愛齊科技 (ALGN) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Align Technology second quarter 2012 earnings call.

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

A brief 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 Ms. Shirley Stacy of Align Technology.

Ms. Stacy, you may begin.

Good afternoon, and thank you for joining us.

I'm Shirley Stacy, Vice President of Corporate and Investor Communications.

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

We issued our second quarter fiscal 2012 financial 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 approximately12 months.

A telephone replay will be available today by approximately 5.30 PM Eastern Time through 5.30 PM Eastern Time on July 26, 2012.

To access the telephone replay, domestic callers should dial 877-660-6853, with account number 292 followed by pound and conference number 396846, 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, and the expected financial results for the third quarter of fiscal 2012.

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

These and other risks are set forth in more detail in our Form 10-K for the fiscal year ended December 31, 2011.

These forward-looking statements reflect 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 for these previous 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 results press release which we have posted on our website under Financial Releases and have furnished to the SEC on Form 8-K.

We encourage listeners to review these items.

We have also posted a set of GAAP and non-GAAP historical financial statements including the corresponding reconciliations and our second quarter conference call slides on our website under Quarterly Results.

Please refer to these files for more detailed information.

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

Tom?

Thanks, Shirley.

Good afternoon, everyone.

On the call today, I'll provide an overview of our second quarter results and discuss the performance of our two operating segments, Invisalign Clear Aligners and Scanner and CAD/CAM Services.

Ken will discuss our Q2 financial results and outlook for Q3 in more detail, and then I'll come back with a few closing comments and open the call up to questions.

The second quarter was another great one for Align, and I'm pleased to report strong results for revenue, operating margin, and EPS all better than our outlook.

During the quarter, strong Invisalign volume grew across all products, customer channels, and geographies, reflected continued increased Invisalign utilization.

Our Scanner and CAD/CAM Services business in North America also grew nicely this quarter and continues to exceed our expectations while Scanner sales in Europe remained challenging and our disappointing results there continue.

For Q2 total Invisalign case volume was 95,300, an increase of 12% sequentially and 25% year-over-year, driven by growth in all customer channels.

From a product view, Invisalign Full and Invisalign Express, which includes Invisalign Express 5, launched last quarter, drove sequential and year-over-year growth.

Invisalign Express 5, our five-stage aligner offering for very simple cases, is hitting the right value point in the market in getting some traction with patients who want to correct a little crowding or spacing but believe current comprehensive orthodontic treatment is just too expensive for minor corrections.

We are primarily seeing Invisalign Express 5 usage from our experienced more customers, both orthos and GPs alike.

These docs are pricing this treatment from around $1,200 to $1,800 a case which is helping them treat more patients and expand the market.

For North American orthodontists, Q2 case volume of 35,400 cases increased 10% from Q1 and 24% year-over-year driven primarily from increased utilization of all Invisalign products.

We believe utilization growth is a result of improved product efficacy from new features and functionality in Invisalign G4, as well as increased patient demand for Invisalign stemming from our consumer marketing initiatives.

We also saw good growth in the Invisalign Teen product in Q2 reflecting our continued progress in the overall teenage ortho segment.

For North American GP dentists, Q2 case volume of 37,300 cases increased 13% from Q1 and 21% year-over-year.

This quarter, we saw another record number of GP submitters combined with an increase in product utilization as our base of GP customers continues to expand and their use of Invisalign increased across the board.

As described a moment ago, Invisalign Express was up nicely for our GP customers in Q2 reflecting the recent launch of Invisalign Express 5.

The teenage orthodontic market, which for us consists of teenagers 11 to 19 years old using any Invisalign product, is the largest segment of orthodontic case starts and represents a great opportunity for us to continue taking share from existing wires and brackets [K] starts.

Q2 was a strong quarter for teenagers using Invisalign with the total number of teens starting treatment at 20,300, or 21.3% of worldwide cases.

This is an increase of 13% sequentially and 29% year-over-year, a nice increase from the same quarter last year when total teenagers grew 7% sequentially and 6% year-over-year.

The Invisalign Teen product is primarily targeted at younger teens, 11 to 15, and has specific features such as compliance indicators and eruption tabs to address the needs of younger patients.

For Q2, Invisalign Teen case shipments were 11,900 thousand cases, an increase of 19% sequentially and 38% year-over-year, very positive indications of our continued progress.

Both orthos and GPs took advantage of the Invisalign Teen Vivera Retainer promotion that ran this quarter which includes a free Vivera Retainer subscription for every Invisalign Teen case a customer buys.

The objective of this promotion is to drive penetration of Invisalign in the teenage ortho segment during the summer season and generate broader trial and use of Vivera retainers.

During Q3 last year when we first offered the Teen Vivera promotion, we saw a strong uptick in Invisalign Teen cases, and since then, the doctors who participated in the promotion have subsequently continued to grow their case volumes consistently.

In addition, Vivera Retainer volume has accelerated steadily as well because of the success we saw last year in case volume and doctor behavior.

Given that impact, we decided to initiate the promotion in May a month earlier than last year in order to have the offering in place for the entire teenage peak summer season.

For international doctors, Q2 case volume of 22,600 cases increased 13% from Q1 and 35% year-over-year, driven primarily by growth in our direct business in Europe, as well as by continued strong performance by our APAC distributor.

In Europe, we had good growth across all countries led by the UK where growth has resumed and where we continue to make good progress with both orthos and GPs.

During the quarter, we launched Invisalign i7 in the UK, a seven-stage aligner offering for minor crowding or spacing.

Much like Invisalign Express 5 in North America, Invisalign i7 increases the treatment options for doctors with a cost-effective product that is specifically designed for minor tooth movement.

