愛齊科技 (ALGN) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Align Technology Q2 2011 Earnings Call.

At this time all participants are in a listen-only mode.

A question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Shirley Stacy of Align Technology.

Thank you, Ms.

Stacy, you may begin.

Good afternoon and thank you for joining us, I'm Shirley Stacy, Senior Director of Corporate and Investor Communications.

Joining me today is Tom Prescott, President and CEO, and Ken Arola, Vice President and CFO.

Before we begin, let me cover some housekeeping items.

We issued our second quarter fiscal 2011 financial results press release today via Globe Newswire, which is available on our website at investor.aligntech.com.

Today's conference call is being audio webcast and will be archived on our website for approximately 12 months.

The telephone replay will be available today by approximately 5.30 p.m.

Eastern Time through 5.30 pm Eastern Time on August 14.

To access the telephone replay, domestic callers should dial (877) 660-6853 with account number 292 followed by pound and conference number 374000, followed by pound.

International callers should dial (201) 612-7415 with the same account number and conference number.

As a reminder, the information that the presenters discuss today will include forward-looking statements, including without limitation, statements about Align's future events, product outlook, expected impact of our recent acquisition of Cadent on our business, and the expected financial results for the third quarter and full fiscal year 2011.

These forward-looking statements are only predictions, and involve risks and uncertainties such that actual results may vary significantly.

These and other risks are set forth in more detail in our Form 10-Q for the fiscal quarter ended March 31, 2011.

These forward-looking statements reflects beliefs, estimates and predictions as of today, and Align expressly assumes no obligation to update any such forward-looking statements.

Please also note that on this conference call we will provide listeners with several financial metrics determined on a non-GAAP basis for comparisons to previously quarters.

Most of these items, together with the corresponding GAAP numbers and the reconciliations to the comparable GAAP financial measures, where practical, are contained in today's financial press release which we have post on our website under Financial Releases, and have furnished to the SEC on form 8-K.

We encourage listeners to review these items.

We've also posted a set of GAAP and non-GAAP historical financial statements, including the corresponding reconciliation and our second-quarter conference call slides on our website at investor.aligntech.com under Quarterly Results.

Please refer to these files for more detailed information.

With that, I'd like to turn the call over to Align Technology's President and CEO, Tom Prescott.

Tom?

Thanks, Shirley.

On the call today, I'll cover some highlights from the second quarter, including an update on our key strategic initiatives, such as a very recent development, the accusation of Cadent.

Ken will follow with some detail on our financial results and outlook for third quarter.

And then I'll come back with some closing comments and open the call for your questions.

Q2 was another strong quarter for Align, driven by record Invisalign revenues and case shipments.

The positive trends in Q1 continued throughout Q2, and as a result, we achieved record Invisalign case shipments across all customer channels, both American orthodontists and GP dentists, and international doctors.

This was also our first combined quarter with Cadent, an emerging leader in the fast-growing market for intra-oral scanners and CAD cam ortho and restorative services.

I'm pleased to report that the integration of Cadent is going well, and our milestones for combining our people and processes are on track.

We've already seen a positive effect on scanner sales from leveraging Align sales and marketing resources, and we continue to be excited about the new opportunities we now have in the digital dentistry and restorative markets.

I'll discuss Cadent in more detail shortly.

I'll start with an overview of key highlights from Invisalign.

From a geographic perspective, North American ortho case volume for Q2 was a record 28,520 cases, an increase of 6% over Q1.

On a year-over-year basis, North American ortho has increased 24%, and most of this growth was from demand from the Invisalign teen product.

Typically, Q2 represents the beginning of the summer season for teen orthodontic case starts.

It also marks the semi-annual qualification period for the Advantage program tier status, which is based on case volume, and is an additional incentive for practices to achieve their targeted levels.

For North American GP dentists Q2 case volume was a record 30,710, an increase of about 8% both sequentially and year-over-year, as GP practices continue to report solid patient traffic in offices, with interest for Invisalign and other high-value procedures.

On the international front, Q2 case volume was a record 16,790 cases, up 4% from Q1 and 5% year-over-year.

The Asia-Pacific region remains strong and continues to out-pace all other geographies with very strong volume growth.

In Europe, despite economic headwinds, Germany and France remain solid, while economic conditions in a few other countries have begun to impact patient activity in doctor's offices.

More specifically, Italy and Spain were softer in Q2, but are improving.

The UK continues to be impacted by the widespread austerity measures in the public and private sectors, as well as a few execution issues that we're addressing.

The UK is growing rapidly for us over the past few years, and our sales coverage lagged in a few areas.

We're hiring a new country manager and expanding sales coverage to create some new territories.

The UK still has great opportunities for growth, and we're confident that growth will resume, especially as the economy improves.

In addition, as we have previously described, the commercial scope and complexity of the international launch of Invisalign G3 was greater than in North America, given the numerous countries and languages involved.

We suspended new doctor training in Europe and reduced the number of clinical education events in Q1 and early Q2 so we would not have to retrain customers after the G3 launch.

Now that this is behind us and our European sales team has resumed their normal schedule, they've gotten back to training new doctors and have re-focused on practice development activities that help doctors increase adoption of Invisalign.

Now let's review the key Invisalign metrics that measure our customer penetration, utilization rates, or what we call same practice sales of our product, as well as the number of new doctors trained.

In Q2, total utilization increased to a record four cases per quarter, driven by a record 6.9 cases per doctor for North American orthos, and a record 2.9 cases per North American GP.

This growth reflects continued penetration of more engaged practices, driven by a number of factors which I'll touch on, including the impact of Invisalign G3.

International utilization was unchanged at 3.9 cases per doctor.

During Q2, we trained a total of 1,365 new doctors, compared to 955 in Q1.

In North America, we trained 845 new doctors, nice growth over the 790 in Q1, primarily from new GPs.

