Align Technology, the clear aligner pioneer

Several years ago, a good friend of mine (my dentist for 40 years and former residential neighbor) in one of our ongoing discussions about stock investments, gave me a heads up about Align Technology (ALGN), the company that pioneered the design, manufacturing and distribution of clear aligners under the Invisalign® brand name. Clear aligners offered an alternative therapy (instead of traditional dental braces) for treating malocclusion, or the misalignment of teeth. After conducting my due diligence, I decided to invest in Align, which subsequently over the recent past two years has realized stronger fundamentals, created substantial value for its shareholders and experienced stronger growth in revenues, net income and EPS that I believe merit mentioning here.

ALIGN TECHNOLOGY BUSINESS

Align Technology designs and manufactures the Invisalign® system, the most advanced clear aligner system in the world, and iTero® intraoral scanners and services. Align’s products help dental professionals achieve the clinical results they expect and deliver effective, cutting-edge dental options to their patients. I highly recommend viewing first the following videos for a visual, easy-to-understand description and explanation about this company’s business:
https://www.youtube.com/watch?v=Y9LHzuSuN8k
Invisalign manufacturing process
https://www.youtube.com/watch?v=vsR0_wTR2a8
For more detailed information, read the FY 2016 10K report:
http://files.shareholder.com/downloads/ALGN/4409427068x0x935…

Align has two operating segments: (1) Clear Aligner and (2) Scanners and CAD/CAM Services. For the year ended December 31, 2016, Clear Aligner revenues represent approximately 89% of worldwide revenue, while Scanner represent the remaining 11%. Align distributes the vast majority of its products directly to its customers, i.e., orthodontists and general practitioner dentists, as well as to restorative dentists, including prosthodontists, periodontists, and oral surgeons. The company also supplies clear aligners to SmileDirectClub, LLC who sells them directly to consumers, with a doctor’s approved prescription.

Global Market & Align’s Market Penetration
According to Align, malocclusion, or the misalignment of teeth, is one of the most prevalent clinical dental conditions, affecting billions of people, or approximately 60% to 75% of the population. Annually, approximately 10 million people in major developed countries elect treatment by orthodontists worldwide, of which approximately 50% or 5 million have mild to moderate malocclusion and are applicable to Invisalign® treatment - Align’s served market. In addition, approximately 100 million people with malocclusion want to straighten their teeth; however, they will not seek orthodontic treatment in a doctor’s office and would instead elect to receive clear aligner treatment in the convenience of their own home - referred to as the doctor-directed at home market.

The Invisalign® system is sold in North America, Europe, Asia Pacific, Japan and Latin America. Its Clear Aligner products include the following:
Comprehensive Products: Invisalign Full; Invisalign Teen; and Invisalign Assist.
Non-Comprehensive Products: Invisalign Express (10 and 5) and Invisalign Lite/i7; Invisalign Go; and SmileDirectClub Aligners.
Non-Case Products: retention products, Invisalign training fees and sales of ancillary products.

The following table provides the case shipment volume for Clear Aligner and shows (a) substantial growth in total case shipment for fiscal years 2015 and 2016; and (b) significant increases in international case shipments for fiscal years 2011 through 2016.


**CLEAR ALIGNER	       NORTH	YoY    INTER-	YoY		YoY**
**Case Shipment Volume  AMERICA  Change NATIONAL Change	TOTAL  Change**
(in thousands)						
FY 2016	                464.5	16.6%	244.7	32.4%	709.2	21.6%
FY 2015	                398.4	17.7%	184.8	32.5%	583.2	22.0%
FY 2014	                338.5	 7.8%	139.5	28.6%	478.0	13.2%
FY 2013	                313.9	13.4%	108.5	25.0%	422.4	16.2%
FY 2012	                276.7	16.0%	 86.8	22.6%	363.5	17.5%
FY 2011	                238.6	19.7%	 70.8	15.1%	309.4	18.6%
FY 2010	                199.4		 61.5		260.9

The Scanners and CAD/CAM Services segment is an emerging technology that enables the dental practitioner to create a 3D image of the patient’s teeth (digital scan) using a handheld intraoral scanner inside the mouth. Digital scanning is more efficient and precise and more comfortable for patients, compared to the mess, discomfort and subjective nature of taking physical impressions. The digitally scanned model is more accurate than a physical impression and substantially reduces the rate of restoration “remakes” so patients are recalled less often, and the appointment time for the restoration is shorter because of fewer adjustments which results in greater overall patient satisfaction. The digital model file can be used for various procedures and services including fabrication of physical dental models for use by labs to create restorative units such as veneers, inlays, onlays, crowns, bridges and implant abutments; digital records storage; orthodontic diagnosis; orthodontic retainers and appliances; and Invisalign digital impression submission. For more details, go to the aforementioned FY 2016 10K Annual Report.

Competitors
For the purposes of this post, Align Technology is compared to the following two major public company competitors:
Dentsply Sirona Inc. (XRAY)
https://www.dentsplysirona.com/en-us/products/orthodontics.h…
Danaher Corporation (DHR)
http://www.danaher.com/our-businesses/business-directory?ere…
http://www.ormco.com/products/

A private company competitor is ClearCorrect, LLC.
https://clearcorrect.com

As the first innovator and creator of clear aligners, Align Technology has aggressively protected and defended its patents and intellectual property rights. Refer to “Litigation against and Agreements with Competitors” later in this post.

CORPORATE FINANCIALS


**ALGN	  XRAY	      DHR**
			
Market Cap  $ 11.09 B  $ 15.1 B	 $ 58.21 B
Employees	6,060    15,700	    62,000
			
52-wk high     145.24	  65.83	     88.01
5/5/17 Price   138.03	  65.59	     84.08
52-wk low	74.48	  55.00	     72.34
			
EV/EBITDA (mrq)			
P/E (ttm)	51.50	  33.81	     25.56
Fwd P/E	        35.67	  20.37	     19.55
P/B (mrq)	10.56	   1.86	      2.45
P/S (ttm)	 9.8	   3.9	      3.4
			
Annual dividend	   0	   0.35	     0.56
Yield	         0.0%	   0.6%	     0.7%

As shown in the following table, FY 2016 was a banner year for Align Technology, realizing significant year-over-year increases in quarterly revenues and quarterly EPS. This trend continues for Q1 2017 with a 30% increase in YoY quarterly revenue and a 70% increase in YoY quarterly EPS.
Source:
http://files.shareholder.com/downloads/ALGN/4426707533x0x939…


**ALIGN	  REVENUE     YoY      EPS $ 	 YoY**
**$ million   Change   diluted	Change**
				
Q1 ‘17	  310.341    30.0%	0.85	70.0%
				
FY 2016	1,079.874    27.7%	2.33	31.6%
				
Q4 ‘16	  293.203    27.3%	0.59	-1.7%
Q3 ‘16	  278.589    34.2%	0.63	85.3%
Q2 ‘16	  269.362    28.6%	0.62	59.0%
Q1 ‘16	  238.720    20.5%	0.50	13.6%
				
FY 2015	  845.486    11.0%	1.77	 0.0%
				
Q4 ‘15	  230.276    15.9%	0.60	25.0%
Q3 ‘15	  207.636     9.4%	0.34   -27.7%
Q2 ‘15	  209.488     8.8%	0.39	-9.3%
Q1 ‘15	  198.086     9.7%	0.44	12.8%
				
FY 2014	  761.653		1.77	
				
Q4 ‘14	  198.600		0.48	
Q3 ‘14	  189.876		0.47	
Q2 ‘14	  192.531		0.43	
Q1 ‘14	  180.646		0.39	

Here’s the Align Q1 2017 financial slide presentation with historical data:
http://files.shareholder.com/downloads/ALGN/4426707533x0x939…

On 4/28/2017, the day after Align Technology announced another record breaking first quarter 2017 results, the Align stock price rocketed upward $25.15 or 20.9% (from $120.09 to $145.24/share) and closed at $134.62/share, up 12.09%. Several days later on 5/4/2017, Align stock price gained 7.5% from $131.97 to $141.89. Align closed the week at $138.03/share.

Over the recent past 52-week period, ALGN has substantially outperformed XRAY, DHR and S&P 500.
http://bigcharts.marketwatch.com/advchart/frames/frames.asp?..