Additionally, Invisalign Teen grew nicely this quarter in Europe and has begun to gain traction in the teenage market albeit off a small base.

We also had very nice growth from China and Japan.

Q2 marked the one-year anniversary of our commercial launch in China where we are successfully executing our focused strategy of working in the top four cities with key opinion leaders and leading orthodontists.

Over the past year, we have successfully launched Invisalign Full and Invisalign Teen in China.

We have made great strides at those KOLs in top doctors and established a strong base of local advocates while gaining access to the pricing system of numerous major public and university hospitals.

We are also seeing good traction from recent initiatives to train Chinese doctors and help them develop the skills and knowledge to build their Invisalign business.

Overall, interest in Invisalign is high, and we remain very optimistic about the long-term growth opportunity there in China.

Q2 growth from our Invisalign distribution partners continues to be driven by our APAC partner.

Our other partners in EMEA and Latin America are also doing well and continue to expand their customer base and drive for utilization growth.

Our Invisalign distribution partners represent an important long-term growth lever, but I'll point out that they are only about 3% of our total worldwide revenue today.

Continued adoption across customer base in Q2 is reflected in our key Invisalign metrics of utilization and new customer training.

Overall utilization rates remain strong across all channels, particularly among North American orthos.

As expected, we trained more GPs this quarter, typical for us as we offer fewer CU1 courses in Q1.

In addition, almost half the total number of new doctors trained in Q2 were international doctors, reflecting our continued growth and expansion outside North America.

Now, let's turn to consumer demand where our integrated consumer marketing platform combines paid media like print, broadcast, and digital along with a mix of PR, event marketing, and social media outreach.

The goal of this platform is to raise awareness of Invisalign and Invisalign Teen as the best options for a healthy, beautiful smile among adults and teens and their parents, particularly moms.

In addition, it is important for us to help these potential patients find a great practice that can meet their needs.

Activity on our consumer website is a good measure of progress on this front.

Prospective patients can get more information, take an interactive smile assessment, and search for Invisalign providers in their area.

At the end of Q2, we had nearly 3 million visitors to Invisalign.com to date this year, up 40% from the same period in 2011.

Website leads are up 45% from this time last year, and we continue to see increasing traffic from mobile device users particularly when our ads are running on TV.

We launched the Invisalign.com mobile site at the end of June to leverage this traffic with a site optimized for mobile visitors particularly those on Smartphones.

Website traffic, like many of our consumer metrics, is positively influenced by our on-air TV presence.

In Q2, we began leveraging the peak teen season by running our twins TV commercials to reach moms and teens.

We'll be on-air with these commercials through the end of August with a short break during the Olympics at the end of July.

Our TV presence during the important summer months is supplemented by radio, digital, and traditional PR and event marketing, including our second year sponsoring Radio Disney's Next Big Thing Tour which includes elements of all those marketing channels.

We began running Radio Disney spots in Q2 and officially kicked off this year's tour on July 1 in the Chicago market and with the online launch of the Disney Invisalign Teen Straight Up Celebration Sweepstakes which will run until the tour ends in December.

We expect another successful year with this Disney initiative as it gives us an opportunity to reach the very engaged Disney teen audience and their parents at local market events and through Disney's radio, TV, and online properties.

On the public relations front, we're continuing to target both moms and adult female audiences through editorial coverage that not only builds awareness for our brand but also educates about the benefits of treatment.

One of our most recent examples from our PR effort on this front was a very nice segment on the CBS daytime talk show The Doctors which aired on July 10 on the Hide It, Fix It, and Flaunt It episode.

The segment, which featured an Invisalign patient and her doctor talking about treatment, reached the show's audiences of more than 3 million viewers.

If you'd like to see the clip, search for invisible braces for crooked teeth, or you can reference the link in today's webcast slides.

Consumer demand initiatives have always been an important part of our strategy for market expansion and sustained growth in North America.

Over the past few years, we have also been laying the foundation for directed consumer advertising in appropriate markets in Europe.

Given these economic times, it may seem counterintuitive, but it is really an opportune time for us to establish our brand, build awareness, and get placements at a lower cost in this area.

We've started to implement programs in select country markets such as our recent launch of TV advertising in Spain, in the UK with an integrated marketing campaign around our sponsorship of the UK version of the Bachelor TV show, and the continued success of the Right Bite campaign in Germany featuring former football star, Matthias Sammer.

All of these are serving to help educate teens and their parents.

Combined with good PR and digital marketing activities across the EU markets, all of these integrated marketing elements are designed to help raise awareness of Invisalign as the best treatment option in this very underpenetrated market.

Moving on to our Scanner and CAD/CAM Services segment, Q2 revenue was $11.9 million compared with $11.8 million in Q1, a slight increase from Q1 which reflected strong North American scanner sales offset by lower service revenue in international scanner sales.

Our Scanner business continues to exceed our expectations in North America.

We're getting leverage from the combined efforts of our Scanner and Invisalign sales team especially at major Invisalign events including the AAO meeting in May and several customer forums held across the US in Q2 which were primarily for GP dentists.

All in all, we're seeing terrific progress in North America, almost good enough to offset some of the performance gap in Europe.

While it appears the capital equipment market remains soft in Europe, we're just not satisfied with our execution and results in this area and are working to remedy the situation.

Given these challenges, over the near-term, we're not expecting any significant improvement from our Scanner and CAD/CAM Services business in this region.

With the majority of our New Jersey consolidation completed, we have closed most of the gaps in Scanner customer service, technical support, and delivery that I mentioned last quarter which were felt most acutely by legacy iTero customers.

Our continued evolution in hardware and software applications, along with our maturing customer support resources, will take care of any remaining matters over the next quarters.

We're making great progress on product, systems, and technology.

As our strategy evolves, our near-term focus is on maximizing Invisalign leverage both in driving new Scanner sales, as well as increasing adoption and utilization of Invisalign.

Since Invisalign Interoperability became available, we have seen digital impressions begin to replace traditional PVS impressions, and as of Q2, 12.8% of North American cases were submitted with a digital impression from an iTero or iOC scanner instead of a PVS impression.

This is up from 9.2% last quarter and 5.9% in Q4 of 2011.

The trend toward accelerating digitization is very positive as Invisalign is one of the very few treatment modalities in dentistry that relies fully upon digital technologies.

This trend also benefits our customers as it reduces cycle time, eliminates hassle, and results in a more positive experience for their patients.

As we invest and accelerate product development, we will launch high value applications like the outcome simulator expected later this year along with even more applications to follow.

We know it is working well in the Scanner business.

We see it every day in North America.

We have an opportunity to replicate that success elsewhere.

We're committed to investing the time and resources needed and know we can get things back on track in Europe.

I'll now turn the call over to Ken for a review of our Q2 financial results.

Ken?

Thanks, Tom.

Before I get started, I would like to remind everyone that there are several items that we exclude from our GAAP results when we report non-GAAP results.

These include acquisition and integration-related costs, amortization of intangible assets, and severance and benefits costs for the New Jersey consolidation.

In my comments today, I will not review the total dollars excluded for non-GAAP gross margin, operating expense, and operating margin, and instead refer you to the press release tables Reconciliation of GAAP to Non-GAAP Key Financial Metrics and the business outlook summary for a complete reconciliation.

Now, let's turn to the second quarter financial results beginning with revenues.

Q2 net revenue was a total of $145.6 million which consisted of Invisalign revenue of $133.7 million and Scanner and CAD/CAM Services revenue of $11.9 million.

This is a sequential increase of 7.8% from $135.1 million in quarter one 2012 and a year-over-year increase of 21.3% from $120.1 million in Q2 2011.

Q2 Invisalign revenue of $133.7 million increased 8.4% compared to Q1 revenue of $123.3 million and increased 17.6% compared to Q2 2011 revenue of $113.6 million.

The sequential increase in Q2 revenue was driven by Invisalign volume growth in all channels and products.

This was partially offset by lower Invisalign ASPs resulting from advantage rebates, promotional activity, product mix, and to a lesser extent, foreign exchange rates.

On a year-over-year basis, Q2 Invisalign revenue growth was driven by volume increases in all channels and products.

Q2 Scanner and CAD/CAM Services revenue of $11.9 million increased from $11.8 million in Quarter One and was driven by North American Scanner sales.

Q2 2011 revenue of $6.4 million included only two months of Scanner and CAD/CAM services revenue as we closed the acquisition of Cadent Holdings, Inc.

on April 29, 2011.

Now, moving on to gross margin and operating expenses.

Q2 GAAP gross margin was $108.8 million, or 74.7%.

This compares to $100.8 million, or 74.6% in quarter one, and $91.1 million, or 75.9% in the same quarter last year.

Q2 GAAP gross margin for Invisalign was 79%, and Scanner and CAD/CAM services was 26.6%.

This compares to 79% and 28.7%, respectively, in Quarter One.

Non-GAAP gross margin for Q2 was $109.2 million, or 75%.

This compares to $101.5 million, or 75.1% in quarter one, and $91.4 million, or 76.1%, in the same quarter last year.

The benefit from increased Invisalign volume was offset by lower ASPs.

For Invisalign, there was no difference between GAAP and non-GAAP gross margin for Q2 or Q1 of 2012 and Q2 of 2011.

For Scanner and CAD/CAM services, Q2 non-GAAP gross margin was 30.3% compared to 34.6% last quarter.

Q2 GAAP operating expenses remained flat at $72.8 million compared to Q1 operating expenses.

Operating expenses for the same quarter last year were $74.5 million.

Q2 non-GAAP operating expense was $71.6 million, and this compares to $71.1 million in quarter one and $68.1 million in the same quarter last year.

Q2 non-GAAP operating expense remained relatively flat from Q1 and reflects a sequential increase in media spend to get in front of the teenage summer season offset by lower compensation-related expenses, consulting expenses, and some deferred head count.

Q2 GAAP operating income was $36 million, or 24.7%.

This compares to $28 million or 20.7% in quarter one and $16.6 million, or 13.8%, in the same quarter a year ago.

Q2 non-GAAP operating income was $37.6 million, or 25.8%, which compares to $30.3 million, or 22.4%, in quarter one, and $23.3 million, or 19.4%, in the same quarter last year.

Q2 GAAP diluted earnings per share was $0.34 compared to $0.26 in quarter one and $0.14 in the same quarter last year.

Q2 non-GAAP earnings per share was $0.34 compared to $0.27 in quarter one and $0.20 in Q2 of last year.

Now, moving on to the balance sheet.

Cash, cash equivalents, and marketable securities, including long-term investments were $304 million.

This is compared to $257.2 million at the end of 2011.

In Q2, we generated roughly $27.3 million in cash from operations compared to $15.4 million in quarter one and $29.7 million in the same quarter last year.

Q2 DSOs were 63 days compared to 63 days in quarter one and 62 days the same quarter last year.

Overall Q2 was another strong quarter, and the first half of the year has been outstanding.

Our business continues to be very healthy, and we're confident we'll continue to build on this over the remainder of the year.

Now, let's turn to our business outlook for Q3 2012 and the factors that inform our view.