We expect continued expansion in our customer base as a result of new GP recruitment activity.

For international, we trained 520 new doctors, compared to around 165 in Q1.

As I just said, with the Invisalign G3 launch behind us, we've gotten back to training new international docs again.

As for a strategic update, you know we have a set of key strategic initiatives which we typically discuss each quarter, and that are detailed in our corresponding earnings slide deck posted on our website.

Since I've described these for a number quarters now, I'll just remind you of each one and then discuss our continued progress in each area.

First, accelerating, product and clinical innovation.

Second, enhancing the customer experience; and you can see these two first initiatives working together in our strategic acquisition of Cadent as we combine Align's and Cadent's best- in-class technology to bring valuable treatment tools chair-side for our customers.

Third, increasing the effectiveness of our consumer demand programs.

And finally, continuing to drive international growth.

I'll start with product and clinical innovation, by providing a brief update on our continued progress with Invisalign G3, and penetration in the overall teenage orthodontic segment.

During Q2, we continued to hear positive feedback from customers on how Invisalign G3 was improving their ability to treat more complex cases, as well on their overall use and recommendation of Invisalign treatment.

This message came through loud and clear while at the AEO meeting in May, where we had an opportunity to interact with thousand of orthodontists' customers.

Consistent with the findings from the survey we conducted last quarter, customers tell us that Invisalign G3 is enabling them to treat more complex cases, that Invisalign G3 is improving their perception that they can achieve better clinical outcomes with Invisalign, which is key for us as we continue to drive further adoption growth, and perhaps most important, that Invisalign G3 gives them greater confidence in clinical outcomes and is having a positive effect on their likelihood of recommending Invisalign.

We're pleased with the continued positive feedback regarding Invisalign G3, and believe it's a key reason that our penetration continues to increase, especially in ortho practices.

We have now successfully launched Invisalign G3 in international markets, including Europe, Asia, Asia-Pacific, Latin America, China, and Japan, all of which have significantly greater case complexity than North America.

We expect over the long term innovations like G3 will be a key driver of our continued growth in both existing markets and expansion into new markets.

Now I would like to move on to the important teenage orthodontics segment, which for us consists of teenagers 19 and younger using any Invisalign product.

In Q2, the number of teenagers starting treatment with Invisalign products was 15,770, or 21% of our total case volume, an increase of 7% sequentially, and 6% year-over-year.

The majority of the growth in teenage cases was driven by the Invisalign Teen product, which grew 9% sequentially and 26% from the prior year, to 8,615 cases.

As I noted earlier, Q2 is the beginning of the summer season for teen ortho case starts, as well as the qualification period for the teen doc locater on our Invisalign Teen website.

In addition, we've had increased TV advertising and PR event marketing activity in support of this teen category, all of which contributed to solid growth.

Overall, we're seeing continued steady adoption and believe we're gaining share.

On a trailing 12-month basis, total teenage cases grew 12% from the prior 12-month period to 60,745 cases, which includes all teenager cases using any Invisalign product through all channels, including GP dentists.

If you include the GP channel on our overall number, total teenage case growth for the past 12 months was up by more than 20%.

GPs were doing more teenage cases during 2009 and early 2010, to meet the minimum case requirement for the proficiency program.

However, over the past 12 months, teenager use of Invisalign in the GP channel declined around 6%, which pulls our overall growth rate down.

In Q2, Invisalign Assist case shipments were almost 5,000, an increase of 3.5% sequentially, and 24% from the same quarter last year.

Over the last year or two, we've been focused on featuring Invisalign Assist as the primary treatment offering for both newly trained and lower-volume doctors.

As a result, use of Invisalign Assist by new doctors is growing at a faster rate.

In addition, existing doctors utilizing Invisalign Assist are reporting greater satisfaction with the product.

These comparisons reflect continued expansion of our customer base, as virtually all new GPs are using Invisalign Assist.

We believe Invisalign Assist will help us expand our customer base, as well as lead to greater adoption of Invisalign by new or low-volume customers.

Turning now to consumer.

Our integrated consumer marketing platform combines traditional print and broadcast media with the right mix of PR, event marketing and social networking.

The goal of this platform is to raise awareness Invisalign, create a position as the best way to a healthier, more beautiful smile, and deliver leads that turn into case starts for our doctors.

We're doing that by extending our leadership in clear aligner therapy among adults, educating teens and moms on the benefits of Invisalign treatment, and continuing to grow the overall clear aligner category.

Q2 marked the start of the busy summer months, when many teens are starting treatment, giving us more opportunities to reach teens and their families.

In Q2, we hosted two satellite media tours.

The first tour was tailored to moms and focused on mom-approved tools to tackle life's hassles.

The second tour also targeted women with a bridal theme of how to tie the knot in style.

As an example of impact, Invisalign Teen was featured in more than 675 print and on-line articles during the quarter.

In August, we'll launch an additional media tour that ties into back-to-school planning and features local and national TV 's mom-on-the-run expert, Colleen Burns.

Invisalign TV advertising for adults and teens stepped up at bit in Q2 as we headed into the summer peak season for teen ortho case starts.

In addition to the Invisalign twins ad, targeted at teens and moms that began earlier this year, you may have seen our new spot for women that began at the end of March.

On the digital and social media front, the Invisalign Mom Advisory Board and our Invisalign-sponsored Momsonbraces.org community continued to grow and produce monthly social media content that reaches thousands of moms on behalf of Invisalign Teen.

We also kicked off our sponsorship of the Bloggy Boot Camp national blogger conference tour, garnering interest from hundreds of bloggers who are interested in working with Invisalign PR on future programs.

As for event marketing, we are in the middle our busiest summer season ever.

Invisalign Teen is currently sponsoring the varsity cheerleading summer camp program, exposing our brand to more than 300,000 teens over the summer.

