愛齊科技 (ALGN) 2013 Q2 法說會逐字稿

Welcome to the Align Technology Q2 2013 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 Shirley Stacy of Align Technology.

Ms. Stacy, you may begin.

Good afternoon.

Thank you for joining us.

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

Joining me today is Tom Prescott, President and CEO; Roger George, Vice President, Corporate and Legal affairs, General Counsel and Interim CFO; and Karen Silva, Vice President of Finance and Corporate Controller.

We issued second-quarter financial results of fiscal 2013 press release today via Market Wire, 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.

A telephone replay will be available today by approximately 5.30 PM Eastern Time through 5.30 PM Eastern Time on April -- excuse me, August 5. To access the telephone replay, domestic callers should dial 877-660-6853, with conference number 411500 followed by pound.

International callers should dial 201-612-7415 with the same conference number.

As a reminder, the information that the presenters discuss today will include forward-looking statements, including without limitations, statements about Align's future events, product outlook and expected financial results for the third quarter of fiscal 2013.

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-K for the fiscal year ended December 31, 2012.

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.

During today's call, we will provide listeners with several financial metrics determined on a non-GAAP basis for comparisons to previous quarters.

Most of these items, together with the corresponding GAAP numbers and the reconciliation to the comparable GAAP financial measures where practical, are contained in today's financial results press release, which we posted on our website under financial releases, and have been 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 statements, including the corresponding reconciliations and our second-quarter conference calls slides on our website under quarterly results.

Please refer to these files for more detailed information.

Finally, please note that our prepared remarks today are more concise than prior calls, and we've intentionally limited our commentary to key business metrics and financial highlights.

This change in format is in response to direct feedback from a recent survey of our analysts' investors, and we hope it addresses their request for briefer conference calls.

We still include a large amount of information in our corresponding slide presentation, and we've added several new pages to this quarter's slide deck, which is posted on our Investor Relations website at investor.aligntech.com.

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

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 our scanner and CAD/CAM services business.

We are pleased to report another good quarter, with better than expected revenues, gross margin, and earnings.

Strong second-quarter results were driven by higher Invisalign volumes and ASPs, with sequential growth across all customer channels.

For Q2, total Invisalign case shipments grew across all customer channels to over 100,000 cases worldwide for the first time, with a total of 106,100 cases shipped.

Year-over-year growth was driven by continued expansion of our customer base and increased Invisalign utilization.

The sequential increase in Q2 reflects strong growth from our international doctors, as well as good growth from both North American GP dentists and orthodontists.

Virtually all Invisalign products were up nicely year-over-year and sequentially.

The exception was Invisalign Assist, which has been flat for the past few quarters, as doctors have shifted to Invisalign Full and Teen cases more frequently.

This is a natural progression, as newly-trained doctors become more experienced users and want to leverage the full offering.

Acceleration of our new product development cycle and key feature improvements, such as Invisalign G4 and our new SmartTrack material, are helping drive increased utilization of Invisalign globally, especially among our higher-volume customers.

We continue to see good adoption and growth of Invisalign worldwide among more experienced customers, driven by increased confidence in clinical outcomes, especially for more complex treatments, especially including teenagers.

Q2 marks the beginning of the busy teen season for orthodontic case starts, as reflected by strong growth in Invisalign case shipments to teenage patients.

Total teenagers treated with Invisalign increased to 23,500 cases in Q2, a year-over-year increase of 16% and a sequential increase of 2%.

In Q2, we started to see the positive impact from expansion of our clear aligner product line, with value-based offerings like Express 5. These products are targeted at patients declining comprehensive treatment, but who still want minor malocclusions treated.

During Q2, we continued to see strong sequential growth from our value-based offerings, driven by better-than-expected demand for Invisalign Express 5 in North America, and Invisalign i7 in Europe.

Both of these offerings meet an important need for patients who want minor correction rather than comprehensive orthodontic treatment, at least for now.

Now let's shift to talk about customers and geographies, starting with a review of the key metrics around Invisalign in utilization and training.

We continue to focus on building our customer base and driving increased utilization among new and existing practices.

For Q2, total Invisalign utilization was 4.4 cases per doctor, an increase from 4.3 in Q1 2013 and Q2 2012, driven primarily by North American orthos and international doctors.

In Q2 of 2013, we added 115 new active American orthos, 1,015 North American GPs, and 1,020 international doctors, for a total of 2,150 new Invisalign doctors.

For North American orthodontists, Q2 Invisalign case volume of 39,500 cases increased 11.6% year-over-year, reflecting cases from new doctors, as well as increased utilization of Invisalign.

Sequential growth of 4.1% was driven primarily by new submitting doctors, which reflects our focus on reengaging orthodontists who are Invisalign trained, but have not actively used Invisalign in their practice for many years.

For North American GP dentists, Q2 case volume of 39,3000 cases increased 5.5% year-over-year and 7.1% sequentially, reflecting continued expansion of our GP customer base, as well as increased utilization.

Q2 case shipments for our international doctors of 27,300 cases increased 20.7% year-over-year and 16.3% sequentially, reflecting strong growth from direct European countries, where we continue to focus on product innovation and clinical education, which is resonating especially well among our orthodontic customers.

All direct country geographies across Europe increased nicely, despite widespread economic challenges, with notable growth in Germany, Austria, Switzerland and Spain, as well as the UK, which appears to be rebounding.

France continues to post the highest growth rate among our direct European countries, albeit off a relatively small base of customers, and is making real progress in the teen segment.

Towards the end of Q2, we held our largest ever international Summit in Rome, which focused on peer-to-peer learning and sharing of clinical techniques and case studies of more complex malocclusions.

We believe it was the best international Summit to date, with over 300 Invisalign practices represented, mostly from Europe, as well as 50 doctors from the Asia-Pacific region.

