# ALIGN TECHNOLOGY INC (ALGN) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from ALIGN TECHNOLOGY INC's 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1097149/000109714923000013/algn-20221231.htm
Accession: 0001097149-23-000013
Filing date: 2023-02-27
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/ALGN/
All MD&A years: /company/ALGN/mda/
Previous year: /company/ALGN/mda/fy2021/ (FY 2021)
Next year: /company/ALGN/mda/fy2023/ (FY 2023)

Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

A discussion regarding our financial condition and results of operations for fiscal 2022 compared to fiscal 2021 is presented under Results of Operations of this Form 10-K. Discussions regarding our financial condition and results of operations for fiscal 2021 compared to 2020 have been omitted from this Annual Report on Form 10-K, but can be found in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 25, 2022, which is available without charge on the SEC's website at www.sec.gov and on our investor relations website at investor.aligntech.com.

Executive Overview of Results

Trends and Uncertainties

Our business strategic priorities remain focused on four principal pillars for growth: (i) international expansion; (ii) GP adoption; (iii) patient demand and conversion; and (iv) orthodontic utilization. Our growth strategy depends on our ability to facilitate the digital transformation of dentistry happening around the world, our continuous focus on innovation, and expansion to meet and exceed evolving customer expectations as the array of products and services available to them increases.

We strive to deliver on each of our strategic growth drivers through a variety of interrelated enterprise-wide efforts including:

•Continuing penetration and adoption of Invisalign products, intraoral scanners and CAD/CAM solutions in international markets by investing in manufacturing operations, research and development, clinical treatment planning, sales and marketing and building our quality and regulatory capabilities in existing and emerging markets globally. For instance, in 2022, we opened a new aligner fabrication facility in Wroclaw, Poland as a part of our strategy to bring operational facilities closer to customers to serve them more quickly and respond to their needs more effectively as well as new treatment planning operations in targeted regional geographies. We also diversified our research and development activities throughout Europe in 2022, which has created a longer term, more stable environment for consistent hiring, retention and innovation in a variety of high technology sectors.

•Targeting growth opportunities with international orthodontists and GP customers, particularly with adopters of digital dentistry platforms by tailoring our sales and marketing strategies, manufacturing operations and resources around the

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unique needs of each customer channel. As we continue growing, we intend to opportunistically expand our research, development, manufacturing, treatment planning, and sales and marketing operations to meet local and regional demand thoughtfully and deliberately. Over the longer-term, we expect international revenues to grow faster than Americas' revenues as a result of growing international demand, our continued investment in international market expansion, the size of the market opportunities and our relatively low market penetration in these regions.

•Building confidence within the GP and orthodontic communities through training and education efforts to increase their adoption and utilization of digital dental practice transformation and clear aligner treatment. Accordingly, we continue to expand our Invisalign customer base by educating new doctors on the benefits of digital dentistry through the Invisalign system and demonstrating to GPs and orthodontists how the iTero portfolio of intraoral scanners and CAD/CAM restorative services and workflows can increase revenues and profitability for their dental practices by enhancing patient experiences and creating operation practice efficiencies.

•Investing in research and development that allows us to innovate, develop and bring to market products and solutions that deliver the ever-increasing clinical precision and predictability that doctors expect with the speed and convenience their patients require.

•Creating demand and enabling patient conversion through targeted investments in advertising and public relations through social media, influencers and other forms of digital communications to encourage treatment by Invisalign trained doctors. We believe that well-designed, targeted sales and marketing promotions that build on our strong brand awareness allow us to differentiate our products and solutions from traditional and emerging competitors. In 2022, we continued to build on the success of the “Invis-is” consumer advertising campaign with creative content and influencers focused on teens and young adults. We expect to make further investments to create additional demand for Invisalign system treatment driving more consumers to dental professionals for those treatments.

•Pursuing new product lines that complement our doctor-prescribed principal products currently available in certain e-commerce and retail channels in the U.S. Similarly, in 2023 we expect to continue to focus on our doctor subscription plan and grow our underpenetrated share of the retainer business through strategic marketing campaigns focused on driving adoption and increasing market share in the U.S.

•Increasing global orthodontic utilization rates as doctors’ clinical confidence in the efficacy and predictability of the Invisalign system increases with advancements in products and technology and as patients and doctors demand treatments that emphasize convenience and safety through fewer visits and less invasive and quicker treatments. In addition, the teenage and younger market makes up 75% of the approximately 21 million total annual global orthodontic case starts each year. As we continue to emphasize the benefits of the Invisalign system for teenage and younger patient treatments through education, training and sales and marketing programs, we expect utilization rates to rise. However, our utilization rates will fluctuate from period to period due to a variety of factors, which may include seasonal trends in our business, consumer demand due to macroeconomic factors, office closures or slowdowns related to COVID-19-and adoption rates for new products and features.

