — |
|
Municipal securities | 3,991 |
| | — |
| | 3,991 |
|
Asset-backed securities | 2,335 |
| | — |
| | 2,335 |
|
Prepaid expenses and other current assets:
| | | | | |
Israeli funds | 2,436 |
| | — |
| | 2,436 |
|
| $ | 624,646 |
| | $ | 159,397 |
| | $ | 465,249 |
|
Derivative Financial Instruments
In September 2015, we began entering into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations on certain trade and intercompany receivables and payables, which are classified within level 2 of the fair value hierarchy. The net loss on these forward contracts was immaterial for the three months ended March 31, 2016. The net gain or loss from the settlement of these foreign currency forward contracts is recorded in Interest and other income (expense), net in the Consolidated Statements of Operations. As of March 31, 2016, the fair value of foreign exchange forward contracts outstanding was a gain of $0.5 million.
The following table presents the gross notional value of all our foreign exchange forward contracts outstanding as of March 31, 2016 (in thousands):
|
| | | | | | | |
| As of March 31, 2016 |
| Local Currency Amount | | Notional Contract Amount (USD) |
US dollar | $ | 22,700 |
| | $ | 22,700 |
|
Euro | €26,600 | | 29,827 |
|
Japanese yen | ¥460,000 | | 4,048 |
|
Australian dollar | A$5,500 | | 4,158 |
|
Hong Kong dollar | HK$ | 33,000 |
| | 4,254 |
|
| | | $ | 64,987 |
|
Note 3. Balance Sheet Components
Inventories
Inventories consist of the following (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Raw materials | $ | 9,676 |
| | $ | 9,950 |
|
Work in process | 9,939 |
| | 7,067 |
|
Finished goods | 3,003 |
| | 2,448 |
|
Total Inventories | $ | 22,618 |
| | $ | 19,465 |
|
Work in process includes costs to produce our clear aligner and intra-oral products. Finished goods primarily represent our intra-oral scanners and ancillary products that support our clear aligner products.
Accrued liabilities
Accrued liabilities consist of the following (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Accrued payroll and benefits | $ | 44,201 |
| | $ | 55,430 |
|
Accrued sales and marketing expenses | 9,015 |
| | 7,071 |
|
Accrued sales rebates | 7,759 |
| | 8,486 |
|
Accrued accounts payable | 7,343 |
| | 13,834 |
|
Accrued sales tax and value added tax | 4,863 |
| | 4,801 |
|
Accrued professional fees | 3,448 |
| | 2,775 |
|
Accrued warranty | 2,704 |
| | 2,638 |
|
Accrued income taxes | 1,793 |
| | 2,646 |
|
Other accrued liabilities | 11,597 |
| | 10,084 |
|
Total Accrued Liabilities | $ | 92,723 |
| | $ | 107,765 |
|
Warranty
We regularly review the accrued warranty balances and update these balances based on historical warranty trends. Actual warranty costs incurred have not materially differed from those accrued; however, future actual warranty costs could differ from the estimated amounts.
Clear Aligner
We warrant our Invisalign products against material defects until the Invisalign case is complete. We accrue for warranty costs in cost of net revenues upon shipment of products. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on replacement costs.
Scanners
We warrant our scanners for a period of one year from the date of training and installation. We accrue for these warranty costs which includes materials and labor based on estimated historical repair costs. Extended service packages may be purchased for additional fees.
Warranty accrual as of March 31, 2016 and 2015 consists of the following activity (in thousands):
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Balance at beginning of period | $ | 2,638 |
| | $ | 3,148 |
|
Charged to cost of net revenues | 816 |
| | 440 |
|
Actual warranty expenditures | (750 | ) | | (583 | ) |
Balance at end of period | $ | 2,704 |
| | $ | 3,005 |
|
Note 4. Goodwill and Long-lived Assets
Goodwill
The change in the carrying value of goodwill for the three months ended March 31, 2016, all attributable to our Clear Aligner reporting unit, is as follows (in thousands):
|
| | | |
| Clear Aligner |
Balance as of December 31, 2015 | $ | 61,074 |
|
Adjustments 1 | 94 |
|
Balance as of March 31, 2016 | $ | 61,168 |
|
1 The adjustments to goodwill during the three months ended March 31, 2016 were due to foreign currency translation.
During the fourth quarter of fiscal 2015, we performed the annual goodwill impairment testing and found no impairment events as the fair value of our Clear Aligner reporting unit was significantly in excess of the carrying value.
Acquired intangible assets are being amortized as follows (in thousands):
|
| | | | | | | | | | | | | | | | | |
| Weighted Average Amortization Period (in years) | | Gross Carrying Amount as of March 31, 2016 | | Accumulated Amortization | | Accumulated Impairment Loss | | Net Carrying Value as of March 31, 2016 |
Trademarks | 14 | | $ | 7,100 |
| | $ | (1,527 | ) | | $ | (4,179 | ) | | $ | 1,394 |
|
Existing technology | 13 | | 12,600 |
| | (3,718 | ) | | (4,328 | ) | | 4,554 |
|
Customer relationships | 11 | | 33,500 |
| | (11,423 | ) | | (10,751 | ) | | 11,326 |
|
Other | 8 | | 285 |
| | (121 | ) | | — |
| | 164 |
|
Total Intangible Assets | | | $ | 53,485 |
| | $ | (16,789 | ) | | $ | (19,258 | ) | | $ | 17,438 |
|
|
| | | | | | | | | | | | | | | | | |
| Weighted Average Amortization Period (in years) | | Gross Carrying Amount as of December 31, 2015 | | Accumulated Amortization | | Accumulated Impairment Loss | | Net Carrying Value as of December 31, 2015 |
Trademarks | 15 | | $ | 7,100 |
| | $ | (1,492 | ) | | $ | (4,179 | ) | | $ | 1,429 |
|
Existing technology | 13 | | 12,600 |
| | (3,577 | ) | | (4,328 | ) | | 4,695 |
|
Customer relationships | 11 | | 33,500 |
| | (10,957 | ) | | (10,751 | ) | | 11,792 |
|
Other | 8 | | 285 |
| | (113 | ) | | — |
| | 172 |
|
Total Intangible Assets | | | $ | 53,485 |
| | $ | (16,139 | ) | | $ | (19,258 | ) | | $ | 18,088 |
|
The total estimated annual future amortization expense for these acquired intangible assets as of March 31, 2016 is as follows (in thousands):
|
| | | |
Fiscal Year Ending December 31, | |
Remainder of 2016 | $ | 1,950 |
|
2017 | 2,600 |
|
2018 | 2,600 |
|
2019 | 2,592 |
|
2020 | 2,582 |
|
Thereafter | 5,114 |
|
Total | $ | 17,438 |
|
Note 5. Credit Facilities
On March 17, 2016, we amended the credit facility, originally entered into on March 22, 2013, and extended the maturity date to March 22, 2017. The credit facility provides for a $50.0 million revolving line of credit, with a $10.0 million letter of credit sublimit. The credit facility also requires us to maintain a minimum unrestricted cash balance of $50.0 million and comply with specific financial conditions and performance requirements. The loan bears interest, at our option, at a fluctuating rate per annum equal to the daily one-month adjusted LIBOR rate plus a spread of 1.75% or an adjusted LIBOR rate (based on one, three, six or twelve-month interest periods) plus a spread of 1.75%. As of March 31, 2016, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.
Note 6. Legal Proceedings
Securities Class Action Lawsuit
On November 28, 2012, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System filed a lawsuit against Align, Thomas M. Prescott (“Mr. Prescott”), Align’s former President and Chief Executive Officer, and Kenneth B. Arola (“Mr. Arola”), Align’s former Vice President, Finance and Chief Financial Officer, in the United States District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock (the “Securities Action”). On July 11, 2013, an amended complaint was filed, which named the same defendants, on behalf of a purported class of purchasers of our common stock between January 31, 2012 and October 17, 2012. The amended complaint alleged that Align, Mr. Prescott and Mr. Arola violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that Mr. Prescott and Mr. Arola violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the amended complaint alleged that during the purported class period defendants failed to take an appropriate goodwill impairment charge related to the April 29, 2011 acquisition of Cadent Holdings, Inc. in the fourth quarter of 2011, the first quarter of 2012 or the second quarter of 2012, which rendered our financial statements and projections of future earnings materially false and misleading and in violation of U.S. GAAP. The amended complaint sought monetary damages in an unspecified amount, costs and attorneys’ fees. On December 9, 2013, the court granted defendants’ motion to dismiss with leave for plaintiff to file a second amended complaint. Plaintiff filed a second amended complaint on January 8, 2014 on behalf of the same purported class. The second amended complaint states the same claims as the amended complaint. On August 22, 2014, the court granted our motion to dismiss without leave to amend. On September 22, 2014, Plaintiff filed a notice of appeal to the Ninth Circuit Court of Appeals. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this amended complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible loss, if any.
Shareholder Derivative Lawsuit
On February 1, 2013, plaintiff Gary Udis filed a shareholder derivative lawsuit against several of Align’s current and former officers and directors in the Superior Court of California, County of Santa Clara. The complaint alleges that our reported income and earnings were materially overstated because of a failure to timely write down goodwill related to the April 29, 2011 acquisition of Cadent Holdings, Inc., and that defendants made allegedly false statements concerning our forecasts. The complaint asserts various state law causes of action, including claims of breach of fiduciary duty, unjust enrichment, and insider trading, among others. The complaint seeks unspecified damages on behalf of Align, which is named solely as nominal defendant against whom no recovery is sought. The complaint also seeks an order directing Align to reform and improve its corporate governance and internal procedures, and seeks restitution in an unspecified amount, costs, and attorneys’ fees. On July 8, 2013, an Order was entered staying this derivative lawsuit until an initial ruling on our first motion to dismiss the Securities Action. On January 15,
2014, an Order was entered staying this derivative lawsuit until an initial ruling on our second motion to dismiss the Securities Action. On October 14, 2014, an Order was entered staying this derivative lawsuit until a ruling by the Ninth Circuit in the Securities Action discussed above. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible losses.
In addition, in the course of Align's operations, Align is involved in a variety of claims, suits, investigations, and proceedings, including actions with respect to intellectual property claims, patent infringement claims, government investigations, labor and employment claims, breach of contract claims, tax, and other matters. Regardless of the outcome, these proceedings can have an adverse impact on us because of defense costs, diversion of management resources, and other factors. Although the results of complex legal proceedings are difficult to predict and Align's view of these matters may change in the future as litigation and events related thereto unfold; Align currently does not believe that these matters, individually or in the aggregate, will materially affect Align's financial position, results of operations or cash flows.
Note 7. Commitments and Contingencies
Operating Leases
As of March 31, 2016, minimum future lease payments for non-cancelable operating leases are as follows (in thousands): |
| | | | |
Fiscal Year Ending December 31, | | Operating leases |
Remainder of 2016 | | $ | 8,375 |
|
2017 | | 7,126 |
|
2018 | | 2,808 |
|
2019 | | 655 |
|
2020 | | 335 |
|
Thereafter | | 111 |
|
Total minimum future lease payments | | $ | 19,410 |
|
Off-balance Sheet Arrangements
As of March 31, 2016, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.