Next weekend, we're once again a sponsor of the US Open of Surfing in Huntington Beach.

Our presence there includes athlete signings at the Invisalign booth, along with branded activities designed to engage teens and their parents through this high-profile event.

Finally, September will mark the kickoff of Radio Disney's Next Big Thing tour, powered by Invisalign Teen.

The tour will visit eight top markets with an Invisalign-sponsored stage show and brand activities in each city.

Our continued investments in these various consumer marketing programs are beginning to move the needle, as more moms and teens become familiar with the benefits of Invisalign treatment, gain confidence in the brand, and ask for it by name.

On the international expansion front, I'd like to provide a brief update on the launch of Invisalign in China.

As previously announced, we accelerated commercial availability of Invisalign in China in conjunction with the international launch of Invisalign G3 in May.

Excuse me.

The new features and functionality delivered with Invisalign G3 are engineered to make Invisalign easier to use with class two and class three patients, and address the higher complexity of malocclusion among the Asian population.

During Q2 we began training orthodontists based in the four major cities of Shanghai, Beijing, Shenzhen, and Guangzhou.

To date, we have completed ten training courses, and have begun converting interest into cases, shipping our first cases and getting patients started in treatment.

The initial response has been very positive, and we will continue to take a gradual approach in China, working with top public hospitals and private clinics, and building relationships with key opinion leaders.

In addition to the successful two-day Invisalign symposium held at Peking University in April, in June, we have significant presence at the China Orthodontics Society meeting, and we also hosted ten key opinion leaders at our European Summit in Barcelona.

Before I turn the call over to Ken, I'd like to update you on the acquisition of Cadent and provide you with some highlights from the quarter.

We closed this acquisition of Cadent on April 29, and since than our team has been working hard to integrate the businesses.

We've finished most of the initial integration activities, and all internal milestones are on track.

The comprehensive integration of our respective products, technology, and infrastructure will evolve over the next several years.

It will also take a while for our cultures to merge, as we get to know our new colleagues and learn from one another.

As we move beyond these initial integration steps, we're also updating our Company strategy and intend to maximize our respective strategic directions, along with identifying new opportunities in the restorative dental market.

The combination of the Align and Cadent technologies and capabilities acts as a significant strategic multiplier as we can now address much greater growth opportunity than either company could before.

While we're still building our new specialty sales team to sell scanners, which will double over the next couple of quarters to around 20 reps, we're already gaining leverage from Align's existing sales and marketing resources by including interoral scanners for Invisalign events.

In fact, we've seen a ramp in new scanner orders during major events like AAO, the European Invisalign Summit, and the GP Summit, which was just held in Las Vegas.

Going forward we will continue to bring Cadent clinical education, products and offerings into all relevant Invisalign meetings, and expect to efficiently drive continued growth through these venues.

To extend that growth, we intend to continue supporting and improving all of the existing Cadent products for both orthodontists and GP restorative customers.

In addition, I'd like to provide a few highlights on progress made for our scanner platform, both the iTero system for GPs, and the IOC system for orthodontists.

During the AAO in May, we released Invisalign interoperability for the IOC system, and our very first case submitted was from a French doctor that morning.

The scan was received on Monday morning, his clin-check was available on Tuesday, and his patient had started her new Invisalign treatment within a couple of weeks, a significant cycle time reduction for the office.

Patients and doctors are reporting a even better more precise fit with their aligners.

Incoming digital scans, replacing traditional PVS impressions, are ramping as orthodontists buy systems.

And Align's in the final beta testing with a new functionality in the iTero 4.0 scanning software that will enable Invisalign interoperability for GP dentists, and expect to release that capability this fall.

More evolutions of our interoral scanner platform is in the works.

As we get closer to pilot testing, we'll discuss with you in greater detail, like we normally do.

I'll now turn the call over to Ken for more detail on our second quarter financials and our outlook for Q3, then Then I'll come back for a few closing comment.

Ken?

Thanks, Tom.

Before I get started with our second quarter financial results, I'd like to remind everyone that our Q2 guidance provided back in April on our Q1 call was for Invisalign standalone operations.

With the acquisition of Cadent closing on April 29, the Q2 results I'll be sharing with you today, include two months of Cadent operations.

During my comments I'll provide a bridge back to our Invisalign standalone guidance for comparative purposes.

With that, let's get started.

Q2 net revenues were a total of $120.1 million, which consisted of Invisalign revenue of $113.6 million, and scanner and CAD cam services revenue of $6.5 million.

Q2 Invisalign revenue of $113.6 million increased 8.4% compared to Q1 revenue of $104.9 million, and increased 21% compared to Q2, 2010 non-GAAP revenue of $93.9 million.

Recall that Q2 2010 non-GAAP revenue excluded the release of $14.3 million of previously deferred revenue for Invisalign Teen replacement aligners.

Q2 Invisalign case shipments of 76,000 increased 6.5% sequentially and 12.6% year-over-year.

The sequential increase in Invisalign revenue primarily reflects higher case volume in North America, with international shipments benefiting from favorable exchange rates.

On a year-over-year basis, Q2 Invisalign revenue growth was driven primarily by higher volume from North America orthos and favorable international average selling prices.

Additionally, there was a favorable impact of approximately 3% relating to the previous changes in deferred revenue policies for Invisalign Teen and Assist.

As for the $6.5 million of scanner and CAD cam services revenue, $2.7 million is related to scanners and $3.8 million is related to services.

Now let's move on to gross margin and operating expenses.

Q2 GAAP gross margin was $91.1 million, or 75.9%.

Invisalign products contributed $89.1 million, generating a 78.4% gross margin, with scanners and CAD cam services contributing $2 million, generating a gross margin of 31.7%.

This compares to GAAP gross margins of $82.2 million, or 78.4% in Q1, and $87 million or 80.4% in the same quarter of last year.