These doctors were blown away by the complexity of cases and the quality of finishes shown.

These doctors routinely treat the most complex cases, and they are excited about our continued cycle of innovation and the significant improvements represented by G4 and SmartTrack, which are essential to treating these more difficult cases.

I'll turn to Asia-Pacific now.

And prior to Q2, Japan and China were our only direct countries in the Asia-Pacific region, but during this last quarter, we successfully completed a transition of countries managed by our Asia-Pacific distributor, back to direct sales and management by Align.

More specifically, six country markets, including Australia, New Zealand, Hong Kong, Singapore, Macao, and Malaysia are now part of the direct Invisalign sales region, and on May 1, we began to recognize direct sales at our full Invisalign average sales price, our ASP, rather than the significantly discounted ASP under the distribution agreement.

We now have an additional 47 employees in our pan-Asia operations.

The remaining seven country markets of Brunei, Indonesia, Philippines, South Korea, Taiwan, Thailand, and Vietnam, will continue under the current distribution model, but are now managed by our Align team.

Our Managing Director for APAC, Julie Tay, is based in the middle of this important geography and has our new offices in Singapore up and running.

I am very excited by the progress she has already made in building a pan-Asia-Pacific organization, and believe she and the team will take this entire team to the next level in the coming years.

I will now briefly discuss our Q2 performance in our traditional direct countries, Japan and China, which continue to represent great growth opportunities for Align.

In Japan, Q2 was another strong quarter for Invisalign case shipments, and we are pleased to see continued progress in this market.

Growth was driven primarily by increased utilization, resulting from improved clinical confidence in Invisalign.

While the Japanese market is still very early in development and small in terms of impact, we believe we can grow strongly over time.

We're also starting to see increased awareness of the value of a beautiful smile that can be achieved through orthodontic treatment, including through clear Align therapy, and believe Invisalign can be a catalyst for real market growth.

Q2 was a good quarter for China, with very strong year-over-year growth and increased repeat usage by doctors, demonstrating the depth of our current doctor base.

We continue to gain traction in China by executing our strategy of gaining key endorsement and adoption of Invisalign from key universities and opinion leaders, through professional education and clinical support.

During Q2, 15 Chinese key opinion leaders, or KOLs, attended the Invisalign Summit in Rome, which resulted in very positive feedback about the product and increased confidence in what can be treated successfully with Invisalign.

In addition, 75 key decision makers from 40 of China's leading private clinics attended our first Invisalign private clinic forum in Hangzhou, resulting in positive endorsement for how Invisalign can help build their practices.

Finally, we are increasing our partnerships with top private practices that are actively promoting Invisalign on their own and want to build their own brands and reputations by aligning themselves with the world's leading clear aligner player, Invisalign.

In Q2, we announced our first North American distribution agreement for an entry level clear aligner product.

I want to briefly recap the highlights from the launch of Realign and the initial response from our distribution partner, Henry Schein Dental.

Realign is a five-stage clear aligner product for cosmetic fixes and minor crowding and spacing issues, such as dental relapse.

Realign offers GP dentists who are not currently using Invisalign the innovative technology and quality of Invisalign aligners as a competitively priced, easy-to-use product for patients with very simple treatment goals, especially among adults.

There are approximately 100 million adult consumers in the US alone that would like to improve their smile and are interested in straighter teeth, but many say they would never consider braces or even seek out an orthodontic consultation.

Over the past 12 years, Align has driven category growth in orthodontics by offering a clear aligner solution that especially appeals to adult patients and by making Invisalign clear aligner therapy through Invisalign-trained orthodontists and GP practices.

We announced Realign on June 6 and launched it at the Henry Schein Dental sales team at their national meeting that same week.

The product and distribution partnership received a great reception from their sales team, along with management, with Realign selected as best new product of the sales meeting.

That enthusiasm is good to have, as all marketing and sales for Realign is being handled by Schein Dental.

Realign became commercially available in mid-June, and we're pleased with the interest we're seeing in doctors.

The Realign professional website had more than 2,500 doctor visits in its first couple of weeks, and the first Realign starter kits have now shipped.

Shifting now slightly to marketing and consumers, in May, we launched a completely new and fully integrated consumer advertising campaign in North America.

The new campaign continues our focus on women and moms of teenagers, and its launch was timed to leverage the busy teen orthodontic season, which runs from late spring until sometime after Labor Day.

While our consumer advertising is always focused on great outcomes and the healthy, beautiful smiles possible with Invisalign, the new Better Smile Every Day campaign is focused on the great treatment journey with Invisalign, where treatment doesn't detract from your everyday life or require you to put any part of your life on hold during treatment.

Initial metrics influenced by our advertising, particularly TV ads, are strong.

For example, we had nearly 2.5 million visitors at Invisalign.com throughout end of Q2, an all-time high, and a strong indicator of consumer awareness and interest in Invisalign treatment.

I would like now to shift to our scanner and CAD/CAM services segment, where Invisalign utilization among scanner customers, particularly orthodontists, continues to grow, and we expect this positive trend to continue.

The drivers for this growth come from better customer and patient experience, driven by recent scanner innovations, including our new i0 scanner, which began shipping in February.

In addition, the recently-launched Invisalign outcome simulator brings a valuable patient education tool right to chairside to help doctors show the benefits of Invisalign treatment to prospective patients.

We continue to see an increase in Invisalign case submissions from a digitally scanned impression instead of a traditional PVS impression.

The percentage of Invisalign cases submitted with a digital scan rather than PVS rose to 22% in Q2, compared to 19% in Q1, and 12% in Q2 a year ago.

This trend is positive for both Align and our customers, as most practices reported faster ClinCheck turnaround and case shipment with less hassle to patients.

And all reports to date indicate better aligner fit.