Indemnification Provisions
In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and our executive officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim.
It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of March 31, 2016, we did not have any material indemnification claims that were probable or reasonably possible.
Note 8. Stock-based Compensation
Summary of stock-based compensation expense
As of March 31, 2016, the 2005 Incentive Plan (as amended) has a total reserve of 23,283,379 shares of which 3,617,914 shares are available for issuance.
Stock-based compensation is based on the estimated fair value of awards, net of estimated forfeitures, and recognized over the requisite service period. Estimated forfeitures are based on historical experience at the time of grant and may be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The stock-based compensation related to all of our stock-based awards and employee stock purchases for the three months ended March 31, 2016 and 2015 is as follows (in thousands):
|
| | | | | | | | |
| Three Months Ended March 31, | |
| 2016 | | 2015 | |
Cost of net revenues | $ | 961 |
| | $ | 978 |
| |
Selling, general and administrative | 9,834 |
| | 8,771 |
| |
Research and development | 1,729 |
| | 1,899 |
| |
Total stock-based compensation | $ | 12,524 |
| | $ | 11,648 |
| |
Options
Activity for the three months ended March 31, 2016 under the stock option plans is set forth below (in thousands, except years and per share amounts):
|
| | | | | | | | | | | | |
| Stock Options Number of Shares Underlying Stock Options | | Weighted Average Exercise Price per Share | | Weighted Average Remaining Contractual Term | | Aggregate Intrinsic Value |
| | | | | (in years ) | | |
Outstanding as of December 31, 2015 | 496 |
| | $ | 15.14 |
| | | | |
Granted | — |
| | — |
| | | | |
Exercised | (30 | ) | | 11.69 |
| | | | |
Cancelled or expired | — |
| | — |
| | | | |
Outstanding as of March 31, 2016 | 466 |
| | $ | 15.37 |
| | 1.84 | | $ | 26,699 |
|
Vested and expected to vest at March 31, 2016 | 466 |
| | $ | 15.37 |
| | 1.84 | | $ | 26,699 |
|
Exercisable at March 31, 2016 | 466 |
| | $ | 15.37 |
| | 1.84 | | $ | 26,699 |
|
There were no stock options granted during the three months ended March 31, 2016 and 2015. All compensation costs relating to stock options have been recognized as of March 31, 2016.
Restricted Stock Units (“RSU”)
A summary of the RSU activity for the three months ended March 31, 2016 is as follows (in thousands, except years):
|
| | | | | | | | | | | | |
| Number of Shares Underlying RSU | | Weighted Average Grant Date Fair Value | | Weighted Remaining Contractual Period | | Aggregate Intrinsic Value |
| | | | | (in years) | | |
Nonvested as of December 31, 2015 | 2,079 |
| | $ | 49.45 |
| | | | |
Granted | 558 |
| | 63.75 |
| | | | |
Vested and released | (646 | ) | | 44.27 |
| | | | |
Forfeited | (61 | ) | | 50.48 |
| | | | |
Nonvested as of March 31, 2016 | 1,930 |
| | $ | 55.29 |
| | 1.67 | | $ | 140,321 |
|
As of March 31, 2016, the total unamortized compensation cost related to RSU, net of estimated forfeitures, was $88.7 million, which we expect to recognize over a weighted average period of 2.5 years.
We have granted market-performance based restricted stock units (“MSU”) to our executive officers. Each MSU represents the right to one share of Align’s common stock and will be issued through our amended 2005 Incentive Plan. The actual number of MSU which will be eligible to vest will be based on the performance of Align’s stock price relative to the performance of the NASDAQ Composite Index over the vesting period, generally two to three years, up to 150% of the MSU initially granted.
The following table summarizes the MSU activity for the three months ended March 31, 2016 (in thousands, except years):
|
| | | | | | | | | | | | |
| Number of Shares Underlying MSU | | Weighted Average Grant Date Fair Value | | Weighted Average Remaining Contractual Period | | Aggregate Intrinsic Value |
| | | | | (in years ) | | |
Nonvested as of December 31, 2015 | 611 |
| | $ | 51.41 |
| | | | |
Granted | 215 |
| | 55.79 |
| | | | |
Vested and released | (253 | ) | | 35.49 |
| | | | |
Forfeited | (25 | ) | | 53.70 |
| | | | |
Nonvested as of March 31, 2016 | 548 |
| | $ | 60.35 |
| | 1.84 | | $ | 39,852 |
|
As of March 31, 2016, the total unamortized compensation costs related to the MSU, net of estimated forfeitures, was $18.9 million, which we expect to recognize over a weighted average period of 1.8 years.
Employee Stock Purchase Plan ("ESPP")
In May 2010, our stockholders approved the 2010 Employee Stock Purchase Plan ("2010 Purchase Plan") which will continue until terminated by either the Board of Directors or its administrator. The maximum number of shares available for purchase under the 2010 Purchase Plan is 2,400,000 shares. As of March 31, 2016, 1,029,526 shares remain available for purchase under the 2010 Purchase Plan.
The fair value of the option component of the 2010 Purchase Plan shares was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:
|
| | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2016 | | 2015 | |
Expected term (in years) | | 1.3 |
| | 1.2 |
| |
Expected volatility | | 33.7 | % | | 31.9 | % | |
Risk-free interest rate | | 0.77 | % | | 0.26 | % | |
Expected dividends | | — |
| | — |
| |
Weighted average fair value at grant date | | $ | 19.96 |
| | $ | 15.98 |
| |
As of March 31, 2016, the total unamortized compensation cost related to employee purchases was $1.7 million, which we expect to recognize over a weighted average period of 0.6 year.
Note 9. Common Stock Repurchase
In April 2014, we announced that our Board of Directors had authorized a stock repurchase program ("April 2014") pursuant to which we may purchase up to $300.0 million of our common stock over the next three years. As of March 31, 2016, we have approximately $100.0 million remaining under the April 2014 stock repurchase program. On May 3, 2016, as part of our $300.0 million April 2014 stock repurchase program, we entered into an ASR to repurchase $50.0 million of our common stock (the "2016 ASR"). Under the terms of the 2016 ASR, we paid $50.0 million on May 4, 2016 and received an initial delivery of approximately 0.5 million shares based on current market prices. The final number of shares to be repurchased will be based on our volume-weighted average stock price during the term of the 2016 ASR, less an agreed upon discount. Commencing immediately after the completion of the 2016 ASR, we will repurchase $50.0 million of our common stock on the open market. These two actions will complete the April 2014 stock repurchase program.
On April 28, 2016, we announced that our Board of Directors had authorized a plan to repurchase up to $300.0 million of the Company's stock. This latest authorization is in addition to the existing $300 million authorization announced in April 2014, which brings the total authorization to $600 million. Any purchases under this stock repurchase program may be made, from time-to-time, pursuant to open market purchases (including pursuant to Rule 10b5-1 plans), privately-negotiated transactions, accelerated stock repurchases, block trades or derivative contracts or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934.
Note 10. Accounting for Income Taxes
Our provision for income taxes was $12.4 million and $11.3 million for the three months ended March 31, 2016 and 2015, respectively. This represents effective tax rates of 23.4% and 23.8%, respectively. Our effective tax rates differ from the statutory federal income tax rate of 35% due to certain foreign earnings, primarily from Costa Rica, which are subject to a lower tax rate, state income tax expense, the tax impact of certain stock-based compensation charges and unrecognized tax benefits.
We exercise significant judgment in regards to estimates of future market growth, forecasted earnings and projected taxable income in determining the provision for income taxes, and for purposes of assessing our ability to utilize any future benefit from deferred tax assets.
As of March 31, 2016, we maintained a valuation allowance of $31.7 million against our deferred tax assets which primarily relate to Israel operating loss carryforwards and Australia capital loss carryforwards. These net operating and capital loss carryforwards would result in us recording an income tax benefit if we were to conclude it is more likely than not that the related deferred tax assets will be realized.
Our total gross unrecognized tax benefits, excluding interest, was $40.9 million and $39.4 million as of March 31, 2016 and December 31, 2015, respectively, all of which would impact our effective tax rate if recognized. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. The interest accrued as of March 31, 2016 is $0.9 million. We do not expect any significant changes to the amount of unrecognized tax benefit within the next twelve months.
We file U.S. federal, U.S. state, and non-U.S. income tax returns. Our major tax jurisdictions are U.S. federal and the State of California. For U.S. federal and state tax returns, we are no longer subject to tax examinations for years before 2000. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2007. Our subsidiary in Israel is under audit by the local tax authorities for calendar years 2006 through 2013. We are currently under audit by the California Franchise Tax Board for fiscal years 2011, 2012 and 2013.
In June 2009, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted a twelve year extension of certain income tax incentives, which were previously granted in 2002. The incentive tax rates will expire in various years beginning in 2017. Under these incentives, all of the income in Costa Rica during these twelve year incentive periods is subject to reduced rate of Costa Rica income tax. In order to receive the benefit of these incentives, we must hire specified numbers of employees and maintain certain minimum levels of fixed asset investment in Costa Rica. If we do not fulfill these conditions for any reason, our incentive could lapse, and our income in Costa Rica would be subject to taxation at higher rates, which could have a negative impact on our operating results. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2016 and 2015. Income taxes were reduced by $8.6 million and $8.2 million for the three months ended March 31, 2016 and 2015, respectively, representing a benefit to diluted net income per share of $0.11 and $0.10 in 2016 and 2015, respectively.
Note 11. Net Income Per Share
Basic net income per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed using the weighted average number of shares of common stock, adjusted for any dilutive effect of potential common stock. Potential common stock, computed using the treasury stock method, includes RSU, MSU, stock options and ESPP.
The following table sets forth the computation of basic and diluted net income per share attributable to common stock (in thousands, except per share amounts):
|
| | | | | | | | |
| Three Months Ended, March 31, | |
| 2016 | | 2015 | |
Numerator: | | | | |
Net income | $ | 40,546 |
| | $ | 36,177 |
| |
Denominator: | | | | |
Weighted-average common shares outstanding, basic | 79,831 |
| | 80,459 |
| |
Dilutive effect of potential common stock | 1,489 |
| | 1,365 |
| |
Total shares, diluted | 81,320 |
| | 81,824 |
| |
| | | | |
Net income per share, basic | $ | 0.51 |
| | $ | 0.45 |
| |
Net income per share, diluted | $ | 0.50 |
| | $ | 0.44 |
| |
For the three months ended March 31, 2016 and 2015, the anti-dilutive effect from RSU, MSU and ESPP was not material.
Note 12. Segments and Geographical Information
Segment Information
Operating segments are defined as components of an enterprise for which separate financial information is available and is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. We report segment information based on the management approach. The management approach designates the internal reporting used by the CODM for decision making and performance assessment as the basis for determining our reportable segments. The performance measures of our reportable segments include net revenues and gross profit.