Q2 gross margin includes amortization of acquired intangible assets from Cadent of $183,000, and integration related costs of $57,000.

Excluding the amortization of acquired intangible assets, and integration related costs, non-GAAP gross margin for Q2 was $91.4 million, or 76.1%.

This compares to non-GAAP gross margins of 77.4% in Q2, 2010, which excludes the benefit resulting from the release of $14.3 million of previously deferred teen revenue.

There was no difference between GAAP and non-GAAP gross margin for Q1, 2011.

The sequential decrease in Q2 non-GAAP gross margin primarily reflects the impact from the acquisition of Cadent, as scanners and CAD cam services carry lower gross margins than Invisalign.

In Q2, scanners and CAD cam services gross margins were impacted by a number of post-closing changes, including a reclassification of trainer costs from sales and marketing to cost-of-sales, as well as higher employee compensation and benefits expense, that will be ongoing.

Additionally, as we offer promotional programs to drive scanner sales, such as a free Invisalign case or free CE1 training with the purchase of a scanner, some portion of scanner revenue will be deferred.

Q2 GAAP operating expense was $74.5 million, of which $62.6 million relates to Invisalign, and $5.5 million relates to scanners and CAD cam services.

Q2 operating expense also includes acquisition and integration-related costs of $5.8 million, and the amortization of a acquired intangible assets of $600,000.

This compares to GAAP operating expense of $61.2 million in Q1 and $41.7 million in the same quarter last year.

Q1 GAAP operating expense included legal and accounting fees of $1.5 million associated with the Cadent transaction.

And Q2 2010 GAAP operating expense included an $8.7 million credit for an insurance settlement related to the OrthoClear litigation.

Excluding these acquisition and integration-related costs and the amortization of intangible assets, Q2'a non-GAAP operating expense was $68.1 million.

This compares to $59.7 million in Q1 and $50.3 million in the same quarter of last year.

The sequential increase in non-GAAP operating expense reflects additional operating costs for scanners and CAD cam services, including incremental sales force and R&D head count, to drive and support revenue growth for both scanners and Invisalign, as well as other costs to integrate the Cadent operations.

It also includes an increased level in consumer advertising to build awareness and excitement ahead of the busy summer months for Invisalign teenage case starts, and our continued investment in international, including Invisalign G3 commercialization, and the China launch.

Q2 GAAP operating income was $16.6 million, of which Invisalign contributed $26.5 million and scanner and CAD cam services lost $3.2 million, resulting from the incremental cost to integrate Cadent operations.

Q2 GAAP operating income also includes acquisition and integration-related costs of $5.9 million and the amortization of acquired intangible assets of $800,000.

This compares to GAAP operating income of $21 million in quarter one and $45.3 million in the same quarter a year ago.

Q1 GAAP operating income included legal and account fees of $1.5 million associated with the Cadent transaction.

Q2, 2010 operating income included a benefit of $14.3 million of net revenues from the release of previously deferred revenue relating to Invisalign Teen replacement aligners.

And a credit of $8.7 million to operating expenses for an insurance settlement related to ortho pre-litigation.

Excluding these items, Q2 non-GAAP operating income was $23.3 million or 19.4%.

This compares to $22.5 million or 21.5% in Q1, and $22.4 million, or 23.8%, in the same quarter last year.

The sequential decrease in non-GAAP operating margin primarily reflects an operating loss from the scanners and CAD cam services for the two months of quarter two.

Q2 GAAP diluted earnings per share was $0.14, compared to $0.20 in quarter one and $0.42 in the same quarter last year.

Q2 non-GAAP earnings per share was $0.20, compared to $0.21 in both Q1 2011 and in Q2 of last year.

Moving on to the balance sheet.

Cash, cash equivalents and marketable securities were $179.5 million, reflecting cash paid for the Cadent acquisition.

This was compared to $312.4 million at the end of 2010.

In Q2, we regenerated roughly $29.7 million in cash from operations, compared to $17.2 million in Q1 and $42.6 million in the same quarter last year.

Q2 DSO's were 62 days, compared to 63 days in Q1 and up slightly from 60 days in the same quarter last year.

Now let's turn to our business outlook for Q3, 2011.

Before I get into the details, I'd like to outline several factors that contribute to our view of Q3.

As you know, our business experienced seasonal and other trends related to our customers and their end-markets that they serve.

The summer timeframe is typically the busiest time for ortho practices that have a high percentage of adolescent and teenage patients.

Last year we saw good sequential growth for Invisalign from Q2 to Q3 in the ortho channel and expect that we will continue to gain share of orthodontic case starts of this year.

We believe the expected growth in teenage case starts will be offset somewhat by slower patient traffic in North America GP and European doctors' offices due to summer vacation schedules.

Additionally, the economy has been a bit softer in some parts of Europe, particularly the UK.

Lastly, sales of capital equipment like interoral scanners are often stronger in the second half of the year and typically peak in Q4.

With that, let's get into our outlook.

For Q3, we expect revenues to be in the range of $118 million to $123 million.

The Invisalign case volume is expected to be in the range of 75,000 to 78,000 cases.

We expect Q3 GAAP gross margin to be in the range of 73.4% to 74%, including amortization of intangibles and integration costs of $300,000.

Excluding these costs, we expect non-GAAP gross margin to be in a range of 73.7% to 74.3%.

The sequential decrease in Q3 non-GAAP gross margin primarily reflects revenue deferrals associated with a new sales promotion that's intended to help drive adoption of Invisalign Teen.

In Q3, for every Invisalign Teen case a doctor starts, they will receive a free order of Vivera retainers that they can use on any patient through the first quarter of 2012.

Q3 non-GAAP gross margin also reflects anticipated additional rebates associated with increased participation in the Advantage rebate program, as well as a full quarter of cost of sales from scanners and CAD cam services.