Macroeconomic Challenges and Military Conflict in Ukraine

Our revenues are susceptible to fluctuations in macroeconomic conditions, in line with inflation, rising interest rates, threats of or actual recessions, fluctuations in currency exchange rates, supply chain challenges, market volatility, wars and military actions, and other factors, each of which impact customer confidence, consumer sentiment and demand. Many of these same factors are also impacting our costs through higher raw material prices, transportation costs, labor costs, supply and distribution operations and the operations of our suppliers. Additionally, many of our international operations are denominated in currencies other than the U.S. dollar and in 2022 were impacted, and may continue to be impacted, by macroeconomic slowing or contraction causing weakening against the U.S. dollar, which is negatively impacting our financial condition and results of operations. While we expect moderation of the strength of the dollar, we also expect the dollar to remain historically strong against many of these currencies. The nature and extent of the impact of these factors varies by time and region and remains uncertain and unpredictable.

The military conflict between Russia and Ukraine increased the unpredictability of the already uncertain macroeconomic conditions during 2022 and may continue to impact this unpredictability. While we continue to employ research and development personnel in Russia as well as certain sales, marketing and administrative personnel, the total number of employees in Russia was significantly reduced in 2022, complementing programs previously underway aimed at maintaining and growing our research and development operations and diversifying the facilities at which our personnel are located.

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Although immaterial to our consolidated financial statements, our commercial business operations in Russia were significantly impacted by the conflict in 2022. Although we remain committed to providing continuity of care consistent with our values and ethical responsibility to patients who are in Invisalign treatment in Russia, we deemed it prudent to align the size of our commercial operations with the ongoing resources needed to perform those functions. Accordingly, in the fourth quarter of 2022, we initiated a restructuring plan to increase efficiencies across the organization and lower our overall cost structure, which reduced the number of employees and our commercial business operations in Russia. Refer to Note 16 “Restructuring and Other Charges” of the Notes to Consolidated Financial Statements for further details.

Our Board of Directors and its applicable committees receive regular updates from management regarding the military conflict between Russia and Ukraine and continue to provide oversight of the risks to our personnel, operations and other areas of strategic importance. Our management continues to closely monitor the situation and evaluate additional ways in which we can support our employees and operations.

COVID-19 Pandemic Update

Although there remains significant uncertainty surrounding the COVID-19 pandemic for regional economies, its global impact has gradually declined. During 2022, we experienced the impacts of the COVID-19 pandemic primarily in the Asia Pacific region, particularly in China, where lockdowns decreased economic activity throughout most of the year. With the easing of the restrictions in China in 2023 and the increased rate of infections, the impacts of the COVID-19 pandemic are likely to persist into 2023 and remain unpredictable, but we expect it to be at a lesser extent than in 2022. Nevertheless, comparing our financial results for the reporting periods of 2023 to the same reporting periods of 2022 or earlier may not be a useful means by which to evaluate our business and results of operations due to volatility in regional business environments caused by the pandemic.

Changing Product Preferences

As the markets for clear aligners and digital processes and workflows used to transform the practice of dentistry continue to mature, we anticipate customer and patient expectations and demands will evolve. We expect to meet customer demands with innovative treatment options that include more choices to address a wider scope of treatment goals and budgets based on our existing and new products. This may result in larger and unpredictable variations in geographic and product mix and selling prices with uncertain implications on our financial statements and business operations.

We strive to manage the challenges from the macroeconomic conditions, the conflict in Ukraine, COVID-19 and the evolution of our target markets by focusing on improving our operations, building flexibility and efficiencies in our processes, adjusting our business models to changing circumstances and offering products that meet market demand. Specifically, we are managing cost impacts through pricing actions, implementing cost saving measures and slowing hiring. We also continue to innovate and introduce new and enhanced products that augment our doctor customer and patient experiences.

Further discussion of the impact of these challenges on our business may be found in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors.”

Key Financial and Operating Metrics

We measure our performance against these strategic priorities by the achievement of key financial and operating metrics. For the year ended December 31, 2022, our business operations reflect the following:

◦Revenues of $3,734.6 million, a decrease of 5.5% year-over-year;

◦Clear Aligner revenues of $3,072.6 million, a decrease of 5.4% year-over-year;

▪Americas Clear Aligner revenues of $1,458.8 million, a decrease of 5.6% year-over-year;

▪International Clear Aligner revenues of $1,349.0 million, a decrease of 10.0% year-over-year;

▪Clear Aligner volume decrease of 7.4% year-over-year and Clear Aligner volume decrease for teenage patients of 0.2% year-over-year;

◦Imaging Systems and CAD/CAM Services revenues of $662.1 million, a decrease of 6.2% year-over-year;

◦Income from operations of $642.6 million and operating margin of 17.2%;

◦Effective tax rate of 39.6%;

◦Net income of $361.6 million with diluted net income per share of $4.61;

◦Cash, cash equivalents and marketable securities of $1,041.6 million as of December 31, 2022;

◦Operating cash flow of $568.7 million;

◦Capital expenditures of $291.9 million, predominantly related to increases in our manufacturing capacity and facilities; and

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◦Number of employees was 23,165 as of December 31, 2022, an increase of 2.8% year-over-year.