We have grouped our operations into two reportable segments which are also our reporting units: Clear Aligner segment and Scanner segment.
| |
• | Our Clear Aligner segment consists of our Invisalign system which includes Invisalign Full, Express/Lite, Teen, Assist, Vivera retainers, along with our training and ancillary products for treating malocclusion. |
| |
• | Our Scanner segment consists of intra-oral scanning systems and additional services available with the intra-oral scanners that provide digital alternatives to the traditional cast models. This segment includes our iTero scanner and OrthoCAD services. |
These reportable operating segments are based on how our CODM views and evaluates our operations as well as allocation of resources. The following information relates to these segments (in thousands):
|
| | | | | | | | |
| For the Three Months Ended March 31, | |
Net Revenues | 2016 | | 2015 | |
Clear Aligner | $ | 219,698 |
| | $ | 187,029 |
| |
Scanner | 19,022 |
| | 11,057 |
| |
Total net revenues | $ | 238,720 |
| | $ | 198,086 |
| |
| | | | |
Gross profit | | | | |
Clear Aligner | $ | 172,067 |
| | $ | 147,960 |
| |
Scanner | 8,560 |
| | 3,130 |
| |
Total gross profit | $ | 180,627 |
| | $ | 151,090 |
| |
Geographical Information
Net revenues are presented below by geographic area (in thousands):
|
| | | | | | | | |
| For the Three Months Ended March 31, | |
| 2016 | | 2015 | |
Net revenues: (1) | | | | |
U.S. | $ | 166,101 |
| | $ | 139,704 |
| |
the Netherlands | 47,400 |
| | 38,645 |
| |
Other international | 25,219 |
| | 19,737 |
| |
Total net revenues | $ | 238,720 |
| | $ | 198,086 |
| |
(1) Net revenues are attributed to countries based on location of where revenue is recognized.
Tangible long-lived assets are presented below by geographic area (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Long-lived assets:(2) | | | |
United States | $ | 122,113 |
| | $ | 112,632 |
|
Mexico | 15,971 |
| | 15,422 |
|
Other International | 9,945 |
| | 8,419 |
|
Total long-lived assets | $ | 148,029 |
| | $ | 136,473 |
|
(2) Long-lived assets are attributed to countries based on entity that owns the asset.
ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
In addition to historical information, this quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, our expectations regarding the anticipated impact that our new products and product enhancements will have on doctor utilization and our market share, our expectation that the policy simplification “Additional Aligners at No Charge" will help increase Invisalign utilization and volume, our expectations regarding product mix and product adoption, our expectations regarding the existence and impact of seasonality, our expectations regarding the financial and strategic benefits of the Scanner and Services ("Scanner") business, our expectations to increase our investment in manufacturing capacity, our expectations regarding the continued expansion of our international markets, the anticipated number of new doctors trained, the expected date our iTero Element Intraoral Scanner will be available, the effectiveness of our new training course and its impact on volumes, our expectations regarding our stock repurchase program, the level of our operating expenses and gross margins, and other factors beyond our control, as well as other statements regarding our future operations, financial condition and prospects and business strategies. These statements may contain words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” or other words indicating future results. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and in particular, the risks discussed below in Part II, Item 1A “Risk Factors”. We undertake no obligation to revise or update these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
The following discussion and analysis of our financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission.
Overview
Our goal is to establish Invisalign clear aligners as the standard method for treating malocclusion and to establish the iTero intraoral scanner as the preferred scanning device for 3D digital scans, ultimately driving increased product adoption by dental professionals. We intend to achieve this by continued focus and execution of our strategic growth drivers set forth in the Business Strategy section in our Annual Report on Form 10-K.
The successful execution of our business strategy and our results in 2016 and beyond may be affected by a number of other factors including:
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• | Additional Aligners at No Charge. In July 2015, we launched a new product policy called "Additional Aligners at No Charge" that addresses one of our customers' top complaints. Previously, we charged customers for additional aligners ordered beyond those covered by the initial treatment plan. With this product policy change, we no longer distinguish between mid-course corrections and case refinements and allow doctors to order additional aligners to address either treatment need at no charge, subject to certain requirements. These changes were effective for all new Invisalign Full, Teen, and Assist treatments shipped worldwide after July 18, 2015 as well as any open Invisalign Full, Teen and Assist cases as of that date. While this policy change was largely immaterial to our cash flows, it does impact the timing at which we recognize revenue. Based on this new product policy, beginning in the third quarter of 2015, we deferred more revenue as a result of providing free additional aligners for eligible treatments. While this product policy change will impact the timing of our revenue recognition, we believe this policy change will result in a significant improvement in customer satisfaction and loyalty, and ultimately increase Invisalign utilization and volume over time. |
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• | New Products, Feature Enhancements and Technology Innovation. Product innovation drives greater treatment predictability and clinical applicability, and ease of use for our customers, which supports adoption of Invisalign in their practices. Increasing applicability and treating more complex cases requires that we move away from individual features to more comprehensive solutions so that Invisalign providers can more predictably treat the whole case, such as with Invisalign G5 for deep bite treatment, Invisalign G6 for premolar extraction and ClinCheck Pro, the next generation Invisalign treatment software tool, designed to provide more precise control over final tooth position and to help Invisalign providers achieve their treatment goals. In addition, we began shipping the next generation |
iTero Element Intraoral Scanner in September 2015 and expect to continue to ramp up our production over the next few quarters accordingly; however, our ability to fulfill existing orders may be impacted by capacity constraints due to a variety of factors, including our dependency on third party vendors for key components in addition to limited production yields. If we are unable to scale production of our iTero Element scanner to meet customer demand, our financial results may be negatively impacted. We believe that over the long-term, clinical solutions and treatment tools will increase adoption of Invisalign and increase sales of our intraoral scanners; however, it is difficult to predict the rate of adoption which may vary by region and channel.
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• | Invisalign Adoption. Our goal is to establish Invisalign as the treatment of choice for treating malocclusion ultimately driving increased product adoption and frequency of use by dental professionals, also known as "utilization rates." Our quarterly utilization rates for the previous 9 quarters are as follows: |
* Invisalign Utilization rates = # of cases shipped divided by # of doctors cases were shipped to
Total utilization in the first quarter of 2016 increased to 4.9 cases per doctor compared to 4.5 in the first quarter of 2015. Utilization among our North American orthodontist customers reached an all time high of 10.4 cases per doctor in the first quarter of 2016 compared to 9.0 in the first quarter of 2015. International doctor utilization increased to 4.7 cases in the first quarter of 2016 from 4.4 in the first quarter of 2015. North American GP doctor utilization increased to 3.0 cases in the first quarter of 2016 from 2.9 in the first quarter of 2015. The increase in North America orthodontist utilization reflects improvements in product and technology, which continues to strengthen our doctors’ clinical confidence in the use of Invisalign such that they now utilize Invisalign more often and on more complex cases, including their teenage patients. Increased International utilization reflects growth in both the EMEA and Asia Pacific regions driven by go-to-market and sales coverage investments, improving clinical education and support as well as ongoing technology innovation. We expect that over the long-term our utilization rates will gradually improve as a result of advancements in product and technology, which continue to strengthen our doctors’ clinical confidence in the use of Invisalign, however, we expect that our utilization rates may fluctuate from period to period due to a variety of factors, including seasonal trends in our business along with adoption rates of new products and features.
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• | Number of new Invisalign doctors trained. We continue to expand our Invisalign customer base through the training of new doctors. In 2015, Invisalign growth was driven primarily by increased utilization across all regions as well as by the continued expansion of our customer base as we trained a total of 9,795 new Invisalign doctors, of which 56% were trained internationally. During the first quarter of 2016, we trained 2,470 new Invisalign doctors. |
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• | International Clear Aligner Growth. We will continue to focus our efforts towards increasing adoption of our products by dental professionals in our direct international markets. On a year over year basis, international volume increased 34.1% driven primarily by strong performance in the Asia Pacific region as well as growth in Europe. In 2016, we are continuing to expand in our existing markets through targeted investments in sales coverage and professional marketing and education programs, along with consumer marketing in selected country markets. We expect international revenues to continue to grow at a faster rate than North America for the foreseeable future due to our continued investment in international market expansion, the size of the market opportunity, and our relatively low market penetration in this region. As our international revenues have increased from $55.9 million in the first quarter of 2015 to $69.9 million in the first quarter of 2016, we are increasingly subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. Although we have historically accepted the exposure to exchange rate movements without using derivative financial instruments to manage risk, in the third quarter of 2015 we initiated a foreign currency economic hedging program to mitigate the foreign currency risk in countries where we have significant monetary assets and liabilities denominated in currencies other than the functional currency. The impact from these forward contracts was not material to our financial statements for the year ended March 31, 2016. |
In addition, as we plan for further international expansion over the next several years, we must provide better support to our customers in these regions and be geographically closer to their practices. Accordingly, we intend to make further investments in our manufacturing over the next few years to enhance our regional capabilities.
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• | Establish Regional Order Acquisition and Treatment Planning facilities: We intend to establish additional Order Acquisition and Treatment Planning facilities closer to our International customers in order to improve our operational efficiency and provide doctors with a great experience to further improve their confidence in using Invisalign to treat more patients, more often. If demand for our product in 2016 exceeds our current expectations, or if the timing of receipt of case product orders during a given quarter is different from our expectations, we may not be able to fulfill orders in a timely manner, which may negatively impact our financial results and overall business. Conversely, if demand decreases or if we fail to forecast demand accurately, we could be required to record excess capacity charges, which would lower our gross margin. |
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• | Operating Expenses. We expect operating expenses to increase in 2016 due in part to: |
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◦ | investments in international expansion in new country markets such as India and Korea; |
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◦ | the increase in sales and customer support resources; and |
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◦ | product and technology innovation to address such things as treatment times, indications unique to teens, and predictability. |
We believe that these investments will position us to increase our revenue and continue to grow our market share.
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• | Stock Repurchase Authorization. On April 28, 2016, we announced that our Board of Directors had authorized a plan to repurchase up to $300.0 million of the Company's stock. Any purchases under this stock repurchase program may be made, from time-to-time, pursuant to open market purchases (including pursuant to Rule 10b5-1 plans), privately-negotiated transactions, accelerated stock repurchases, block trades or derivative contracts or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934. |
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• | Accelerated Stock Repurchase. On May 3, 2016, as part of our $300.0 million April 2014 stock repurchase program, we entered into an Accelerated Stock Repurchase (ASR) agreement to repurchase $50.0 million of our common stock (the "2016 ASR"). Under the terms of the 2016 ASR, we paid $50.0 million on May 4, 2016 and received an initial delivery of approximately 0.5 million shares based on current market prices. The final number of shares to be repurchased will be based on our volume-weighted average stock price during the term of the 2016 ASR, less an agreed upon discount. (Refer to Note 9 "Common Stock Repurchase", of the Notes to condensed consolidated financial statements for details on common stock repurchase). |
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• | 10b5-1 Stock Repurchase Plan. On May 3, 2016, we also entered into a stock repurchase plan under which we will repurchase up to $50 million of our common stock. This stock repurchase plan is in addition to, and will become effective upon, the completion of the 2016 ASR. This stock repurchase plan will operate in accordance with guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934. Accordingly, transactions, if any, will be effected in accordance with the terms of the share repurchase plan, including specified price, volume, and timing conditions. |
Results of Operations
Net revenues by Reportable Segment
We group our operations into two reportable segments: Clear Aligner segment and Scanner segment.