In Q3, we expect GAAP operating expenses to be in a range of $69.6 million to $71.6 million, which includes amortization of acquired intangible assets of $900,000, and $1.4 million for retention and integration-related costs.

Excluding these costs, we expect Q3 non-GAAP operating expenses to be in a range of $67.3 million to $69.3 million.

The increase in Q3 operating expense reflects investments in key areas, including sales force coverage for North America and Europe, marketing programs in support, and R&D projects focused on accelerating installed-base growth for scanners and increased adoption of Invisalign.

Beyond Q3, we expect there will be fluctuations in spending as we continue to ramp head count associated with the scanner sales force and trainers, along with the timing of media spend, significant trade shows and industry events, and continued international expansion.

We expect Q3 GAAP operating margin to be in a range of 14.4% to 15.8%, and GAAP earnings per share to be in the range of $0.14 to $0.17.

We expect Q3 non-GAAP operating margin to be in a range of 16.7% to 18%, and non-GAAP earnings per share to be in a range of $0.17 to $0.20.

In Q3, we expect the effective tax rate to be approximately 28%, and diluted shares outstanding to be approximately 82 million.

We expect cash on hand to be approximately $195 million to $200 million.

Now I'd like to transition to provide a couple of directional comments and perspective on 2011.

From a revenue perspective, we believe we are focused on the right strategic levers, and with our expanded product family, including scanners and CAD cam services, we expect to gain incremental leverage from our investments, and believe we will continue to grow and gain share during the back half of the year.

We expect GAAP diluted earnings per share for the year to be in a range of $0.65 to $0.70, which includes acquisition and integration-related costs and amortization of acquired intangibles.

Excluding these costs, we expect non-GAAP diluted earnings per share for the year to be in a range of $0.75 to $0.80.

With that, I'll now turn the call back over to Tom for some closing comments.

Thanks, Ken.

We're pleased with our overall progress and believe that our strong Q2 results stem from good execution of the right strategy.

Our goal from the beginning here was to continue this good execution, while managing through the potential distraction of the Cadent acquisition and integration.

As you can see from our results, the core Invisalign business remains very strong.

Customers are recognizing the benefits from significant innovation like G3, and trusting us to help them deliver great clinical outcomes on more complex cases.

In addition, Align is becoming an even more valuable partner as we expand the market and deliver practice growth.

And as a result, we're earning a bigger role in their practices and their success.

The increasing usage of Invisalign for more complex cases will especially serve us well as we seek additional growth outside of North America, where highly complex cases are the norm.

For some, it's the dog days of summer.

For us, it's just about our busiest time of the year as consumer marketing initiatives are in full swing, moms and teens are out shopping for braces or Invisalign, and our team is working hard to wrestle share away from traditional treatment.

We're doing our best to continue the solid execution, even through these uncertain times, and I look forward to updating you on our continued progress during our next call.

With that, I'll turn it over to the operator for questions.

Operator?

Thank you ladies and gentlemen at this time we will be conducting a question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Matt Dolan with Roth Capital Partners.

Please proceed with your question.

Hi guys, good afternoon.

Good afternoon.

First question, Tom, is on Teen.

You went over qualitatively the impact that you saw in the quarter.

Can you maybe compare what we should expect in terms of the magnitude of that impact in Q3, relative to where you are in Q2?

Was it for all of Q2 or only part of it, and maybe we get the full impact in Q3, is that a fair way?

Well first of all, at a high level, the guidance in the framework Ken provided captures that, so that's at a quantitative level that's captured.

At a qualitative level, we believe that we're going to continue to make gradual progress.

This is both the busiest time of the year, it's also our trickiest time to take share.

But with -- as I think I described -- with the combination of recognition for complexity of cases, with G3, the clear feedback we got while at AAO, and the good coverage we've got out in the marketplace, consumer programs all coming on-line, we think this is -- this will be a great test for us this year, and we expect to continue to take some share.

But it is a wrestling match out there against the big players.

Okay.

Then shifting to Europe and some of the areas where you experienced some softness, is there any way to quantify what you've seen there and where you are in terms of taking corrective action?

Is this something that continues to pressure you for the next few quarters or something that maybe you can offset with some sales and marketing tactics.

Well in general, a year, year and a half ago we saw some softness more in Germany.

Their economy is moving along pretty well.

And for us, Germany and France are strongest.

Italy and Spain were pretty slow in Q1 but we saw recovery in Q2, and so despite the challenges there, we would expect for our business to see some progress there.

UK has been -- which was for us the biggest individual country market -- has been hit the hardest over the last year or so as the austerity measures have affected virtually every part of that economy.

In addition -- so now we come back to what we can do.

In the other places we continue to make incremental progress in each of those other markets, investing incrementally in sales coverage and programs and the like.

In the UK we're going a bit further.

We're working hard to build a better team there, bringing in new country management, which we're in process of doing, and adding some additional resources.

There are chunks of that geography in UK that have not been covered adequately by us, and they present opportunities.

So we think the UK will get back.

That's the execution part.

More substantively, I think that will happen more visibly as their broader economy improves.

And we think that's -- I can't put a time frame around that.

I guess, let me ask you in a different way.

If I just look at your international procedure case volume was up mid-single-digits for the first time in a long time.

Prior to that it's been 20% or better than 30%.

Is this kind of the new normal for the next few quarters due to these challenges?

You know, there's two things.

I think with the UK slowing down in general, that has had an effect.

The second thing is, we had a better than expected Q1, which on a sequential basis, takes a little bit of that, that comp, makes that comp tougher.

But the bigger issue is, given to some other companies that we know of that do business over there, we've done pretty well, given the environment.

I think we can do better than that in the UK, but I don't think we're going to get, we might not get that back to that high level of growth until the broader European engine starts to hum again.

Okay, and then Tom, on the expense side of things, you've mentioned that operating margins -- we'll see some fluctuations in spending?