And with that, I will now turn the call over to Roger for review of our Q2 financial results.

Roger?

Thanks, Tom.

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 our press release tables entitled reconciliation of GAAP to non-GAAP key financial metrics and business outlook summary for a complete reconciliation.

Let's review our second-quarter financial results.

Q2 net revenue was a total of $163.8 million, which consisted of Invisalign revenue of $153.3 million, and scanner and CAD/CAM services revenue of $10.5 million.

Q2 net revenue increased 6.7%, from $153.6 million in Q1 of 2013, and 12.5%, from $145.6 million in Q2 of 2012.

Year-over-year revenue growth reflects increased Invisalign volume and higher ASPs, primarily from the transition of our APAC distributor into a direct sales region.

The sequential increase in revenue primarily reflects higher Invisalign case shipments, driven by both North America and international, as well as higher international ASPs.

Recall that for Q1 '13, clear aligner revenue includes $4.4 million from consolidating Vivera retainer product shipments down to one per year.

In addition, beginning June 15, 2013, we are no longer charging a fee associated with our mid-course correction orders.

And as a result, Invisalign clear aligner revenue for Q2 of '13 was decreased by $1.2 million, which reflects the revenue deferred to provide free mid-course corrections for open cases shipped between April 1 through June 15 of 2013 that are now eligible for the new mid-course correction policy.

In Q1 of '13, Invisalign clear aligner revenue was decreased by $2.7 million, which reflected the estimated deferred revenue for open cases as of March 31, 2013 that were expected to be eligible for the new policy.

Q2 Invisalign revenue of $153.3 million increased 8.3% compared to Q1 revenue of $141.6 million, and increased 14.7% compared to Q2 2012 revenue of $133.7 million.

The sequential increase in Q2 revenue reflects increased Invisalign volume and higher international ASPs.

On a year-over-year basis, Q1 Invisalign revenue growth was driven by increased Invisalign shipments and higher ASPs.

Q2 2013 scanner and CAD/CAM services revenue was $10.5 million.

This is a sequential decrease of 12.4% compared to Q1 revenues of $12 million, and a decrease of 12% from Q2 last year.

Q1 '13 scanner and CAD/CAM services revenue includes $1.4 million that was reserved in Q3 and Q4 of 2012 for the new iTero scanner upgrade program, which was launched in Q1 of '13.

This upgrade program was successfully implemented, and the full reserve was not utilized.

Q2 scanner shipments recognized were essentially flat from last quarter, but we had a record number of ortho scanners sold, reflecting our continued success in leveraging the Invisalign install base of customers.

Moving on to the income statement, to gross margin and operating expenses.

Q2 GAAP gross margin was $123.7 million, or 75.5%.

This compares to $112.8 million, or 73.5% in Q4, and $108.8 million, or 74.7% in the same quarter last year.

There is no difference between GAAP and non-GAAP gross margin this quarter, or for Q1 '13, but compares to non-GAAP gross margin of $109 million, or 74.9% in the same quarter last year.

Q2 GAAP gross margin for Invisalign was 78.4%, and scanner and CAD/CAM services gross margin was 33.9%.

This compares to 77.2% and 29.3% respectively in Q1, and 79% and 26.6% respectively in the same quarter last year.

For Invisalign, there's no difference between GAAP and non-GAAP gross margin for Q2 or Q1 2013, and Q2 2012.

The sequential increase in gross margin primarily reflects higher Invisalign volumes.

On a year-over-year basis, Invisalign gross margins declined slightly, due to higher material costs for the SmartTrack aligner material.

For scanner and CAD/CAM services, there is no difference between GAAP and non-GAAP gross margin for Q2 or Q1 2013, but compares to non-GAAP gross margin of 28.4% in the same quarter last year.

The sequential increase reflects lower manufacturing spend.

On a year-over-year basis, scanner gross margins increased due to lower training costs and scanner standard costs.

Q2 GAAP operating expense was $85.8 million compared to Q1 '13 operating expense of $150.9 million, and Q2 '12 operating expense of $72.8 million.

Q1 '13 GAAP operating expense includes long-lived assets and good will impairment charges of $67 million.

There is no difference between GAAP and non-GAAP operating expenses this quarter, but compares to non-GAAP operating expenses were $83.9 million in Q1 and $72.5 million in the same quarter last year.

The increase in Q2 operating expense is primarily due to higher TV media and advertising spending, and includes expenses for our Asia-Pacific operations as of May 1.

Q2 GAAP operating profit was $37.9 million, or 23.1%.

This compares to GAAP operating loss of $38.1 million, or 24.8% negative in Q1, and operating profit of $36 million, or 24.7% in the same quarter a year ago.

There is no difference between GAAP and non-GAAP operating profit this quarter, but compares to non-GAAP operating profit of $28.9 million, or 18.8% in Q1, and $36.5 million, or 25.1% in the same quarter last year.

Q2 GAAP diluted earnings per share was $0.36, compared to diluted earnings per share of negative $0.52 in Q1, and earnings per share of $0.34 in the same quarter last year.

There is no difference between GAAP and non-GAAP diluted EPS this quarter, but compares to $0.26 in Q1, and $0.34 in Q2 of last year.

Moving on to the balance sheet.

Cash, cash equivalents, and marketable securities, including long-term investments, were [$341.3 million] (technical difficulty)This is compared to $35.61 million (sic - see press release "$356.1 million") at the end of 2012.

In Q2, we generated roughly $53.3 million in cash from operations, compared to $10.4 million in Q1, and $27.4 million in the same quarter last year.

During Q2, we purchased approximately 2.6 million shares of our common stock at an average price of $35.01 per share, for a total of approximately $92.7 million.

We have now completed the remaining authorized repurchases under our stock repurchase program.

Q2's days sales outstanding were 62 days, compared to 64 days in Q1 and 63 days in the same quarter last year.

Now let's turn to our business outlook for Q3 2013 and the factors that inform our view.

The first half of 2013 is off to a good start, and our customers continue to report stable patient traffic in their offices through June and into July.

For North American orthos, most teen case starts occur in the summer months, and we expect the positive impact we saw in Q2 from teenagers to continue into Q3.

In addition, busy teen ortho practices typically means that they will have fewer adult consultations in order to accommodate the summer rush for kids before school starts.

Q3 is typically a seasonally slower quarter for North American GPs and international doctors, who spend fewer days in the office due to summer vacations and extended holidays, especially true for the Southern European countries, where offices can be closed for weeks.

With these factors considered, we would expect Invisalign case volume for North American GPs and international doctors to be down sequentially from strong Q2 shipments, and we expect North American ortho volume to be up sequentially.

Our new mid-course correction policy took effect June 15, 2013, and we expect the usage rate for mid-course correction orders to approximate the revenue deferrals and will therefore offset each other going forward.

In addition, as a result of no longer charging and billing customers for mid-course correction orders, we anticipate a reduction of approximately $700,000 per quarter, a small price for improving the Invisalign customer experience and helping doctors achieve great treatment outcomes for their patients.

For scanner and CAD/CAM services, we expect revenue to be down sequentially from Q2, reflecting lower ASPs and an increasingly competitive environment.

With that as the backdrop, Q3 Invisalign case volume is anticipated to be in the range of 103,600 to 106,100 cases, reflecting 12% to 15% year-over-year growth.

We expect Q3 total revenues to be in the range of $154.9 million to $160 million.

We expect Q3 gross margin to be in a range of 73.7% to 74.2%.

In Q3, we expect operating expense to be in a range of $84.8 million to $86.9 million, which primarily reflects higher legal fees and delayed head count with some hires that took longer to get on board.

We expect Q3 operating margin to be in a range of 19% to 19.8% and EPS to be in a range of $0.28 to $0.30.

In Q3, we expect the effective tax rate to be approximately 24%, diluted shares outstanding to be approximately 81.6 million, and cash on hand to be in a range of $370 million to $380 million.

Now I will turn the call over to Tom for closing comments.

Thanks, Roger.

Overall, Q2 was another strong quarter, and we're pleased with our continued progress.

We've delivered solid execution on the important strategic initiatives currently underway.

The economy continues to be a challenge in many geographies, but patient traffic to the dental industry remains steady, notwithstanding the summer seasonality we expect to see in some of our doctors' offices.

The continued growth in Invisalign adoption and utilization worldwide is a result of continued investment in R&D, new product development, improved and expanded sales coverage, and in major markets, supported by consumer demand programs.

The Invisalign product and customer experience keeps getting better and better, giving doctors confidence to use Invisalign on more patients with increasing treatment complexity.

This can really be seen in our teen patient population.

At the same time, we believe we're just beginning to address a real market need with Invisalign Express and i7 for patients who just want to fix minor malocclusions at an affordable price point.

We're adding to this positive momentum with two new additions to our executive team.

Today, in a separate release, we announced that David White is joining Align as our new CFO.

And John Graham is joining us as our new VP of Marketing and CMO.

Both bring tremendous experience and energy to the organization, and are each excited about the opportunities ahead.

You'll have the chance to get to know each of them as we update you on progress throughout the rest of the year.

Finally, I would like to thank Roger George, Karen Silva, and the rest of the finance team for doing a great job of taking care of business while our CFO search was underway.

And with that, let's get right to the questions.

(Operator Instructions)

Robert Jones, Goldman Sachs.

I wanted to start with teen.

Obviously, some high expectations for this category over the summer months.

In fact, it really was the only segment where you didn't substantially beat our expectations.

Looks like it grew about 16% last quarter, year-over-year you're 27%.

I think for the full year last year, you grew about that as well.

So I was just curious, how the teen growth, obviously while strong, how it's been measuring up to your internal expectations?

First of all, I think we're very comfortable with where we are with teen and with a little lower sequential, this is not a completely linear business.

We're very comfortable that, given that there's two elements of that, there's international, there's North American orthos, and there are GPs.

GP channel fluctuated a bit more.

The ortho channel continues to have very, very good year over growth rates and in general, we're pleased.

That positions us pretty well for the summer.

I think the way we think about teen is it's a key growth opportunity, but it's going to be a steady climb, given that teens are the base business for orthos and they are going to convert -- continue to convert to Invisalign more cautiously than they will for adult patients.

All the initiatives we've got under way, coverage, evolution of the product with G4, SmartTrack, and all of those things support that.

And we're comfortable that we're going to have a good, strong teen summer.

That's great, Tom.

I guess my follow-up would be more broad, just around the operating margin guidance, 19% to 19.8%.

Relative to what you did this quarter, looks like you're also guiding gross margins to decline sequentially into 3Q, as well.

I guess just maybe if you could spend a little time helping us think about the drop in profitability from this point?

And then maybe if you're comfortable commenting on if you're still confident that you'll exit the year near that 25% operating margin level?

I guess the Q3 guidance stands for itself, and we're comfortable putting that out there.

The fundamental driver in this business is volume.

And if you take a look at the quarter we just reported, we did a little better on volume and a little better on pricing, and we're getting up in that neighborhood at the low end of our model at 23%-plus operating margin.

So we expect volume to be down a bit in Q3.

That's very typical.

If you look at every quarter over the last six, seven, eight years, it's been the case.

And along -- and we're not just going to pull spending back in important strategic areas.

So along the way, you're going to see a little less operating margin.

But again, with the guidance out there for Q3, with our expectations that we typically build volume into Q4, we fully expect with all of these initiatives coming online that we can approach the low end of that long-term model, around that 25% range.

That's great.

John Kreger, William Blair.

Tom, could you talk a bit more about what drove the surprisingly good ASP trend?

Maybe if you do -- did an apples to apples comparison with Asia, if you had that fully in your P&L last year, what would the trend have been?

I'm going to ask Karen to take that in just a minute.

And I know that we didn't -- we're not modeling it for disclosure.

We've modeled it internally.

It was a contribute -- I'll start by saying the APAC revenue for two-thirds of the quarter, May-June, was a contributor.

But probably the bigger contributor was net ASP in North America, where we had larger participation, with some lower volume customers reengaging with orthos and some GPs, and didn't participate as heavily on the advantaged side.

That was a big factor.

If we take that, plus some smaller factors, a little positive FX and then Asia-Pacific, you've got them together.

And I'll ask Karen Silva, our VP of Finance, to maybe comment a little more.

Sure, Tom.

So for the quarter, we experienced several million dollars from the uptick from the Asia-Pacific.

They came on.

We bought them as of May 1, so we had two months under our belt.

And so we can -- we expect that that will move forward in the future quarters.

And offsetting that, of course, will be additional sales and marketing spend, which we took on the majority of their sales team and that will continue (multiple speakers) (laughter).

Very helpful.

Just a quick follow-up to that.

Do you still view the longer-term trend in ASP to be down due to mix, or is your thinking about that changing?

So I think over time, we would expect, as the low end offerings grow for minor malocclusions, we would expect mix to be -- to bring ASP down total.

I think the team put together a couple new slides based on a lot of questions like this, and we try to break out the elements there.

I think if you look into that, you can see that stable to up, you'll be able to separate mix-driven change from what we'll call real price.

And -- but the biggest factor driving it down in general is going to be mix.

Second factor would be, probably, advantage among high volume customers, but you can intuit that from the breakout we're giving you now.

Great.

And then one last one.

After the favorable ruling that you got during the quarter from the ITC, have you seen that have any impact on volumes or market share?

Do you -- would you expect in the second half of the year, or is that more of a longer-term opportunity in your view?

From our perspective, it's -- if there's any volume, it's very small.

And I think this is really more about asserting the right IP so we can continue to build the business for our customers and shareholders over the longer term.

Great.

Jon Block, Stifel.

Great.

Real solid quarter, so I guess I have to be picky, if you would.

But North American ortho, maybe that was the only area that didn't blow out our numbers.

So maybe can you speak to what's going on with SmartTrack and how it's being received there?

What it's doing to utilization?

And then also, Tom, just as a function of that, are you hearing from the field that it's helping the guys shorten treatment time?

We've done some work there.

And if so, how is that being received from the doctors?

Let me start there, John.

We've got no solid clinical data at a level that we could claim it.

There's a lot of experimentation going on with treatment cycles and adjunctive therapy.

But from our perspective, we're not anywhere near where we would want to posit a change in treatment times, so I'll start there.

The -- we're very comfortable with where we are with ortho, and one of the dynamics this last quarter is that we're engaging with some really good practices that have not been customers of Invisalign for quite a long time.

And they are reengaging with us, seeing what can be done and they're-- so they're not really Advantage customers.

They are now getting trial and usage, and some of them throw in 5 or 10 cases where we hadn't seen anything before.

So what you see is a tail growing on the ortho side that actually was a contributor to less advantaged, a higher ASP.

The way -- the specific answer to your question on innovations like SmartTrack and the big release or two we do a year, right?

Like G4, SmartTrack, et cetera, is that our core base of orthos and GPs and international doctors will get experience with that quickly, given their volume, and they will immediately start changing behavior, doing more complex cases, doing more teens, for example, and then that steadies out over time.

What's going on now is what I just spoke about a moment ago, where the less frequent ortho submitters, the doctors are using us less, are actually trying it more, becoming more comfortable, actually seeing a change in the product.

They are just not as frequent users, and so they're not getting as rapid a feedback, but we're getting very good traction there.

So what I would say is, this is a very consistent transition with the early adopters and frequent users getting the biggest bang for the buck and then working down through the base of users.

But again, them taking longer to recognize those advantages, but leading to utilization.

So it's another reason, with the base growing on GP and the active base growing a bit on ortho, while utilization is flattish for both.

But there's actually a good news story underneath that.

Yes, that makes sense.

And then that's where it dovetails into my next question, which is, I don't have the number right in front of me, but the number of GPs trained, I think you said was over a thousand.

That was well above where we were.

And that actually goes back to pre-proficiency noise, I hate to use that word again.

But where big time guys were coming on board, you were partnering with these doctors, and they were excited to be part of the Invisalign story.

So can you talk to what's going on in the field?

Is that the feeling out there?

And they have now a lot at their disposal, between Express 10, Express 5, et cetera, where these guys realize, I want to be doing Invisalign because of the additional revenue kicker to my practice, and that's leading to the really impressive new doc numbers?

There's a whole set of reasons why an orthodontist or a dentist that wasn't doing Invisalign comes to Invisalign, and it starts with their patient interest.

Patients are asking, doctor, why don't you do this?

It comes to the fact that they have got -- they had good clinical reasons for not doing it.

They have a busy restorative practice, yet they are influenced by friends.

It fits well into a good restorative cosmetic dental practice.

On the ortho side, the docs that really weren't our customers, I'll stay on GP for a moment and come back to ortho.

We did train over a thousand, and we see strong interest out there in adding Invisalign to practice.

It is one of the best practice-building vehicles today in general dentistry, for sure.

On the ortho side, I think the biggest vector there is the evolution in the product and the customer experience.

The product just is getting better.

And along with that, they are more comfortable.

They don't have to make compromises on the finishes.

They can promise to mom and dad, for a teenager, or to the patient themselves.