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• | Our Clear Aligner segment consists of our Invisalign system which includes Invisalign Full, Teen and Assist ("Full Products"), Express/Lite ("Express Products"),Vivera retainers, along with our training and ancillary products for treating malocclusion. |
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• | Our Scanner segment consists of intra-oral scanning systems and additional services available with the intra-oral scanners that provide digital alternatives to the traditional cast models. This segment includes our iTero scanner and OrthoCAD services. |
Net revenues for our Clear Aligner segment by region and our Scanner segment by region for the three months ended March 31, 2016 and 2015 is as follows (in millions):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended, March 31, | |
Net Revenues | 2016 | | 2015 | | Net Change | | % Change | |
Clear Aligner Revenues: | | | | | | | | |
North America | $ | 135.7 |
| | $ | 118.8 |
| | $ | 16.9 |
| | 14.2 | % | |
International | 69.9 |
| | 55.9 |
| | 14.0 |
| | 25.0 | % | |
Invisalign non-case | 14.1 |
| | 12.3 |
| | 1.8 |
| | 14.6 | % | |
Total Clear Aligner net revenues | $ | 219.7 |
| | $ | 187.0 |
| | $ | 32.7 |
| | 17.5 | % | |
Scanner net revenues | 19.0 |
| | 11.1 |
| | 7.9 |
| | 72.0 | % | |
Total net revenues | $ | 238.7 |
| | $ | 198.1 |
| | $ | 40.5 |
| | 20.5 | % | |
Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Clear Aligner Case Volume by Region
Case volume data which represents Invisalign case shipments by region for the three months ended March 31, 2016 and 2015 is as follows (in thousands):
|
| | | | | | | | | | | | |
| For the Three Months Ended, March 31, | |
Region | 2016 | | 2015 | | Net Change | | % Change | |
North American Invisalign | 110.5 |
| | 91.1 |
| | 19.4 |
| | 21.3 | % | |
International Invisalign | 53.2 |
| | 39.7 |
| | 13.5 |
| | 34.1 | % | |
Total Invisalign case volume | 163.7 |
| | 130.8 |
| | 32.9 |
| | 25.2 | % | |
Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Total net revenues increased by $40.5 million for the three months ended March 31, 2016, respectively, as compared to the same period in 2015, primarily as a result of Invisalign case volume growth across all regions and most products.
Clear Aligner - North America
In the three months ended March 31, 2016, Clear Aligner North America net revenues increased by $16.9 million compared to the same period in 2015 primarily due to Invisalign case volume growth of approximately $25.3 million across all channels and products. These increases were offset in part by lower average selling prices ("ASP") which decreased net revenues by approximately $8.4 million. The decrease in ASP was as a result of higher net revenue deferrals of $4.9 million primarily due to the impact of our new additional aligner product policy launched in July 2015, and, to a lesser extent, due to higher promotional discounts in the current period compared to the same period in the prior year of $4.1 million. The decrease in ASP was offset in part by the price increase on our Full products effective April 1, 2015.
Clear Aligner - International
In the three months ended March 31, 2016, Clear Aligner international net revenues increased by $14.0 million compared to the same period in 2015 primarily driven by Invisalign case volume growth of $19.1 million across all products. This was offset in part by lower ASP which decreased net revenues by approximately $5.1 million. The decrease in ASP was primarily a result of the unfavorable impact from foreign exchange rates of $2.7 million due to the weakening of the Euro compared to the U.S. dollar in the current period compared to the same period in the prior year, higher net deferrals of $2.6 million mainly due to the impact of our new additional aligner product policy launched in July 2015, and, to a lesser extent, due to a product mix shift towards lower priced Invisalign products. These decreases were partially offset by an increase in ASP due to the price increase on our Full products effective July 1, 2015 as well as our transition to a direct sales model in certain Asia Pacific countries.
Clear Aligner - Invisalign Non-Case
Invisalign non-case net revenues consists of training fees and ancillary product revenues. Invisalign non-case net revenues increased by $1.8 million for the three months ended March 31, 2016, respectively compared to the same period in 2015 primarily due to increased Vivera volume both in North America and International.
Scanner
Scanner net revenues increased $7.9 million for the three months ended March 31, 2016, respectively, compared to the same period in 2015 primarily as a result of an increase in the number of scanners recognized as we began shipping our next generation iTero Element scanner in September 2015, and, to a lesser extent, an increase in ASP.
Cost of net revenues and gross profit (in millions):
|
| | | | | | | | | | | | |
| Three Months Ended March 31, | |
| 2016 | | 2015 | | Change | |
Clear Aligner | | | | | | |
Cost of net revenues | $ | 47.6 |
| | $ | 39.1 |
| | $ | 8.5 |
| |
% of net segment revenues | 21.7 | % | | 20.9 | % | | | |
Gross profit | $ | 172.1 |
| | $ | 148.0 |
| | $ | 24.1 |
| |
Gross margin % | 78.3 | % | | 79.1 | % | | | |
Scanner and Services | | | | | | |
Cost of net revenues | $ | 10.5 |
| | $ | 7.9 |
| | $ | 2.6 |
| |
% of net segment revenues | 55.0 | % | | 71.7 | % | | | |
Gross profit | $ | 8.6 |
| | $ | 3.1 |
| | $ | 5.5 |
| |
Gross margin % | 45.0 | % | | 28.3 | % | | | |
Total cost of net revenues | $ | 58.1 |
| | $ | 47.0 |
| | $ | 11.1 |
| |
% of net revenues | 24.3 | % | | 23.7 | % | | | |
Gross profit | $ | 180.6 |
| | $ | 151.1 |
| | $ | 29.5 |
| |
Gross margin % | 75.7 | % | | 76.3 | % | | | |
Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Cost of net revenues for our Clear Aligner and Scanner segments includes salaries for staff involved in the production process, the cost of materials, packaging, shipping costs, depreciation on capital equipment used in the production process, amortization of acquired intangible assets from Cadent, training costs and stock-based compensation.
Clear Aligner
Gross margin declined slightly for the three months ended March 31, 2016 compared to the same period in 2015 primarily due to lower ASP related to our new Additional Aligner policy implemented in July last year.
Scanner
Gross margin increased for the three months ended March 31, 2016 compared to the same period in 2015 primarily due to higher ASP and lower costs of our iTero Element scanner.
Selling, General and administrative (in millions):
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| | | | | | | | | | | | |
| Three Months Ended March 31, | |
| 2016 | | 2015 | | Change | |
Selling, general and administrative | $ | 112.2 |
| | $ | 88.3 |
| | $ | 23.9 |
| |
% of net revenues | 47.0 | % | | 44.6 | % | | | |
Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Selling, general and administrative expense includes personnel-related costs including payroll, commissions and stock-based compensation for our sales force, marketing and administration in addition to media and advertising expenses, clinical education, trade shows and industry events, product marketing, outside consulting services, legal expenses, depreciation and amortization expense, the medical device excise tax ("MDET") and allocations of corporate overhead expenses including facilities and IT.
Selling, general and administrative expense for the three months ended March 31, 2016 increased compared to the same period in 2015 primarily due to higher compensation related costs of $11.7 million as a result of increased headcount, which led to higher salaries, stock based compensation and commissions and higher marketing costs. In addition, in the first quarter of 2015 there was a refund of MDET taxes paid in 2014 of $6.8 million as our aligners which are now no longer subject to the excise tax. These increased expenses were partially offset by lower outside litigation costs of $1.4 million.
Research and development (in millions):
|
| | | | | | | | | | | | |
| Three Months Ended March 31, | |
| 2016 | | 2015 | | Change | |
Research and development | $ | 15.1 |
| | $ | 13.9 |
| | $ | 1.2 |
| |
% of net revenues | 6.3 | % | | 7.0 | % | | | |
Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Research and development expense includes the personnel-related costs including stock-based compensation and outside consulting expenses associated with the research and development of new products and enhancements to existing products and allocations of corporate overhead expenses including facilities and IT.
Research and development expense for the three months ended March 31, 2016 increased compared to the same period in 2015 due to higher compensation costs from additional headcount and salary increases.
Interest and other income (expense), net (in millions):
|
| | | | | | | | | | | | |
| Three Months Ended March 31, | |
| 2016 | | 2015 | | Change | |
Interest and other income (expense), net | $ | (0.4 | ) | | $ | (1.5 | ) | | $ | 1.1 |
| |
Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Interest and other income (expense), net, includes foreign currency translation gains and losses, interest income earned on cash, cash equivalents and investment balances, gains and losses on foreign currency forward contracts and other miscellaneous charges.
Interest and other income (expense), net for the three months ended March 31, 2016 increased slightly compared to the same period in 2015 due to increased interest income on higher balances of cash, cash equivalents and investments and strengthening of the Euro against U.S. dollar.
Income tax (in millions):
|
| | | | | | | | | | | | |
| Three Months Ended March 31, | |
| 2016 | | 2015 | | Change | |
Provision for income taxes | $ | 12.4 |
| | $ | 11.3 |
| | $ | 1.1 |
| |
Effective tax rates | 23.4 | % | | 23.8 | % | | | |
Our provision for income taxes was $12.4 million and $11.3 million for the three months ended March 31, 2016 and 2015, respectively. This represents effective tax rates of 23.4% and 23.8%, respectively. Our effective tax rates differ from the statutory federal income tax rate of 35% due to certain foreign earnings, primarily from Costa Rica, which are subject to a lower tax rate, state income tax expense, the tax impact of certain stock-based compensation charges and unrecognized tax benefits.
We exercise significant judgment in regards to estimates of future market growth, forecasted earnings and projected taxable income in determining the provision for income taxes, and for purposes of assessing our ability to utilize any future benefit from deferred tax assets.
As of March 31, 2016, we maintained a valuation allowance of $31.7 million against deferred tax assets primarily related to Israel operating loss carryforwards and Australia capital loss carryforwards. These net operating and capital loss carryforwards would result in us recording an income tax benefit if we were to conclude it is more likely than not that the related deferred tax assets will be realized.
Our total gross unrecognized tax benefits was, excluding interest, $40.9 million and $39.4 million as of March 31, 2016 and December 31, 2015, respectively, all of which would impact our effective tax rate if recognized. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. The interest accrued as of March 31, 2016 is $0.9 million. We do not expect any significant changes to the amount of unrecognized tax benefit within the next twelve months.
We file U.S. federal, U.S. state, and non-U.S. income tax returns. Our major tax jurisdictions are U.S. federal and the State of California. For U.S. federal and state tax returns, we are no longer subject to tax examinations for years before 2000. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2007. Our subsidiary in Israel is under audit by the local tax authorities for calendar years 2006 through 2013. We are currently under audit by the California Franchise Tax Board for fiscal years 2011, 2012 and 2013.