What does that mean?

I know your long-term target is 25% to 30%.

In the near term, you're in the high teens in Q3.

Maybe calibrate Q3 relative to that long-term target -- is this the high end of the fluctuation, low end or right in the middle?

Well, this is Ken, Matt.

So from an operating expense point of view, we'll have a couple things going on here that are somewhat offsetting.

First of all, as you know we're adding additional sales head count in place for the scanner business in North America, as well as trainers who actually get the systems installed in the doctors' offices, as we're looking at volumes here in the business.

So there will be an increase in sales expense as we go forward from that perspective.

And also in the R&D area as we continue to invest in having applications at tier sites, those types of things.

If you think about some of the seasonalities in the business, what I was trying to describe is, we have big trade shows in the fourth quarter, like the ADA, and greater New York trade show.

We have pretty significant presences there, so there's more cost associated with those trade shows.

We come off a little bit more in advertising in the fourth quarter than we do in the second quarter or third quarter, and we had a pretty heavy push this past quarter for advertising.

So I really refer you to those kind of things and thinking through your model here.

But over the next several quarters we're still going to be adding in costs to integrate Cadent until we get it fully integrated and we get sales teams built out and training teams built out, et cetera.

Etc.

So -- .

Go ahead, Matt.

Sorry.

So Q3 is what in this range of fluctuation.

Are we in the middle, or is it high or low?

I would describe it more in the middle.

You will see it go down a little bit over time, depending again on seasonality of trade shows, those types of things.

But you'll see it go up at different periods of time, too.

Like again, coming into quarter two of next year, quarter three of next year, and we push heavy on advertising again, you'll see expenses going up.

Also, if you think about timing of employee compensation and benefits, Q1 we have our annual cycle for that as well.

So I'd say it was probably in the middle of the range.

The other thing I'll just add, to pile on.

This is a long-term model for us.

We're more confident then ever that we can live very well inside that model, and expect over time to create leverage in the business in every area.

Okay.

Thanks for the time.

Thanks Matt.

Next question?

Our next question comes from the line of Jonathan Block from SunTrust Robinson Humphrey.

Please proceed with your question.

Thanks and good afternoon.

Hi John.

Hi, Tom.

Maybe the first one, Ken, for you.

You gave out a lot of numbers and it's going to be very helpful when we get to back over the transcript, but one that I'm just trying to pull out and I want to throw it out in front of you.

I think you said the Invisalign-only business on a non-GAAP basis, the operating income was $26.5 million.

Is that right?

And then if you're sort of running through at your normalized tax rate, the Invisalign standalone would have been $0.24 versus your guidance of $0.19 to $0.21.

Is that fair.

That's the way I would work the math.

Absolutely, John.

Okay, so $0.24 standalone.

Got it.

Then, this builds a little bit on Matt's earlier question.

On international, I know you can't really hold off demand per se, just the way your business model works.

But you were rolling out G3 throughout the quarter.

It was Tom, as you described it, a very complex launch, a lot of different languages.

Would you describe the end-user demand in your international markets as mid- to high-single-digits, whatever you put up, or do you think it's a little bit greater than that?

And the fact that you've now got G3 fully out there, we can see some modest re-acceleration in the international growth rate?

From everything we can see, first of all, when you look at the numbers, our degree of penetration in Europe, even in our -- the five core countries, is even -- is an order of magnitude less than North America, which is already low.

So there doesn't appear to be any issue with underlying demand.

If you look at some of the reports from some of the other larger dental players that have been reporting good patient demand and traffic, including geographies in Europe as well as North America, we think the fundamental demand is there.

For us, this was a very big lift to commercialize G3.

Just taking Europe, forget the rest of world for just the movement.

In all those different languages with support models in each country, and literately the team pulled away from their -- what I call the normal cycle of practice development and planning for evolution of their practice -- and were really laying the groundwork for this release, training up to the release and then supporting after that release.

We didn't do, -- for good reason -- we didn't train new docs, which had been a growth driver.

We didn't do some of those other activities.

Clinical study clubs, workshops and the like, because we would have had to go back and re-do those with G3, obviously.

It was that different for the user experience.

So with all that said, we're very comfortable and the field team is very comfortable in Europe that all the demand is still there, and that this was an investment of effort, especially given the relatively higher case complexity to give them, to give our doctors a better tool.

Now, we had a chance to check in with that, and just as we did with AAO in May, we were at our International Summit, really more a European Summit in mid-June, and the feedback, very fresh for them.

Again, at AAO we had a couple quarters of usage.

But literately after just roughly a month of usage, the feedback from, virtually all orthodontist base of attendees was outstanding, and reinforces our belief that was the right thing to do.

So for us, this was -- maybe I'll say it this way -- a strategic use of tactical resources.

We expected this to happen when we pulled away from training and all those other practice-development, practice-building activities.

So, we expect that to return, and if I go back to the last question, separate and aside from the economy, we expect a normal rhythm to return to this business.

Frankly, even as we head towards holiday, we're seeing that from that business.

Okay, great, maybe one or two more quick ones.

Tom, I'll probably, ask you this question for quarters to come.

I know it's a little bit early, but you mentioned some of the orthodontists submitting cases via Cadent.

When you take a step back, and I know your sample size is pretty small, but what are you seeing from those physicians?

In other words, are you seeing just a tremendous step up in utilization from those docs that have made the transformation over to digital?

Are you seeing a little bit of a step up?

Is there no change at all?

Any clarity there, considering that's probably the future of where you're headed with your work flow would be helpful?

Sure.

Again, we've had the more IOC systems sold.

Orthodontists, that's been the events at AAO and all that, but we've been successful with both selling GPs the iTero system and orthos the IOC.

the orthos with the IOC are the ones currently submitting cases, and we've seen -- they are using them on virtually all Invisalign cases.