 **YoY                YoY                  YoY**
**REVENUE $M     ALGN    Change     XRAY    Change    DHR (a)    Change**

FY 2016	     1,079.9	27.7%   3,745.3    40.0%    16,882.4	17.0%
FY 2015	       845.5	11.0%	2,674.3	   (8.5%)   14,433.7	12.2%
FY 2014	       761.7	15.4%	2,922.6	   (1.0%)   12,866.9	 4.1%
FY 2013	       660.2	17.9%	2,950.8	    0.8%    12,360.9	 5.5%
FY 2012	       560.0		2,928.4		    11,720.8	
						
**NET INCOME $M**						
FY 2016	       189.7	31.7%	  429.9	   71.1%     2,553.7   (23.9%)
FY 2015	       144.0	(1.2%)	  251.2	  (22.2%)    3,357.4	29.2%
FY 2014	       145.8   126.8%	  322.9	    3.1%     2,598.4	(3.6%)
FY 2013	        64.3	 9.5%	  313.2	   (0.3%)    2,695.0	12.7%
FY 2012	        58.7		  314.2		     2,392.2	
						
**EPS diluted $**						
FY 2016	        2.33	31.6%	   2.78	    6.1%	3.65.  (23.0%)
FY 2015	        1.77	 0.0%	   2.62	    4.8%	4.74	30.6%
FY 2014	        1.77   126.9%	   2.50	    6.4%	3.63	(4.5%)
FY 2013	        0.78     9.9%	   2.35	    5.9%	3.80	13.1%
FY 2012	        0.71		   2.22		        3.36

Note:
(a) Danaher Corp. has four business segments, of which Dental is the smallest, representing, for example, 16% or $2.7 billion of the total $16.8 billion revenue for FY 2016.

MARGINS

While Align’s annual gross margins have stabilized at much higher levels than XRAY and DHR, its annual operating and profit margins have increased significantly over the recent past five FYs.


**FY MARGINS	ALGN	 XRAY	  DHR**
**GROSS:**			
2016	       75.5%	53.4%	55.3%
2015	       75.7%	56.7%	53.8%
2014	       76.0%	54.7%	53.2%
2013	       75.5%	53.5%	51.1%
2012	       74.4%	53.2%	51.6%
**OPERATING:**			
2016	       23.1%	12.1%	16.3%
2015	       22.3%	14.0%	15.0%
2014	       25.4%	15.3%	15.9%
2013	       14.3%	14.2%	17.1%
2012	       15.3%	13.0%	17.3%
**PROFIT:**			
2016	       17.6%	11.5%	15.1%
2015	       17.0%	 9.4%	23.3%
2014	       19.2%	11.1%	20.2%
2013	        9.7%	10.6%	14.7%
2012	       10.5%	10.7%	13.1%


VALUE CREATION: ROIC-WACC SPREAD

As shown in the following table, for the recent past 5 fiscal years, Align Technology has realized exceptionally strong increases in Return on Invested Capital (ROIC) and superior ROIC-Weighted Average Cost of Capital (WACC) spreads or Economic Value Add (EVA) compared with those of XRAY and DHR. Currently, on 5/5/2017, Align is creating 47.8 cents of pure economic value for every dollar invested.


**ALGN**	 ROIC	 WAAC	 EVA	**XRAY**	ROIC	WAAC	EVA	**DHR**	 ROIC	WAAC	EVA
											
5/4/17	59.1%	11.3%	47.8%  5/4/17	5.5%	9.4%   -3.9%   5/4/17	 7.5%	7.3%	0.3%
											
2016	58.1%	 9.5%	48.6%	2016	7.1%	9.6%   -2.5%	2016	 6.5%	7.5%   -1.0%
2015	47.2%	10.4%	36.8%	2015	8.7%	9.9%   -1.2%	2015	 6.2%	7.9%   -1.7%
2014	52.8%	 9.8%	43.0%	2014	9.6%	8.3%	1.4%	2014	 6.9%	8.1%   -1.2%
2013	25.5%	19.2%	 6.3%	2013   10.2%	9.8%	0.5%	2013	10.4%	9.6%	0.8%
2012	24.4%	14.3%	10.0%	2012   10.4%	8.4%	2.0%	2012	10.9%	8.0%	2.8%


CAPITAL STRUCTURE

Align Technology has a rock solid capital structure as shown in the following table.


**CAPITAL	                     ALGN	     XRAY	       DHR**
**STRUCTURE**			
Cash (mrq)	          $ 261.0 M	  $ 383.9 M	   $ 803.9 M
Working Capital	          $ 552.6 M	$ 1,111.6 M	 $ (208.9) M
Current ratio (mrq)	      2.51	      2.44	      1.05
Total Capitalization	$ 1,044.9 M	$ 8,125.9 M	$ 22,218.5 M
LT Debt (mrq)	              $ 0 M	$ 1,511.1 M	 $ 9,729.3 M
Total Debt	              $ 0 M	$ 1,532.2 M	$ 11,950.1 M
Total Equity (mrq)	$ 1,044.9 M	$ 8,125.9 M	$ 23,076.8 M
Debt/Equity (mrq)	      0.0%	     18.6%	      40.9%
Debt/Capitalization	      0.0%	     15.9%	      33.4%

Align Technology has strong free cash flow.


**FCF	ALGN	XRAY	 DHR**
($ M)			
2016	177	176	2,932
2015	185	121	3,289
2014	203	160	3,293
2013	167	(20)	3,047
2012	 95	106	2,957
2011	100	142	2,292
2010	111	129	1,867
2009	 67	 49	1,612
2008	 25	161	1,665
2007	 45	123	1,484

• As of March 31, 2017, Align had $644.2 million in cash, cash equivalents and marketable securities compared to $700.0 million as of December 31, 2016.

• In Q1’17, the company purchased a new headquarters building in San Jose, California for approximately $44.1 million.

• Align paid $36.5M for employee taxes related to the net settlement of vesting employee stock awards during the quarter.

• Align repurchased approximately 0.04 million shares of stock for $3.8 million in Q1’17 under the 2014 Repurchase Program. Align has $300.0 million available for repurchase under its 2016 Repurchase Program announced on April 28, 2016.

• On 5/3/17, Align announced that it has entered into an accelerated stock repurchase agreement (ASR) with Wells Fargo Bank, National Association, to repurchase $50 million of Align’s common stock as part of Align’s $300 million stock repurchase program announced on April 28, 2016. Under the terms of the ASR, Align has agreed to repurchase $50 million of its common stock through Wells Fargo, with an initial delivery of approximately 261,000 shares. The final number of shares to be repurchased will be based on Align’s volume-weighted average stock price during the term of the ASR transaction, less an agreed upon discount. The ASR transaction is expected to be completed approximately three months from May 3, 2017 and will be funded with the Company’s cash-on-hand.

I always check a company’s stock-based compensation for any significant impact on the company’s free cash flow. Align has been transparent by specifically addressing this item in its news release announcements about quarterly and annual results.


**STOCK-BASED		  YoY		  YoY		  YoY**
**COMPENSATION	ALGN	Change	XRAY	Change	  DHR	Change**
(million $)						
2016	        54.1	 2.3%	41.3	61.3%	129.8	25.0%
2015	        52.9	32.9%	25.6	 0.7%	103.8	22.6%
2014	        39.8	50.6%	25.4	 1.3%	 84.7	
2013	        26.4	23.1%	25.1	13.1%	 NA	
2012	        21.5	12.1%	22.2	 5.9%	 NA	
2011	        19.2	19.2%	20.9	11.4%	 NA	
2010	        16.1		18.8		 NA	


Q2 2017 BUSINESS OUTLOOK

For the second quarter of 2017 (Q2 '17), Align provides the following guidance:


**Q2 ’17 GUIDANCE	          Q2 ‘16**
**FINANCIAL OUTLOOK:**		
Net Revenues 	              $ 340 M - $ 345 M	        $ 269.362 M
Gross Margin	                    74% - 75%	           76.2%
Operating Margin                  21.0% - 21.7%	           24.2%
Net Income per Diluted Share	 $ 0.71 - $ 0.74	   $0.62
		
**BUSINESS METRICS:**		
Case Shipments	                  221 K - 224 K	             177 K
Capital Expenditure	        $ 30 M  - $35 M	          $ 18.8 M
Stock-based Compensation Expense       $ 14.7 M	        $ 13.699 M

Regarding its tax rate, during the first quarter of 2017, Align adopted accounting standards update entitled “Improvements to Employee Share-Based Payment Accounting”. Under this new standard, excess tax benefits and deficiencies associated with employee share-based payments are no longer recognized as additional paid-in capital on the balance sheet but instead are recognized directly to income tax expense or benefit in the income statement for the reporting period in which they occur. Under this new standard, the company expects its Q2 effective tax rate to be approximately 21%, which includes $2 to $3 million in excess tax benefits.