Other Statistical Data and Trends

•As of December 31, 2022, over 14 million people worldwide have been treated with our Invisalign system. Management measures these results by comparing to the millions of people who can benefit from straighter teeth and uses this data to target opportunities to expand the market for orthodontics by educating consumers about the benefits of straighter teeth using the Invisalign system.

•For the fourth quarter of 2022, total Invisalign cases submitted with a digital scanner in the Americas increased to 92.5%, up from 89.1% in the fourth quarter of 2021 and international scans increased to 86.8%, up from 80.8% in the fourth quarter of 2021. For the fourth quarter of 2022, 97.4% of Invisalign cases submitted by North American orthodontists were submitted digitally.

•The total utilization rate in 2022 was 18.9 cases per doctor compared to 20.8 cases per doctor in 2021 and 16.1 cases per doctor in 2020. Our utilization rates have declined in 2022 due to the macroeconomic conditions, COVID-19 impacts, and other factors as described in the Trends and Uncertainties section above. In general, we expect utilization rates to rise over time although they are likely to fluctuate from period to period.

•North America: The utilization rate among our North American orthodontist customers was 89.2 cases per doctor in 2022 compared to 98.1 cases per doctor in 2021 and 67.3 cases per doctor in 2020 and the utilization rate among our North American GP customers was 13.9 cases per doctor in 2022 compared to 14.3 cases per doctor in 2021 and 9.6 cases per doctor in 2020.

•International: International doctor utilization rate was 16.2 cases per doctor in 2022 compared to 17.5 cases per doctor in 2021 and 14.5 cases per doctor in 2020.

* Invisalign utilization rates are calculated by the number of cases shipped divided by the number of doctors to whom cases were shipped. Our International region includes Europe, Middle East and Africa (“EMEA”) and Asia Pacific (“APAC”). Latin America (“LATAM”) is excluded from the International region based on its immateriality to the year; however is included in the Total utilization.

Results of Operations

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Net Revenues by Reportable Segment

We group our operations into two reportable segments: Clear Aligner segment and Systems and Services segment.

•Our Clear Aligner segment consists of Comprehensive Products, Non-Comprehensive Products and Non-Case revenues as defined below:

•Comprehensive Products include, but are not limited to, Invisalign Comprehensive and Invisalign First.

•Non-Comprehensive Products include, but are not limited to, Invisalign Moderate, Lite and Express packages and Invisalign Go and Invisalign Go Plus.

•Non-Case products include, but are not limited to, retention products, Invisalign training, adjusting tools used by dental professionals during the course of treatment and Invisalign Accessory Products that are complementary to our doctor-prescribed principal products such as aligner cases (clamshells), teeth whitening products, cleaning solutions (crystals, foam and other material) and other oral health products available in certain e-commerce channels in select markets. We also offer in the U.S. and Canada, a Doctor Subscription Program which is a monthly subscription program based on the doctor’s monthly need for retention or limited treatment. The program allows doctors the flexibility to order both “touch-up” or retention aligners within their subscribed tier and is designed for a segment of experienced Invisalign trained doctors who are currently not regularly using our retainers or low-stage aligners.

•Our Systems and Services segment consists of our iTero intraoral scanning systems, which includes a single hardware platform and restorative or orthodontic software options. Our services include subscription software, disposables, rentals, leases, pay per scan services, as well as exocad’s CAD/CAM software solutions that integrate workflows to dental labs and dental practices.

Net revenues for our Clear Aligner and Systems and Services segments by region for the year ended December 31, 2022, 2021 and 2020 are as follows (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","","","Year Ended December 31,"],["Net Revenues","","2022","","2021","","Change","","2021","","2020","","Change"],["Clear Aligner revenues:"],["Americas","","$","1,458.8","","","$","1,544.8","","","$","(85.9)","","","(5.6)","%","","$","1,544.8","","","$","1,010.2","","","$","534.5","","","52.9","%"],["International","","1,349.0","","","1,498.7","","","(149.7)","","","(10.0)","%","","1,498.7","","","965.4","","","533.2","","","55.2","%"],["Non-case","","264.8","","","203.7","","","61.1","","","30.0","%","","203.7","","","125.8","","","77.8","","","61.9","%"],["Total Clear Aligner net revenues","","$","3,072.6","","","$","3,247.1","","","$","(174.5)","","","(5.4)","%","","$","3,247.1","","","$","2,101.5","","","$","1,145.6","","","54.5","%"],["Systems and Services net revenues","","662.1","","","705.5","","","(43.5)","","","(6.2)","%","","705.5","","","370.5","","","335.0","","","90.4","%"],["Total net revenues","","$","3,734.6","","","$","3,952.6","","","$","(217.9)","","","(5.5)","%","","$","3,952.6","","","$","2,471.9","","","$","1,480.6","","","59.9","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Clear Aligner Case Volume