In other words, they're immediately going away from PVS.

So their behavior has been -- with a GP, it's more around work flow and productivity; for an ortho it's around differentiating their practice and improving the patient experience.

A number one dissatisfier for the patient is that -- what they call a yucky PVS impression.

The upshot is, we're seeing them where they put a system in place, use it across the board for all their impression-taking, and they're very very excited.

Now at a quantitative level, we can actually measure fit, control, we've actually done studies with a number of docs that did trial for us, and blinded, patients and doctors got multiple sets -- aligners and PVS, and they were able to, in almost every case, picked -- they didn't know which one, we randomized it for them.

But we had the control, they picked the IOC system aligner for fit and quality of fit and everything else.

We think there's longer-term great opportunities for us, not just to deliver better patient experience.

I guess that's both a little bit of qualitative and quantitative.

I'm not sure if that gets to your question.

No, it does, perfect.

Then I'll follow-up with you guys off-line with the rest.

Thanks.

Thanks, John.

Next question, please.

Our next question comes from the line of Spencer Nam with Madison Williams.

Please proceed with your question.

Thanks for taking my questions.

Just a couple questions here.

First of all, on China, I'm curious whether you guys could provide a little more detail on how the operations are, unfolding?

You guys already training doctors and how do you expect the up-take on these cases would be?

There could be some pent up demand, for example, in the coming months.

What are you guys initially seeing out of China?

Well, I mean, if I had to describe several words to describe our approach, it's going to be a gradual building of a very strong foundation.

The foundation is going to come from the key opinion leaders and the teachers, the top orthodontist and the chairs of these important ortho and dental schools, literately doing cases, they and their staff.

We want them to actually see the results and then be able to teach it.

Maybe there's an argument to be made for moving more quickly, but as we looked at this, we saw the biggest single country market after the United States, and we believe we have the luxury of really doing this right, and so we're investing in that right foundation.

As we move through 2011 into 2012, we're going to see those cases come about being finished, and we will have the opportunity to potentially step on the gas in the 2013 time frame a bit more.

But really, the first year or two is going to be to build the right base of users, and then to ensure they're getting great results on these highly complex cases.

So I'd rather have you be in sync with that, knowing that we're taking a thoughtful kind of foundational approach here, rather than just going for a big bang fast.

Great that's helpful.

And then the second question is, I guess it's kind of a two-pronged question, but essentially similar in its flavor.

China, you may run into this sort of knock-off issues, the illegal use, the infringement of IP on Invisalign.

In the US, you also have some competitors floating out there.

How do you describe the US competitive situation, and also, with respect to China, how are you guys going to protect your IP on Invisalign?

Let me maybe start with the US, and there are a variety of places people can get aligners.

There's some big companies, like the majors that have been trying for ten years and more, longer than we've been around, to build clear aligner businesses, with some success.

We never underestimate anybody.

Then, you can buy low-end cases from labs and all kinds of places.

You certainly are aware of the litigation we've got going with Clear Correct, which we believe clearly infringes.

And we're going to continue to pursue that, where those opportunities exist.

But we think, in general, competition's a good thing.

We just think people ought to invent it if they're going to go compete in a certain way.

So our shareholders ought to know that we are both -- we're going to be very willing to defend our intellectual property over time, but we're also moving ahead at a very fast clip, and we continue to file new disclosures and get new patents issued, and we're consistently ranked as one the most innovative medical devices out there, with patent scorecard and that sort of thing.

Again, the best way to compete is to keep moving forward and innovating.

By the same token we're going to be a tough competitor, and that includes enhancing our own product and bringing the G3 quality and the Invisalign quality to the whole thing.

Very few people can match what we do and how we do it.

If I go offshore again, we've organized our affairs in China so that we have very much just a commercially facing operation.

And yet we do have, we do have patents on file and issued there, including I think two of them, that have earlier dates compared to any other products and companies over there.

I mean, we're going to China with our eyes wide open and know it's a free-for-all competitively, but we are already being referred to as the real aligner company.

Some of the doctors have spoken in -- about just how limited any of the local offerings are.

And so our goal is -- this goes back to the previous question about how fast are we going to go?

We're going to further differentiate the quality and control of, for even the most complex cases, so that the most, the leading orthodontists in the country can say this is what you need to be using, it's a completely different experience.

That's another good reason.

That will ultimately, because of the high case complexity, be a huge differentiator for us.

That said, it's a competitive world, and we're prepared to go compete.

And making sure we do that is the order of the day.

Thanks much.

Thank you, Spencer.

Next question, please.

Our next question comes from the line of Ethan Roth with WJB Capital Group.

Please proceed with your question.

Thanks for taking my question, and congrats on the great quarter here.

Thank you.

So my first question is related to your higher EPS guidance.

I'm just trying to understand what is driving the upside.

Is that a function of sales maybe out-performing expectations this quarter, or even maybe the Cadent integration progressing a little bit faster than originally planned?

Are you talking about Q3 specifically, Ethan?

I'm Talking about the annual.

Talking about the annual.

Okay, just wanted to make sure.

Couple things here.

We gave out some non-GAAP EPS guidance back in the call last quarter.

That was before we really had rolled around in what was going on in the Cadent business and also with our business itself.

With the strong performance we had this quarter of the underlying Invisalign business and generating the $0.20 earnings per share on the non-GAAP basis, we thought it was one, appropriate to put out what we think is a range of guidance for the full year; and two, keeping in mind that we still have integration costs that we're going to be adding into the business over the remainder of the year.

As Tom said on the call, the integration is going well and proceeding very nicely.

We've just had some nice growth in the underlying business -- that'd be the Invisalign business.

If I just add one more piece of it -- and you're not seeing it in revenues at this time -- but we had mentioned that we had some good presence at trade shows like the AAO show back in the May time frame, and a lot of doctors visiting the booth, interested in interoral scanners as well.

