愛齊科技 (ALGN) 2014 Q2 法說會逐字稿

Greetings and welcome to the Align Technology Inc.

second-quarter 2014 earnings conference.

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

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Shirley Stacy, Vice President of Corporate and Investor Communications.

Thank you, you may begin.

Good afternoon and 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 and David White, CFO.

We issued second quarter 2014 financial results today, which is available on our website at investor.aligntech.com.

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

The telephone replay will be available today by approximately 5.30 PM Eastern time through 5.30 PM Eastern time on July 31.

To access the telephone replay, domestic callers should dial (877)660-6853 with conference number 13585899 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 third quarter of 2014.

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

These and other risks are set forth in more detail in our form 10-K for the fiscal year ended December 31, 2013 and our form 10-Q for the first quarter of FY14.

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.

We have posted a set of GAAP and non-GAAP historical financial information and the corresponding reconciliations and our second quarter conference call slides on our website under quarterly results.

Please refer to these files for more detailed information.

With that, I'll 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 second quarter and briefly discuss the performance of our two operating segments: Invisalign Clear Aligner and Scanner and Services.

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

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

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

Q2 was a good quarter and we're pleased with our results.

Record revenues, which increased 17.5% year over year, were driven by increased Invisalign volume across North America, EMEA and Asia Pacific regions as well is higher Invisalign ASPs.

We also had a record quarter for scanner and services revenues with unit volumes up over 50% year over year.

Our performance in Q2 reflects continued, focused execution of our strategic plan, including our 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 further.

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 the teen patient segment, which is still primarily a North America focus today, we had a very good start to the summer season.

In Q2, a total of 28,333 teenagers began treatment with Invisalign worldwide, up a 8.6% sequentially and up 20.4% year over year.

The summer months of June, July and August are typically the time that most teenagers start orthodontic treatment and so far this summer looks to be solid.

We're pleased with our continued progress in this, the largest and most important segment of the orthodontic market.

During Q2 we ran teen promotions intended to address potential barriers to teen adoption including for mom acceptance.

The goal of these promotions was to increase utilization among high-volume North American orthodontists who infrequently use Invisalign for their teen patients.

Results were favorable as targeted doctors that participated grew their teen volume for Invisalign significantly higher than non-targeted high-volume orthos.

We're continuing these promotions into Q3, which has historically has been our largest teen quarter.

While I'll touch on our performance by region in a moment, this is a good time to talk about driving growth in new geographies.

Today we're announcing further expansion in the EMEA region with 14 additional European countries moving from distributor coverage to our direct sales organization.

As with the previous countries we added in Q1, we do not expect a material impact for some time.

In the near-term, we will leverage the existing infrastructure in adjacent country markets as we build local sales organizations to drive long-term market penetration.

While individually small today, taken together these new country markets will complement our growing base and increase critical mass across Europe.

We continue to be excited about the longer-term growth potential in this important region both in our existing country markets and these new ones.

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

In Q2 we continued successful programs to commercialize Invisalign G5, our latest innovation specifically designed for deep bite treatment.

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

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

During the quarter we saw a good initial use of G5, especially in the EMEA and APAC regions where doctors are routinely treating more complex cases.

Finally, brand strength, our third key growth driver, we are working to build and leverage the strength of the Invisalign brand to create consumer demand and drive purchase intent among consumers in more and more countries worldwide.

We continue to make great progress here, so let's start with North America, our largest market for consumer marketing.

In Q2, we created more than 331 million consumer impressions through 426 media placements.

Q2 also saw the launch of new teen focused programs to leverage the busy teen treatment season, including new social media platforms specifically designed to engage with the teen audience on Tumblr and Instagram.

To further support that strategy, we sponsored four DigiTour 2014 events that the Invisalign teen brand directly to more than 17,000 teen consumers.

Our efforts to influence the teen market will continue in Q3 as we leverage the DigiTour program and its popular YouTube channel to bring original content featuring Invisalign to millions of teens.

In September, which is been designated as self-improvement month, a variety of PR and social media will provide a relevant connection to the Invisalign brand and our outreach to teens, moms and adult patients.

Switching to EMEA, our new, more localized consumer initiatives targeted at high potential and underpenetrated cities in Europe are proving to be successful.

In particular, we're seeing strong impact in growth from these campaigns on our social media platforms with social media engagement up more than 150% over last year.

We believe this has helped support our continued progress in this region.

Continuing our strategy of using real patients to tell the Invisalign story to consumers, we launched a competition in the UK called Invisalign Changed My Life.

Past Invisalign patients can share their story of how their life has been transformed by their new smile and the two winning smiles and their stories will be featured in our marketing materials, on Invisalign websites and in press and social media.

Winners will be announced at a VIP event at the National Portrait Gallery in London, later this year.

In Asia-Pacific we participated recently in the PR launch of two new Invisalign dedicated practices in Singapore.

Just two examples of how doctors in the APAC region are leveraging the strength of the Invisalign brand to reach consumers in their respective markets.

In combination, these three proven strategic growth drivers: market expansion, product innovation and brand strength, are helping to extend growth in our most important country markets while opening up new ones.

Let's now touch on the progress we're making in these regions starting with North America.

For Q2, North American Invisalign volume was up 4.2% sequentially and up 7.6% year over year.

The sequential increase in Q2 reflects growth from both North American orthodontists and GP dentists.

The year-over-year increase reflects continued expansion of our customer base, as well as increased utilization from our North American ortho customers including teenager cases.

For our international business, comprised of EMEA and APAC, for Q2 we continued to see strong growth of Invisalign case volume from international doctors with total case volume up 12% sequentially and 26.3% year over year, reflecting momentum across these markets.

In EMEA growth was strong across all core countries and up 20.8% year over year, with France and Spain leading the way.

Progress was driven by incremental investment in sales coverage, continued enhancements in clinical education programs and growing doctor confidence as innovation in Invisalign product continues.