Case volume data which represents Clear Aligner case shipments for the year ended December 31, 2022, 2021 and 2020 is as follows (in thousands):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Total case volume","","2,358.7","","","2,547.7","","","(189.0)","","","(7.4)","%","","2,547.7","","","1,645.3","","","902.4","","","54.8","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Total net revenues decreased by $217.9 million in 2022 as compared to 2021, primarily due to unfavorable foreign exchange rates, a decrease in both Clear Aligner case volumes and scanner volumes, partially offset by increases in Clear Aligner non-case revenues, service revenues and an increase in Clear Aligner average selling price (“ASP”).

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Clear Aligner - Americas

Americas net revenues decreased by $85.9 million in 2022 as compared to 2021, primarily due to a decrease in case volumes of 9.4% which reduced net revenues by $145.3 million, partially offset by an increase in ASP which increased net revenues by $59.4 million. Higher ASP was mainly due to processing fees charged on most shipments and price increases in certain markets which increased net revenues by $54.2 million along with lower net deferrals which increased net revenues by $34.5 million. The increases in ASP were partially offset by unfavorable promotional discounts and sales credits which reduced net revenues by $25.1 million.

Clear Aligner - International

International net revenues decreased by $149.7 million in 2022 as compared to 2021 due to a 5.0% decrease in case volumes, which decreased net revenues by $75.1 million, and lower ASP, which decreased net revenues by $74.6 million. Lower ASP was largely due to unfavorable foreign exchange rates which resulted in lower net revenues of $150.6 million, a product mix shift to lower priced products which decreased net revenues by $60.5 million, and unfavorable promotional discounts which decreased net revenues $39.4 million. The decrease in ASP was partially offset by processing fees charged on most shipments which increased net revenues by $94.1 million and lower net deferrals which increased net revenues by $81.4 million.

Clear Aligner - Non-Case

Non-case net revenues increased by $61.1 million in 2022 compared to 2021 mainly due to increased volume for retention products across most regions primarily driven by Vivera retainers.

Systems and Services

Systems and Services net revenues decreased by $43.5 million in 2022 as compared to 2021 primarily due to a lower number of scanners sold which decreased net revenues by $97.1 million and lower scanner ASP which decreased net revenues by $9.0 million. The decreases were partially offset by higher service and other revenues which increased net revenues by $62.6 million mostly due to a larger scanner install base.

Cost of net revenues and gross profit (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Clear Aligner"],["Cost of net revenues","","$","844.4","","","$","772.7","","","$","71.7","","","$","772.7","","","$","569.3","","","$","203.4"],["% of net segment revenues","","27.5","%","","23.8","%","","","","23.8","%","","27.1","%"],["Gross profit","","$","2,228.2","","","$","2,474.4","","","$","(246.2)","","","$","2,474.4","","","$","1,532.1","","","$","942.2"],["Gross margin %","","72.5","%","","76.2","%","","","","76.2","%","","72.9","%"],["Systems and Services"],["Cost of net revenues","","$","256.4","","","$","244.5","","","$","11.9","","","$","244.5","","","$","139.4","","","$","105.1"],["% of net segment revenues","","38.7","%","","34.7","%","","","","34.7","%","","37.6","%"],["Gross profit","","$","405.6","","","$","461.0","","","$","(55.4)","","","$","461.0","","","$","231.1","","","$","229.9"],["Gross margin %","","61.3","%","","65.3","%","","","","65.3","%","","62.4","%"],["Total cost of net revenues","","$","1,100.9","","","$","1,017.2","","","$","83.6","","","$","1,017.2","","","$","708.7","","","$","308.5"],["% of net revenues","","29.5","%","","25.7","%","","","","25.7","%","","28.7","%"],["Gross profit","","$","2,633.8","","","$","2,935.4","","","$","(301.6)","","","$","2,935.4","","","$","1,763.2","","","$","1,172.1"],["Gross margin %","","70.5","%","","74.3","%","","","","74.3","%","","71.3","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Cost of net revenues includes personnel-related costs including payroll and stock-based compensation for staff involved in the production process, the cost of materials, packaging, freight and shipping related costs, depreciation on capital equipment and facilities used in the production process, amortization of acquired intangible assets and training costs.