In June 2009, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted a twelve year extension of certain income tax incentives, which were previously granted in 2002. The incentive tax rates will expire in various years beginning in 2017. Under these incentives, all of the income in Costa Rica during these twelve year incentive periods is subject to reduced rate of Costa Rica income tax. In order to receive the benefit of these incentives, we must hire specified numbers of employees and maintain certain minimum levels of fixed asset investment in Costa Rica. If we do not fulfill these conditions for any reason, our incentive could lapse, and our income in Costa Rica would be subject to taxation at higher rates, which could have a negative impact on our operating results. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2016 and 2015. Income taxes were reduced by $8.6 million and $8.2 million for the three months ended March 31, 2016 and 2015, respectively, representing a benefit to diluted net income per share of $0.11 and $0.10 in 2016 and 2015, respectively.
Liquidity and Capital Resources
We fund our operations from product sales and the proceeds from the sale of our common stock. As of March 31, 2016 and December 31, 2015, we had the following cash, cash equivalents, and short-term and long-term marketable securities (in thousands): |
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Cash and cash equivalents | $ | 154,418 |
| | $ | 167,714 |
|
Short-term investments | 393,660 |
| | 359,581 |
|
Long-term investments | 132,690 |
| | 151,370 |
|
Total | $ | 680,768 |
| | $ | 678,665 |
|
Cash flows (in thousands):
|
| | | | | | | | |
| | Three Months Ended March 31, |
| | 2016 | | 2015 |
Net cash flow provided by (used in): | | | | |
Operating activities | | $ | 30,680 |
| | $ | 35,645 |
|
Investing activities | | (35,316 | ) | | (36,661 | ) |
Financing activities | | (9,106 | ) | | (7,097 | ) |
Effect of exchange rate changes on cash and cash equivalents | | 446 |
| | (1,780 | ) |
Net decrease in cash and cash equivalents | | $ | (13,296 | ) | | $ | (9,893 | ) |
As of March 31, 2016, we had $680.8 million of cash, cash equivalents and short-term and long-term marketable securities. Cash equivalents and marketable securities are comprised of money market funds and debt instruments which include corporate bonds, U.S. dollar dominated foreign corporate bonds, commercial paper, municipal securities, U.S. government agency bonds, U.S. government treasury bonds and asset-backed securities. We do not enter into investments for trading or speculative purposes.
As of March 31, 2016, approximately $464.8 million of cash, cash equivalents and short-term and long-term marketable securities was held by our foreign subsidiaries. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S. The costs to repatriate our foreign earnings to the U.S. would likely be material; however, our intent is to permanently reinvest our earnings from foreign operations, and our current plans do not require us to repatriate them to fund our U.S. operations as we generate sufficient domestic operating cash flow and have access to external funding under our current revolving line of credit. Additionally, we have taken certain preliminary steps to implement an international corporate structure more closely aligned with our international operations. This potential corporate structure may reduce our overall effective tax rate and may increase our domestic cash flows through changes among our wholly-owned subsidiaries in how we get compensated for the use of our intellectual property, and how we structure our international procurement and sales operations. We believe that income taxed in certain foreign jurisdictions at a lower rate relative to the U.S. statutory rate will have a beneficial impact on our worldwide effective tax rate over the medium to long term. The decrease in effective tax rate will benefit our financial position and results of operations.
In April, 2014, our Board of Directors had authorized a stock repurchase program pursuant to which we may purchase up to $300.0 million of our common stock over the next three years. As of March 31, 2016, we have approximately $100.0 million remaining under the April 2014 stock repurchase program. We expect to finance future stock repurchases with current cash on hand. On May 3, 2016, as part of our $300.0 million April 2014 stock repurchase program, we entered into an accelerated stock repurchase program to repurchase $50.0 million of our common stock (the "2016 ASR"). Commencing immediately after the completion of the 2016 ASR, we will repurchase $50.0 million of our common stock on the open market. These two actions will complete the April 2014 stock repurchase program. (Refer to Note 9 "Common Stock Repurchase", of the Notes to condensed consolidated financial statements for details on common stock repurchase).
On March 22, 2013, we entered into a credit facility for a $50.0 million revolving line of credit, with a $10.0 million letter of credit sublimit, and has a maturity date on March 22, 2017. (Refer to Note 5 "Credit Facility", of the Notes to condensed consolidated financial statements for details of the credit facility).
We believe that our current cash and cash equivalents and marketable securities combined with our positive cash flows from operations will be sufficient to fund our operations and stock repurchases for at least the next 12 months. If we are unable to generate adequate operating cash flows, we may need to suspend our stock repurchase program or seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations. Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.
Operating Activities
For the three months ended March 31, 2016, cash flows from operations of $30.7 million resulted primarily from our net income of approximately $40.5 million as well as the following:
Significant non-cash activities:
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• | stock-based compensation of $12.5 million related to equity incentive compensation awards granted to our employees, and |
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• | depreciation and amortization of $4.8 million related to our fixed assets and acquired intangible assets, offset in part by |
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• | excess tax benefits from our share-based compensation arrangements of $8.1 million. |
Significant changes in working capital:
| |
• | an increase of $20.8 million in accounts receivable which is a result of the increase in net revenues, |
| |
• | an increase of $14.7 million in deferred revenues corresponding to the increases in case shipments, and |
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• | a decrease of $14.5 million in accrued and other long-term liabilities primarily due to the payment of our 2015 bonus. |
Investing Activities
Net cash used in investing activities was $35.3 million for the three months ended March 31, 2016 primarily consisting of purchases of marketable securities of $143.9 million, and property, plant and equipment purchases of $20.2 million. These outflows were partially offset in part by $128.8 million of maturities and sales of our marketable securities.
For the remainder of 2016, we expect to spend an additional $45.0 million to $50.0 million on capital expenditures for estimated total capital expenditures of $65.0 million to $70.0 million for 2016 primarily for additional manufacturing capacity and infrastructure including a project to implement a new enterprise resource planning system. Although we believe our current investment portfolio has little risk of impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain unimpaired.
Financing Activities
Net cash used in financing activities was $9.1 million for the three months ended March 31, 2016 primarily resulting from payroll taxes paid for vesting of restricted stock units through share withholdings of $22.6 million. These outflows were offset in part by $8.1 million from excess tax benefits from our share-based compensation arrangements and $5.4 million in proceeds from issuance of common stock.
Contractual Obligations
Our contractual obligations have not significantly changed since December 31, 2015 as disclosed in our Annual Report on Form 10-K. We believe that our current cash, cash equivalents and short-term marketable securities combined with our existing borrowing capacity will be sufficient to fund our operations for at least the next 12 months. If we are unable to generate adequate operating cash flows and need more funds beyond those available under our credit facility, we may need to suspend our stock repurchase program or seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations. Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.
Off-Balance Sheet Arrangements
As of March 31, 2016, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.
Indemnification Provisions
In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim.
It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of March 31, 2016, we did not have any material indemnification claims that were probable or reasonably possible.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of our financial condition and results of operations is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of condensed consolidated financial statements requires our management to make estimates and judgments that affect the reported amounts of assets and liabilities, net revenues and expenses and disclosures at the date of the financial statements. We evaluate our estimates on an on-going basis, including those related to revenue recognition, accounts receivable, intangible assets, legal contingencies, impairment of goodwill and income taxes. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates.
We believe the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements. These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2015:
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• | Stock-based compensation expense; |
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• | Goodwill and finite-lived acquired intangible assets, |
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• | Impairment of goodwill, finite-lived acquired intangible assets and long-lived assets, and |
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• | Accounting for income taxes. |
Recent Accounting Pronouncements
See Note 1 “Summary of Significant Accounting Policies” of the Notes to Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements.
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to foreign currency exchange rate and interest rate risks that could impact our financial position and results of operations.
Interest Rate Risk
Changes in interest rates could impact our anticipated interest income on our cash equivalents and investments in marketable securities. Our cash equivalents and investments are fixed-rate short-term and long-term securities. Fixed-rate securities may have their fair market value adversely impacted due to a rise in interest rates, and, as a result, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. As of March 31, 2016, we had approximately $456.0 million invested in available-for-sale marketable securities. An immediate 10% change in interest rates would not have a material adverse impact on our future operating results and cash flows.
We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. We do not have interest bearing liabilities as of March 31, 2016, and, therefore, we are not subject to risks from immediate interest rate increases.
Currency Rate Risk
We operate in North America, Europe, Asia Pacific, Costa Rica and Israel. As a result of our international business activities, our financial results could be affected by factors such as changes in foreign currency exchange rates or economic conditions in foreign markets, and there is no assurance that exchange rate fluctuations will not harm our business in the future. We generally sell our products in the local currency of the respective countries. This provides some natural hedging because most of the
subsidiaries’ operating expenses are generally denominated in their local currencies as discussed further below. Regardless of this natural hedging, our results of operations may be adversely impacted by exchange rate fluctuations.
In September 2015, we entered into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations on cash and certain trade and intercompany receivables and payables. These forward contracts are not designated as hedging instruments and do not subject us to material balance sheet risk due to fluctuations in foreign currency exchange rates. The gains and losses on these forward contracts are intended to offset the gains and losses in the underlying foreign currency denominated monetary assets and liabilities being economically hedged. These instruments are marked to market through earnings every period and generally are one month in original maturity. We do not enter into foreign currency forward contracts for trading or speculative purposes. As our international operations grow, we will continue to reassess our approach to managing the risks relating to fluctuations in currency rates. It is difficult to predict the impact hedging activities could have on our results of operations. The fair value of foreign exchange forward contracts outstanding as of March 31, 2016 was not material.
Although we will continue to monitor our exposure to currency fluctuations, and, where appropriate, may use financial hedging techniques in the future to minimize the effect of these fluctuations, the impact of an aggregate change of 10% in foreign currency exchange rates relative to the U.S. dollar on our results of operations and financial position could be material.
ITEM 4.CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of March 31, 2016, to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.
Changes in internal control over financial reporting.
There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Securities Class Action Lawsuit
On November 28, 2012, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System filed a lawsuit against Align, Thomas M. Prescott (“Mr. Prescott”), Align’s former President and Chief Executive Officer, and Kenneth B. Arola (“Mr. Arola”), Align’s former Vice President, Finance and Chief Financial Officer, in the United States District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock (the “Securities Action”). On July 11, 2013, an amended complaint was filed, which named the same defendants, on behalf of a purported class of purchasers of our common stock between January 31, 2012 and October 17, 2012. The amended complaint alleged that Align, Mr. Prescott and Mr. Arola violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that Mr. Prescott and Mr. Arola violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the amended complaint alleged that during the purported class period defendants failed to take an appropriate goodwill impairment charge related to the April 29, 2011 acquisition of Cadent Holdings, Inc. in the fourth quarter of 2011, the first quarter of 2012 or the second quarter of 2012, which rendered our financial statements and projections of future earnings materially false and misleading and in violation of U.S. GAAP. The amended complaint sought monetary damages in an unspecified amount, costs and attorneys’ fees. On December 9, 2013, the court granted defendants’ motion to dismiss with leave for plaintiff to file a second amended complaint. Plaintiff filed a second amended complaint on January 8, 2014 on behalf of the same purported class. The second amended complaint states the same claims as the amended complaint. On August 22, 2014, the court granted our motion to dismiss without leave to amend. On September 22, 2014, Plaintiff filed a notice of appeal to the Ninth Circuit Court of Appeals. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this amended complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible loss, if any.