I think you have a lot of those things moving in that direction, but in the end of the day, we wanted to make sure we updated the guidance we gave last quarter on a non-GAAP basis.

Okay, thanks and just my second question's regarding the 3Q revenue guidance.

If I take the $120 million you did this quarter and just add an additional month of Cadent revenue, I get to the high end of your sales guidance for 3Q, I know there's a lot of different moving parts there.

But seems like the underlying business has some pretty positive momentum.

Q3 is seasonally pretty strong in North America.

So is that you guys being conservative given everything that's going on with the economy in Europe, or maybe the Cadent sales?

Thanks.

No, we call the business like we see it.

I think you've just got to go back to the comments I made, which was in North America with the teen product in the marketplace, we think the ortho channel has opportunities to continue to gain share away from wires and brackets.

Typically, during the summer the GP business, as well as the international business, tends to fall off a bit, just due to seasonality with holiday seasons and vacation schedules, we're anticipating that will occur again this summer, and yes, you will get a full quarter of scanner and services revenue in this as well.

So those are really the three moving parts.

You've got -- summers tend to pretty slow in the international arena, particularly in core Europe.

Then in the domestic side of it, GPs -- there's a lot of holidays and vacation schedules going on with families and doctors and other things that impact that side of the business.

Thanks very much.

Okay.

Thanks Ethan, next question, please?

(Operator Instructions)

Our next question comes from the line of Jeff Warshauer from Sidoti & Company.

Please proceed with your question.

Hi, good afternoon everyone.

Thanks for taking my call.

Afternoon.

Just one question today.

I was wondering if you guys still had plans to roll out the manufacturing facility outside of North America and if that was more of a function of capacity, or looking for cost savings down the road?

Tom Prescott here Jeff.

It's both.

We're actually -- we've been making incremental investments with some new technology into our existing facility.

We would look to enhance that over time.

At the right time, at the near-term, given the continuing growth in North America, we're probably leaning a little more into incremental expansion in our existing facility in North America, or something like it.

And then we'll layer on some capacity in the broader Euro area sometime a little more down the road.

But that's our current posture.

The way I'd have you think about it would be kind of in the normal course of costs and investment, and all those kinds of things.

Okay.

Thanks a lot.

Thanks Jeff.

Operator, we'll take one last question, please.

Our last question comes from the line of Jeff Matthews with Ram Partners.

Please proceed with your question.

Hi everybody.

Hi Jeff.

Hi Jeff.

I have a two-parter.

One is, with Cadent, has there been any unwanted turnover in the management team?

And then the second question is -- Tom, you mentioned fighting it out with competition, that you're duking it out in the marketplace.

I just wondered if there's anything new under the sun in terms of any competitive aligners or new technologies out there that you're seeing, or if that's just normal course of business?

Thanks.

Sure.

I'll take the first part and that is, we're really thrilled with the Cadent team.

When we looked at this, we wanted more than just products or anything like that.

We were looking at a complementary set of capabilities, a complementary set of skills, and a whole bunch of new opportunities and restorative that we were more ortho-focused, they do both ortho and restorative.

The short answer to your question is, Tim Mack, their CEO is now our Senior VP of Business Development and reports directly to me, out helping us build this thing further, and think about relationships and alliances with others.

Every other -- the first week of the announcement of this deal and then right after closing, literally all the reporting structures were re-done.

Their entire organization has been integrated into ours, and it's been a lot of learning for everybody, but of the senior team -- and actually I'm hard-pressed to think about down a level or two -- we haven't lost anybody we wanted to, and everybody's working pretty hard.

But boy, they're in a position at -- we're the students, and we're learning restorative from them, and we're helping them get after the dreams they've always had, including one the founders, Avi Kopelman, who has actually decided to relocate his family out here to the Bay area, where he can have even greater impact.

So we're pretty excited by that.

We have a lot of work to do.

The teams are working at it.

Very pleased as I said.

All of our internal milestones are on track or finished.

When I talked about the wrestling match in the summer season for teen starts, most of that is with the traditional brackets players.

Anything but tradition, every one of these brackets manufacturers has gotten their game better with lingual, with self-ligating, with clearer, smaller, lower-profile brackets, and this is still the, the dominant form of treatment by this community of specialists.

So for us to get mom and teen to go to a teen product, we really have to work pretty hard.

It's a change in behavior for them.

And as I keep re-emphasizing, we're doing great.

And even though by some device standards this is not doubling or tripling, but by dental market and ortho market standards, the growth we've achieved here is spectacular, and our competitors don't like it.

On the other side, clear aligner players.

As I said, I think to an earlier question, there's a lot of players providing clear aligners from the majors.

We certainly expect MTM to come out some point from dense ply.

And we have seen Simply Five for many years in its variations from Ormco, and you know of Clear Correct.

There's a lot of ways to buy especially a very simple case.

So this is why we continue to make sure we're a good competitor with Invisalign Express, and we bring all the features and capabilities of G3 and the latest and greatest technology to make sure whoever we're up against for any other treatment, we're continuing to be the best choice, as well as the best value.

But there's been no -- there have been no big entrants or no big news, it's just a very hotly contested space.

We're doing our best to continue win share and grow the market.

Understood.

Thanks very much.

And I just -- if I can do one more quick thing.

Someone handed me a note, I misspoke earlier.

We actually have, have five patents now issued in China, and are continuing to assert more.

So I apologize for that.

That's great.

Well, thank you everyone for joining us today.

This concludes our conference call.

We look forward seeing you at upcoming financial conferences, including the Morgan Stanley and UBS healthcare conferences in September.

If you have any further questions, please contact Align Investor Relations.

Thanks, and goodbye.

Ladies and gentlemen, this does conclude today's teleconference, you may disconnect your lines at this time.

Thanks for your participation.