Clear Aligner

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The gross margin percentage decreased in 2022 as compared to 2021 primarily due to a higher mix of additional aligners, higher freight costs and increased manufacturing spend as we continue to ramp our new manufacturing facility in Poland.

Systems and Services

The gross margin percentage decreased in 2022 as compared to 2021 primarily due to manufacturing inefficiencies from lower production volumes and lower ASP. These factors were partially offset by higher service revenues.

Selling, general and administrative (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Selling, general and administrative","","$","1,674.5","","","$","1,708.6","","","$","(34.2)","","","$","1,708.6","","","$","1,200.8","","","$","507.9"],["% of net revenues","","44.8","%","","43.2","%","","","","43.2","%","","48.6","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Selling, general and administrative expense generally includes personnel-related costs, including payroll, stock-based compensation and commissions for our sales force, marketing and advertising expenses including media, market research, marketing materials, clinical education, trade shows and industry events, legal and outside service costs, equipment, software and maintenance costs, depreciation and amortization expense and allocations of corporate overhead expenses including facilities and Information Technology (“IT”).

Selling, general and administrative expense decreased in 2022 compared to 2021 primarily due to lower incentive compensation, lower advertising and marketing costs and lower allocations of corporate overhead expenses. These decreases were offset by higher salaries expenses, fringe benefits and stock-based compensation from increased headcount as well as higher equipment, software and maintenance costs.

Research and development (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Research and development","","$","305.3","","","$","250.3","","","$","54.9","","","$","250.3","","","$","175.3","","","$","75.0"],["% of net revenues","","8.2","%","","6.3","%","","","","6.3","%","","7.1","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Research and development expense generally includes personnel-related costs, including payroll and stock-based compensation, outside service costs associated with the research and development of new products and enhancements to existing products, software, equipment, material and maintenance costs, depreciation and amortization expense and allocations of corporate overhead expenses including facilities and IT.

Research and development expense increased in 2022 compared to 2021 primarily due to higher salaries expense, fringe benefits and stock-based compensation as we continue to focus our investments in innovation and research in addition to higher allocations of corporate overhead expenses, outside services costs and equipment and materials costs. These increases were partially offset by lower incentive compensation.

Restructuring and other charges (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Restructuring and other charges","","$","11.5","","","$","\u2014","","","$","11.5","","","$","\u2014","","","$","\u2014","","","$","\u2014"],["% of net revenues","","0.3","%","","\u2014","%","","","","\u2014","%","","\u2014","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Restructuring and other charges includes $7.3 million of severance and related costs, in addition to lease termination charges and asset impairments.

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Income from operations (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Clear Aligner"],["Income from operations","","$","1,134.4","","","$","1,325.9","","","$","(191.4)","","","$","1,325.9","","","$","768.0","","","$","557.8"],["Operating margin %","","36.9","%","","40.8","%","","","","40.8","%","","36.5","%"],["Systems and Services"],["Income from operations","","$","179.8","","","$","259.1","","","$","(79.4)","","","$","259.1","","","$","96.1","","","$","163.1"],["Operating margin %","","27.2","%","","36.7","%","","","","36.7","%","","25.9","%"],["Total income from operations 1","","$","642.6","","","$","976.4","","","$","(333.8)","","","$","976.4","","","$","387.2","","","$","589.2"],["Operating margin %","","17.2","%","","24.7","%","","","","24.7","%","","15.7","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

1    Refer to Note 15 “Segments and Geographical Information” of the Notes to Consolidated Financial Statements for details on unallocated corporate expenses and the reconciliation to Consolidated Income from Operations.

Clear Aligner

Operating margin percentage decreased in 2022 compared to 2021 primarily due to lower gross margin.

Systems and Services

Operating margin percentage decreased in 2022 compared to 2021 primarily due to higher operating expenses as a percentage of net revenues as well as lower gross margin.

Interest income (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Interest income","","$","5.4","","","$","3.1","","","$","2.3","","","$","3.1","","","$","3.1","","","$","\u2014"],["% of net revenues","","0.1","%","","0.1","%","","","","0.1","%","","0.1","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Interest income generally includes interest earned on cash, cash equivalents and investment balances.

Interest income increased in 2022 compared to 2021 primarily due to higher interest rates during 2022, which was partially offset by the interest earned from the arbitration award related to our investment in SmileDirectClub in the first quarter of 2021.

Other income (expense), net (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Other income (expense), net","","$","(48.9)","","","$","32.9","","","$","(81.8)","","","$","32.9","","","$","(11.3)","","","$","44.3"],["% of net revenues","","(1.3)","%","","0.8","%","","","","0.8","%","","(0.5)","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Other income (expense), net, generally includes foreign exchange gains and losses, gains and losses on foreign currency forward contracts, interest expense, gains and losses on equity investments and other miscellaneous charges.