As we enter Q3, we continued to see solid patient traffic and activity in our customers' offices.

Our North America orthos are busy with new teenage case starts, and we expect Q3 to be a strong teen quarter for Invisalign.

For North American GPs, we expect seasonality to be a factor as we're anticipating doctors will have less in-office days due to vacations.

Our international doctors had a great first half of the year, stronger than expected, and we anticipate Q3 to be a slower period particularly for Southern Europe countries where many customers take extended summer holidays.

As a result, Invisalign case volume is anticipated to be in a range of 94,800 to 96,300 cases which reflects a year-over-year increase of 19.5% to 21.3%.

This compares to a year-over-year increase of 25.3% in quarter two, 2012 and 19.8% in Quarter Three, 2011.

Our Invisalign shipment volumes are an important metric pointing to the continued progress and strength of the business.

For Q3, we expect the Scanner and CAD/CAM Service business to be down sequentially from quarter two, given summer seasonality for capital equipment purchases.

In addition, there are no major industry or Invisalign customer events in Quarter Three that would give us additional selling opportunities like we had in Q2 with the AAO in May, as an example.

We also expect Q3 Scanner sales in Europe to be flat.

With that as a backdrop, we expect Q3 revenues to be in a range of $136.8 million to $140.8 million.

Overall, revenues reflect lower Invisalign ASPs resulting from deferrals associated with the Invisalign Teen Vivera Retainer promotion, advantage rebates, and headwinds from foreign exchange rates.

Now, let's move on to gross margin.

We expect Q3 GAAP gross margin to be in a range of 73.4% to 73.8%, and we expect non-GAAP gross margin to be in a range of 73.6% to 74.1%.

The expected sequential decrease in non-GAAP gross margin reflects lower Invisalign ASPs, as just mentioned.

In Q3, we expect GAAP operating expense to be in a range of $71.7 million to $72.4 million, we expect Q3 non-GAAP operating expense to be in a range of $70.6 million to $71.3 million, slightly down from Q2.

We expect Q3 GAAP operating margins to be in a range of 21% to 22.4%, and GAAP earnings per share to be in a range of $0.26 to $0.28.

We expect Q3 non-GAAP operating margin to be in a range of 22% to 23.5% and non-GAAP earnings per share to be in a range of $0.27 to $0.29.

In Q3, we expect the effective tax rate to be approximately 25%.

Diluted shares outstanding to be approximately 83.5 million, and cash on hand to be in the range of $345 million to $355 million.

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

Thanks, Ken.

Overall, Q2 was another outstanding quarter for Align.

As you can see from our results, there are a lot of good things going on in our Business, with visible progress in virtually every area of the Company.

Our doctors' offices remain busy, and while we are anticipating the combination of a slower summer period and some promotional activity lowering Q3 revenue a bit, our outlook for Invisalign volume growth of 20%-plus year-over-year is even higher than we reported in Q3 last year and demonstrates our continued growth in adoption and utilization worldwide.

We continue to be confident about the future due to our low market penetration, outstanding offerings, and solid execution of a winning strategy.

We are committed to tracking toward our long-term financial model with the right combination of revenue and earnings growth.

I look forward to sharing this continued progress with you at the end of Q3, and with that, I'll open the call to questions.

Operator?

Thank you.

Ladies and gentlemen, we will now be conducting a question-and-answer session.

(Operator Instructions)

Our first question is from Matt Dolan with ROTH Capital Partners.

Please go ahead.

Good afternoon, nice quarter.

Hi, Matt, thank you.

First question is looking at the Q3 guidance, I think you mentioned a survey on the last call.

Clearly, the teenage segment is building here into the summer season.

Last year, we didn't see as much seasonality as you're implying with your guidance.

Maybe you can talk to what's new on the international side and the GP side that would make this year unique?

Yes, I guess -- right, start with, Matt, is if you think back a year ago, coming off of quarter two particularly in international, we typically see some nice growth Q1 to Q2.

Growth was a lot less in quarter two last year, which growing off that base into the summer months we actually had an increase in revenues during the summer months with the international business.

It's different this year in the fact that we had what I would call more of a normal Q2 for us as far as the volume was there from the doctors all quarter long.

We saw some good strength in Europe this last quarter.

Now, rolling into the summer where we're looking at going back to what we would normally see or typically see which is doctors being out of the office on holidays and not seeing that same growth we saw last year.

That was the main part of it.

Okay.

And then domestically?

Domestically, GPs -- depending upon the summer, they have been up and they have been down.

Last year it was some nominal growth in GPs on a quarter-over-quarter basis, and this year we're again expecting it to be kind of the same.

Okay.

Great.

The second question is on China.

We get this a lot, so I wanted to relay it on to you on this call.

It seems like international is healthy.

Can you quantify, or give us any type of direction of how much is coming beyond Europe?

I think, Matt, I'll take that.

Qualitatively first, China is a very small part of our -- it is small today in revenue.

It is large in terms of opportunity, and so this idea of going very, very slowly to build the right base so we can go faster later is still a very important theme.

It's still a very small contributor to top line.

That will change, say, over a five-year period substantially.

We're -- I'm just trying to find the right way to describe this.

In general, those smaller geographies outside the US, are growing more rapidly than international in general, which is growing more rapidly than North America, if I'd stack it up that way.

Does that get at your question?

Sure, and we'll follow up later.

The last one, on your duplicative costs with this transition in New Jersey.

Are those stripped out of your non-GAAP results?

Or are those -- would those be further cost reduction to think about down the road?

And if so, maybe you can help us understand how much those might be on a go-forward basis?

So, costs in relation to duplicative costs of employees and those types of things -- those are in our non-GAAP numbers.