Shareholder Derivative Lawsuit
On February 1, 2013, plaintiff Gary Udis filed a shareholder derivative lawsuit against several of Align’s current and former officers and directors in the Superior Court of California, County of Santa Clara. The complaint alleges that our reported income and earnings were materially overstated because of a failure to timely write down goodwill related to the April 29, 2011 acquisition of Cadent Holdings, Inc., and that defendants made allegedly false statements concerning our forecasts. The complaint asserts various state law causes of action, including claims of breach of fiduciary duty, unjust enrichment, and insider trading, among others. The complaint seeks unspecified damages on behalf of Align, which is named solely as nominal defendant against whom no recovery is sought. The complaint also seeks an order directing Align to reform and improve its corporate governance and internal procedures, and seeks restitution in an unspecified amount, costs, and attorneys’ fees. On July 8, 2013, an Order was entered staying this derivative lawsuit until an initial ruling on our first motion to dismiss the Securities Action. On January 15, 2014, an Order was entered staying this derivative lawsuit until an initial ruling on our second motion to dismiss the Securities Action. On October 14, 2014, an Order was entered staying this derivative lawsuit until a ruling by the Ninth Circuit in the Securities Action discussed above. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible losses.
In addition, in the course of Align's operations, Align is involved in a variety of claims, suits, investigations, and proceedings, including actions with respect to intellectual property claims, patent infringement claims, government investigations, labor and employment claims, breach of contract claims, tax, and other matters. Regardless of the outcome, these proceedings can have an adverse impact on us because of defense costs, diversion of management resources, and other factors. Although the results of complex legal proceedings are difficult to predict and Align's view of these matters may change in the future as litigation and events related thereto unfold; Align currently does not believe that these matters, individually or in the aggregate, will materially affect Align's financial position, results of operations or cash flows.
ITEM 1A.RISK FACTORS
We depend on the sale of the Invisalign system for the vast majority of our net revenues, and any decline in sales of Invisalign treatment for any reason, or a decline in average selling prices would adversely affect net revenues, gross margin and net income.
We expect that net revenues from the sale of the Invisalign System, primarily Invisalign Full and Invisalign Teen, will continue to account for the vast majority of our total net revenues for the foreseeable future. Continued and widespread market acceptance of Invisalign by orthodontists, GPs and consumers is critical to our future success. If orthodontists and GPs experience a reduction in consumer demand for orthodontic services, if consumers prove unwilling to adopt Invisalign as rapidly as we anticipate or in the volume that we anticipate, if orthodontists or GPs choose to use a competitive product rather than Invisalign or if the average selling price of our product declines, our operating results would be harmed.
Demand for our products may not increase as rapidly as we anticipate due to a variety of factors including a weakness in general economic conditions.
Consumer spending habits are affected by, among other things, prevailing economic conditions, levels of employment, salaries and wage rates, gas prices, consumer confidence and consumer perception of economic conditions. A general slowdown in the U.S. economy and certain international economies or an uncertain economic outlook would adversely affect consumer spending habits which may, among other things, result in a decrease in the number of overall orthodontic case starts, reduced patient traffic in dentists’ offices, reduction in consumer spending on higher value procedures or a reduction in the demand for dental services generally, each of which would have a material adverse effect on our sales and operating results. Weakness in the global economy results in a challenging environment for selling dental technologies and dentists may postpone investments in capital equipment, such as intra-oral scanners. In addition, Invisalign treatment, which currently accounts for the vast majority of our net revenues, represents a significant change from traditional orthodontic treatment, and customers and consumers may be reluctant to accept it or may not find it preferable to traditional treatment. We have generally received positive feedback from orthodontists, GPs and consumers regarding Invisalign treatment as both an alternative to braces and as a clinical method for the treatment of malocclusion, but a number of dental professionals believe that the Invisalign treatment is appropriate for only a limited percentage of their patients. Increased market acceptance of all of our products will depend in part upon the recommendations of dental professionals, as well as other factors including effectiveness, safety, ease of use, reliability, aesthetics, and price compared to competing products.
The frequency of use of the Invisalign system by orthodontists or GPs may not increase at the rate that we anticipate or at all.
One of our key objectives is to continue to increase utilization, or the adoption and frequency of use, of the Invisalign System by new and existing customers. If utilization of the Invisalign System by our existing and newly trained orthodontists or GPs does not occur or does not occur as quickly as we anticipate, our operating results could be harmed.
We may experience declines in average selling prices of our products which may decrease our net revenues.
We provide volume based discount programs to our doctors. In addition, we sell a number of products at different list prices. If we introduce any price reductions or consumer rebate programs; if we expand our discount programs in the future or participation in these programs increases; if our product mix shifts to lower priced products or products that have a higher percentage of deferred revenue, our average selling prices would be adversely affected and our net revenues, gross profit, gross margin and net income may be reduced. In July 2015, we launched a new product policy called "Additional Aligners at No Charge" that addresses one of our customer's top complaints. With this product policy change, we no longer distinguish between mid-course correction and case refinements and allow doctors to order additional aligners to address either treatment need at no charge, subject to certain requirements. Based on this new product policy, beginning in the third quarter of 2015, we deferred more revenue as a result of providing free additional aligners for eligible treatments. Additionally, as we grandfathered over 1 million open cases, we will recognize lower revenues as additional aligners are shipped for at least the next two years until these cases complete.
We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and results of operations.
Although the U.S. dollar is our reporting currency, a portion of our net revenues and net income are generated in foreign currencies. Net revenues and net income generated by subsidiaries operating outside of the U.S. are translated into U.S. dollars using exchange rates effective during the respective period and are affected by changes in exchange rates. As a result, negative movements in currency exchange rates against the U.S. dollar will adversely affect our net revenues and net income in our consolidated financial statements. The exchange rate between the U.S. dollar and foreign currencies has fluctuated substantially
in recent years and may continue to fluctuate substantially in the future. As a result, beginning in September 2015, we began entering into currency hedging transactions in an effort to cover some of our exposure to foreign currency exchange fluctuations. These transactions may not operate to fully or effectively hedge our exposure to currency fluctuations, and, under certain circumstances, these transactions could have an adverse effect on our financial condition.
As we continue to grow, we are subject to growth related risks, including risks related to excess or constrained capacity at our existing facilities.
We are subject to growth related risks, including excess or constrained capacity and pressure on our internal systems and personnel. In order to manage current operations and future growth effectively, we will need to continue to implement and improve our operational, financial and management information systems and to hire, train, motivate, manage and retain employees. We may be unable to manage such growth effectively. Any such failure could have a material adverse impact on our business, operations and prospects. In addition, in order to meet the demands from expected volumes, we purchased a second manufacturing facility in Juarez, Mexico. We began manufacturing aligners in this second facility in September 2015 while continuing to manufacture Aligners at our existing facility in Juarez. Our ability to plan, construct and equip additional manufacturing facilities is subject to significant risk and uncertainty, including risks inherent in the establishment of a new manufacturing facility, such as hiring and retaining employees and delays and cost overruns as a result of a number of factors, any of which may be out of our control. If the transition into this additional facility is significantly delayed or demand for our product exceeds our current expectations, we may not be able to fulfill orders timely, which may negatively impact our financial results and overall business. In addition, because we cannot immediately adapt our production capacity and related cost structures to changing market conditions, our manufacturing capacity may at times exceed or fall short of our production requirements. In addition, if product demand decreases or we fail to forecast demand accurately, we could be required to write off inventory or record excess capacity charges, which would lower our gross margin. Production of our intra oral scanners may also be limited by capacity constraints due to a variety of factors, including our dependency on third party vendors for key components in addition to limited production yields. Any or all of these problems could result in the loss of customers, provide an opportunity for competing products to gain market acceptance and otherwise harm our business and financial results.
If we fail to sustain or increase profitability or revenue growth in future periods, the market price for our common stock may decline.
If we are to sustain or increase profitability in future periods, we will need to continue to increase our net revenues, while controlling our expenses. Because our business is evolving, it is difficult to predict our future operating results or levels of growth, and we have in the past not been and may in the future not be able to sustain our historical growth rates. If we do not increase profitability or revenue growth or otherwise meet the expectations of securities analysts or investors, the market price of our common stock will likely decline.
Our financial results have fluctuated in the past and may fluctuate in the future which may cause volatility in our stock price.
Our operating results have fluctuated in the past and we expect our future quarterly and annual operating results to fluctuate as we focus on increasing doctor and consumer demand for our products. These fluctuations could cause our stock price to decline or significantly fluctuate. Some of the factors that could cause our operating results to fluctuate include:
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• | limited visibility into and difficulty predicting the level of activity in our customers’ practices from quarter to quarter; |
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• | weakness in consumer spending as a result of the slowdown in the U.S. economy and global economies; |
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• | changes in relationships with our distributors; |
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• | changes in the timing of receipt of Invisalign case product orders during a given quarter which, given our cycle time and the delay between case receipts and case shipments, could have an impact on which quarter revenue can be recognized; |
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• | fluctuations in currency exchange rates against the U.S. dollar; |
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• | our inability to scale production of our iTero Element scanner to meet customer demand; |
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• | if participation in our customer rebate or discount programs increases our average selling price will be adversely affected; |
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• | seasonal fluctuations in the number of doctors in their offices and their availability to take appointments; |
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• | success of or changes to our marketing programs from quarter to quarter; |
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• | our reliance on our contract manufacturers for the production of sub-assemblies for our intra-oral scanners; |
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• | timing of industry tradeshows; |
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• | changes in the timing of when revenue is recognized, including as a result of the introduction of new products or promotions, modifications to our terms and conditions or as a result of changes to critical accounting estimates or new accounting pronouncements; |
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• | changes to our effective tax rate; |
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• | unanticipated delays in production caused by insufficient capacity or availability of raw materials; |
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• | any disruptions in the manufacturing process, including unexpected turnover in the labor force or the introduction of new production processes, power outages or natural or other disasters beyond our control; |
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• | the development and marketing of directly competitive products by existing and new competitors; |
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• | major changes in available technology or the preferences of customers may cause our current product offerings to become less competitive or obsolete; |
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• | aggressive price competition from competitors; |
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• | costs and expenditures in connection with litigation; |
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• | the timing of new product introductions by us and our competitors, as well as customer order deferrals in anticipation of enhancements or new products; |
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• | unanticipated delays in our receipt of patient records made through an intraoral scanner for any reason; |
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• | disruptions to our business due to political, economic or other social instability, including the impact of an epidemic any of which results in changes in consumer spending habits, consumers unable or unwilling to visit the orthodontist or general practitioners office, as well as any impact on workforce absenteeism; |
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• | inaccurate forecasting of net revenues, production and other operating costs, |
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• | investments in research and development to develop new products and enhancements; and |
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• | our ability to successfully hedge against a portion of our foreign currency-denominated assets and liabilities. |
To respond to these and other factors, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations. Most of our expenses, such as employee compensation and lease payment obligations, are relatively fixed in the short term. Moreover, our expense levels are based, in part, on our expectations regarding future revenue levels. As a result, if our net revenues for a particular period fall below our expectations, whether caused by changes in consumer spending, consumer preferences, weakness in the U.S. or global economies, changes in customer behavior related to advertising and prescribing our product, or other factors, we may be unable to adjust spending quickly enough to offset any shortfall in net revenues. Due to these and other factors, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. You should not rely on our results for any one quarter as an indication of our future performance.