Other income (expense), net decreased in 2022 compared to 2021 primarily due to a $43.4 million gain associated to the arbitration award related to our investment in SmileDirectClub recognized in the first quarter of 2021 as well as $30.5 million of higher net foreign exchange losses from the weakening of international currencies against the U.S. dollar in 2022 as compared to 2021.

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Provision for (benefit from) income taxes (in millions):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,","","","","Year Ended December 31,"],["","","2022","","2021","","Change","","2021","","2020","","Change"],["Provision for (benefit from) income taxes","","$","237.5","","","$","240.4","","","$","(2.9)","","","$","240.4","","","$","(1,396.9)","","","$","1,637.3"],["Effective tax rates","","39.6","%","","23.7","%","","","","23.7","%","","(368.6)","%"]]
[[/GREPCENT_TABLE]]

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

The increase in our effective tax rate for the year ended December 31, 2022 compared to the same period in 2021 is primarily attributable to decreased earnings in low tax jurisdictions and an increase in the amount of foreign earnings subject to US tax in 2022. Additionally, a change in U.S. tax laws effective January 1, 2022 which requires capitalization and amortization of research and development expenses incurred after December 31, 2021 increased our effective tax rate for the year ended December 31, 2022.

During 2020, we completed an intra-entity transfer of certain intellectual property rights and fixed assets to our Swiss subsidiary, where our EMEA regional headquarters is located beginning January 1, 2020. The transfer of intellectual property rights did not result in a taxable gain; however, it did result in a step-up of the Swiss tax deductible basis in the transferred assets, and accordingly, created a temporary difference between the book basis and the tax basis of such intellectual property rights. Consequently, this transaction resulted in the recognition of a deferred tax asset and related one-time tax benefit of approximately $1,493.5 million during the year ended December 31, 2020, which is the net impact of the deferred tax asset recognized as a result of the additional Swiss tax deductible basis in the transferred assets and certain costs related to the transfer of fixed assets and inventory. The amortization of this deferred tax asset depends on the profitability of our Swiss headquarters and the recognition of this tax benefit is allowed for a maximum recovery period of 15 years.

The U.S. Inflation Reduction Act of 2022 (“IRA”) was enacted in the United States on August 16, 2022. The IRA imposes a 15% alternative minimum tax on the financial statement income of certain corporations which is effective for tax years beginning after December 31, 2022, as well as a 1% excise tax on the net fair market value of stock repurchases made after December 31, 2022. Based upon our analysis of the IRA, we have determined there is no impact to our tax provision for the year ended December 31, 2022. We will continue to evaluate the impact of these tax law changes on future periods.     

Liquidity and Capital Resources

Liquidity and Trends

As of December 31, 2022 and 2021, we had the following cash and cash equivalents and short-term and long-term marketable securities (in thousands):

[[GREPCENT_TABLE]]
[["","","December 31,"],["","","2022","","2021"],["Cash and cash equivalents","","$","942,050","","","$","1,099,370"],["Marketable securities, short-term","","57,534","","","71,972"],["Marketable securities, long-term","","41,978","","","125,320"],["Total","","$","1,041,562","","","$","1,296,662"]]
[[/GREPCENT_TABLE]]

As of December 31, 2022 and 2021, approximately $653.7 million and $713.8 million, respectively, of cash, cash equivalents and marketable securities were held by our foreign subsidiaries. We intend to continue reinvesting our foreign subsidiary earnings indefinitely and expect the additional costs upon repatriation of these foreign earnings not to be significant. We generate sufficient domestic operating cash flow and have access to external funding under our $300.0 million revolving line of credit. We believe that our current cash balances and the borrowing capacity under our credit facility, if necessary, will be sufficient to fund our business for at least the next 12 months.

The sanctions against Russian banks or international bank messaging systems due to the military conflict between Ukraine and Russia could impact our ability to access our cash in Russia but would not materially impact our liquidity position. As of December 31, 2022, cash and cash equivalents domiciled in Russia, which is required to fund their current operating requirements, represent approximately 2.6% of our total cash, cash equivalents and marketable securities.

Our material cash requirements as of December 31, 2022 are as below:

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•Our purchase commitments for goods and services, excluding capital expenditures, totaled $1,151.7 million, of which $860.8 million will be payable within the next 12 months. These commitments primarily relate to agreements with contract manufacturers and suppliers, sales and marketing services, research and development services and technological services.

•We expect our investments in capital expenditures to exceed $200.0 million for the next 12 months. Capital expenditures primarily relate to building construction and improvements as well as additional manufacturing capacity due to international expansion. Despite the challenging market conditions, we intend to expand our investments in research and development, manufacturing, treatment planning, sales and marketing operations to meet actual and anticipated local and regional demands.

•We have future operating lease payments of $158.3 million, which includes $14.3 million for leases that have not yet commenced as of December 31, 2022. Refer to Note 4 “Leases” of the Notes to Consolidated Financial Statements for details on the lease payments.