The only thing we pull out from a GAAP to non-GAAP are severance-associated costs and the like.

As far as the consolidation is concerned itself -- the New Jersey consolidation -- we talked a while back about being able to enjoy about $1 million of cost savings per quarter, about $4 million per year after we complete that transition.

It looks like we're right on track with that as far as the cost reduction with the move itself.

What we will see coming into play here is the fact that in the Scanner business as it has been growing in particular in North America very nicely, we have had to add more trainers in to do the installs of the units in doctors' offices, and that is going to be an offset a bit to the cost savings we've seen with the New Jersey consolidation.

And then with the more recent issues we have been dealing with the iTero systems and doctors in the marketplace with customer service point of view, we've actually had to layer in some additional resources to get after that from a customer care and a technical support point of view.

That would be also some offset to the savings that we're saying we'd enjoy.

Great.

I'll get back in line.

Thanks.

Thank you.

Our next question is from John Kreger from William Blair.

Please go ahead.

Hi, thanks very much.

Can you just review what's driving the lower ASPs both in your second quarter results, and what seems to be implied in Q3 guidance?

Yes, John, this is Ken.

Probably one of the -- there is a couple of drivers here in Q2 and then will continue into Q3.

It has to do with our Advantage rebate program and also the Teen Vivera promotion, more specifically.

And then in Q3, there is also the impact of foreign exchange rates more heavily on the business.

That we can't do a lot about, obviously.

I'll come back to the other two.

The Advantage program is a program we have been having.

We've been in place for a number of years now, and it really rewards the highest volume doctors.

It's a good ROI for us because doctors submit more cases to us, but they enjoy a little bit of a rebate associated with that.

But, in all reality, we don't put a lot of effort into supporting those particular doctors as we do a low volume doctor who needs a lot of customer care support and technical support in getting through the case.

From an ROI perspective, it is a very positive program for us, and it returns a nice profitability in relation to even doctors who are not getting any rebates.

More specifically, sometimes we run programs like the Teen Vivera promotion to drive volume and get doctors moving up in their number of cases they're doing.

As we said on the call, very successful last year in running the Teen Vivera promotion, and we're running it again this year.

We started it a month earlier.

That is very specific to the summer months here and as a doctor turns a case in to us -- a teen case in to us -- they will get to use a Vivera case between now and the end of March next year.

There is some associated revenue deferrals with that because we're offering a Vivera case to the doctor along with the teen product so there is a bundling effect, and we defer a portion of that revenue.

And, we will get that revenue back as the doctor takes the Vivera case.

John, if I can pile in for just a second.

In general, pricing is very stable for us globally.

With the exception of FX for a moment, most of the changes that are happening in ASP are because we're pulling on certain levers.

Ken laid out a few of them.

Over time, we'll expect ASP to go down a bit more as mix evolves.

And, with products like Express and i7 and Express 5, those are incremental cases we probably wouldn't have gotten that come with the roughly equivalent gross margins, but our market expanding for us, and we'll -- so the visible ASP may go down.

We're going to have to help you unpack that over time so you realize it is not us necessarily losing price, it is an evolution of the business.

Great.

Thanks, that's very helpful.

Question -- flipping over to the Scanner and CAD/CAM Services business.

Can you just update us on what is driving the decline in gross margin?

And, as you complete the integration, can we expect that to start trending up again?

Yes, John, so Q2 to Q3 -- sorry, Q1 to Q2 gross margin decline had to do a couple of specific items.

First of all, we revised our scanners on the scanners back at the end of quarter four.

We had units shipping in quarter four that we actually didn't recognize revenue until quarter one.

They had a lower standard cost associated with them.

That is because we do the install with the doctor, and that's the point in time we recognize revenue.

With the revised standards, they actually increased a little bit.

We added additional manufacturing resources so it increased the standards a bit.

We see that coming through in shipments we made for the remainder of quarter one and into quarter two now that scanners are getting installed at just a little higher cost.

The other piece of it is, we have been adding resources in trainers over the past few quarters and you see the impact of that.

That has to do with making sure we can support the number of scanners we're placing in North America and getting the doctors trained on the system.

So, those two things are some of the bigger drivers.

Thanks.

Finally, can you just comment on the macro environment in Europe and how it might be impacting your business?

It seems like the core Invisalign business continues to do surprisingly well, but Cadent's faltering a little bit.

Are either of those really being impacted by the tougher backdrop?

I'm not going to hide behind the economy for a minute.

Let us talk Invisalign for just a moment.

What we focused on in Europe over the last year, year and a half, is execution that we could control.

And if you remember, a year-plus ago we were struggling in the UK and in some other geographies.

In some cases, we've reconstituted the sales team or the leadership of that country, relooked at programs.

In some cases like i7 have rolled out new products, and we're growing again very nicely.

UK led the international team this year in terms of individual country markets in Europe.

It is great to see.

UK economic environment hasn't gotten better in the last year.

So, I would say we have the benefit of better execution, using that as an example, and still really low penetration.

We still have lots of headroom for growth.

The example of Spain, we're growing very nicely in Spain, and these are -- we're all watching the news every day.

I think accepting a calamitous financial outcome there, I believe, in general, we can continue to motor through this and find opportunities for growth with good execution.

Doesn't mean things can't change.

On the Scanner side, it is a little harder to move that rock uphill because, principally, there is a piece of capital equipment that practices don't need to buy today.

They're doing physical impressions, PVS, other impression materials today.

This is about productivity, and in a period of time when there's great uncertainty, the easier default is not to invest in this kind of new capital.

So, I think that is a factor.

But in addition, we're not where we want to be, and we're working really hard with our partner on that.