In the APAC region Invisalign case volume increased 42.3% year over year.

China continued to deliver above our expectations, more than doubling case volume compared to the same quarter last year.

We also saw strong growth from Japan, Australia and New Zealand as well is the Southeast Asia countries.

doctors across this region routinely treat more complex cases and continue to more rapidly try and adopt product innovations like Invisalign G5.

In addition, given we're still in early days of growth in this region, our doctors are realizing significant benefits from our clinical education programs.

In June we held our first ever Invisalign Asia-Pacific summit in Singapore with more than 450 Invisalign doctors attending from across the region.

We are very pleased by the participation and the great post-summit feedback.

The summit program included presentations on the development and advancement of the Invisalign system with particular focus on Invisalign G5.

Some of the most valuable elements of our Invisalign summit program: our peer to peer led clinical sessions, case sharing roundtable sessions and practice development workshops.

All were attended with standing room only.

We continue to learn a great deal from our customers in this region as they deliver outstanding clinical outcomes on the most challenging orthodontic cases we see in the world today.

Turning to our scanner business, Q2 was another great quarter for our scanner and services segment, which was up both sequentially and year over year, with scanner units up over 50% year over year.

During Q2, we launched the new iTero 5.2 software upgrade, designed to increase practice efficiency and significantly expand the extensive array of iTero features currently available.

This upgrade enhanced the customer experience by adding a new orthodontic laboratory workflow, Vivera scan, Vivera pre-debonding and new algorithms for faster Invisalign scanning.

With this new upgrade, our customers have seen Invisalign scan time reductions of more than 25%, even while preserving the high quality data required to ensure a great fit for the Invisalign system.

Vivera pre-to-debonding allows a doctor to scan their patient before they debond or remove the patient's brackets and wires.

This important capability allows them to order Vivera retainers while the patient is still in treatment, eliminating the need for temporary retention.

This iTero feature is now in limited market release and expected to move to full release in mid Q3.

We also launched new iTeros monthly subscription packages and multiple scanner subscription discount programs that have been well received by new and existing customers.

Overall, we continue to be pleased with the performance of our scanner business and the positive impact it is having on our Invisalign business.

For Q2, the percentage of Invisalign cases submitted digitally from a scanner in North America rose to 32.7% compared to 30.2% in Q1 and 25.3% in Q2 a year ago.

With that, I'll now turn the call over to David for a review of our Q2 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.

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

Revenue for the second quarter was a record $192.5 million, up 6.6% from the prior quarter and up 17.5% from the corresponding quarter a year ago.

Second quarter Clear Aligner revenue of $179.7 million was up 6.8% sequentially and up 17.2% year over year.

Sequential growth reflected increased case volume by both North American and international regions.

ASPs were essentially flat.

Our year-over-year growth reflected case volume growth across all channels, as well is favorable ASPs from a higher mix of full Invisalign products, a higher mix of international business, as well as the favorable impact of our acquisition of our APAC distributor in May 2013.

For the second quarter, total Invisalign shipments of 119,333 cases were up 6.3% sequentially, rebounding nicely from a slow start in Q1, but offset by some softness in June in North America.

Year-over-year growth of 12.4% was driven by increased utilization from our international and North American customers, as well as continued expansion of our customer base.

For North American orthodontists, Q2 Invisalign case volume increased 3.7% sequentially and 10.1% year over year.

For North American GP dentists, case volume increased 4.7% sequentially and 5% year over year.

For international doctors, Invisalign case volume increased 12% sequentially and 26.3% year over year.

In Q2 we added 920 new North American doctors and 1,380 new international doctors for a total of 2,300 new Invisalign doctors.

Together this represented a 22% sequential increase as a result of a higher number of planned training events.

Total Invisalign utilization for Q2 was 4.4 cases per doctor, up slightly from 4.3 last quarter.

North American ortho utilization was a 8.4, up from 8.1 last quarter.

North America GP utilization was 2.9, flat from last quarter and international doctor utilization was 4.5, up from 4.3 last quarter.

Second-quarter revenue for our scanner and services segment was a record $12.8 million, a 3.1% sequential increase reflecting continued penetration and market share gains.

On a year-over-year basis, our scanner and services segment increased 21.6%, driven by a 50.7% increase in scanner volume.

Moving on to gross margin, second-quarter overall gross margin was 75.6%, down sequentially 0.4 points and up 0.1 points year over year.

Clear Aligner gross margin for the second quarter was 78.8%, down 0.3 points sequentially and up 0.4 points year over year.

The sequential decline was primarily the result of increased training events which are only marginally profitable.

The year-over-year increase was primarily the result of higher ASPs.

Q2 gross margin for our scanner segment was 29.5%, down 4.1 points sequentially and down 4.4 points year over year.

The sequential decrease was primarily the result of increased service and warranty costs.

The year-over-year decrease was primarily the result of lower ASPs, as we reduced our scanner pricing last year.

Q2 operating expenses were $96.7 million.

On a sequential basis, operating expenses were up $1.3 million due primarily to increased marketing programs and headcount.

This was partially offset by a benefit from a refund of medical device excise taxes we paid previously in Q1.

On a year-over-year basis, Q2 operating expenses were up $11 million incidental to the growth of the business, which primarily relates to headcount additions.

This increase was also partially offset by the aforementioned medical device excise refund and elimination of the tax altogether.

Our second-quarter operating margin was 25.3%, up 2.2 points sequentially and year over year.

Our quarter over quarter improvement was primarily driven by higher Invisalign volume.

With regards to our second-quarter tax provision, our tax rate was 26.8%.

Our Q2 rate was negatively impacted by a one-time discrete item of $2.1 million, primarily related to prior years.

Second-quarter diluted earnings per share was $0.43 compared to $0.39 reported in Q1 and $0.36 reported in the same quarter last year.

Moving on to the balance sheet, for the second quarter, our accounts receivable balance was $131 million, up approximately 3.8% sequentially.

Our overall DSO was 61 days, a two-day improvement sequentially, and was down one day over the same period a year ago.

Capital expenditures for the second quarter were $5 million, primarily relating to manufacturing capacity additions.

Cash flow from operations for the second quarter was $69.7 million and free cash flow for the second quarter defined as cash flow from operations less capital expenditures, amounted to $64.8 million.

Cash, cash equivalents and marketable securities, including both short and long-term investments were $502.7 million.

This compares to $472 million at the end of 2013, an increase of $30.7 million.

During Q2 we paid $70 million under an accelerated stock repurchase plan or ASR for an initial delivery of approximately 997,000 shares of Align common stock.

The final number of shares repurchased will be determined at completion of the ASR based on the Company's volume weighted average stock price during the term of the ASR less an agreed-upon discount.

The ASR is expected to be completed by July 29, 2014.

There remains approximately $230 million available for repurchases under the existing stock repurchase authorization, of which $30 million is expected to be used for repurchases over the next nine months.

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

We're pleased with the business and remain confident in our ability to continue to drive growth of Invisalign globally.

While customers reported stable overall patient traffic, our June case receipts in North America were a little softer than our expectations.

Most teen case starts occur in the summer months and we expect the positive impact we saw in Q2 from teenagers to continue in Q3.

Consistent with previous summers, busy teen ortho practices typically 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.

As such, we anticipate Invisalign case shipments to be down to flat sequentially from Q2 for North American GPs and international doctors.

This is a more pronounced effect in Europe.

For our scanner business, we expect it to be down sequentially, in line with lower capital equipment sales in the summer.

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

Invisalign case volume is anticipated to be in the range of 118,100 to 120,500 cases, roughly flat with our Q2 results but consistent with our historical Q2 to Q3 three-year average.

We expect net revenues to be in the range of $186.3 million to $190.2 million, slightly down relative to our case volume outlook due to lower scanner revenues, higher promotional activity and other factors impacting ASPs.

We expect gross margin to be in the range of 75.1% to 75.6%, flat to slightly down sequentially from Q2, primarily reflecting lower ASPs as just mentioned.

We expect operating expenses to be in the range of $96.7 million to $97.4 million.

This is flat to slightly up when compared to Q2, reflecting continued investment in our strategic growth drivers.

Our operating margin should be in the range of 23.2% to 24.3%.

Our effective tax rate should be approximately 23% and diluted shares outstanding to be approximately 82.1 million net of any stock repurchases.

Taken together, we expect diluted EPS to be in the range of $0.41 to $0.44.

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

Thanks, David.

We are pleased to deliver these financial results along with continued progress on key strategic initiatives.

Our long-term goal is that some day Clear Aligner treatment will replace brackets and wires as the standard of care in orthodontics.

When we see solid adoption of key new product innovations like Invisalign G5 and are able to grow our penetration of the teen market, which is always the hardest share to gain, we know we are on the right track.

Over the next few months, the entire Align team will be committed to ensuring our customers and their practices are thriving with patients that are overjoyed not just with their new smile, but also with the Invisalign journey that helped them get there.

I look forward to sharing our progress with you as we move forward.

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

Operator?

Thank you.

Ladies and gentlemen, at this time we will be conducting a question and answer session.

(Operator Instructions)

One moment please while we poll for questions.

Robert Jones, Goldman Sachs.

Hi this is Nathan Rich on for Bob today.

I wanted to start with your comments around June being a little bit softer.

Your case volume guidance for the third quarter I think looked pretty good given that, like you said, it is a seasonally slower quarter.

Could you just go into a little bit more detail on specifically what you saw in June and how that informed your outlook for the third quarter?

Sure, Nathan.

This is David.

So I think you understand that when we put our guidance together, it's informed by a number of factors and so this is really just one data point of many and the comment specifically in the call related to a softness in June relative to our expectations.

What I mean by that, we had expected a certain amount of lift from May to June and while we saw the lift, we didn't see the lift that we had hoped for.

On the basis of that, that had some bearing on our guidance and had that not been the case, we might have guided Q3 a little bit differently.

That said, also one of the other data points was the fact that our Teen business was very strong in the quarter, up 20% year-over-year, up 9% quarter-over-quarter.

Another good factor, Tom mentioned that we got off to a good start.

I think that's certainly one of those factors that contributes to it.

June, July and August are typically weaker in North America GP practices, so it's not entirely surprising.

We've certainly seen this in the past.

I think when we look at our guidance overall we look at it relative to history, particularly from Q2 to Q3, our guidance from a volume standpoint and so forth is pretty consistent with historical Q2 to Q3 transitions.

Even at that, it's up at the midpoint of guidance, it's up 14%, 14.5% year-over-year, which we think is great relative to any peers in the industry.

Great, that makes a lot of sense.

I also wanted to shift quickly to ASP growth.

It seemed like in North America, I think ASPs were up about 1.5%.

We've seen a couple of quarters of nice growth year-over-year.

I was wondering if you could help us understand what might be driving that?

Is one of the factors growth from new dentists who might not be doing the volume needed to get to the discount and that might be helping North America ASPs?

So, ASPs are influenced by a number of things.

When you unpack it, it is dependent upon product mix, it's dependent upon geographic mix, it's dependent upon channel mix between ortho and typical GPs and how they participate in our Advantage program and so forth.

So if you look at it over the last year and as we look at it going forward, we continue to believe that as we treat more and more complex cases and as our international business grows, that those two factors will have an effect of, over a long-term, of raising ASPs.

We've seen that certainly over the last year.

As it relates North America, I think the one variable there in North America that also has a bearing on ASPs in North America primarily relates to the product mix.

That product mix is counterbalanced you might say by two things.

One is the complex cases that our orthos are handling as their utilization grows and their practices grows, that tends to influence ASPs in one direction, and dependent also on which orthos that is coming from.

On the GP side, where they're typically handling more simple cases that tends to be the other end of the barbell, you might say.

We've not typically given breakouts and outlook on those, but we think the trends on ASPs across all regions will be influenced by those same factors.

Great, thanks a lot and congratulations on a great quarter.

Thanks, Nathan.

Thanks, Nathan.

Glen Santangelo, Credit Suisse.

Thanks and good evening.

Tom, just while I take your long-term growth guidance of 15% to 25% in perspective.

If I look over the last 18 months or so, you've been sort of trending at the bottom end of that range and if you look next quarter, obviously you're guiding below that range and I understand the issues in June, maybe impacting the third quarter guidance.

But as I look at North America more broadly, that will be the third quarter in a row of sort of single-digit growth and I'm just curious, is there anything to talk about with respect to maturation of the market or it getting more difficult to compete for market share against brackets and wires?

How should we think about the growth from a longer-term perspective?

A great question and the simple statement is that we're very committed to our long-term model.

We have a great deal of confidence and then we go and test our selves against a number of measures.

One is our own expectations, which we don't talk about externally.

Another is industry peers and then finally, how much head room do we have left?

In every direction we look, we can't even see the ceiling.

Our relative penetration into just part of the market in North America, for example where there has been a little deceleration is something like 9% or 10%, 10% or 11%.

Every time we evolve the product and we can better compete for complex cases like deep bite across a wider number of orthodontists or dentists that do orthodontics, we then have an opportunity to go compete for that case, but it takes time.

The more complex the case, the longer that time.

We get them to try two or three cases, it might take 6 to 9 to 12 months to see that case really progressing and then build confidence that they can deliver the results they want.

So with every more significant evolution that projects to us competing for more complex cases, at least in North America and to a certain extent Europe, the longer it takes us to do that.

The exception probably for that is in Asia, what we're seeing is much faster uptake on new features just because the cases they treat every day are all so much more difficult.

The average case that presents is so much more complex, so they're looking for any tool that can work to solve that problem and there's less I'd say, maybe ingrained legacy behavior among the clinicians.

Brackets and wires have been here for a hundred years.

So for us, it's really about market adoption, clinical proof, clinical excellence to demonstrate that we can actually help them deliver those great results and an understanding, practice by practice we're starting a process of increasing confidence, slow, steady adoption.

I'll point you back to our Teen share gain, which is the hardest share and most of that gain is in North America.

That's the hardest case for us to win because mom, dad and the doctor are all targeted to be perfect.

If they believe there's any clinical trade-off, they're just not going to put that kid into Teen.

Finally, you raised competition and I think more competition is good for everybody.

Everybody's sword gets sharper, right?

So what I would say is, brackets and wires companies, their games have all improved.

That's a good thing for the industry.

That's a good thing for our customers and their patients.

There's more clear liner players, but for the most part, they're at the low end and it's more noise than anything else.

What's going on for us is really delivering two to three X growth in a segment, pointing toward mainstream, but not there yet, especially for ortho, in a segment that's growing maybe low single-digits.

So we're going to compete like the dickens and take what we can, but it is not an issue of limited headroom or maturation and market opportunity.

I appreciate those comments.

Maybe if I could just follow up on the competition perspective.

As I think about ASP, David I appreciate your comments that the ASP is rising due to the mix and the slant towards international and more complex cases.

Is there anything to say about organic pricing trends, if we were to take mix out of the equation?

I think we actually tried, the couple of last slides in the webcast slide package, we tried to breakout what we'll call full type cases and limited treatments, non-comprehensive treatments.

What you can see from both of those, when we adjust, when we normalize for factors like FX and the like, we're pretty stable to up a little bit.

What I would say, using North America as an example, when there's a little less volume than we expected and you can make that as the case for June.

Since we had a little deceleration both in GP and ortho, we got a little less participation among the Advantage doctors and that translates to them not achieving the same level for Advantage or getting as much total discount.

We would rather have ASP go down for that reason and have them fill up their practice with Invisalign.

So in our minds, that's the one element of ASP that we're not thrilled with, being up a little bit.

We're happy with mix shift driving that, we're happy with the rest of it.

But this is an area where we continue to have opportunities to compete and it means of some of our Advantage doctors didn't participate as fully as we thought in Q2, but stable pricing is the message underneath all that.

Okay, last question then I'll jump off.

David, the cash is sort of piling up on the balance sheet.

You've obviously started to buyback a little bit of stock here.

How should we think about the plans for capital deployment going forward?

Should we think about it as more share repo down the road or Tom, I don't know if there's a strategic message that you want to try to deliver?

Yes, I'll just add when we announced in April our accelerated stock repurchase plan, we announced at the same time that we were committed to a $300 million purchase over the three years that are ahead of us with the first $100 million of that being expected to occur in the first year.

We will close that ASR completely out next week and we'll then repurchase the remaining amount under that $100 million initial tranche, you might say, over the balance of the year.

I think the only guidance we've given is that there will then be another $200 million to follow over the next couple of years.

I don't think we've got anything more to add to that at this point.

Okay, thanks for the comments.

I'll finish your comment.

To the extent we're going to do anything, it would probably be more in the area of technology versus -- we don't feel like the money is burning a hole in our pocket.

We're funding, we have a great free-cash-flow machine, we're funding our Research and Development, our expansion around the globe, our building of brand, our development of a better company that's more scalable and most of those show up on the income statement not the balance sheet.

With that said, we continue to have dialogue with the Board, but we're not going to run around and start looking at everything that's for sale.

The idea is to build a great organic business and build out our scanner install base and bring digital tools and capabilities to our customers.

That reduces friction for them and leads to some benefit for us.

You see that showing up at Invisalign and we're going to pour the coal on the fire as we build out the Invisalign franchise as well.

So I think at this point time we're trying to stay very focused and execute on the strategy we laid out at the Analyst Meeting a month or so ago.

Okay, thank you.

Take care.

John Block, Stifel Nicholas.

Great, thanks.

Good afternoon, guys.

Maybe my first question builds on Glen's a little bit, North America a little bit more specifically to North American GP volume.

I believe that was up, obviously a lot of numbers, but I believe that was up 5% year-over-year and I'm looking through and it seems like Express was actually down year-over-year.

Can you, Tom speak specifically to North American GP growth?

Because I'm being pulled in two directions.

One, I would think the scanners, that should help drive utilization maybe within the GP channel, but then on the other side is it possible the growth in 2012 and part of 2013 was inflated a bit through Invisalign 5 and some of the promos there?

So maybe if you can talk to those dynamics, that would be very helpful?

Sure, GP first of all, is building out a GP channel and the biggest GP dental market, which is North America, is a strategic priority.

There are very few companies that have successfully built out with a specialty product that requires some missionary work, built out a high preference doctor product to this very fragmented base of customers that cover a huge range of procedures day to day in their office.

We're still early in that journey, so we don't think that's linear.

But it's very, very important to us and we're going to get it right over time and we still grow faster than all of our peers with consumable products and everything else that are calling on this channel whether that's direct or whether that's through distribution.

The second part of your question maybe is both mix and channel and that's Express 5 or 10, a little more specific to GP, correct?

Yes.

So, what I would say is two things.

One, it's not a lack of emphasis by us and when we do promotions as we did maybe a year, 1.5 years ago on Express 5 and 10 is to get trial.

Our positioning for the Express products from the very beginning, both 5 and 10, were for the more experienced customers.

Not just orthos, but GPs that had experience doing Invisalign treatment and could comfortably look at a malocclusion and set expectations for that patient and know what they could deliver in 5 stages or 10.

It's hard and there's a limited degree of malocclusion treatment that's predictable with those shorter treatments.

So I think what's happened over time, first the good news is we're winning on the high-end, we're taking share on more complex cases, we're winning in Teen, which is wonderful.

Our strategy at the other end was to make sure we're competing up and down the line and we're doing fine there.

It's just that relative, there's more doctors have said I'd rather just go to an assist case.

I'd rather do a full case if I have to worry about doing it in 10 stages.

If it's 17 stages on full, I'm fine with that.

If they're an Advantage doctor and they're a significant Advantage doctor, the difference in price isn't even that great between Express 10 and a full case so I think the reality is, let's just call it settling in.

Now I would say, and there was a question earlier, there is more noise and competition with both bracket players, with specialty brackets for six-month treatments as well as there has been for a while, a lot of players offering simple treatments.

But none of them seem to work that well and what we're going to do is stay committed to delivering treatments we can stand behind so that what we show in the ClinCheck is what gets delivered to the patient.

There's very few companies out there that can make that statement.

So more of a mix shift, still in love with the channel.

It's a long-term journey and I'd just say it's settling in.

But there's a lot more movie to be seen here I think, A for the GP channel, and B, for the different offerings that will evolve over time.

Okay, great.

I've got one more question and maybe one clarification.

You mentioned the promotions on the Teen side of things and you've certainly run promos there before with Vivera and other stuff like that.

But I think, Tom, you were sort of alluding to a specialized promotion for high-volume orthos that had not really used Invisalign for teens before so is this the start of something new here?

Very targeted promotions to try to get some guys on board for Teen and we're sort of in the first inning of that?

The short answer is yes.

Directed practices with great businesses that haven't been confident enough to use Invisalign Teen yet, I think coming on the heels of SmartTrack and G5, seen a lot of clinical evidence and hearing from colleagues how well it's working and then us trying to compete for the toughest case to steal from brackets and wires in that office and having some success in a targeted way.

Call it increased support and focus by the team and a little better financial proposition for that practice.

I think it is very early, but so far so good.

I hope we have more good news to report to you at the end of Q3, but that's a very targeted approach.

Okay great and last one, a clarification.

David, I think this is for you.

You mentioned some of the year-over-year margin expansion from the elimination of med device tax, but did you actually also recognize a credit in the quarter and was that a credit to the OpEx numbers that you reported?

Yes, John, so there were basically three, you might say, moving parts in the quarter.

We did receive a medical device tax refund from payments we had made in early Q1 prior to our engagement with the IRS at that point in time.

So those were refunded to us in the quarter.

They amounted to about $1.2 million and contributed about $0.015 to EPS.

The other moving parts were the ASR was about $0.005 accretion and then we had some discrete items -- or a discrete item.

It relates to taxes.

It had a one-time, nonrecurring impact of about $0.03 unfavorable.

So net-net, about $0.01 unfavorable across those three moving parts.

Perfect, very helpful.

Thanks for your time, guys.

Thanks, John.

Steve Beuchaw, Morgan Stanley.

Thanks so much.

Good afternoon, everyone.

One question as a bit of a retrospective on the first half of the year.

Thinking back to comments you made in January and then gave us a bit more clarity on in April given everything that was going on with the weather.

You commented that there were patients who were having some difficulties scheduling, especially here in the Northeast and the Midwest.

I wonder at this point do you have a sense for; number one, whether all that volume has come back through the system and number two, how much of an impact it might've had in terms of dynamics in 2Q relative to Q1 where you might've had a few folks come back through the system that couldn't get there in the first quarter?

Steve, it's a good question and it's very, very difficult to pin down.

We tried to survey our customers and kind of help interrogate their schedules and calendars to get a sense of what that rescheduling shuffle looked like.

There were two or three or four cycles of this in January and February and later in March and each one of those periods of prolonged bad weather sent everybody scurrying.

I think at the point when we talked about it before is, when that happens in an ortho office they kind of reschedule everybody as they can.

When it happens in a GP's office where we're already a smaller part of the relative practice, a lot of people coming in are in pain, they have a serious problem, they're in the middle of a restoration.

The Invisalign case reschedules in that office are going to get pushed pretty far down the path to priority.

They're going to deal with people with endodontic problems that need to get in there very quickly.

So what we heard from our customers as we were getting into April was things were finally settling down.

Short answer is we have no quantitative view.

I wish we could, but we have quantitative view if there were ultimately people that never came back, nor do our customers know what happened.

What they do know is their patient volumes, procedure volumes and patient traffic was reduced in those periods and in general, I think most of our practices feel it's returned to normalize levels.

Okay, that's really helpful.

And then the one on Europe, if we think back to 2013 and the acquisition of the distributor in Asia, it was a bit of a tailwind.

It sounds like you're not expecting a proportional tailwind with the changes to distribution in Europe?

So I guess question one is why is that?

Is it as simple as you're not bringing on reps from the distribution network?

Then two, how could we see the contribution from the direct selling effort there ramp over time?

Thanks.

Sure.

A couple of things; first, I think this is very important and it's strategic for us.

It is different because in Asia-Pacific we had a going business with 50 employees and significant volume.

In fact, their volume is growing faster than any other finite geography in the country and then we also gave -- so that was meaningful volume and it was growing 40% a year, something more than that, 30% to 40%.

We are actually giving that distributor a 50% discount to do all of the clinical education training, support, promotion, consumer, everything.

So we got all that volume, actually increased that volume overnight.

Increased that volume, but overnight doubled the revenue per case coming in.

We would have the same scenario with this, I'll call it a steady process that we're going at in Europe where we've rethought, with our distribution partner that had a very large geography in many countries, seen that our distribution partner's focus was on a number of other countries and geographies: the Middle East, Turkey, Russia and not as much on former Eastern European countries, the Nordic countries, et cetera, where we had either presence close to being direct or directly adjacent to where we had meaningful mass.

The idea was that rather than acquisition we would just bring those back.

We would invest in those geographies in a thoughtful, organized way and that's what's happening, but instead of bringing in a going business we're bringing in geography and in a few cases, very small volumes.

In the short term, we'll pivot to put a small level of incremental resources leaning on our adjacent country sales forces and management teams and over time, we'll start slowly to build some direct teams in the more important country geographies.

But it's much more of a long-term complement to the excellent growth we're seeing in Europe and EMEA and over time it will be able to leverage the critical mass we've already got building into these countries in Northern, and Southern, and former Eastern Europe.

Again, very different story, very important to us, but it won't be meaningful in revenue terms in the near-term.

Great.

Really appreciate the feedback.

Great.

Thanks, Steve.

Next question please.

Jeremy Feffer, Cantor Fitzgerald.

Hi, good afternoon.

Thanks for taking my question.

I wanted to start on some of the marketing initiatives OUS?

I appreciate the color you gave on that, Tom.

I'm wondering if you could provide maybe in qualitative details, also piggybacking on some of the comments you guys made at your Analyst Day on some of the progress you're making in China beyond the KOLs?

Talk about maybe some of the barriers.

I know these events you describe tend to be well attended, but how is it translating into volumes again, qualitatively and what kind of barriers are you running into, if any?

Certainly, first of all we are doing business in all of the major institutions.

The delivery of care is organized into kind of what looked like hospitals and there are a series of specialists and generalists that deliver care both through private and what I'll call public.

In many of these more public hospitals, we are in the programs to be included with those systems.

It takes a long time.

It doesn't mean it's every one.

In parallel with that, there is clinic operators opening daily, weekly almost.

There is 20 million to 50 million reasonably wealthy Chinese to which basic healthcare services and access to oral care is a new thing, very, very attractive and they're very drawn to our brand.

So the third thing is, we built our business in China starting six years ago or something like that from developing clinical relationships and research relationships and so we have excellent relationships and have earned respect from some of the most influential KOLs and they're actually helping us educate as part of their role.

We have advisory boards over there and in our minds, this is an incredibly valuable thing because they're treating the most complex cases we see in the world.

It's stunning, the complexity they're dealing with and we're learning more about what the appliance can do, what Invisalign can do and how we should modify our protocols.

We're actually doing clinical research over there with them.

That has significantly impacted many of the hospitals and teaching institutions around China and over time, as we talked about during Analyst Day, we are going to be moving out of just the major cities to the smaller, second-tier cities.

They're only 10 to 15 million population, right.

We're getting good traction both on a purely private side with clinic operators as well as the big hospitals.

Not everybody, but the barriers for us are really around clinical excellence, clinical education and support and we're not trying to go fast per se.

We're trying to do it right and yet, I think we said doubling.

I'll just give you the number.

Our increase in volume, our China business was up 178% versus the same quarter a year ago.

So even though we're trying to take a thoughtful approach to this, it's growing very, very rapidly.

So we're pleased and the barriers are really around competition, traditional brackets and wires and there are some local players, but we're doing just fine and we're staying humble and hungry.

Okay, I appreciate that color.

One other on iTero, obviously nice progress this quarter.

What type of long-term run rate, I know you're not going to give longer-term guidance on iTero specifically, but maybe conceptually.

What kind of growth can that segment -- as you expand its capabilities and as more dentists embrace the concept of digital dentistry, what kind of growth can that segment really generate?

Obviously, as it ties in with Invisalign case growth, how big can that segment get?

Sure.

Let me give you a future state description.

This is not guidance, to be clear.

Of course.

We talked about this a little bit at the Analyst Day.

We believe that high-quality internal scanners will be ubiquitous over time at chair side and busy practices will have multiple units.

It may segment to where there's higher performance standards and very low, more quadrant or individual tooth to support just specific restorative procedures.

But with that said, we believe they're going to be ubiquitous and seeing that trend and believing that and being committed to supporting that with improving value propositions, better performance and having the best scanner, our goal is to build the biggest standalone scanner install base in the industry.

And if not number one, then a very close number two.

Can we do that against the big players?

We'll see, so far we're doing all right.

We are the fastest growing and the largest standalone install base out there of anybody.

Sirona has a huge start on everybody.

Most of their scanners are not standalone, they're with an integrated systems.

So in our mind, that's how big it is and when we help our customers' offices, whether that be an orthodontist or a GP dentist become fully digital, we can help them remove friction from so many other procedures and processes.

It's better for the patient, it's better for the practice.

Everything happens faster, smoother, quicker, cycle times get compressed, quality goes up.

We think costs will go down for everything and we intend to be in the middle of that.

So we think that's a very big market and when we're ready, we'll start thinking globally again.

We're building this model out in North America and at some point in time, I think as both Raphael Pascaud and Tim Mack spoke about, there are opportunities to revisit thinking about a number of countries and regions globally, but it's a little too early for that.

Okay, appreciate the color.

Thank you very much.

Thanks very much.

Brandon Couillard, Jefferies.

Good afternoon.

Tom, this is the second quarter in a row it looks like where North American doc trainings were down almost 20% year-over-year.

Is there something seasonal going on there?

What should we look for in the second half of the year?

Do you think that's a direct factor in terms of the moderating North American case volume trends?

No, let me start in reverse order here.

No to the last, for sure.

There is enormous interest in Invisalign in practice.

We're training more orthodontists again now, we're training more GPs and we're training a lot of doctors internationally.

For a long time there was very little training going on outside the US.

The global rate of training for us has actually gone substantially up, but I think you're asking a question more about North America and there are two or three factors going on.

One, we're still ramping up a very new entry-level course called Invisalign Fundamentals.

We're still ramping it up.

We got behind in Q1 given weather and even into Q2 where offices were in a scramble mode to reschedule patients and generate stronger cash flows and all that.

I still think we're building up capability to do a more intensive Invisalign Fundamentals class which is the new one and we're very satisfied we're on the right track.

We think there are tens of thousands more GPs that want and would like to have a procedure like Invisalign in their practice.

So again, we don't think there's any headroom issues there, but with that said I think this is a ramp-up for us with a very new program that's a bit more intensive and more time on the front end committed by sales force.

And on the back end, immediately after the training program with a few more members of the staff, not just the doctor attending at a time when the doctors are scrambling with weaker cash flow months and schedules in the office that were tough.

April was one of the places that showed up.

I think going forward, our clinical education programs continue to get better, we're going to see more impact.

We continue to see good results in general from better entry point training.

What you don't see because we don't really report, we do a lot of next level training.

We don't report those because they're not new doctors trained and that whole process is getting better as well as we continue to be able to tell the clinical innovation story and demonstrate how they can use these new features.

Those things are continuing to be well attended by both experienced orthos and GPs.

So no issues from our perspective, just part of the journey.

In terms of the EMEA expansions, just curious why now?

Why make those pushes in those markets?

Is there a rate limiting factor in terms of the amount of capacity you have as a Management team to focus and execute those well?

Sure.

I'll step back a little bit for a moment and what I'd say is this is not so much -- if it appears happenstance, it's not.

This is really coming out of a series of thoughtful discussions over the last 1.5 years or 2 with our partner in a realistic check-in about where their priority was going to be and the opportunity that was being missed over time with some of these countries and geographies that were being underserved and interest by clinicians in those countries in getting trained and getting started, et cetera.

Rather than pivot back a huge number of countries overnight and hit the problem you described, which is what we do with 25 countries overnight?

We've, in a thoughtful, organized way, done this in a couple of phases and you are seeing a second phase here of this.

That's purposely for the reason you just described as the outcome we don't want.

We want first of all to be responsive to the customers in those regions.

We want this to be a good news story and we also just don't intend to step up and have a visible sign of what I'll say in the shorter-term, fairly low productive headcount expansion in this geography.

So this is a phasing process.

It's being done in a thoughtful way and we're really leveraging the adjacent country solid mature leadership teams to take advantage of that.

So that's what you're seeing and over time we'll incrementally look for those opportunities.

Super, thank you.

Next question, please.

Jeff Johnson, Robert W. Baird.

Thank you.

Good afternoon, guys.

Let me just ask two very quick ones if I could, Tom.

Most of my questions have been answered, but on the European distributors there, still trying to feel out the size of that.

I hear what you're saying, that it's small relative to Asia Pac.

Anything you can give us maybe on the base of volumes there?

Is it 10% what was in Asia Pac, is it 50% what was in Asia Pac or maybe you could give us employees?

We know there were the 50 employees in Asia Pac or 15 sales reps in Asia Pac.

Anything to help us size these 25 countries versus the Asia Pac efforts?

Sure.

I'll make it very simple.

Zero employees we're picking up, very little book of business, many interested customers, but consider these start-up geographies which is to the earlier question, it's very important to us to do, makes a great deal of sense and it's a wonderful complement to the base we're building with critical mass in these other countries, but we're basically picking up opportunity, we're not picking up volume.

It's not even enough volume to talk about so I'm not even going to put a percent on it.

It's very small.

Okay, that's helpful.

Only other question then, if I look at the second to last slide in your slide deck, one of the ASP slides, I'm struck by two things: one, the big uptick we saw three quarters ago and then the stability we've now seen in those ASPs over the last three quarters.

So one, is it just the lack of some of the Express 5, Express 10 trialing in that, that maybe drove some of the earlier volatility around those prices that you see in that chart?

Is that mainly what's been driving the stability there the last three quarters?

And once we get, if I back into your third-quarter ASP guidance, it looks like it's somewhere right around there, maybe a little bit below where it's been the last three quarters on a worldwide basis, but what happens after the next quarter?

Are we kind of stable at this trend line or what takes it up the next tranche from here?

Sure.

Let me just point to something you said, which is basically, yes we had promotion.

The thing that was moving Express, we had two or three things going on and it happened over a more extended period of time because we had both a promotion in trial and expiration of promotions that lasted a couple quarters in North America.

We also had some things going on with i7 and i14 in Europe which wasn't as usable because there's not as much volume among GPs and they're generally treating harder cases so there was a little less interest there.

Over time, we've got a decent base built now.

I think we've started out with experienced doctors where an Express 5 or 10 offering fits and they use it for a patient that is not ready for comprehensive treatment, wants to spend a bit less money, but just want to deal with a smaller degree of crowding or close a small space.

So I'd say that's pretty steady in volume and while there's a little bit of volume growth, it's being swamped by the significant growth we're getting in Teen, generally a little more complex cases and what's going on as well in Europe and in Asia.

Both of those things on the full product are really moving geographic mix, on full cases, are really moving that ASP number.

The last point, I'll let David talk a little bit about our guidance for Q3.

You were asking a question about why is that pointing down a little bit and I'll let David speak to that.

Thank you.

Well, Jeff you're talking a little bit about volatility.

Like I said earlier, there's a lot of factors that influence ASP.

As it specifically relates to Q3, to use that as a case in point, as our business shifts a little bit more predominately to Teen business in the summer quarter and as we see some softening seasonally in the international region, which typically has more complex cases, the higher ASPs and so forth, the net effect of that is that we see lower ASPs in Q3.

Notwithstanding the fact that may add a little bit of volatility, you might say, into the ASP's on a quarter to quarter basis, the comment I made earlier about the long-term trend, we still believe.

We believe the trend will continue to be favorable from an ASP standpoint primarily for many other reasons as I previously indicated.

Since this is the last question, I'm just going to add one thing in there since it didn't get asked during the call and we didn't make comment on it in our prepared remarks.

You'll recall in our Q1 conference call we talked about some overall expectations for 2014 as it related to where we stand against relative to our operating model.

Given some of the issues we had in Q1, we reaffirmed that in the second quarter -- excuse me, the end of the first quarter call.

If you look at where we are today, the first two quarters with the Q3 guide we've given, we continue to believe, as we did when we entered 2014, that the second half of 2014 would be stronger than the first half.

A large piece of our belief was the fact that we were investing heavily in a number of our strategic growth initiatives and that the gestation period of those investments would not begin manifesting themselves until the second half of the year or later.

So as we sit here at this call and as we look at the second half of the year, we continue to believe that and believe that we can deliver revenue within that operating model and we believe that our operating margins should still be consistent with 2013 as we indicated at the beginning of the year.

So I just wanted to add that since it didn't get brought up in our formal remarks and opportunity didn't really come up during our Q&A session.

Shirley?

We have room for one last question, I believe.

John Kreger, William Blair.

Hi this is Robbie on for John.

Thanks for having me.

Just one quick one on the scanner side.

As you have seen increased competition in the ortho offices from a couple of other guys who have launched scanners and concentrated on that space recently, how has that impacted adoption rate by orthos?

Has it accelerated them or has it taken longer as they evaluate new products?

I think that's a big help.

A year or two years ago, orthos were kind of scratching their heads thinking hmm, I think I need to own a cone beam scanner, but I hadn't put much thought intra-oral scanners.

They all have digital x-ray, cone beam, CT, every other gadget you can imagine.

Now, you see orthos saying I am going to own at least one in a busy office.

One of the drivers for that happens to be Invisalign because we're very digitally enabled as a treatment and a customized treatment.

I think over time you may see an evolution in brackets and wires within other kinds of appliances that are enabled and improved by digital planning and everything else.

I think it's just going to accelerate that and as they see value, they'll do it.

Now, as to competition, again, everybody gets better when there's more players in it and while you are not going to win every one, market adoption is a bigger force, I think, than competitive share battles.

I would rather have the tide coming in with everybody thinking I've got to buy one and then the opportunity to make the case that we have the best one rather than the former.

So I think, while it does mean they're going to try a few different scanners and play with them, we've actually had some people that bought a different scanner and sent it back saying it doesn't do what I need.

Can you bring an iTero in?

So again, we're doing very, very well and we're pleased with our progress.

There's a lot of installed base sockets open and up for competition over the next few years out there.

Great, thanks very much.

Thanks.

Actually, operator, we've got one more question, please.

Chris Lewis, Roth Capital Partners.

Good afternoon.

Thanks for fitting me in here.

Hi, Chris.

Tom, at the Analyst Day, you talked quite a bit about the product evolution of Invisalign in terms of the efficacy and applicability so I understand you're still in the early days of rolling out G5 deep bite.

But can you give us any sense of when we could expect to hear more details around new product enhancements and potential new treatment indication announcements?

It's a great question.

Amazingly, our customers are asking us the same thing.

We try to have a discipline -- we were out of our comfort zone at the Analyst Day.

We probably showed a little more than we were normally comfortably doing because it was very important for us to frame our strategic intent and you understood why we were confident that we could actually argue long-term to think about standard of care.

We'd rather not sell futures, either to our customers or to our owners and would rather them know that we're working on all the major indications and our goal is to make Invisalign easier to use and more predictable than brackets and wires to get great results.

So I think we showed things like extraction, where there's an interest, but in terms of putting a timeframe on it and what and how we'll do it, I'd rather not do it.

There are rich opportunities ahead for us either around an indication specific solution or around a lot of other things we can do to make Invisalign more mainstream and we're working on all those.

Sorry.

Great.

Congrats on the quarter.

Thank you, Chris.

Thank you.

Thanks, Chris.

Thank you, everyone for joining us.

This concludes our call today.

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