•We have $249.9 million available for repurchase under the stock repurchase program authorized by our Board of Directors in May 2021 (“May 2021 Repurchase Program”). Our stock repurchase program is subject to periodic evaluations to determine when and if repurchases are in the best interests of our stockholders, taking into account prevailing market conditions. Refer to Note 10 “Common Stock Repurchase Programs” of the Notes to Consolidated Financial Statements for details on our stock repurchase programs. Subsequent to the fourth quarter, in January 2023, our Board of Directors authorized a new plan to repurchase up to $1.0 billion of our common stock. Additionally, in February 2023, we entered into an ASR to repurchase $250.0 million of our common stock, completing our 2021 Repurchase Program. Under the Inflation Reduction Act of 2022, effective January 1, 2023, excise tax of 1% is applicable to stock repurchases. We are currently evaluating the impact of this provision, if any, on our results of operations and cash flows.

Sources and Use of Cash

The following table summarizes our Consolidated Statements of Cash Flows for the year ended December 31, 2022, 2021 and 2020 (in thousands):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2022","","2021","","2020"],["Net cash provided by (used in):"],["Operating activities","","$","568,732","","","$","1,172,544","","","$","662,174"],["Investing activities","","(213,316)","","","(563,430)","","","(231,506)"],["Financing activities","","(501,686)","","","(458,332)","","","(30,808)"],["Effects of foreign exchange rate changes on cash, cash equivalents, and restricted cash","","(11,514)","","","(12,117)","","","10,480"],["Net (decrease) increase in cash, cash equivalents, and restricted cash","","$","(157,784)","","","$","138,665","","","$","410,340"]]
[[/GREPCENT_TABLE]]

Operating Activities

For the year ended December 31, 2022, cash flows from operations of $568.7 million resulted primarily from our net income of approximately $361.6 million as well as the following:

Significant adjustments to net income

•Stock-based compensation of $133.4 million related to equity awards granted to employees and directors; and

•Depreciation and amortization of $125.8 million related to our investments in property, plant and equipment and intangible assets.

Significant changes in working capital

•Increase of $241.9 million in deferred revenues due to the deferral of revenue on shipments over the period as well as timing of revenue recognition;

•Increase of $130.1 million in inventories primarily due to lower shipment volumes over the period in addition to our efforts to manage stock at appropriate levels as required; and

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•Decrease of $121.9 million in accrued and other long-term liabilities primarily due to the payment of our 2021 corporate bonus as well as timing payment of other activities.

For the year ended December 31, 2021, cash flows from operations of $1,172.5 million resulted primarily from our net income of approximately $772.0 million as well as the following:

Significant adjustments to net income

•Stock-based compensation of $114.3 million related to equity awards granted to employees and directors;

•Depreciation and amortization of $108.7 million related to our investments in property, plant and equipment and intangible assets; and

•Gain related to our SDC arbitration award of $43.4 million.

Significant changes in working capital

•Increase of $462.6 million in deferred revenues primarily related to increased case volumes in our Clear Aligner segment, increased scanner volumes in our Systems and Services segment and timing of revenue recognition;

•Increase of $262.1 million in accounts receivable which is primarily a result of the increase in our sales;

•Increase of $158.5 million in accrued and other long-term liabilities and an increase of $124.6 million in prepaid expenses and other assets due to the timing of prepayment and activities; and

•Increase of $112.5 million in inventories to support our demand, including safety stock, due to shipping delays during the COVID-19 pandemic as well as long lead times with our suppliers.

Investing Activities

Net cash used in investing activities was $213.3 million for the year ended December 31, 2022 which primarily consisted of purchases of property, plant and equipment of $291.9 million, purchases of marketable securities of $28.0 million and $12.3 million cash paid relating to a business acquisition. These outflows were partially offset by sales and maturities of marketable securities of $121.1 million.

Net cash used in investing activities was $563.4 million for the year ended December 31, 2021 and primarily consisted of purchases of property, plant and equipment of $401.1 million and purchases of marketable securities of $200.9 million, which were partially offset by $43.4 million of proceeds from our SDC arbitration award.

Financing Activities

Net cash used in financing activities was $501.7 million for the year ended December 31, 2022 which consisted of payments related to our common stock repurchases of $475.0 million and payroll taxes paid for equity awards through share withholdings of $52.8 million, which were partially offset by $26.1 million of proceeds from the issuance of common stock under our employee stock purchase plan.

Net cash used in financing activities was $458.3 million for the year ended December 31, 2021 which consisted of payments related to our accelerated stock repurchase arrangements of $375.0 million and payroll taxes paid for equity awards through share withholdings of $108.9 million which were partially offset by $25.6 million of proceeds from the issuance of common stock.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and disclosures at the date of the financial statements. We evaluate our estimates on an on-going basis and use authoritative pronouncements, historical experience and other assumptions as the basis for making the estimates. Actual results could differ from those estimates.