LITIGATION AGAINST AND AGREEMENTS WITH COMPETITORS

As the first innovator, developer and manufacturer of clear aligners, Align Technology has aggressively protected and defended its patents and intellectual property rights.

When Align faced a huge competitor with deep pockets, the company prudently settled and sought collaboration, e.g., Ormco, a subsidiary of Danaher Corporation.
http://investor.aligntech.com/releasedetail.cfm?releaseid=40…
On 8/17/2009, Align Technology announced that it has reached a settlement with Ormco Corporation (Ormco), a subsidiary of Danaher Corporation, to end all pending litigation between the parties and to begin a new strategic collaboration. As part of the settlement, Align will make a cash payment of approximately $13 million to Ormco and issue approximately 7.6 million shares of Align’s Common Stock to Danaher Corporation, Ormco’s ultimate parent, that after issuance will be equal to approximately ten percent ownership interest in Align. Based on the closing price of Align’s Common Stock on Friday, August 14, 2009 the value of the shares is approximately $77 million.
Align and Ormco have also agreed upon an exclusive collaboration over the next seven years to develop and market an orthodontic product that combines the Invisalign(R) system with Ormco’s Insignia(R) orthodontic brackets and arch wires system to treat the most complex cases. Each party will retain ownership of its pre-existing intellectual property, and each party will be granted intellectual property licenses in their respective field for jointly-developed combination products.

When Align faced a small start-up company, it prudently fought to protect its patents and rights, e.g., OrthoClear.
In 2002, Align ousted its founder Zia Chishti, who thereafter developed OrthoClear, a similar product, which resulted in several legal disputes involving allegations of patent infringement, false advertising, defamation and trademark infringement. The case was settled in 2006, when Align paid OrthoClear $20 million, and OrthoClear agreed to end its operations.

Align has a litigious history with ClearCorrect, primarily concerning patent infringements. In 2001, ClearCorrect was founded by Ellis Pumphrey, a dentist in Houston, TX, who initially used Invisalign® and later switched to Ortholcear. When Orthoclear ceased operations, Pumphrey established in 2006 his own private company ClearCorrect, LLC that developed and distributed its own product which the company aggressively protected by firing the first salvo at Align Technology, setting off an ongoing litigious battle between the two in the clear aligner market.
The latest occurred on 1/31/2017, when Align Technology announced that it has filed a lawsuit against ClearCorrect Holdings, Inc., and ClearCorrect Operating, LLC and Your Smile Direct LTD of Dublin, Ireland for patent infringement in the Chancery Division of the High Court of Justice of the United Kingdom. In the lawsuit, Align asserts that ClearCorrect infringes four Align patents by marketing, importing, and selling ClearCorrect’s clear aligners, and that Your Smile Direct infringes three Align patents by marketing, importing, and selling ClearCorrect aligners under the Your Smile Direct brand. Roger E. George, Align Technology vice president and general counsel, stated, "The International Trade Commission already found Align’s U.S. patents to be infringed by ClearCorrect. We believe that ClearCorrect is now infringing Align’s European patents by offering its aligners to consumers through Your Smile Direct and to practitioners through its own distribution throughout the United Kingdom. We will continue to assert and defend our intellectual property rights against infringement by Your Smile Direct, ClearCorrect, or any other company, both in the United States and internationally.”
http://investor.aligntech.com/releasedetail.cfm?ReleaseID=10…

CONCLUSION

Align Technology has successful developed and produced a popular viable product line - Invisalign - that has significantly enabled strong fundamentals, superior value creation for shareholders, a solid capital structure with zero debt and strong growth performance in revenues, net income and EPS, especially for FY 2016 and Q1 2017. This current trend is noteworthy for further scrutiny and analysis

As always, conduct your own due diligence and decision-making.

Regards,
Ray

24 Likes

I own this but cannot buy more because of the current steep price.

However, I am confident about the future.

Very interesting write-up - thank you.

I looked at Align but decided earnings did not have much of a chance to wildly exceed expectations thus I would be limited to increases in E without much of an increse in P/E
Unlike something like ISRG that could go beyond it’s initial prostate niche.
Wish I had thought of it years ago when the kids were getting braces

I agree there may not be the double-whammy (PE & E) but I think the single whammy (E) may be good enough. So I am glad I am in. The problem is getting more: P.