Align Technology, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Align Technology, Inc. (“Align”) is a global medical device company specializing in the design, manufacture and marketing of Invisalign clear aligners for the treatment of malocclusion, or the misalignment of teeth, as well as intraoral scanners and CAD/CAM systems. The company’s products and services are sold to orthodontists and dentists as a substitute for traditional metal braces.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Align primarily operates in two segments: the Clear Aligner segment, which primarily includes Invisalign aligners, and the Systems and Services segment, which includes intraoral scanners, software, and CAD/CAM systems.

Align has shown impressive growth and profitability in the past few years, but the business model is not very easy to understand, and the moat isn’t very big to be considered the best investment, but still a good one. Let’s get into details.

Business Overview

Align operates its business through two primary segments:

  1. Clear Aligner Segment: This segment encompasses the Invisalign system, the primary revenue generator for the company. It includes the sale of Invisalign clear aligners, along with related treatment planning and production services. This segment caters directly to orthodontists and general dentists, who provide Invisalign treatment to patients. Align’s competitive advantage lies here in its brand recognition, innovation, and proprietary technology.

  2. Systems and Services Segment: This segment is composed of intraoral scanners (such as the iTero line), software services, and CAD/CAM systems. It contributes to Align’s ecosystem by digitizing dental workflows and enhancing the efficiency of dental practices. The products are also sold to orthodontists, dentists, and increasingly to other dental professionals. There’s an increasing interest from the industry in digital dentistry.

Financial Performance Let’s analyze the financials using data from the latest earnings reports and SEC filings, particularly the Form 10-K for the year ended December 31, 2022, the Form 10-Q for the quarter ended September 30, 2023, and earnings call transcripts.

Note: numbers are rounded.

  • Revenue Growth: Align has demonstrated impressive revenue growth over the past few years, driven by increased adoption of Invisalign aligners and continued growth in scanner sales. This can be seen in the financials below. Revenue grew year-over-year by 15% for the nine months ended September 30, 2023. Also, there’s a revenue growth of 6.1% in 2023 compared to 2022, and the company expects to continue this growth trend. For 2022 revenues were about $3.94 billion as compared to $3.69 billion in 2021, a 7% growth.

  • Gross Profit: As one would expect from a manufacturing company, Aligns gross margins are very healthy (approximately 70-72%) showing excellent cost control. Gross margin decreased slightly year-over-year from 72.5% for 2022 to 71.6% in 2023 for the nine months ended September 30, 2023. This means, for every $100 they sell, they make a gross profit of around 71-72$.

  • Operating Expenses: The company’s operational expenses have increased slightly in recent times due to increased investments in R&D, marketing, sales, and administrative staff and higher employee compensation. SG&A expenses are roughly 45% of revenues, while research and development expense is about 12% of revenues.

  • Net Income: The net income has declined from $781 million in 2021 to $279 million in 2022. However, the net income has recovered to about $500 million for 2023 for the nine-month period ended September 30, 2023. Although the company experienced higher expenses in the recent past, it has a high potential to grow revenue and profitability due to its business.

  • Free Cash Flow: The business continues to generate lots of cash flow, which is what a good company should strive for. Cash flow from operations increased from $427 million to $738 million year-over-year from the first nine months of 2022 to the first nine months of 2023, a massive jump.

  • Financial Strength and Capital Structure Align has a fairly stable balance sheet. The company has a solid cash position ($1.4B in cash and marketable securities) as of September 30, 2023. Long-term debt is about $800 million, which is a manageable figure, as its equity amounts to about $2.9 billion.
    • From the analysis of the balance sheet, the total current assets are 1.54 times more than the total liabilities which shows good financial health.
  • Recent Developments and Management’s Outlook Align has continued to focus on its digital dentistry platform, enhancing the Invisalign system, and expanding the adoption of iTero scanners. The company has also emphasized its direct-to-consumer marketing efforts. They mentioned in the last earning call that the first half of 2024 is going to have strong sales as most of their clients are purchasing new tools. Management is also focusing on international markets and their expansion as well.

Economic Moat Analysis

Align’s moat can be classified as narrow with some solid competitive advantages:

  • Brand Recognition: Invisalign is the pioneer in clear aligners and enjoys strong brand recognition among both professionals and consumers. This is supported by the fact that there are more than 14.3 million patients treated with the Invisalign system.
  • Proprietary Technology: Align continuously invests heavily in research and development, leading to improvements in aligner design, material science, and software. The company has over 1,350 granted and over 250 pending patents. This creates a barrier for competitors looking to produce comparable products.
  • Switching Costs: Once orthodontists have started using the Invisalign system or any of the other Aligns products, they tend to stick with them, because there’s a learning curve associated with each of those products. The process of getting into a new platform could be timely and costly.
    • Notably, there are very low switching costs for consumers, who are the end-users of the products.

These advantages aren’t wide enough to make it a wide-moat company because of the strong competition, and also its business is not exactly a necessity. It is more of a discretionary purchase that could see huge drops in difficult periods. However, these aspects are still valuable for the company.

Risk Factors

Align faces several risks that may erode its moat and hinder growth:

  1. Intense Competition: The dental industry is quite competitive, with new entrants and existing players looking to copy the Invisalign design or come up with newer alternative solutions. There’s also significant price pressure because of the increase in competition.
  2. Technological Disruption: The rapidly evolving nature of digital dentistry means that a competitor might develop a superior technology or product that could bypass the align system. This is a big risk.
  3. Economic Slowdown: Orthodontic treatment is often viewed as an optional or discretionary expense. An economic downturn, or high-inflation period, could reduce the number of consumers willing to undergo orthodontic treatment, thereby hurting the company’s revenue.
  4. Pricing Pressure: If the company cannot improve the effectiveness of their products, they might be forced to lower prices to attract new customers, while keeping older ones.
  5. Regulatory Challenges: Regulatory requirements, FDA approvals, and other requirements must be met for their products and treatments. New regulations or changes in existing regulations can materially affect the company.

Business Resilience Despite these risks, Align demonstrates considerable business resilience:

  • Strong Brand Loyalty: The Invisalign brand has huge customer loyalty which allows for consistent demand, as the product is well known and liked by the customers.
  • Proprietary Technology: They continue to innovate and make their product better, increasing the product quality as well. The company does well to protect its IP, which creates barriers for new competitors to enter the market.
  • Large Customer Base: Align has a sizable client base comprising a variety of orthodontists, dentists, and other medical specialists. So the sales volumes aren’t entirely reliant on just a few customers, giving the business more stability.
  • Diversified Geographic Presence: The company is also geographically diversified with sales presence in a lot of countries all over the globe. This gives it geographical diversification that protects against a regional economic slump.

Understandability: 3 / 5 Although the core product is relatively simple and easy to comprehend, the complex manufacturing processes, software components, and intricate marketing strategies add a degree of complexity to the business. Understanding the financials, tax situations and how all the different operating expenses are allocated is quite difficult.

Balance Sheet Health: 4 / 5 Align has a good current ratio and reasonable debt position, especially relative to its equity and operations. It’s not a flawless balance sheet as the company has a lot of goodwill (and intangible assets), but it’s manageable for now. The company has a good cash balance and low debt, which gives it great room to grow.

In conclusion, Align is an intriguing and profitable company but one must be careful. The company is an innovative business but also faces significant risks like competition and tech disruption. However, its business is still a solid, and well-established one with plenty of opportunities ahead.