When markets sold off sharply on Wednesday, they took Align Technology (NASDAQ:ALGN) down 6.5% on the day. After the company reported third-quarter results, however, that daily drop looks like a rounding error. ALGN stock fell 22% after hours, and is still down nearly 20%.
The company issued soft Q4 guidance. And the market is always pricing stocks in the future. So is the double-digit drop warranted?
Align reported revenue growing 31.2% to $505.3 million. Sales from Clear Aligner rose 25% to $427.1 million. Net income was equally impressive as the company made $100.9 million, up 22.2% from last year. EPS rose 22.8% to $1.24. That sales growth outpaced EPS growth should have investors wondering what Align spent its money on in the quarter. Selling, general and administrative rose to $213.87 million, up from $169.5 million last year.
ALGN Q3 Earnings Highlights
Align now has 6.1 million patients to date, with over 1.4 million of them teens. Teenagers starting treatment with Invisalign grew 41.1% Y/Y and 25.6% Q/Q. The company benefited from strong adoption in all regions, with North American orthodontists leading this. The APAC region also grew while seasonality in EMEA slowed the pace of growth.
Q3 marked the eighth straight quarter that the Invisalign teenage patient volumes outpaced the growth of the adult patient group. The shift towards younger patients is a positive development. The market size is large because teenagers are traditionally the age group looking to straighten their teeth. This gives doctors a chance to grow their patient list at a faster pace in the quarters ahead.
Unfortunately, Q4 guidance shook the investor confidence after the company forecast revenue in the range of $505-$515 million. EPS could be as low as $1.10-$1.15, compared to a consensus view of $1.33. This outlook pales in comparison to Q3 revenue growth for Clear Aligner and Invisalign Case Shipments, which was up 35.3% from last year. The slower sequential growth is due to costs for training new doctors, promotional programs, lower ASPs, and unfavorable foreign exchange. These headwinds could continue in the current quarter and would explain why management is cautious.
Despite the downbeat guidance, investors should realize Clear Aligner benefited from a gross margin of 75.3%. This is 2.6 points lower than last year for reasons already mentioned. Scanner and Services gross margin was 63.9%, up 3.9 points Y/Y. This segment benefited from better manufacturing efficiencies.
In the upcoming quarter, Align Technology will test a program, dubbed “Project Apple,” in New York. The company will launch the targeted media campaign on November 5. Potential customers will be directed to Invisalign branded locations. A branded kiosk at the Oculus Center is part of this pilot project. If successful, doctors will gain awareness of the new tools, services, and support. Direct consumers will gain familiarity with the locations and the pilot practices.
Outlook for ALGN
Align forecasts a sequential increase in business volume, thanks to strength in EMEA’s seasonality. But it also expects slowness in APAC, following the strong summer period in China. The iTero business will also be flat quarter-over-quarter for the same reason of coming off a strong Q3. To sustain the momentum in the iTero business, Align will continue investing in it. This includes a rollout plan in China and with key DSO partners in the U.S. market.
Revenue growth in the low 30’s in 2018 will outpace Align’s long-term model. Although the stock trades at a premium, the stock’s sell-off creates an entry point for patient investors.
Disclosure: Author does not own shares in any of the companies mentioned.