And -- but that is a journey.

And -- but we are in the process of reengaging there.

We trained up almost 120 orthos.

That's a big number for us.

Plus, the numbers coming out of universities that are -- which are small classes.

But I'll call that a good step in the right direction.

Jeff Johnson, Robert W. Baird.

Roger, I was hoping I could start with you.

Just one more question on third quarter guidance, if I could.

The OpEx commentary on sales force was helpful on why that might be dragging margins down a little bit more next quarter.

And obviously, Tom's comments on volumes makes sense from a fixed cost leverage standpoint.

But why gross margin?

Why would gross margin be down a bit next quarter with the higher ASPs from Asia-Pac?

You had gross margin up year-over-year this quarter.

Why would gross margin go down year-over-year next quarter?

Just trying to understand that better.

I'm going to ask Karen to pull the numbers out to give you the quantitative answer.

Sure.

Give us a second, will you.

Yes, and maybe Tom, I'll ask two quick questions, then, to finish mine off.

Just Realign, out of the 2,500 docs that you said had visited the Realign site so far, any idea how many of those are new docs who have never done an Invisalign case before, versus maybe past Invisalign users?

Just trying to -- I don't think there's going to be much cannibalization there, but obviously that would be a good cross check on that.

And then on the DTC side, which -- ramping that back up in May pretty aggressively, and going to continue it through the summer.

Is there a lagging impact on that?

Did the May and June increase DTC influence 2Q yet, or are those benefits probably more of a third quarter-type event?

Let me take this in reverse order.

Yes.

I'll start with the last one.

There's two elements of any consumer demand.

There's brand building and awareness over the long term.

And I'll call it excitement and energy.

And again, if you think about the integrated nature of our platform, we've got both the traditional media with a lot of digital vehicles, social, very tied in with PR, gaming, and a whole bunch of other areas.

With that, you activate interest in a whole bunch of ways.

So it can start a search for a doctor.

It can start a background information and all of that.

At the end of the day, I would call the launch, which was timed to start with the beginning of the teen season, create a lot of excitement in offices and energy and all of that.

But the value is really a quarter -- two or three or four quarters ahead, and then taking that to the next level.

So we're -- this is just -- we view this as more strategic than tactical, and I would say we're in the early innings there, still, of what's possible.

So that's one.

Remind me, sorry, your second question?

I think that was--

Just the Realign on the 2,500 docs--

On the Realign question, the 80,000-plus customer list that Schein has, by definition none of them are certified Invisalign customers.

Could -- we've actually been asked by a few doctors, hey, could I try one?

Schein calls on me occasionally.

We have said, there's no reason why you couldn't, but it won't have quite the same features that say, Express 5 would.

It won't have a ClinCheck they could adjust.

It will have a ClinCheck-type setup they approve, but it won't give them the flexibility to customize the treatment as much.

And so we have a few doctors that said they would be interested out of curiosity, but by definition, we expect this to be a greenfield of doctors that are, some of them, many of them are already buying clear aligner offerings from a local lab or a big lab.

And our view is, we ought to be able to do that better than anyone else in the world, and just as cost effectively for them, brought to them by a trusted partner in Schein.

That's the theory of that case.

And I guess with that, I'll kick it back to Roger and Karen and see if they are ready to talk about the elements there in gross margin.

Sure, Jeff.

This is Karen.

So couple things going on with the gross margin.

Some of this is related to ASPs down, being down for sure.

And then we also have slightly higher cost per case on the Invisalign side, as we are expecting number of liners per case to be just slightly up.

Now, there's a few other little small pieces to it, but we also expect a little bit more in depreciation, as we have some fixed assets that we'll be putting into production here in the next -- in this quarter.

Okay, and just trying to understand the ASPs being down.

If they were up a little this quarter and you get a full three months of the Asia-Pac distributor changeover in the third quarter, were ASPs naturally just swinging down in third quarter for what reason?

We have a number of factors.

Certainly, one, we have a planned FX.

We did got a little -- we did a little better than that last year.

There were a number of contributors before on price.

We would plan an advantage, participation with our big ortho customers, and maybe plan on a little lower ASP, higher advantaged participation, which we would view as a positive thing, of course.

And then finally, we're running a bit of a promo.

I think there was something in a webcast slide.

We're running a bit of a promotion, a little different one at some of these re-engaged orthos, that have not been big Invisalign customers, to get them to trust us to help them work on teen patients through the summer.

And that will have some impact on price, but we think that will be a very valuable way to get them to get a really good experience in a shorter period of time.

Get that trial, repeat usage, and then hopefully sustainable adoption.

So that we -- as we project that, if we're successful with it, we'll be very happy.

That would have a little bit of a negative impact on ASP, but we would view that as a very good investment.

Got it.

Brandon Couillard, Jefferies.

Roger, looks like the scanner and services cost of goods fell to what looks like their lowest level since the deal closed.

What drove that improvement?

And any chance you could give us an update on where cadence stance stands in terms of operating profitability at this point?

Sure.

The improvement to -- I'll tell you what, Karen's got the quantitative data in front of her, so I'll let her hit the gross margin question.

Sure.

So scanner and services margin increased sequentially, primarily because we had higher production of volumes, and we also had lower manufacturing spend.

We also had lower intangible amortization, since we reduced our intangibles last quarter, as well.

I'll build on that a little bit.

I'll take the next part of it on where we are with -- I'll just say, not just profitability.

Part of making this business an even more valuable part of the family here is, it's not just profitable.

It's strategically valuable.

We continue to be convinced, the latter.

It is strategically valuable.

We see leverage on the Invisalign side.

But if we have stand-alone profitability at issue, we're behind where we expected to be.

The installed base hasn't grown as fast as we would like.

Pricing certainly has come down with competitive offerings, and it has taken us a little longer to get platform changes.