I believe over time we are going to be able to make that better.

But, I think there is also -- different from the Invisalign business, there is execution that hasn't turned it around yet.

Great.

Thank you.

Sure.

Thank you.

Our next question is from the line of Glen Santangelo from Credit Suisse.

Please go ahead.

Yes, thanks, and good afternoon.

I just want to follow up for a minute on John's ASP question because it is clear that you laid out a whole bunch of issues, whether it be the FX issue, the rebate issue, or the promotional opportunities.

I was wondering, Ken, would you feel comfortable isolating this FX issue to give us a sense for how big it is so we can think about what is within your control and not within your control as we model ASP out for the next couple quarters?

Sure.

If you think about FX rates, the impact to us this last quarter if you look at our international business was probably in that $500,000, $600,000 range.

So, pretty small overall to the revenue base.

But going forward, looking at FX rates that -- in particular for the euro I'm talking about -- that have been running around low $1.30s over the past several quarters and now bouncing around in the low $1.20s, it will have a more pronounced impact on us going from Q2 to Q3.

Okay.

Do you care to quantify that at all?

We haven't given you specifics on our revenues for international so I don't want to make a comment specifically on that.

Could I maybe assume though based on the guidance you're giving us today you're assuming that euro remains in the low $1.20s.

I think that is a fair call.

What we look at is where the rates have been running as we come into the quarter just before earnings, and we're looking at our guidance for the quarter.

We make the best call we can.

So, I would say that is probably a fair range to be in.

Okay.

Tom, could you maybe talk a little bit more about the Scanner business?

You mentioned that you're starting to see some of the benefits of integrating the sales teams here in North America.

Could you quantify that?

Are you starting to -- could you elaborate more on the leverage you're seeing as a result of the combination of the effort of those two sales forces?

Sure.

We've got -- we're headed toward 200 total people out touching customers in North America, and we're 30,000-plus customers in North America that we have good credible relationships with.

And, it provides an opportunity to do some qualification and assessment of opportunity, and then we really rather than dragging a Scanner around individual offices, we use these events where we get them all together.

Study clubs, workshops, CE1, CE2s, forums, summits, and obviously, trade shows where all the other trade vendors are in the room.

We've done a very good job of cross-selling and working.

The first job, I think, all of our owners said is don't take your eye off the Invisalign ball.

I think we've demonstrated we didn't do that.

But in addition, we've got attention from our Invisalign customer base, and quite a few of them are either having discussions or have already bought a Scanner.

So, that is our best opportunity.

As we've built the Scanner sales force, we have roughly one scanner rep per region in the country, and in large areas like L.A. or New York, kind of two-ish or so.

Two or three.

They are very much a part of the daily rhythm with the Invisalign teams, and a lot of open communication, a great amount of partnering.

So, with very little cultural effort, the two teams have grown very close together, and we're pretty efficient about finding opportunities, and then using these environments where we have got a group of customers together to demo and close sales.

We expect that to continue, and I think if you look at the good start we got off for selling scanners last year, we just expect over time that's going to continue.

On the opposite side, the Invisalign side, we're starting to get real leverage out of these accounts whether they be orthodontist or GP dentists that are now increasing utilization of Invisalign because it is easier and patients are happy, and all of those things.

So, that's just for interoperability.

You see what is going on with the number of increasing cases from that.

When we start putting tools like the outcome simulator which we showed a little piece of during the Chicago mid-winter which will be out later this year, this is testing incredibly strong with our customers.

They literally, when we demo it with them to get some user interface information, they don't want to take it off their Scanner when it is time to leave.

So, there are other tools coming out that will make it much, much easier to interact with patients, do case assessment, and ultimately submit cases to us that is really going to reduce friction around the entire Invisalign experience.

And then, on the whole restorative side, there is a whole host of opportunities for us to leverage great enterprise environment we've got at Invisalign and Align Technology where we literally communicate with 30,000, 40,000 customers every day on a very robust external-facing environment, and we're starting with the best Scanner in the world.

From our perspectives, we've gotten past all of the table stakes issues, and now we're at a point as we start bringing out a flow of software and new hardware evolutions and capabilities, it just gets better and better.

Again, setting Europe aside, there is a whole set of issues we're working on.

We're pretty excited by the broader set of opportunities that are evolving.

That's helpful.

Tom, if I could just ask you one last question, and then I'll hop off.

I just wanted to quickly touch on the competitive landscape.

As you move down the market a little bit toward i7 or the Express line, you start to get a little bit more indirect competition where maybe Danaher or Dentalign, ClearCorrect, those guys are.

Are you worried at all about the competitive landscape?

The impact of that on pricing?

Just what are you seeing in the marketplace?

First of all, what's the -- Andy Groves said it best in Only the Paranoid Survive, a great little book.

But, if there is a combination of being confident and paranoid at the same time, maybe the definition of schizophrenia, that is where we are.

The great thing is why would anybody, given a choice, at a certain value point in the market, settle for anything less than the best aligner product in the world?

For any five-stage or seven-stage product, we should be able to move more efficiently to create the greatest and most predictable amount of movement for any occlusion you're trying to fix.

So, our view is that we're not pricing our value products any different than what the market already has, and truth be told, our variable cost per unit is probably the lowest in the world.

We have a great deal of flexibility.

The margins on those products are sound.

These are market-expanding, and I think it is a good thing that if other manufacturers are moving into this area -- growing, it is going to make it more acceptable for people to use clear aligners.

It will build skills.

We think best product, best market over time wins.

Obviously, we're paranoid about much bigger and better equipped players, but by the same token, we're competing through innovation and cycle times and speed and all that.

Okay.

Thank you.

Sure.

Thank you, Glen.

Thank you.

Our next question is from the line of Spencer Nam from ThinkEquity.

Hi, thanks for taking my questions.

Just a couple of questions here.

On the pricing -- unit pricing side, I can understand why US pricing is coming down because of promotions and all of that, but I also see the -- your pricing coming down on international market.

It has been coming down fairly steadily over the last couple of years.

And, I was just wondering what's driving that?

There is a couple of things driving it, Spencer.

First of all, foreign exchange rates.

If you go back a year ago, the euro was running in the low $1.40s.

$1.40 to $1.44 to the dollar.

Today, it is running in the low $1.20s.

Call it, $1.22, $1.23.

That has a big impact on a year-over-year basis on the international side of the business.

Couple of other components are we have introduced a new product this last quarter called Invisalign i7 into the European markets.

So, as volume there grows, it's at a lower price point so we will have some mix going on.

Also, our distributors have been growing very nicely as we pointed to over the last several years, and overall, the pricing point there is basically half list price, in essence, because they're selling at distributor pricing and they're taking care of all of the customer issues.

As the mix -- as distributors grow internationally and as some of the lower-priced products grow, over time, you will see more of an impact to ASP from mix.

Spencer, on kind of a net profitability perspective, our international partners -- even with that discount for that, we don't have the offsetting support costs.

So, that falls through nicely.

It's volume.

The second thing is that margins are comparable on these lower-end offerings to our Full, Teen, and all of those other products.

So, those are -- other than FX -- let's just call it a net negative effect.

Everything else fits into our P&L nicely, and then one exception would be, say, a promotion in North America or Europe if we run it, which we would look like at payback from that.

But, in a period, it might look like that's negative.

Great.

That is helpful.

On this promotions going on in the US, I know you are mindful of your competitive landscape, but I was also wondering whether you -- the part of the promotion was related to the competitive aspects that you tried to ensure the high volume Invisalign physicians, dentists, remained with Invisalign instead of jumping over to a competitor and so forth.

Is that calculated in your strategy of aggressively pushing the rebate program?

Every program, every promotion has its own rationale, and we look at what we're trying to accomplish with it.

In the Teen Vivera promotion, it was not so much for competitive reasons.

It was to expand the value and accomplish two objectives.

The first is, I think as I mentioned a few minutes ago was, if we can -- teen is the hardest share to gain because no orthodontist or dentist treating teens wants to do anything other than perfect for outcomes.

They don't want to sacrifice any clinical advantage or leverage.

So, as we've evolved teen and the Teen product in G3, G4, et cetera, we're cracking that more complex case now and helping that doctor deliver perfect -- their definition of perfect with mom or dad.

The goal of anything we do to accelerate teen usage is a persistent effect, office by office where they take advantage.

If we can get a good ROI on a program like the Teen Vivera program, and they do incrementally more teen cases during that busy season when they have got the highest patient flow for those teen starts.

That utilization level remains, and they move up from there.

So, when we look back at a year ago, this is a persistent effect, and therefore, it is very virtuous.

The payback is very positive.

We get revenue deferral from that which we pick up a couple quarters later.

The second thing that is really positive is we're trying to widen the base of repeat Vivera usage.

And so, many of these orthodontists that bought Teen Vivera promotion or bought Teen, get Vivera.

They hadn't used much Vivera.

As they start getting really good feedback from patients, they start ordering more Vivera.

So, the Vivera usage is also persistent, and our goal is to widen the base of Vivera users, which is happening.

So, that program had two objectives.

Both are being met, and it was targeted right at the busy summer season, less so a competitive kind of a dynamic.

Thanks, Spencer.

Next question, please?

Our next question comes from Steve Beuchaw with Morgan Stanley.

Thanks for taking the questions.

Tom, I wanted to drill down a bit more on the number of users in the quarter and the growth of the user base.

We've talked about this before.

This growth rate is very high, and as you commented before, this is clearly borne out.

You are doing a terrific job training not just more users but getting to people that are really going to fare very well with this system.

How do you, at this point, dimension the sustainability of the growth of that user base?

How long can that hold up?

And is there an upper bound in the US in terms of the right base of users?

Let's break this into two pieces, Steve.

The first is orthos.

We're -- we think there is 9,000 to 10,000 practicing orthos in North America, and we're just now have a 5,000 number in front of the submitters on an annual basis.

It has taken us 13 years to get there.

So, we have got half of the active orthodontists in North America we're not doing any business with.

Some of those practices are very desirable practices with high-end, big volume, and all that.

That represents a long-term opportunity that we're going to crack through continuing to evolve the product and delivering great results.

What we call predictability and all that.

That's just a long journey toward acceptance and adoption.

Our view is standard of care some day.

That is our hope.

The second -- so we could train them, but the tougher journey there is not a training dynamic, it is acceptance.

Acceptance of clear aligner therapy as a standard, and then, secondly, us getting that share.

The second one, I think, may be where your question was specifically targeted around GP customers.

With 130,000 to 140,000 GPs, we have just trained a slice of them, and we have this long journey with them going on where it usually takes two or three years to -- with some exceptions -- it takes two or three years to get them to where this is starting to become routinized even with a practice that is interested and engaged.

So, from seeing our utilization, we have this long tail of lower volume practices that are slowly percolating along doing their thing.

For practical purposes, we could probably -- we have done some segmentation in the GP base.

There is probably a practical number, but even if we wanted to say maybe half of the GPs wouldn't be appropriate for Invisalign in the next five years, that still leaves us with more than double the install base we have got of users today.

So from our purposes, as we recruit for new doctors, we're really trying to qualify that they really want to bring something different into practice and put effort into it.