Our future success may depend on our ability to develop, successfully introduce and achieve market acceptance of new products.
Our future success may depend on our ability to develop, manufacture, market, and obtain regulatory approval or clearance of new products. There can be no assurance that we will be able to successfully develop, sell and achieve market acceptance of these and other new products and applications and enhanced versions of our existing product or software. The extent of, and rate at which, market acceptance and penetration are achieved by future products is a function of many variables, which include, among other things, our ability to:
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• | correctly identify customer needs and preferences and predict future needs and preferences; |
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• | include functionality and features that address customer requirements; |
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• | ensure compatibility of our computer operating systems and hardware configurations with those of our customers; |
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• | allocate our research and development funding to products with higher growth prospects; |
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• | anticipate and respond to our competitors’ development of new products and technological innovations; |
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• | differentiate our offerings from our competitors’ offerings; |
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• | innovate and develop new technologies and applications; |
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• | the availability of third-party reimbursement of procedures using our products; |
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• | obtain adequate intellectual property rights; and |
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• | encourage customers to adopt new technologies. |
If we fail to accurately predict customer needs and preferences or fail to produce viable technologies, we may invest heavily in research and development of products that do not lead to significant revenue. Even if we successfully innovate and develop new products and produce enhancements, we may incur substantial costs in doing so, and our profitability may suffer. In addition, even if our new products are successfully introduced, it is unlikely that they will rapidly gain market share and acceptance primarily due to the relatively long period of time it takes to successfully treat a patient with Invisalign. Since it takes approximately 12 to 24 months to treat a patient, our customers may be unwilling to rapidly adopt our new products until they successfully complete at least one case or until more historical clinical results are available.
Our ability to market and sell new products may also be subject to government regulation, including approval or clearance by the FDA, and foreign government agencies. Any failure in our ability to successfully develop and introduce or achieve market acceptance of our new products or enhanced versions of existing products could have a material adverse effect on our operating results and could cause our net revenues to decline.
A disruption in the operations of our primary freight carrier or higher shipping costs could cause a decline in our net revenues or a reduction in our earnings.
We are dependent on commercial freight carriers, primarily UPS, to deliver our products to our customers. If the operations of these carriers are disrupted for any reason, we may be unable to deliver our products to our customers on a timely basis. If we cannot deliver our products in an efficient and timely manner, our customers may reduce their orders from us and our net revenues and operating profits could materially decline. In a rising fuel cost environment, our freight costs will increase. If freight costs materially increase and we are unable to pass that increase along to our customers for any reason or otherwise offset such increases in our cost of net revenues, our gross margin and financial results could be adversely affected.
We are dependent on our international operations, which exposes us to foreign operational, political and other risks that may harm our business.
Our key production steps are performed in operations located outside of the U.S. At our facility in San Jose, Costa Rica, technicians use a sophisticated, internally developed computer-modeling program to prepare digital treatment plans, which are then transmitted electronically to Juarez, Mexico. These digital files form the basis of the ClinCheck treatment plan and are used to manufacture aligner molds. Our order acquisition, aligner fabrication and shipping operations are conducted in Juarez, Mexico. In addition to the research and development efforts conducted in our North America facilities, we also carry out research and development at locations in Moscow, Russia. In addition, our customer-care, accounts receivable, credit and collections and customer event registration organizations are located at our facility in San Jose, Costa Rica. We also have operations in Israel where the design and wand assembly and our intra-oral scanner are manufactured. Our reliance on international operations exposes us to risks and uncertainties that may affect our business or results of operation, including:
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• | difficulties in hiring and retaining employees generally, as well as difficulties in hiring and retaining employees with the necessary skills to perform the more technical aspects of our operations; |
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• | difficulties in managing international operations, including any travel restrictions to or from our facilities located in Russia and Israel; |
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• | fluctuations in currency exchange rates; |
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• | increased income taxes, and other restrictions and limitations, if we were to decide to repatriate any of our foreign cash balances back to the U.S.; |
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• | import and export license requirements and restrictions; |
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• | controlling production volume and quality of the manufacturing process; |
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• | political, social and economic instability, including as a result of increased levels of violence in Juarez, Mexico or the Middle East. We cannot predict the effect on us of any future armed conflict, political instability or violence in these regions. In addition, some of our employees in Israel are obligated to perform annual reserve duty in the Israeli military and are subject to being called for additional active duty under emergency circumstances. We cannot predict the full impact of these conditions on us in the future, particularly if emergency circumstances or an escalation in the political situation occurs. If many of our employees are called for active duty, our operations in Israel and our business may not be able to function at full capacity; |
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• | acts of terrorism and acts of war; |
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• | geopolitical risks around the Ukraine and the possibility of additional sanctions against Russia which continue to bring uncertainty to this region; |
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• | interruptions and limitations in telecommunication services; |
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• | product or material transportation delays or disruption, including as a result of increased levels of violence, acts of terrorism, acts of war or health epidemics restricting travel to and from our international locations or as a result of natural disasters, such as earthquakes or volcanic eruptions; |
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• | burdens of complying with a wide variety of local country and regional laws; |
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• | trade restrictions and changes in tariffs; and |
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• | potential adverse tax consequences. |
If any of these risks materialize in the future, we could experience production delays and lost or delayed revenue.
We earn an increasingly larger portion of our total revenues from international sales and face risks attendant to those operations.
We earn an increasingly larger portion of our total revenues from international sales generated through our foreign direct and indirect operations. As a result of these sales operations, we face a variety of risks, including:
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• | local political and economic instability; |
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• | the engagement of activities by our employees, contractors, partners and agents, especially in countries with developing economies, that are prohibited by international and local trade and labor laws and other laws prohibiting corrupt payments to government officials, including the Foreign Corrupt Practices Act, the UK Bribery Act of 2010 and export control laws, in spite of our policies and procedures designed to ensure compliance with these laws; |
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• | although it is our intention to indefinitely reinvest earnings outside the U.S., restrictions on the transfer of funds held by our foreign subsidiaries, including with respect to restrictions on our ability to repatriate foreign cash to the U.S at favorable tax rates; |
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• | fluctuations in currency exchange rates; and |
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• | increased expense of developing, testing and making localized versions of our products. |
Any of these factors, either individually or in combination, could materially impact our international operations and adversely affect our business as a whole.
If we are unable to accurately predict our volume growth, and fail to hire a sufficient number of technicians in advance of such demand, the delivery time of our products could be delayed which could adversely affect our results of operations.
Treatment planning is a key step leading to our manufacturing process which relies on sophisticated computer technology requiring new technicians to undergo a relatively long training process. Training production technicians takes approximately 90 to 120 days. As a result, if we are unable to accurately predict our volume growth, we may not have a sufficient number of trained technicians to deliver our products within the timeframe our customers expect. Such a delay could cause us to lose existing customers or fail to attract new customers. This could cause a decline in our net revenues and net income and could adversely affect our results of operations.
Our headquarters, digital dental modeling processes, and other manufacturing processes are principally located in regions that are subject to earthquakes and other natural disasters.
Our digital dental modeling is processed in our facility located in San Jose, Costa Rica. The operations team in Costa Rica creates ClinCheck treatment plans using sophisticated computer software. In addition, our customer facing operations are located in Costa Rica. Our aligner molds and finished aligners are fabricated in Juarez, Mexico. Both locations in Costa Rica and Mexico are in earthquake zones and may be subject to other natural disasters. If there is a major earthquake or any other natural disaster in a region where one of these facilities is located, our ability to create ClinCheck treatment plans, respond to customer inquiries or manufacture and ship our aligners could be compromised which could result in our customers experiencing a significant delay in receiving their completed aligners and a decrease in service levels for a period of time. In addition, our headquarters facility in California is located in the San Francisco Bay Area. An earthquake or other natural disaster in this region could result in a disruption in our operations. Any such business interruption could materially and adversely affect our business, financial condition and results of operations.
Our information technology systems are critical to our business. System integration and implementation issues and system security risks could disrupt our operations, which could have a material adverse impact on our business and operating results.
We rely on the efficient and uninterrupted operation of complex information technology systems. All information technology systems are vulnerable to damage or interruption from a variety of sources. As our business has grown in size and complexity, the growth has placed, and will continue to place, significant demands on our information technology systems. To effectively manage this growth, our information systems and applications require an ongoing commitment of significant resources to maintain, protect and enhance existing systems and develop new systems to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards and changing customer preferences. We are in the process of implementing a multi-year, company-wide program to transform certain business processes or extend established processes, including the transition to a single enterprise resource planning ("ERP") software system to perform various functions. The implementation of additional functionality in the ERP system entails certain risks, including difficulties with changes in business processes that could disrupt our operations, such as our ability to track orders and timely ship products, manage our supply chain and aggregate financial and operational data. During transitions we must continue to rely on legacy information systems, which may be costly or inefficient, while the implementation of new initiatives may not achieve the anticipated benefits and may divert management's attention from other operational activities, negatively affect employee morale, or have other unintended consequences. Additionally, if we are not able to accurately forecast expenses and capitalized costs related to the project, this may have an adverse impact on our financial condition and operating results.
If the information we rely upon to run our businesses were to be found to be inaccurate or unreliable, if we fail to properly maintain our information systems and data integrity, or if we fail to develop new capabilities to meet our business needs in a timely manner, we could have operational disruptions, have customer disputes, lose our ability to produce timely and accurate reports, have regulatory or other legal problems, have increases in operating and administrative expenses, lose existing customers, have difficulty in attracting new customers or in implementing our growth strategies, or suffer other adverse consequences. In addition, experienced computer programmers and hackers may be able to penetrate our network security and misappropriate our confidential information or that of third parties, create system disruptions or cause shutdowns. Furthermore, sophisticated hardware and operating system software and applications that we either internally develop or procure from third parties which we depend upon may contain defects in design and manufacture, including “bugs” and other problems that can unexpectedly interfere with the operation of the system. The costs to eliminate or alleviate security problems, viruses and bugs could be significant, and the efforts to address these problems could result in interruptions that may have a material adverse impact on our operations, net revenues and operating results.