We believe the following critical accounting policies and estimates affect our more significant judgments used in the preparation of our consolidated financial statements. For further information on all of our significant accounting policies, see Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements under Item 8.

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Revenue Recognition

Our revenues are derived primarily from the sale of aligners, scanners, and services from our Clear Aligner and Systems and Services segments. We enter into sales contracts that may consist of multiple distinct performance obligations where certain performance obligations of the sales contract are not delivered in one reporting period. We measure and allocate revenues according to ASC 606-10, “Revenues from Contracts with Customers.”

Determining the standalone selling price (“SSP”) in order to allocate consideration from the contract to the individual performance obligations is the result of various factors, such as changing trends and market conditions, historical prices, costs, and gross margins. While changes in the allocation of the SSP between performance obligations will not affect the amount of total revenues recognized for a particular contract, any material changes could impact the timing of revenue recognition, which would have a material effect on our financial position and result of operations. This is because the contract consideration is allocated to each performance obligation, delivered or undelivered, at the inception of the contract based on the SSP of each distinct performance obligation.

We allocate revenues for each clear aligner treatment plan based on each unit’s SSP. Management considers a variety of factors such as same or similar product historical sales, costs, and gross margin, which may vary over time depending upon the unique facts and circumstances related to each performance obligation in making these estimates. In addition to historical data, we take into consideration changing trends and market conditions. For treatment plans with multiple options, we also consider usage rates, which is the number of times a customer is expected to order more aligners after the initial shipment. Our process for estimating usage rates requires significant judgment and evaluation of inputs, including historical usage data by region, country and channel.

We estimate the SSP of each element in a scanner system and services sale taking into consideration same or similar product historical prices as well as our discounting strategies.

Unfulfilled Performance Obligations for Clear Aligners and Scanners

The estimated revenues expected to be recognized in the future related to our unfulfilled performance obligations, including deferred revenues and backlog, as of December 31, 2022 is $1,515.4 million. This estimate includes both product and service unfulfilled performance obligations and the time range reflects our best estimate of when we will transfer control to the customer and may change based on customer usage patterns, timing of shipments, readiness of customers' facilities for installation, and manufacturing availability some of which involve significant judgement. Generally, our deferred revenue will be recognized over a period of one to five years.

Goodwill and Finite-Lived Acquired Intangible Assets

Goodwill and acquired intangible assets with finite lives are subject to impairment testing and are reviewed for impairment when events or circumstances indicate that the carrying value of an asset is not recoverable and the carrying amount exceeds its fair value. We evaluate the recoverability of the carrying value of these identifiable intangible assets based on estimated undiscounted cash flows to be generated from such assets. If the cash flow estimates or the significant operating assumptions upon which they are based change in the future, we may be required to record impairment charges.

Assumptions and estimates about future values and remaining useful lives of our acquired intangible assets are complex and subjective. They can be affected by external factors such as industry and economic trends and internal factors such as changes in our business strategy and internal forecasts. Our ongoing consideration of all these factors could result in impairment charges in the future.

If we were to have impairments to goodwill or finite-lived acquired intangible assets, it could adversely affect our operating results. During the fiscal year 2022 and 2021, we did not have any impairment charges related to our goodwill or acquired intangible assets.

Accounting for Income Taxes

We are subject to income taxes in the U.S. and numerous foreign jurisdictions. The evaluation of our uncertain tax positions involves significant judgment in the interpretation and application of U.S. GAAP and complex domestic and international tax laws related to the allocation of international taxation rights between countries. We are also required to evaluate the realizability of our deferred tax assets on an ongoing basis in accordance with U.S. GAAP, which requires the assessment of both of our historical and future performance as well as other relevant factors. Realization of our deferred tax assets is dependent on our ability to generate future taxable income which is determined based on assumptions such as

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estimated growth rates in revenues, gross margins, future cash flows and discount rates. The accuracy of these estimates could be affected by unforeseen events or actual results, and the sustainability of our future tax benefits is dependent upon the acceptance of these valuation estimates and assumptions by the taxing authorities.

Accounting for Legal Proceedings and Litigation

Estimates of probable losses resulting from litigation are inherently difficult to make, particularly when the matters are in early procedural stages with incomplete facts and information. The final outcome of legal proceedings is dependent on many variables difficult to predict and, therefore, the ultimate cost to entirely resolve such matters may be materially different than the amount of current estimates. Consequently, new information or changes in judgments and estimates could have a material adverse effect on our business, financial condition, and results of operations or cash flows.

Recent Accounting Pronouncements

See Note 1 “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements in Item 8 for a discussion of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein.