愛齊科技 (ALGN) 2014 Q1 法說會逐字稿

Greetings, and welcome to the Align Technology Q1 2014 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded.

It's now my pleasure to turn the conference over to your host, Shirley Stacy, VP Corporate and Investor Communications.

Thank you.

You may begin.

Good afternoon, and thank you for joining us.

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

Joining me for today's call is Tom Prescott, President and CEO; and David White, CFO.

We issued first-quarter 2014 financial results today via Marketwired, 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.

Telephone replay will be available today by approximately 5:30 PM Eastern Time through 5:30 PM Eastern Time on April 30.

To access the telephone replay, domestic callers should dial 877-660-6853, with conference number 13579429, 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 limitation, statements about Align's future events, product outlook, and the expected financial results for the second quarter of 2014.

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, 2013.

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 conference call, we will provide listeners with several financial metrics determined on a non-GAAP basis to aid comparisons between our current and historical financial results.

These items, together with the corresponding GAAP numbers and the reconciliations to the comparable GAAP financial measures, are contained in today's financial results press release, which we have posted on our website at investor.aligntech.com under Financial Releases, and have been 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 first-quarter conference call slides on our website under Quarterly Results.

Please refer to these files for more detailed information.

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

Tom?

Thanks, Shirley.

Good afternoon, everyone, and thank you all for joining us.

On the call today, I'll provide some highlights from our first quarter, and briefly discuss the performance of our two operating segments: Invisalign clear aligner, and iTero scanner and services.

I will also provide some color on our orthodontist and GP dentist customers, as well as progress in our geographies around the world.

David will then share more detail on our first-quarter financials, and discuss our outlook for the second quarter.

Following that, I will come back and summarize a few key points, and then open the call up to your questions.

We are pleased with our overall first-quarter results, with better-than-expected revenue and earnings.

Record first-quarter revenue increased nearly 18% year over year, driven by strong Invisalign volume.

This solid growth reflects continued expansion of our customer base, as well as increased adoption and utilization, as doctors treat more patients with Invisalign.

Despite numerous global economic challenges, our Business remains strong, with growth driven by continued progress in our EMEA and Asia Pacific regions.

Our performance in Q1 reflects continued focused execution of our strategic plan, including three key growth drivers, which are: market expansion, product innovation, and brand strength.

I'll provide a brief update on each of these before discussing our results.

First: market expansion.

This strategic growth driver encompasses the many ways we are working to grow the adult-treatment category, increase our share of teen treatment, and in parallel, open up new geographies.

In Q1, we continued targeted investments into our existing markets, including North America, Europe, and the Asia-Pacific region, through a combination of sales coverage and support, along with professional marketing and clinical education programs.

As mentioned during our January call, we are further expanding our directly covered markets in Europe by converting some of these countries previously managed by our EMEA distributor back to direct sales geographies.

In Q1, we began this process by bringing Scandinavia, Portugal, and Greece back in-house.

While we don't expect to see immediate material impact from these markets, we are excited about their longer-term potential and the opportunity to connect more directly with our customer base in those countries.

Our second growth driver is product innovation, which aims to create greater doctor preference through an intense focus on innovation, and deliver increased adoption and utilization for our products.

In Q1, we launched Invisalign G5 innovations for deep bite treatment worldwide.

Deep bite is a very pervasive functional orthodontic problem that presents in almost half of the existing ortho case starts in North America, and approximately a third of the case starts in Asia.

And while experienced doctors have been using Invisalign to treat deep bite for years, Invisalign G5 is designed to make treatment with Invisalign easier for our doctors, and help them achieve even better clinical outcomes.

Early indicators show a high level of enthusiasm around Invisalign G5.

We saw a record attendance at our Invisalign G5 launch events, with more than 4,000 doctors attending Invisalign G5 webinars in North America, and more than 1,800 doctors in a series of launch events in Europe and Asia.

In the first couple of months post-launch, we have seen both an initial increase in the number of doctors submitting deep bite cases, as well as in the number of deep bite cases started worldwide.

With the greatest incremental growth coming from international orthos, it is not too surprising that the doctors outside North America typically treat more complex cases.

We also began the phase launch of ClinCheck Pro with 3D controls in Q1.

ClinCheck Pro is our latest software innovation that provides doctors with more precise control over final tooth position during treatment planning.

Just eight weeks into the launch, 83% of targeted doctors are using ClinCheck Pro.

These early metrics for both Invisalign G5 and ClinCheck Pro trial and adoption give us confidence that we are delivering meaningful innovations to our customers.

And finally, brand strength is our third key growth driver.

Invisalign is the most recognizable brand in our industry, and we continue to build equity in this valuable brand through a very integrated consumer marketing platform that includes TV, media, social networking, and event marketing.

After what is typically a lighter Q4 in terms of media investment, Q1 saw an increase in North America media activity that delivered more than 1.2 million unique visitors to Invisalign.com, and year-over-year increases in all related activities on our consumer website.

Extensive usage of social media and traditional PR continue to help enable meaningful discussions around Invisalign treatment, leading to 53 million impressions from social media platforms just in Q1 alone.

While on a smaller scale in Europe, we continue to invest steadily in integrated consumer marketing campaigns in all major direct markets, and are taking initial steps towards more significant PR and consumer programs in our Asia-Pacific region.

We've included more details on our consumer activities in our webcast slides.

In combination, these three proven strategic growth drivers are helping to extend growth in our strongest geographies, while starting to tap into other meaningful growth opportunities around the world.

Now let's talk about how we did in Q1, by sharing some customer and geographic highlights, starting with North America.

For Q1, North America Invisalign volume was up sequentially from Q4, and up 9% year over year, despite reduced patient traffic and fewer effective days in office, as reported by a significant number of our customers who were affected by severe Winter storms across the US and Canada.

The sequential increase in Q1 primarily reflects growth from our North American orthodontists, while North American GP dentists were relatively unchanged from Q4.

The year-over-year increase reflects expansion of our customer base, as well as increased adoption and utilization among North American orthodontists.

In the teen market, which makes up the majority of orthodontic treatments globally, we had a solid quarter, and over 26,000 teenagers worldwide began treatment with Invisalign, up slightly from Q4, and consistent with fewer teen case starts that occur during the Winter months.

The teen market remains one of the largest growth opportunities for Invisalign, over the mid to long term, and we continue to invest in enhancing product applicability to increase doctor confidence in teen treatment, along with go-to-market initiatives in sales coverage and in consumer programs to drive adoption.

For Q1, as anticipated, Invisalign case volume from international doctors in our EMEA and Asia-Pacific regions decreased slightly on a sequential basis due to fewer days in the office from Winter holidays in Europe, as well as the lunar new year period in Asia-Pacific.

On a year-over-year basis, international volume increased 31%, reflecting strong growth in both EMEA and Asia-Pacific, driven by go-to-market and sales coverage investments, ever-improving clinical education and support, and excitement around new products like Invisalign G5.

Taken together, these important steps increase doctor confidence in Invisalign treatment and lead to increased adoption.

In the EMEA region, Q1 Invisalign case volume was unchanged from Q4, and increased 24% year over year.

Growth was driven by strong demand from orthodontists in our core country markets, where we saw significant increases in France, Spain and Germany, and in the UK, where we are seeing continuing signs of recovery.

In Q1, Asia-Pacific Invisalign case volume decreased slightly sequentially, but increased 51% year over year with significant growth across all markets.

Q1 was another good quarter for our scanner and services segment, which was up both sequentially and year over year.

The momentum we had exiting last year continued into Q1, which resulted in better-than-expected scanner revenue.

Our scanner and services segment continues to benefit from leveraging our combined sales and marketing resources, and taking full advantage of Invisalign and industry events, such as the Chicago Midwinter Meeting in February.

We also further enhanced the functionality and flexibility of our iTero scanner for restorative procedures by announcing connectivity with DENTSPLY Implants' ATLANTIS custom abutments, which will help deliver a more optimal dental implant patient experience and outcome.

In a separate release today, we announced our new iTero 5.2 software upgrade.

The iTero 5.2 upgrade is designed to increase practice efficiency, and significantly expand the extensive array of iTero features currently available.

These enhancements will reduce total Invisalign scan time, and a new Vivera pre-bonding feature will allow simulated digital removal of traditional wire and brackets for retention fitting prior to completion of orthodontic treatment.

Commercial availability of the iTero 5.2 upgrade will begin in May of 2014.

We've included some more details on the iTero software upgrade in our webcast slides alongside this.

The continued trend in digital dentistry leads to better back-office integration, improved clinical workflows, and greater use of intraoral scanning, setting up significant growth opportunities for our scanner business.

The iTero scanner has proven to be the best intraoral scanner, with the greatest utility for customers, and Align is well positioned to benefit from this trend.

As of Q1, the percentage of Invisalign cases submitted in North America rose to 30.2% compared to 26.6% in Q4 and 19.4% in Q1 a year ago.

We continue to support an open systems approach to digital impressions, remain committed to working with other intraoral scanning companies, specifically by way of enabling interoperability for use with Invisalign treatment.

Our ultimate goal is to further build and strengthen the Invisalign franchise, and while we're pleased to have one of the best scanners in the market with the most utility for our customers, we will also continue to do everything we can to create additional leverage for Invisalign business.

It's in our strategic best interest to validate and qualify other third-party scanners; and when we have more news to report to you, we will be happy to update you.

With that, I'll now turn the call over to David for a review of our Q1 financial results.

David?

Thanks, Tom.

Before I get into the details, I'd like to note that, unless stated otherwise, all the financial information I'll discuss will be presented on a GAAP basis.

Also, beginning this fiscal year, we are consolidating some of the additional product and geographic breakdowns that we provide.

We will continue to explain the performance of our products and geographies, and include commentary as appropriate; however, we believe a consolidated view of our quarterly financials is more consistent with disclosures from our respective peer group.

With that, let's review our first-quarter financial results.

Revenue for the first quarter was a record $180.6 million, up 1.3% from the prior quarter, and up 17.6% from the corresponding quarter a year ago.

First-quarter Clear Aligner revenue was $168.2 million, was up 1.2% sequentially, and up 18.8% year over year.

Our year-over-year growth reflected higher Invisalign volumes, led by our international doctors, as well as higher international ASPs.

For the first quarter, total Invisalign shipments of 112,200 cases were up approximately 1,000 cases, largely due to the factors Tom described earlier.

Year-over-year growth of 14.3% was driven by volume growth of our international doctors' case shipments, as well as continued expansion of our customer base.

For North American orthodontists, Q1 Invisalign case volume increased 3.9% sequentially and 10.5% year over year.

For North American GP dentists, Q1 Invisalign case volume decreased 1% sequentially, and increased 7.4% year over year.

For international doctors, Invisalign case volume decreased 1% sequentially for seasonal factors; however, increased 31.2% year over year.

We continue to focus on training new Invisalign providers worldwide, and in Q1, we added 630 new North American doctors and 1,255 new international doctors for a total of 1,885 new Invisalign doctors.

While the number of Invisalign doctors trained in Q1 was down sequentially because of fewer training courses offered in Q1, it was up 9% year over year.

Total Invisalign utilization for Q1 was 4.3 cases per doctor, flat with the same period last year, and slightly down from 4.4 cases per doctor in Q4.

First-quarter revenue for our scanner and services segment was $12.4 million, a 2.8% sequential increase over the fourth quarter, reflecting continued penetration and market share gains.

On a year-over-year basis, our scanner and services segment increased 3.3%, reflecting a 46.5% increase in scanner volume, which was offset somewhat by price and the effect of an iTero scanner upgrade program, which benefited last year's first-quarter results by $1.4 million.

Moving on to gross margin, first-quarter overall gross margin was 76%, down sequentially 0.5 points, and up 2.5 points year over year.

Clear Aligner gross margin for the first quarter was 79.1%, down slightly sequentially, and up 1.9 points year over year.

The year-over-year increase was primarily the result of higher ASPs and lower inventory reserves, as we transitioned to our new SmartTrack material in Q1 a year ago.

Q1 gross margin for our scanner segment was 33.6%, up 2.5 points sequentially, and up 4.3 points year over year.

Q1 operating expenses were $95.4 million.

On a sequential basis, operating expenses were up $11.9 million, due primarily to increased employee compensation expense related to our annual employee performance review process, which includes salary increases and promotions, as well as annual stock grants.

Q1 also includes a benefit of approximately $600,000 from discontinuing the accrual for our medical device excise tax, which I'll explain shortly when I discuss our outlook for Q2.

On a year-over-year basis, Q1 operating expenses were up $11.5 million year over year when compared to our non-GAAP operating expenses a year ago, primarily incidental to the growth of the Business, as well as headcount additions.

Our first-quarter operating margin was 23.1%, down 6.6 points sequentially, and up 4.3 points when compared to non-GAAP operating margin reported last year, and directly related to our higher volumes and gross margins, as I just described.

With regards to our first-quarter tax provision, our tax rate was 23.5%.

First-quarter diluted earnings per share was $0.39 compared to $0.51 reported in Q4, and compared to a non-GAAP diluted EPS of $0.26 reported in the same quarter last year.

Moving on to the balance sheet: For the first quarter, accounts receivable balance was $126.2 million, up approximately 11.4% sequentially.

Our overall DSO was 63 days, a 6-day increase sequentially, mainly due to a slower start for the quarter, and was down 1 day over the same period a year ago.

Capital expenditures for the first quarter were $5 million.

Cash flow from operations for the first quarter was $18 million.

And free cash flow for the first quarter, defined as cash flow from operations less capital expenditures, amounted to $13 million.

Cash and cash equivalents, marketable securities, including both short- and long-term investments, were $505 million; this compared to $472 million at the end of 2013, an increase of $33 million.

We also announced today our commitment to return $300 million to shareholders over the next three years through a share repurchase program.

As part of this plan, we intend to purchase approximately $100 million of shares over the next 12 months.

Our strong balance sheet and healthy cash flow position affords us the opportunity to continue investing in our strategic growth drivers, while simultaneously returning cash to our shareholders through a share repurchase program.

This program will also help offset dilution from our employee equity plans.

Our management team and Board of Directors believe that our Business represents an attractive investment opportunity for both current and potential investors, and the repurchase program demonstrates the Company's ongoing commitment to increasing shareholder value.

Before I comment on the outlook for the second quarter, let me come back to the earlier comment I made with regards to medical device excise taxes.

Well in advance of the implementation of the medical device tax in January of last year, and on an ongoing basis since then, we had consulted with advisors and held extensive discussions with the IRS on the subject of the medical device tax and its application at Align.

In March of this year, the IRS informed us that it was now their position that our Clear Aligner business qualifies for a full tax exemption.

As a result, we stopped paying and accruing medical device taxes on our Clear Aligner business in March.

As I indicated previously, this benefited the quarter by approximately $600,000.

On an ongoing basis, it will amount to a savings of approximately $1.8 million per quarter, based on our current Clear Aligner revenue levels.

Our second-quarter guidance, which I will get to momentarily, reflects this.

While we didn't have the benefit of this news in January when we gave directional comments for 2014, we had anticipated some incremental benefit from the medical device tax.

Accordingly, we continue to believe our operating margin for 2014 should be consistent with 2013 actual results, and not view this new information as an update to those aspirations.

Let's now turn to our business outlook for the second quarter and the factors that inform our view.

Q2 is seasonally a busier quarter for our international doctors, and we anticipate Invisalign case shipments to increase sequentially from Q1.

Our North American doctors report improving patient traffic flow in their office and an increase in new patient consults; therefore, we expect Invisalign case shipments in North America to be up from Q1, as well.

For our scanner business, we had a good start for the year, and we anticipate building on this momentum in Q2.

With this as a backdrop, we expect the second quarter to shape up as follows.

Invisalign case volume is anticipated to be in the range of 116,500 to 119,500 cases.

We expect net revenue to be in the range of $181.7 million to $186.5 million.

We expect gross margin to be in the range of 74.6% to 75.2%.

The sequential decrease from Q1 primarily reflects higher training costs, revenues, and costs, which carry lower gross margins.

We expect operating expenses to be in a range of $96.8 million to $98.7 million.

This sequential increase reflects greater TV media spend, as we get in front of the teenage Summer rush; continued international investment; and our participation in a number of customer events, including the upcoming AAO Meeting in May and our first ever Asia-Pacific Summit in June; offset by lower medical device taxes, as previously discussed.

Our operating margin should be in the range of 21.3% to 22.4%.

Our effective tax rate should be approximately 23.0%.

And diluted shares outstanding to be approximately 83.6 million, excluding any stock repurchases during the quarter.

Taken together, we expect EPS to be in the range of $0.36 to $0.39.

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

Thanks, David.

We're pleased to have 2014 started off with these solid results.

The Align team continues to execute well against both strategic and financial objectives as we work to extend the growth of our Invisalign franchise and begin to create greater leverage from our scanner business.

Based on continued solid operating results and progress towards our long-term strategic objectives, our Board of Directors has authorized a $300-million share repurchase program, which David described earlier.

We believe returning excess cash to shareholders, beyond what we need to invest in the Business, is the right thing to do.

Over the next month or two, much of the Align management team will be with customers at the AAO Meeting in New Orleans later this week to see thousands of orthodontists from North America and across the world.

We're also going to be in Singapore in June for our first ever APAC Summit, which will be a sold-out event with over 400 key customers from Asia-Pacific.

In addition, we are very much looking forward to spending time with our investors during upcoming conferences, including our analyst meeting on May 29 in New York, where we'll provide a more comprehensive view of our strategy and why we believe Align's best days are still ahead.

With that, I'll say thank you for your time today, and turn the call back to the operator for some questions.

Operator?

(Operator Instructions)

John Kreger, William Blair.

It's actually [Robbie Fada] in for John.

Congrats on the great quarter.

Just wanted to start with a question on the second-quarter guidance.

It looked like the first quarter came in a little bit better than expected; weather didn't seem to be an issue; and the slow starts that you had talked about last quarter, you seemed to be able to push through those pretty well.

Yet the second-quarter guidance seems like it's a little bit more conservative relative to our expectations.

What is driving your thought process that would prevent it from being a significant step up from Q1?

Robbie, I'll start maybe from a qualitative perspective, let David come back and comment more quantitatively.

In this case, we think is the net activity level, the patient traffic, that did have some impact in North America.

And while most of those appointments probably got rescheduled, it took a little time to do that.

That showed up a little bit more on the GP side than the Ortho side.

Some of that softness will play into Q2 shipments, especially with the earlier part of March that that volume growth you would have seen is deferred a bit.

As we certainly ended the quarter, we had very strong, robust pipeline.

And doctors are reporting patients are in and offices are full and all those dynamics are good.

But clearly, there was a month or two hit or miss through the quarter that was tough.

Qualitatively, that's the biggest part of the shift into the first part of Q2.

I'll let David add to it if he wants to add some color.

The only thing I would add is when we put our guidance together, we look at seasonality trends over the last three or four years the Company has experienced; we look at information that we get from the field, in terms of demand we're seeing from individual doctors and so forth; and we use all that to try and inform our guidance.

If you look at our historical seasonality and you look at how much we're projecting -- if you look at our guidance today and how much that is as a percentage increase or growth year over year, it is slightly down from where our three-, four-year average has been, but it's not significantly.

And so those factors that Tom just inferred cause it to be tempered a little bit for the second quarter from what it might historically have been otherwise.

Got it.

That's helpful.

What do you guys see the patient traffic trends right now looking like?

And do you see them improving?

Did you see them in March and April start to get a little bit better?

Well, certainly March -- we'll stop with March.

Definitely a significant think the cascade of what weather caused surprised our customers a little bit, and they went through an awful lot of reschedule churn.

Our customers, pretty much across the board, are reporting full offices and busy practices.

And if anything, it's sharpened their appetite to get back to growing the practice.

I think a chunk of the industry had a softer start, which for our customers means lower-cash-receipts months, and they don't like that.

So in general, we think things are healthy; but I'll come back to the comment earlier.

With all that happening, we're seeing a pretty big sequential increase Q1 to Q2, and that's implied in our guidance.

So we're pretty comfortable the direction the business is going, but it's still a pretty big step up for Q2.

Great.

Thanks very much.

Jon Block, Stifel.

The first question is actually just on the Express cases.

If I look at full versus Express, I think you're giving us, David, as you mentioned, a little less granularity than in the past.

But Express cases were up roughly 5% year over year.

In 2013, Express was up 35%; so clearly you had a more difficult comp.

But can you talk to what might be going on specific to the Express cases?

Is it just a tough comp thing, and now Express 5 is two years removed?

Or are some of these wires-and-brackets guys -- we've heard the environment there is "a street fight." Are they starting to throw some clear aligners in to try to get some of the wire-and-bracket share?

Thanks.

Let me take this in a couple of ways.

One, probably the biggest factor that makes the comp issue tougher is we were really driving for initial trial with Express 5. You go back a year, even two years, and we were trying to go as wide as we could to get initial trial.

We aren't doing those promos anymore.

We got trial; it actually has been pretty sticky in the practices we targeted, which, for Express 5, was a more experience customer that knew what they could move in five stages.

There is noise; and at the low-end, more on the GP side.

There are a lot of labs providing these.

We spoke about this in the context of thinking about the realign product and working out through a new channel with Henry Schein -- and so I think there is some noise out there.

The competitive environment is, I think, roughly the same; and we don't see what I'll call really credible technology-based products at the low end or at the high end, other than what you're aware of.

So the bigger factors with Express are two.

One, that comp issue from prior promotions-driven volumes, which worked; we got a good test and trial and adoption, although it came to stasis lower.

And then secondly, and in some ways better than our original expectations for growth on full cases, as our applicability gets wider, both in North America and especially outside North America with the greater complexity cases they're treating.

And with 51% growth in volume in Asia year over year, those are just about all full cases.

So in some ways, it's a wonderful problem.

On a percentage basis, Express is certainly growing lower -- but high-quality problem.

Okay.

That was very helpful, Tom.

And maybe just two more quick ones.

David, it's hard to do the implied math on the ASP that you're laying out for 2Q because you're giving a little less on non-case and scanner.

But just looking at your case volumes at the low end and your revenues at the low end, and thinking $22 million comes from Other and Scanner, it seems like you're walking down the implied ASP from $1,400 or $1,405 this quarter to maybe like $1,360, $1,370.

Can you talk to that?

Because, again, as Tom just mentioned, a lot of the growth is coming from these full cases.

So why would we see a stepdown in ASP that dramatically sequentially?

Good question.

A lot of that, Jon, has to do with our estimations as to the effects of mix in the next quarter.

When we think about mix, Tom was talking about geographically -- Asia-Pac being strong and so forth.

When we think about Q2, we're anticipating a bigger rebound on North America, given the softness it started out with.

And that's where we do some of the simpler cases.

Actually, when you think about it, that's where we do a large percentage of the Express types of cases.

So as North America rebounds, it tends to lower that ASP quarter over quarter as a result.

And I'll jump in on top of that.

The second part of that North America trend that we see, the pipeline activity goes directly to our Advantage Program for top doctors.

Because of the softer market environment and dynamics in Q1, the number of doctors, even big orthos, fell short of what their expectations were; and maybe they didn't get the pricing.

We had a lot of GPs that didn't deliver volume and didn't get the kind of pricing.

It's not the way we want a higher ASP when our customers don't do the volume they or we expected, but it's a fact.

So as we project greater activity, greater volumes from these committed customers, that's a direct relationship to ASP.

Those two factors together make up the difference.

Okay, and last one, if I could just quickly ask.

You clearly brought on a lot of sales reps in North America last year, and I think it was maybe about this time last year; yet we're seeing a decel in North American cases.

It was a messy quarter from a weather perspective, et cetera; but can you just talk at a high level?

Are these guys taking longer to get ramped up?

Are we seeing a little bit of the law of diminishing returns from the last 40 reps you brought on?

How have those sales reps performed in the field over the past nine months?

Sure.

There's an easy one.

We think actually the team is performing very, very well.

We're certainly one of the first to go out in our space of dentistry.

But I think at least the direct sell through -- not through distribution, where there's a buffering effect for timing -- I think the direct sell companies in general are all going to be looking at it a little bit softer period in North America, offset to some extent by Europe or Asia growth.

Our team is doing great.

We still believe we're very -- we know we're very underpenetrated.

And we believe there are still opportunities to feather in more sales coverage, and we will do that over time.

If it significant enough to talk about in numbers, we'll do as we done before and describe that.

But, no, I think the deceleration you're describing, once we normalize for all the factors in our business, including the APAC distributor, our core growth rates continue to be about 16%.

And that's even off of a very big basis; that's not across the world equivalently.

But our biggest market covered is still North America.

The teams doing is very, very well there.

This is not a perfectly linear business, and it certainly isn't perfect.

But I think we're on the right track here, and we have got a lot of confidence in the team.

Thank you.

Glen Santangelo, Credit Suisse.

Tom, I just wanted to follow up; and David, I just want to follow up on the guidance for 2Q.

It sound like you're assuming that patient traffic is picking up; and you modeled the case shipment, and you've modeled the revenues that way.

But, David, if I heard you correctly in your prepared remarks, you were suggesting that gross margins would be down sequentially, as well as operating profit margins would be down sequentially?

Maybe I understand the gross margins a little bit, if it's a mix or ASP issue.

But could you elaborate a little bit more on why the margins stepped down so much in Q2?

A couple of things.

When we think about Q2, and I thought initially you were going to talk about Q1.

But if you look at the quarter, Q1 was 76% gross margin for the total Company.

And the middle of our guidance is somewhere around 75% or so; so it's down about 1 point.

Some of that is due to the fact that Q2, we typically see a pick-up in revenues and costs associated with training activities.

And those training activities, typically, we price and so forth at very, very de minimis margin.

And so the effect of that increase in the non-case revenue associated with training, that picking up quarter over quarter, it tends to bring the overall gross margins down.

And that's the principal reason between Q1 and Q2.

On the operating margin side, our operating expenses, we did guide up a little bit quarter over quarter.

Some of that is due to the fact that Q2 is typically a heavy promotional period for us, particular as we get ready for the summer season for teens and so forth.

We have a number of promotions that we typically begin in the second quarter and a number of media campaigns that get kicked off in the second quarter in advance of that summer season.

And so you see a little bit of pick-up in our expenses associated with that.

And as we've also talked about, throughout this year we're investing in what we called a number of global strategic imperatives, which Tom talked about in his prepared remarks and so forth.

The largest component of that has to do with market expansion.

And some of that is geographic coverage expansion; some of that is territory coverage increases, and so forth.

And so that also tends to be a little bit of the reason for the pick-up in operating expenses.

Okay.

That's helpful.

Thanks so much.

Tom, maybe if I can just follow up.

Obviously we got the news from the ITC intra-quarter here, and obviously that was good news for you guys.

Could you maybe elaborate maybe a little bit more on where the Company goes from here, where that situation stands?

And as you view the situation at ClearCorrect, do you think it's an opportunity for your sales force to go after and start to try to sign those doctors up and start to take that market share?

How do you think about the competitive landscape at this point?

And is there anything else beyond ClearCorrect that's on your periphery that you're paying attention to?

If there's a place where we can be both confident in our strategy and paranoid as all get out, that's kind of where we live.

We assume everybody wants into this market and are working very hard to do so.

There are no other competitive dynamics, other than what I commented on a moment ago.

And our best strategy forward to deal with that is to innovate like crazy, keep bringing better value to our customers, and make the product work better and better.

Our goal long term is standard of care.

I would rather not comment specifically.

The process is still in final stages of working out.

I do have Roger George here with us.

And whatever he wants to comment on from a practical perspective, next steps ClearCorrect, ITC-specific, -- Roger, please, maybe do so.

Sure.

Why don't I do it this way.

With Tom's comments to your question, would you like to refine the question at all that I might respond to?

I'm not sure how I'd refine it.

Basically, is there any injunctions placed against ClearCorrect?

Will they be out of the market soon?

I'm guessing really, just trying to understand if you all believe that it's an opportunity to ultimately take that market share at some point in the foreseeable future.

Let me start with that point.

Our sales force has been pretty aware for quite some time that we don't really share any customers with ClearCorrect.

We don't really have any customers who are Invisalign providers who are also doing cases with ClearCorrect.

And in a lot of cases or in a lot of the instances, doctors who are doing cases with ClearCorrect are those who were not invited to do cases with us anymore for various reasons.

The order that was issued by the International Trade Commission is a cease and desist order, saying that ClearCorrect has to stop importing goods.

Meaning their software digital treatment plans that infringe our patents, and that they've got to stop producing aligners with that stuff.

They have responded that the cease and desist order doesn't change their life, and that it's still business as usual for them.

I don't know how you can read a very long, detailed order saying cease and desist from the Federal Government that they've got to stop, but that's the position they are taking.

They intend to appeal various parts of that order; and we intend to move forward, based on what the order says.

And we'll be going back to patent litigation in Texas to take up the damages part of our case.

Glen, if I could just maybe finish the thought off here.

We have said before, we didn't feel that much of a headwind from them; and we don't think there's that much of a tailwind.

We obviously love to grow our customer base with doctors that believe in clear aligner treatment; and over time, we'll work on doing that.

But in terms of a shared customer base or big opportunity, that's not the way we're thinking about this one.

Okay.

Thanks so much.

Robert Jones, Goldman Sachs.

Just looking at the ASPs, and specifically the international ASPs, again, it's expanded significantly year over year.

But I imagine that obviously is related to the switch in 2013 to direct distribution.

If I look at that international ASP sequentially, it seems like a little bit more of a steady state forming there.

Tom, I know you mentioned bringing a few other countries or, I should say, going direct in a few other countries.

How should we think about the ASP on international?

Is what we've seen the last two quarters starting to solidify into a more normalized run rate?

Short answer is, yes, notwithstanding FX, notwithstanding some of the other things we might do.

There's a clearer mix shift in Europe, in Asia towards full cases because of the greater complexity in general they treat.

And then secondly, there's a bit of a price premium in each of those markets over North American pricing that has persisted.

With that said, once get past May 1, the comp will be cleaner; the read-through will be cleaner, relative to ASP versus volume.

But even with Asia, volume up 51%, you know what that's done for our net ASPs there.

So I think it is stabilizing.

But I'd say given that growth outside North America has been significantly faster than in, to the extent ASP holds, to the extent that we're able to get more complex cases with widening applicability -- things like deep bite and more -- then I think it does buffer us against some mix shift to the low end here North America.

And it does buffer us a little against the negative effects of FX, if and when that comes.

But the trend, in general, is just as you described.

Okay, that's helpful.

Just on iTero, if I could sneak some in on the scanner side, news flow there has been pretty positive.

But if I look at unit growth of 46.5% year over year versus sales growth, any insight you can give us on discounts and promotions, trade-ups.

And then, is there a different way we should be thinking about unit versus revenue growth going forward?

Maybe David and I can tag team a little bit.

I will just say in general, the market has gotten more competitive.

We've met that competition; we have a very premium scanner; and we aren't the lowest-priced unit.

But just about a year ago, we basically made a decision to simplify pricing and reduce pricing.

That's been rewarded.

So in general, volume has grown faster than revenue, if you look at a year-over-year basis.

But we're confident over time we can make this a profitable and increasingly valuable part of the franchise.

David, if you want to add color there, please.

The only thing -- when you drill down a little bit, certainly volumes are up.

I think in my prepared comments, it was something north of 40% year over year in volumes.

There are two things from a revenue standpoint, when you look at it year over year, one of which is the fact that a year ago we had a special promotion going on for iTero for upgrades as we released the new version.

When you normalize for that, you see -- well, that was a -- that had the effect of increasing revenues last year.

And the volume of scanners.

And the volumes of scanners is, as I said, up about 46% or so.

So ASPs at this point are pretty stable.

We took some pricing actions when we announced the new iTero scanner about a year ago.

Pricing has been pretty stable over the past year.

Going forward, we'll see a pretty normalized rate of business, as it continues to grow and we continue to see adoption of the product.

That makes a lot of sense.

And then the other one on the scanner.

Obviously looking at an impressive chart here of digitally-submitted Invisalign cases.

You probably get this question every quarter, Tom.

But any progress, other than the current scanners out there in the market that can submit Invisalign cases digitally?

Any progress on some of the other larger installed bases and the ability to work with them?

Well, I was as clear and overt as I could be in my comments; and they stand for themselves.

But the reality is, it's not trivial; and every scanner is different.

And in effect, we are releasing a new factory floor technology at the front end of a process.

And the other party would have to be very certain that it will work well, and that's what are after.

When there is news there, we'll be happy to report it.

And we expect it would make our customers even happier and, over time, build greater strategic advantage for the Invisalign franchise.

So it is a priority; I think it's in our interest to do so; and I'll stop there.

Great.

Thanks for the questions.

Steve Beuchaw, Morgan Stanley.

I have one for David and one for Tom.

David, I wonder if you could even qualitatively walk us through the margin profile over the balance of the year.

There's been a lot of focus on the first quarter and the guide for the second quarter, but you given us a perspective on 2014 in totality.

Can you remind us what the key levers we should be thinking are over the balance of the year?

Any perspective, if you have it, on how operating expense growth might trend would be very helpful.

And then, Tom, for you, I wonder if you could, without stealing all the thunder, comment on the analyst meeting that is coming up.

It's not something you do every year.

This is the first, I want to say, in about four years.

So why now, and what should we be focusing on?

I'll let David go first on his, and then I'll be happy to comment.

Steve, on our gross margin profile, I'm going to focus my comments primarily on the Invisalign side of our business since that pretty much dominates our overall margin profile as a Company.

When you look at Invisalign and you look at our margin profile and so forth, it's perhaps most heavily influenced by really a couple of factors.

One is product mix, which drives ASP.

And when I talk about product mix, I probably should drill down a little bit more, really more from the standpoint of geographic mix.

As we've seen our International business continue to grow at faster rates than North America, that has had the effect of lifting ASPs overall for the Company.

As we lift those ASPs, that has the effect of lifting our gross margins overall at the same time.

On the cost side, our cost model today benefits from high utilization in the factory, high volumes.

And as we continue to grow the business, we continue to benefit from better absorption of fixed overhead in the factories, which drives down cost on a per-case basis.

So as we think about going out over the next year or so, if those trends continue -- our business continues to grow as we would expect -- and as our International business continues to increase as a percentage of the total mixes of the Company, then our expectation would be that our gross margins should see some uplift to them.

Now, I temper that a little bit from the standpoint that when you look at our business model that we've guided overall and from a long-term standpoint, we said our overall gross margin business model is somewhere in the 73% to 78% range.

And we are consistently operating well within that, if not at the high side of that.

So I wouldn't want you to get too far over what we've already guided from that perspective, but those are the drivers that have perhaps the most influence on gross margin.

From an OpEx standpoint, in January, we talked a lot about some of the investments that we are making as a Company and how those investments were a part of a concerted effort on our part to balance our growth profile for the year and for the long term, and the investments it would take to drive that relative to what our operating margins as a Company might be.

The direction we've given really for this year is our aspirations would be to achieve the same type of operating margin performance in 2014 as what we did in 2013.

If I can pile on just to finish that one off a little bit with a hammer.

This year is a little bit like last year in some ways, where our investment framework is more front-end loaded for the year -- headcount expansions, key initiatives, some stepup in consumer spending versus a year ago.

We were still developing new ads we launched in May.

Were out in market in Q1, Q2 with a little more consumer, fully-loaded headcount in place versus maybe partial year last year.

In parallel with that, in Q1, we had a little bit of volume challenge, right?

We had some headwinds in terms of, certainly the North America market.

All those things add up -- and a little less momentum going into Q2 for volume -- all those things add up to, say, a little more pressure on operating margin.

What David has described is getting back towards an operating margin profile roughly equivalent to last year, which means a pretty big lift in the second half.

But we believe the pieces are place to go do that.

And as much as we showed last year, we believe when those come together, we can demonstrate that progress and then quarter to quarter hope to overperform the kind of numbers David was pointing to.

Hopefully that takes care of the model.

You want to shift briefly to the Analyst Day?

Absolutely.

Perfect.

All right, so yes, it has been a while -- I think three, three-and-a-half years; and there's a reason for that.

We've had our heads down for a couple of years, executing like crazy.

We believe we've really changed the state of the enterprise in many, many ways.

One of those is visible in product and market impact, in growth, in the financial progress we're making.

And there are other ways that -- most of our owners haven't had a chance to meet the members of the senior management team.

We've got an incredibly talented group of folks here.

And this provides and affords our owners an opportunity to get to know them, to hear from them about our markets, our geographies, how our technology is evolving, and how we're going to scale the business.

So it's I believe Thursday, May 29.

We're looking forward to spending the better part of a one-half day together.

Hopefully you'll take away what we believe, which is great excitement about where we are today, but even more about what the future looks like.

And we'll focus a lot on strategy evolution there.

Thanks so much, everyone.

Brandon Couillard, Jefferies.

Tom or David, any chance you could quantify the mix of Asian Invisalign cases as a percent of total or as a percent of the International business?

And then could you give us an update around uptake in China and how that's performing relative to your internal plan?

Without giving numbers, because we haven't broken out that detail level, the very substantial majority of all of our volume outside North America is full cases.

There are fewer teen cases treated, as many of the countries in Europe where we have a little more maturity have state plans basically free for brackets and wires.

We are getting teen cases; that's growing nicely, but it's on a pretty small base.

The bulk of what gets treated are full and mostly adult cases today.

So I'll leave that there.

China is going gangbusters, as is Japan, as are some other geographies.

The team has big ideas about how we can make that a very big business.

You start to see that showing up in just year over year in volume, which then you can tell there's leverage on the revenue side.

So we're right on track with our very aggressive game plans, and the team is working like the dickens to continue that.

Thanks.

Then one more, Tom.

With respect to the new ClinCheck software, the enhanced functionality seems pretty significant in terms of what the practitioners are able to do themselves.

Do you perceive that as a case volume driver?

And if you could elaborate on what some of the early feedback has been, that would be helpful.

Well, and again, our highest-volume customers that treat the most cases and a lot of the most complex cases sometimes do the most ClinCheck cycles just to get it perfect before they press go.

This really reduces those cycles.

When they're getting close, instead of sending it back to their -- even a treat technician that knows their treatment approach very well -- and describing a little lateral movement or a little rotation of two or three teeth, they can actually move that.

And it's a virtual model that actually moves and shows collisions, and then they can send it in; and the treat tech goes -- Ah, got it.

As some of our doctors tell us, it might cut through one, two, or three treatment cycles in communication while they are close.

So we think, yes, the output is greater adoption and getting a greater share of their practice.

But it starts with having the customer get what they want more quickly and having the customer experience be better.

More precision -- it gives them more confidence in the treatment, and it reduces hassle factor a bit.

So all those things are on the side of good, and we're getting a lot of positive feedback from our doctors, most of whom are more experienced, many of whom are orthodontists, about -- Boy, this is just what I wanted.

I've been waiting for this for a long time.

Thank you.

Thank you.

Jeff Johnson, Robert W. Baird.

A lot of my questions have been answered, but let me just throw a couple more out there.

One, Tom, on the International ASP and following up on Jon's question and another one we had as well, last quarter you talked about the shift going away from i7, away from Express 5, and up to Express 10 and i14, and that being one of the drivers, along with just plain international mix of a slow, steady rise in ASPs going forward.

Yet to Jon's point on one of the earlier questions, it looks like your implied guidance is for ASPs to be down sequentially, at least in the second quarter.

So I am just trying to reconcile those two.

Should I think about that slow, steady ASP rise being more of a long-term guidance, but there can be some volatility from quarter to quarter just based on mix?

Or how should I think about that?

This is David.

I think you just hit it right there.

From quarter to quarter, there is seasonality in our business -- different seasonality in Asia versus Europe versus North America.

And that tends to influence geographic mix, which will affect ASPs.

When we talk about our ASP trend over time and a mix shift towards International business, where there is a much heavier concentration on complex cases and that driving ASPs, that's more of a long-term type of trend as we see it today.

And so you shouldn't take our guidance as necessarily being anything that would be indicative of a change in that trend and our expectations.

(multiple voices) Go ahead.

I'm sorry

No.

Please, Tom.

Go ahead.

I was just going to say, reiterating, our expectations are that our North American doctors will be busier.

Much of that volumes comes through our Advantage customers, and we want them to deliver that volume and get that discount.

That will directly relate to ASP in North America, which tends to skew that down a little bit.

Yes.

Okay, that's helpful.

And then, David, just two quick follow-ups.

One, in the absence of share repurchases this year, what would you expect?

The share count has been fairly stable here over the last couple of years, but stock price is up quite a bit.

Would you expect, absent share repurchases, share count to trend up this year?

And then a second one.

Just technically, can you tell me why you're not subject to the MedTech tax any longer?

I'm trying to figure out if there's any derivative read-through to any of my other companies?

The way I would look at it as it relates to share count, is I think the guidance we gave for Q2 was 83.6 million shares.

One of the things that obviously increases that is going to be stock options as they vest, which we pretty much don't grant any longer.

But we still have a tail of those that are still cycling through the final vesting on those.

And then we have employee RSUs.

If I was modeling it, I would just simply look at what our historical uptick has been quarter over quarter and assume that and apply that to basically the guidance we gave you as it related to Q2 for shares outstanding.

Okay.

As it relates to the medical device tax, it's a little bit more complex.

But let me see if I can make it real simple.

Our business is a little bit unique relative to many other companies in our space.

We sell directly to doctors.

We don't sell through wholesale channels and so forth.

And so a year plus ago, when we were evaluating the applicability of the medical device tax to the Company and so forth, with the advice of outside consultants and so forth, and given that this is a very new law that was still subject to some interpretation, our assessment at that time was that our Company would most likely fall under the ruling and we would have to pay medical device taxes.

During the course of that year, that evaluation, however, was on a number of subjective criteria that is outlined in the law.

So over the course of the last year, we've had a number of dialogues with the IRS.

And in the course of that, and in the course of re-reviewing our case and how those subjective guidelines apply to us, the IRS informed us in March that they believe that we should be exempt from the medical device tax based on that subjective criteria and how they apply to our business.

So effectively, we have stopped accruing for the taxes effective in March.

And I just want to say here, we don't think this is a cookie-cutter.

I would urge you not to make assumptions that another business or model might apply.

I'll say our team has done good work.

It's not quite finished yet in terms of an overall process.

But as we finish this off and have more to disclose under this, there will be a little more information.

But, again, you're hearing it in real time.

There are accounting implications and accrual implications, which is why we're dealing with it as a Q1 issue and a Q2 guidance matter.

Just to pile on to Tom's comment, it is a case-by-case assessment.

And so our case facts are going to be different from almost any other company you would look at.

And so I don't think you can rinse and repeat necessarily what we've applied here.

Then just to quick follow-ups on that.

There's no catch-up provision or anything where you can go back and capture device tax that you paid over the last four-and-a-half quarters -- anything like that?

Good question.

I think the answer to that is, yes.

We have historically paid about $8.3 million between 2013 and the first two months of this calendar year.

We have applied for a refund for that.

The refund, however, though, is processed through a separate division of the IRS.

Obviously, they talk to one another, but that separate division has to go through audit and approve it.

That audit has not been completed.

When it does, we would expect the answer to come back that we would get a full refund.

Just to be really clear, we can't project that.

It is in process, and there's nothing more than what you just heard can we do anything with.

Understood.

And just so I'm doing the math right, that's about 100 basis points per quarter going forward here of margin benefit, relative to how we had set our models up?

It's about $1.5 million to $2 million of expense a quarter.

That comes out of cost.

At our current revenue run rates.

Yes.

All right.

Understood.

Thanks, guys.

Chris Lewis, ROTH Capital Partners.

I just wanted to go back on the volume guidance for the second quarter at 11% year over year.

That's still healthy double-digit growth, but a slight pullback versus the 14% this quarter and that high teen to low 20% range in the second half of last year.

Understand weather played a factor there with delaying some cases and possibly pushing out some of those shipments and time the revenue is recognized.

But, Tom, beyond the weather, are there any other factors or some of those market challenges that you had mentioned that's contributing to that volume outlook in the second quarter?

Chris, no, the look at the business is actually pretty clean.

If I norm for a lot of factors that have impacted revenue and volume, our growth as a Company is somewhere in the neighborhood of 16% through all the different factors that have been puts and takes over the last year or two -- volume, revenues, et cetera.

Q2 guidance is impacted by an improving March receipts, which means improving April shipments.

But we weren't at the rate we wanted to be.

If we had been running for all of March at a receipts level, we would be a little bit more bullish in our guidance, and so figure that 30-day lapse.

The business has responded.

We are really comfortable with our pipeline, but all that is factored into our Q2.

So, yes, it's a little underwhelming; but it's going the right direction.

We believe we're still going to get to the place for the year where we are going to have another really terrific year.

Putting this in broader context, the orthodontic market is probably growing in mid-single-digits maybe in a good year 6%; in a bad year, 3% to 5%.

We are growing in almost every market two to three to four X that rate.

So our view is, as long as we're doing that, whatever the absolute number quarter to quarter is, we are less worried about.

The contrary would be true if we thought there was some new fundamental competitive dynamic or something going on in the market.

We don't see any of those factors.

The business is actually doing great.

We're going to AAO this week to see thousands of our orthodontist customers.

And we're very bullish about the business both, I'd say, near and mid term, as well as long term.

Great.

Thanks for the color there.

On the deep bite G5, I know it is still relatively early, but sounds like you saw a lot of excitement with the G5 launch events you talked about.

Maybe you can just provide some more feedback you've seen from those customers and the reception so far in the field?

Sure.

First thing is we've seen the use of the deep bite features go up significantly.

It's very early.

Where we have doctors that were already treating some deep bites, they are jumping right on it because bite ramps and some other features make it easier for them to actually do those treatments.

Where we have doctors that hadn't done deep bite before, it's a more -- Let me try two or three cases and see how it evolves.

We're seven weeks since release, and you would have had to have a deep in process.

So we're very early in terms of those doctors that were not doing with deep bite with clear aligners.

But were doing very good feedback from them.

And we are approaching a point a quarter in, three, six, nine months in, we're really going to see the acceleration of those cases.

And we believe that really impacts utilization growth in that area.

A lot of the doctors in Europe that were treating deep bite are really excited about this, and we're seeing the same thing happen there.

A little bit of a lag in Asia, as they're treating extraction cases more in general.

But, again, seven weeks in since release, since launch.

We have a whole bunch of internal metrics we use that are all green.

And we've got a lot to learn in the months and quarters ahead.

But some of these hard deep bite cases are a year and a half to sometimes two years long.

And so we're going to be learning as we go through the next 6 to 12 months about how the product is evolving, and we will make improvements as we go along; but all good so far.

If I could just stick one more in.

On the R&D line, it looks like expense jumped up quite a bit there over the fourth quarter and first quarter of last year.

So maybe just walk us through the reasons behind that increase.

We have some headcount expansions.

We have program spending in a couple of important areas.

We are, what I would say in general, when we come back at Analyst Day, start talking about IP, we're inventing more things; we're writing more disclosures; we're filing for more patents -- all those factors.

We're very active in terms of technology at large, R&D specifically, and clinical research, and some other areas that are going on.

So you'll have a chance to meet our Head of R&D at the Analyst Day, Zelko Relic, as well as our marketing leader and talk about how we see the pipeline evolving, what's possible in the future state.

And this is the money we're investing to do those things.

Chris, I would just add to that, reinforce, I guess, the comments I made earlier.

As you look at, broadly speaking, our expenses went up from Q4 to Q1 for a number of things.

¶ Q4 was artificially lower because of some forfeitures we had of stock, which give us a credit for stock compensation expense.

And then Q1 is a restart on Social Security taxes; we have our annual focal process for employee compensation, et cetera.

So generally speaking, those are the largest drivers quarter over quarter and coupled with the comment Tom just made as it relates to some of our strategic growth drivers that we're also investing in.

Okay, congrats on the quarter.

Thank you, everyone.

This concludes our conference call today.

We look forward to seeing you at upcoming financial conferences, industry meetings, and, of course, our Analyst Meeting in New York on May 29.

If you haven't already, please register for the Analyst Meeting.

The link to the registration is on our Earnings Press Release that we issued today.

Or if you need any more information, please contact Investor Relations.

Have a great day.

Bye-bye.

This concludes today's teleconference.

You may disconnect your lines at this time, and thank you for your participation.