So look, say it as it is, we still think there's great strategic value to be had.

We're behind where we expect to be on profitability, but we still are very committed to this business.

The number in terms of digital case submission certainly continues to ramp impressively.

How should we be thinking about that business as we get into the third quarter and second half of the year, in terms of sequential revenue trend?

In terms of the scanner business?

Or in terms of the utilization of digital scans?

The scanner and services revenue.

Scanner -- again, we've got two -- we have two or three factors that made the revenue growth story tougher for us.

The first is that, certainly, pricing has come down per unit versus what we thought about a couple of years ago.

That's a reality.

We're dealing with it.

And we're making solid progress.

The team's working their tail off.

Secondly, we've turned off some of the services stream.

We're trying to drive more to digital, high tech, manufacturing, modelists, all that, and we're doing a lot of that in Juarez, where we have better gross margins.

We're working closely with lab partners and others.

But we've actually turned off what was a pretty significant part of that user base with IQ, a bracket placement tool.

We just didn't feel like we would scale it.

So if you really look at one of the contributors to the service stream coming down, that was one of the biggest factors that we really -- roughly a year ago, we gave the notice and we've kind of pulled that down.

We've made the decision not to reinvest, for now, into a completely new suite of tools and software, manufacturing technology.

We could go back to that with better profitability in the business over time.

But in general, this -- the restorative business has seasonality just like the Orthodontic business.

People don't do a lot of restorative work unless it's an emergency over summertime, vacations, holidays.

Dentists' offices are closed for some vacations and all that.

So there's a little more seasonality for general dentistry in the summer.

Certainly, in Europe, for sure.

What -- we don't have much restorative base there.

And then we would expect Q4 to get busy, both on the capital equipment spending side and back to the growing services again.

So there's probably a bit more pronounced seasonality in restorative dentistry than orthodontics, because the teen season in ortho masks that.

Okay.

And Roger, real quick, could you -- any chance you could quantify the impact of the medical device tax in the second quarter?

Yes, hold on, we'll pull that number up for you.

$2.1 million is the answer.

Super.

Chris Cooley, Stephens.

Congratulations on the great quarter.

If you could maybe just explain a little bit, or give us your views.

When you look at the Schein agreement, longer term, does that help you better penetrate the existing 10% to 15% of the market that are using independent labs?

Or does that really scale the reach for the Company over time?

Then I have just one quick follow-up.

Sure.

I think it does both of those.

And then the other -- because there is some usage going on.

We've seen it.

We've surveyed to it, and we -- from a variety of small, medium and large labs, they are getting clear aligner offerings.

Which we think we can do better than, and give them that great value proposition, delivering it through a great partner like Schein.

The second thing is, there are more and more people having conversations with their family dentist.

Not ready to go see an orthodontic specialist yet, which we then we would encourage, or to go see another dentist that's doing Invisalign.

Many times, dentists don't want to refer them to another dentist that is doing Invisalign.

And they are simply not sure yet, they want to go commit the effort in practice to integrate a procedure like Invisalign.

So this does give them an opportunity to at least try very simple cases from a Company they can trust and a partner they really respect in Schein.

So ultimately, it gets at the widest part of the dental industry that we're not touching today, and really don't have a meaningful way to get at.

And then secondly, I think it can help support longer-term category growth for clear aligner therapy.

I appreciate that.

And then just as a quick follow-on, you have an enviable position of having a very nice cash position on the balance sheet.

And now that you've wrapped up the prior repurchase that was authorized, just thoughts on how we should be thinking about the cash build there on the balance sheet and future uses?

Sure.

Fair question.

I would say this is a continuing topic, important topic for the Align board of directors, and we continue to get input from our owners about their views on capital allocation.

How we should think about ensuring value for those shareholders.

And we will continue to share those views with our board.

But I would say we have been busy after this last quarter.

Let us go back and pile up a little bit more, and we're going to try to continue to run the business as good stewards.

Congratulations on a good quarter.

Spencer Nam, Janney Capital.

Just had a couple of questions, here.

Number one, in terms of your revenue guidance for the third quarter, the last year there was a little bit of a surprise with the patient volumes suddenly dropping off for whatever reason, possibly due to dentists taking more time off during summer months.

How has that -- those possibilities were included in your guidance, with the current guidance that you provided today?

Sure.

I guess maybe asking the question differently of myself (laughter), did we learn anything from last year?

In retrospect, and we've known this for some time, though, one of the most important trends that has some predictive value is patient traffic in offices in North America.

And as we reconstruct Q3 and Q4 of 2012, it is very clear that a significant deceleration in patient visits started actually in Q2, and we didn't see it because of just how strong Q4 of 2011, Q1 and Q2 of 2012 were.

Other dental players started seeing it in Q2.

It surprised us in Q3, and our methods of understanding volume and activity in offices didn't yield that.

It was not until literally the big players like Schein and Patterson were reporting widespread downturn in patient traffic and procedures that we were able to go back and look at this.

So what have we learned?

We've learned to continue to be humble, and we've instituted a series of new surveys and pulses of offices.

Not just asking customers what their expectations are, but actually trying to determine what their patient traffic procedures volumes are month-over-month, and to understand if there's any foreshadowing for future.

So we have the same visibility we've always had in our Business.

We take this very seriously.

This is a challenging business to forecast, given the fragmentation.

But we are -- but all of that, to your original question, is loaded into our view of what, hopefully, looks like whatever normal might be, a more normal, seasonal Q3.

All right.

Thank you very much for that detail, Tom.

Just quick follow-up on Asia.

Clearly you guys saw a lot of strength there, including ASP.

That actually went up dramatically, in my view.

I'm curious how -- what -- how much do we expect in terms of maintaining that sort of strength out there, in terms of China still hasn't opened up fully.