System upgrades and enhancements require significant expenditures and allocation of valuable employee resources. Delays in integration or disruptions to our business from implementation of these new or upgraded systems could have a material adverse impact on our financial condition and operating results.
Additionally, we continuously upgrade our customer facing software applications, specifically the ClinCheck and MyAligntech software. Software applications frequently contain errors or defects, especially when they are first introduced or when new versions are released. The discovery of a defect or error or the incompatibility with the computer operating system and hardware configurations of customers in a new upgraded version or the failure of our primary information systems may result in the following consequences, among others: loss of revenue or delay in market acceptance, damage to our reputation or increased service costs, any of which could have a material adverse effect on our business, financial condition or results of operations.
Furthermore, our business requires the secure transmission of confidential information over public networks. Because of the confidential health information we store and transmit, security breaches could expose us to a risk of regulatory action, litigation, possible liability and loss. Our security measures may be inadequate to prevent security breaches, and our business operations and profitability would be adversely affected by, among other things, loss of customers and potential criminal and civil sanctions if they are not prevented.
There can be no assurance that our process of improving existing systems, developing new systems to support our expanding operations, integrating new systems, protecting confidential patient information, and improving service levels will not be delayed or that additional systems issues will not arise in the future. Failure to adequately protect and maintain the integrity of our information systems and data may result in a material adverse effect on our financial position, results of operations and cash flows.
Competition in the markets for our products is intense and we expect aggressive competition from existing competitors and other companies that may introduce new technologies in the future.
Currently, our products compete directly against products manufactured and distributed by various companies, both within and outside the U.S. Many of these manufacturers, including Danaher Corporation, 3M, Sirona Dental Systems, Inc. and Dentsply International, have substantially greater financial resources and manufacturing and marketing experience than we do and may, in the future, attempt to develop an orthodontic system similar to ours or combine technologies that make our product economically unattractive. The expiration of certain key patents commencing in 2017 owned by us may result in additional competition. Existing competitors may begin offering products more similar to ours. We may face more intense competition if new entrants to the clear aligner market are significantly larger than we are with greater resources and the ability to leverage their existing channels in the dental market to compete directly with us. In addition, corresponding foreign patents will start to expire in 2018, which may lead to increased competition in some of the markets outside the U.S. Large consumer product companies may also enter the orthodontic supply market. Furthermore, we may face competition in the future from new companies that may introduce new technologies. We may be unable to compete with these competitors and one or more of these competitors may render our technology obsolete or economically unattractive. If we are unable to compete effectively with existing products or respond effectively to any products developed by new or existing competitors, our business could be harmed. Increased competition has resulted in the past and may in the future result in volume discounting and price reductions, reduced gross margins, reduced profitability and loss of market share, and reduce dental professionals’ efforts and commitment to expand their use of our products, any of which could have a material adverse effect on our net revenues, volume growth, net income and stock price. We cannot assure you that we will be able to compete successfully against our current or future competitors or that competitive pressures will not have a material adverse effect on our business, results of operations and financial condition.
If the security of our customer and patient information is compromised, patient care could suffer, and we could be liable for related damages, and our reputation could be impaired.
We retain confidential customer and patient information in our processing centers. Therefore, it is critical that our facilities and infrastructure remain secure and that our facilities and infrastructure are perceived by the marketplace and our customers to be secure. Despite the implementation of security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. If we fail to meet our clients’ expectations regarding the security of healthcare information, we could be liable for damages and our reputation could be impaired. In addition, patient care could suffer, and we could be liable if our systems fail to deliver correct information in a timely manner. Our insurance may not protect us from this risk.
Our success depends in part on our proprietary technology, and if we are unable to successfully enforce our intellectual property rights, our competitive position may be harmed. Litigating claims of this type is costly and could distract our management and cause a decline in our results of operations and stock price.
Our success will depend in part on our ability to maintain existing intellectual property and to obtain and maintain further intellectual property protection for our products, both in the U.S. and in other countries. Our inability to do so could harm our competitive position. As of March 31, 2016, we had issued 390 U.S. patents, 288 foreign issued patents, and 345 pending global
patent applications.
We intend to rely on our portfolio of issued and pending patent applications in the U.S. and in other countries to protect a large part of our intellectual property and our competitive position; however, our currently pending or future patent filings may not result in the issuance of patents. Additionally, any patents issued to us may be challenged, invalidated, held unenforceable, circumvented, or may not be sufficiently broad to prevent third parties from producing competing products similar in design to our products. In addition, any protection afforded by foreign patents may be more limited than that provided under U.S. patents and intellectual property laws. We also rely on protection of our copyrights, trade secrets, know-how and proprietary information. We generally enter into confidentiality agreements with our employees, consultants and our collaborative partners upon commencement of a relationship with us; however, these agreements may not provide meaningful protection against the unauthorized use or disclosure of our trade secrets or other confidential information, and adequate remedies may not exist if unauthorized use or disclosure were to occur. Our inability to maintain the proprietary nature of our technology through patents, copyrights or trade secrets would impair our competitive advantages and could have a material adverse effect on our operating results, financial condition and future growth prospects. In particular, a failure to protect our proprietary rights might allow competitors to copy our technology, which could adversely affect our pricing and market share. In addition, in an effort to protect our intellectual property we have in the past been and may in the future be involved in litigation. The potential effects on our business operations resulting from litigation that we may participate in the future, whether or not ultimately determined in our favor or settled by us, are costly and divert the efforts and attention of our management and technical personnel from normal business operations.
Litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling could include monetary damages or, in cases where injunctive relief is sought, an injunction prohibiting us from selling our products. Any of these results from our litigation could adversely affect our results of operations and stock price.
While we believe we currently have adequate internal control over financial reporting, we are required to assess our internal control over financial reporting on an annual basis and any future adverse results from such assessment could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.
Pursuant to the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated by the SEC, we are required to furnish in our Form 10-K a report by our management regarding the effectiveness of our internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. While we believe our internal control over financial reporting is currently effective, the effectiveness of our internal controls in future periods is subject to the risk that our controls may become inadequate because of changes in conditions, and, as a result, the degree of compliance of our internal control over financial reporting with the existing policies or procedures may become ineffective. Establishing, testing and maintaining an effective system of internal control over financial reporting requires significant resources and time commitments on the part of our management and our finance staff, may require additional staffing and infrastructure investments, and would increase our costs of doing business. If we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls or conclude that our internal controls are ineffective), we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
If we lose our key personnel or are unable to attract and retain key personnel, we may be unable to pursue business opportunities or develop our products.
We are highly dependent on the key employees in our clinical engineering, technology development, sales, training and marketing personnel and management teams. The loss of the services provided by those individuals may significantly delay or prevent the achievement of our product development and other business objectives and could harm our business. Our future success will also depend on our ability to identify, recruit, train and retain additional qualified personnel, including orthodontists. Few orthodontists are accustomed to working in a manufacturing environment since they are generally trained to work in private practices, universities and other research institutions. Thus, we may be unable to attract and retain personnel with the advanced qualifications necessary for the further development of our business. Furthermore, we may not be successful in retaining our key personnel or their services. If we are unable to attract and retain key personnel, our business could be materially harmed. In addition, our ability to recognize revenue on the direct sales of our intra-oral scanners depends in part upon our ability to schedule and staff trainings. The loss of the services provided by these individuals or our ability to timely hire such personnel in sufficient numbers based on our volume growth, may harm our business. If we are unable to retain our trainers or replace such individuals with persons having equivalent technical expertise and qualifications, or if we are unable to successfully instill such technical expertise in newly hired personnel or accurately predict the number of such personnel needed, our net revenues could be materially harmed.
If we infringe the patents or proprietary rights of other parties or are subject to a patent infringement claim, our ability to grow our business may be severely limited.
Extensive litigation over patents and other intellectual property rights is common in the medical device industry. We have been sued for infringement of third party’s patents in the past and we may be the subject of patent or other litigation in the future. From time to time, we have received and may in the future receive letters from third parties drawing our attention to their patent rights. While we do not believe that we infringe upon any valid and enforceable rights that have been brought to our attention, there may be other more pertinent rights of which we are presently unaware. The defense and prosecution of intellectual property suits, interference proceedings and related legal and administrative proceedings could result in substantial expense to us and significant diversion of effort by our technical and management personnel. An adverse determination of any litigation or interference proceeding to which we may become a party could subject us to significant liabilities. An adverse determination of this nature could also put our patents at risk of being invalidated or interpreted narrowly or require us to seek licenses from third parties. Licenses may not be available on commercially reasonable terms or at all, in which event, our business would be materially adversely affected.
We maintain single supply relationships for certain of our key machines and materials technologies, and our business and operating results could be harmed if supply is restricted or ends or the price of raw materials used in our manufacturing process increases.
We are highly dependent on manufacturers of specialized scanning equipment, rapid prototyping machines, resin and other advanced materials, as well as the optics, electronic and other mechanical components of our intra-oral scanners. We maintain single supply relationships for many of these machines and materials technologies. In particular, our CT scanning and stereolithography equipment used in our aligner manufacturing and many of the critical components for the optics of our scanners are provided by single suppliers. We are also committed to purchasing the vast majority of our resin and polymer, the primary raw materials used in our manufacturing process for clear aligners, from a single source. If these or other suppliers encounter financial, operating or other difficulties or if our relationship with them changes, we might not be able to quickly establish or qualify replacement sources of supply and could face production interruptions, delays and inefficiencies. In addition, technology changes by our vendors could disrupt access to required manufacturing capacity or require expensive, time consuming development efforts to adapt and integrate new equipment or processes. Our growth may exceed the capacity of one or more of these manufacturers to produce the needed equipment and materials in sufficient quantities to support our growth. Conversely, in order to secure supplies for production of products, we sometimes enter into non-cancelable purchase commitments with vendors, which could impact our ability to adjust our inventory to reflect declining market demands. If demand for our products is less than we expect, we may experience additional excess and obsolete inventories and be forced to incur additional charges and our profitability may suffer. In the event of technology changes, delivery delays, or shortages of or increases in price for these items, our business and growth prospects may be harmed.
We depend on a single contract manufacturer and supplier of parts used in our iTero scanner and any disruption in this relationship may cause us to fail to meet the demands of our customers and damage our customer relationships.
We rely on a third party manufacturer to supply key sub-assemblies for our iTero Element scanner. As a result, if this third party manufacturer fails to deliver its components, if we lose its services or if we fail to negotiate acceptable terms, we may be unable to deliver our products in a timely manner and our business may be harmed. Any difficulties encountered by the third party manufacturer with respect to hiring personnel and maintaining acceptable manufacturing standards, controls, procedures and policies could disrupt our ability to deliver our products in a timely manner. Finding a substitute manufacturer may be expensive, time-consuming or impossible and could result in a significant interruption in the supply of our intra-oral scanning products. Any failure by our contract manufacturer that results in delays in our fulfillment of customer orders may cause us to lose revenues and suffer damage to our customer relationships.
We primarily rely on our direct sales force to sell our products, and any failure to maintain our direct sales force could harm our business.