So, could we step on the gas and train 10,000 a year, sure.

I'm not sure we'd get to a better place, but the head room is there to do that.

One on your -- what you're hearing from the sales force now that we have another quarter under our belts here.

Specifically, what are you hearing from the sales channel in terms of broader orthodontic patient flow in the US?

Given your results and what we heard from one of the big diversified players this morning, it sounds like ortho in the quarter very solid.

Would you take any issue with that?

Was it solid throughout the quarter?

What are you assuming in the third quarter in terms of the sustainability of that strength?

Thanks so much.

Sure.

Danaher Ormco, we think, is probably the share leader in North America and worldwide in terms of case starts.

They're probably defining what we'd probably call the market dynamics in a complete way.

You have to unpack that a bit and success or not success, I guess, is probably defined more by products and what's being used.

From our perspective, Q2 was a great quarter for us with orthos.

In fact, Q2 was a great quarter in virtually every area, every channel, every product.

So, Q3 is typically a strong quarter, but again, we're up against these really good competitors like Danaher and Dentsply and 3M and their divisions, and they're doing everything they can with their offerings and products to hold traditional or even more modern bracket offerings.

We believe we'll continue to be able to wrestle share away from them over time and would expect that we'll have -- I think, as Ken described in his outlook -- we'll have a lot of contribution from orthodontists especially in North America in Q3.

That is pretty typical.

So, I think the offices are pretty active.

The summer rush is on.

Moms and dads are taking kids in when they're out of school, and it's shopping season for the orthodontic industry at least in North America.

So, I think all that portends -- we have got to go get more than our fair share in Q3 and see what it looks like when we talk in a quarter.

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

Our next question is from the line of Brandon Couillard with Jefferies.

Thanks for taking the question here.

Tom, could you speak to the demand trends you experienced inter-quarter and maybe into early '13?

I'm particularly interested in how June may have fared, mostly in the US relative to your expectations?

Secondarily, to what degree, if at all, do you perceive the Invisalign product is less sensitive to, say, to the whims of consumer confidence or discretionary spending?

I'll make the first one easy, because we typically don't talk about flow of business.

What we do talk about is the things that give rise to flow of business, and what I would say is activities in office with our team, promotions and programs and consumer -- all those demand drivers are running well, and we expect to -- whatever is possible to do, as best as possible.

Again, the -- so I'm not going to comment specifically on the detail inside a quarter.

The shipments and our performance have to kind of speak for itself, and we give a lot of detail about that.

Your second part of your question, I completely lost it.

I totally apologize.

I was doing pretty well until I got there.

I was so trying to say politely I'm not going to answer your question.

Please ask your second part again.

To what degree you think the product may be less sensitive to consumer confidence or discretionary spending relative to history?

Thanks.

You're very gracious.

We actually test this a fair amount, and we still know that cost is one of the primary reasons why a consumer says I'm not going to do orthodontic treatment right now.

They rate it very highly.

They say not right now.

$5,000, $6,000, $7,000.

We've got a few examples going on to test that a little bit with low-end offerings.

And, interestingly, we have doctors that are saying with Express 5, for example -- they're treating a patient with Express 5. As a result, they believe they're going to get the patient back in two or three years for full treatment.

Fixing a little bit of crowding or a little spacing has that patient more excited about making this a priority.

So, it is an interesting step one toward comprehensive treatment.

The second part of your question is called recession-proofing.

There is no such thing, I think, in the real world.

I would say that in general, teen and pediatric orthodontics is, when it comes time for that, families really trying hard to make that fit.

We have spoken externally about the size of North America for consumers, and we kind of pegged that around 23 million, 24 million people in general are interested, available, capable of paying, and rate getting a better smile very high.

If we go back and look at some testing we did in 2008-2009 in the middle of the meltdown.

If we -- with consumer confidence being shattered, if we lost half of that potential in terms of willing and able, we still are dramatically underpenetrated.

So, A, orthodontic treatment is underpenetrated.

B, our product with its value proposition which is more expansive than orthodontic treatment in general, is really underpenetrated.

Best thing we've got going for us right now, relative to your second question which I completely forgot a minute ago, is that underpenetration is a wonderful thing.

We have lots of headroom for growth.

Thanks.

Ken, on the cash flow side, were there any one-time items that may explain the year-over-year decline in the operating cash flow?

And then, if you can explain just how D&A was down year-over-year?

That would be helpful.

The cash question, this year -- well, actually as we exited last year and moved into this year, we've actually had some more capital purchases in relation to the -- in relation to getting the factory up and running in Juarez.

That had some impact to us there.

And also, in things like we benefited related to tax provisions and stock-based comps, those types of things.

So, I think that answers most of that question.

The other one on DSOs.

DSOs have been pretty consistent at around low 60s -- 62, 63 days.

We don't anticipate that changing a whole lot.

Customers are paying us pretty routinely here.

Our terms are 60 days with the doctors in North America.

So, having DSOs hold in there, we feel pretty good about that.

I meant depreciation and amortization.

Sorry, depreciation and amortization.

Sorry, I thought you meant DSOs.

Depreciation and amortization will pick up here, that already has started a little bit.

The reason being is, we put new equipment into the Juarez facility as we bought a new facility down there last year, outfitted it.

And, the equipment that we had in, and we have been running with for many years is fully depreciated.

So, you are going to see more depreciation coming from that equipment.

Thanks.

Thank you, Operator.

That concludes our call.

We appreciate your time today.

If you have any follow-up questions, you can reach Align Investor Relations.

Have a great day.

Thank you.

Ladies and gentlemen, this concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.