How do you see Asian market unfolding over the next several quarters?

I think, as Karen talked, if you take ASP to start with, as Karen spoke about a moment ago, the big jump -- one of the big contributors to Company ASP performance was the 50% step-up -- or the 100% step-up, the doubling of effective price for the biggest part of our geography in Asia-Pacific through the distributors.

May 1, that converted to a more normal global price for our Invisalign ASP versus giving the distributor -- selling to the distributor at 50%.

That will continue.

That's persistent.

As Karen also talked about, there's an offsetting OpEx step-up, with 47 new employees that came in.

But we believe -- we know day one, contribution margins are actually net positive on that very first that came in -- very first case that came in on May 1, even with the step-up.

The second part of the question, I believe you asked is, how confident are we about the longer-term growth?

We really are just getting started in many of these geographies.

Our penetration is order of magnitude, or more or less than in North America or Europe, and in places like China, we're seeing the path towards a growth in Japan.

We're seeing the path towards growth, and understanding that these cases, most of the cases in Asia are dramatically more complex than in North America.

The evolutions in product technology, and easier to do these complex cases makes a very big deal for them.

So on balance, this is strategically very important.

We believe we can continue to grow there.

And we're in the process of making investments to do that.

Next question, please?

Glen Santangelo, Credit Suisse.

Hi, this is actually Jeff Bailin in for Glen.

That's all right.

You had you some pretty impressive growth in your international case volume this quarter, up over 20%, and particularly impressive in Europe, given some of the macro challenges we've been hearing about there.

Can you talk about what you think is supporting your growth there?

And maybe how you'd characterize the growth rates in case volumes in Europe, relative to how you're growing in Asia-Pacific?

And I just want to clarify, Jeff.

You want me to unpack Europe specifically a bit more?

Yes, that would be great, and just what you think is supporting the growth there.

Perfect.

Okay.

Got it.

I think if you may remember, as we talked about early in the year, we didn't give annual guidance.

But we did signal that we -- our operating margin, we would have a little more drag early in the year, based on investments in new consumer demand, which we've now rolled out, based on product evolutions, which we're in the middle of, and based on coverage expansion.

And that was happening both in North America and Europe.

If I take Europe specifically, we have changed some country leadership, where we felt it was time for that.

That takes a little while to work out.

And one of the things, when you struggle a bit in a challenging economy, it helps you find where you can be better.

So there's the virtuous part of that challenge.

We've invested in some of the geographies we weren't -- our coverage wasn't complete in.

We've added a number of sales reps in Germany.

We've added some management structure in some of these countries where they were getting big enough.

We've added coverage in the UK, in France, incrementally in Spain.

And so we've incrementally added resources alongside of this product evolution, which has been better and better received by these doctors, mostly orthodontists in general, that treat in general harder cases, and have very high standards.

So as the product has gotten better, we've been more comfortable to make incremental coverage investments.

And while there was a bit of a cost lead first and a volume lag second, I think that plus all the other initiatives we've got going, start to give us the kind of volumes we can be comfortable with.

And we have a reasonable confidence that while we won't be linear, I think we are pretty confident that we can continue to grow faster in Europe and North America, and faster in Asia than Europe and North America.

Great, and one quick follow-up, shifting to the Scanner business, if I can.

During the past, you've discussed potentially being open to partnerships with other scanner vendors, particularly for digital case submission.

Is that something that you still think could make sense and that the Company is open to?

Yes, we signaled that during our Q1 call, because we were going to be right in the middle of customer central with the AAO and some other big trade shows.

We still believe that is strategically valuable.

We also are realistic that we're not going to sell every scanner out there.

We believe we've got the best scanner still in the market, and if we can qualify a couple of the leading scanners out there and bring that value to their customers, our respective customers, there's potential benefit all around.

Great.

Chris Lewis, Roth Capital Partners.

First, on the Express segment that, that came in quite ahead of our volume expectations for the quarter.

So I was hoping you could maybe provide some more commentary on that segment and where that growth came from during the quarter.

And then longer term, with the growth of some of the lower-priced segments, how does that impact your margins and your ASPs over time?

Yes, the short answer for the volume growth in Express 5 is North American GP.

We're still getting started in Europe with i7 and i14, but good, solid traction for that very cost-sensitive patient that has been presented with a comprehensive treatment and says, not ready to spend $5,000 or $6,000, or $4,000 to $5,000.

I really want this little space or that little crowding fixed.

And this gives the doctor in the practice an opportunity to at least get after that chief complaint.

The second part of your question -- so it's North America GP to start with.

The second part of your question is around gross margin, I think.

And at the end of the day, I think the longer discussion is contribution margin.

The gross margin in the very short term is a little bit worse, but very comparable to say the full.

Over the mid to longer term, gross margin, as we continue to automate processes, will probably be as good as or better on the lower -- on the simpler cases than they are the harder cases.

Fewer ClinCheck cycles, refinements, things like that.

So very, very comfortable.

On a contribution margin, when we net out the direct cost of sales, marketing, it might actually be better than that.

But again, it's early days.

Our goal is to continue to build at both ends, aim for becoming standard of care someday, which is our long-term goal, which really means we have to earn our way into the specialist's office and those GPs that do a lot of orthodontic cases as their tool of choice.

At the same time, widen the base and -- with things like Realign, Express 5, 10, i7 and 14, hit a niche that isn't really being addressed today, with people, frankly, that don't want brackets.

Okay, great.

And then turning to the International side, I was wondering if you could quantify the incremental revenue impact, the direct conversion in Asia-Pac had on the quarter?

We're not providing that level of breakout, but I think you can maybe back into it a little based on historical numbers we've given.

But I think when you see the ASP impact, you know it's meaningful.

And the growth rate's there to support greater meaning in the future.

Okay.

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