愛齊科技 (ALGN) 2016 Q3 法說會逐字稿

Greetings, and welcome to the Align Technology, Inc.

third-quarter 2016 earnings conference call.

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

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

(Operator Instructions) As a reminder, this conference is being recorded.

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

Thank you, Ms. Stacy.

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 from today's conference call is Joe Hogan, President and CEO; David White, CFO; and John Morici, incoming CFO.

We issued third-quarter 2016 financial results today via market wire, which is available on our website at investor.aligntech.com.

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

A telephone replay will be available today by approximately 5:30 p.m.

Eastern Time through 5:30 p.m.

Eastern Time on November 21st.

To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13646649 followed by #. 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 statements about Align's future events, product outlooks, and the expected financial results for the fourth quarter of 2016.

These forward-looking statements are only predictions, and involve risks and uncertainties that are set forth in more detail in our most recent periodic reports filed with the Securities and Exchange Commission.

Actual results may vary significantly, and Align expressly assumes no obligation to update any forward-looking statements.

We have posted historical financial statements, including the corresponding reconciliation and our third-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, Joe Hogan.

Joe?

Thanks, Shirley.

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

Today in conjunction with our Q3 earnings announcement, we also announced the retirement of David White, who will step down as CFO on November 10.

David has been a key contributor to our business growth over the past three years, and the Board and I want to thank David for his dedication, and wish him the best in his retirement.

We are fortunate that David will stay on with the Company through February 2017 to work on certain planning and ERP implementation projects, and ensure a smooth transition with his successor, John Morici.

I'm pleased to have John join Align and here with us today on this call.

I've known and respected John for years.

I've watched him grow and kept up with his career for over 16 years, and have a huge amount of confidence in him.

John is an experienced CFO and General Manager who can partner with me and the leadership team to accelerate progress.

He has financial experience across several large dynamic companies, including Abbott Labs, GE, NBC Universal, so he can scale with the growth we expect from Align in the upcoming years.

John doesn't officially start until the 10th, so we won't make him answer any questions about the business, but he will be happy to take a couple of your questions during Q&A about why he's so excited about joining Align.

Let me now turn to our third-quarter results.

On our call today, I'll provide some financial highlights, and then briefly discuss the performance of our two operating segments, clear aligners and intra-oral scanners.

Dave will provide more detail on our financial results and discuss our outlook for the fourth quarter.

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

Q3 was a solid quarter with revenue margin and EPS each above the high end of our guidance.

Our results were driven by record Invisalign case volume, up 20.5% year-over-year, reflecting growth across all customer channels and geographies, as well as continued demand for iTero scanners.

The Q3 North American Clear Aligner volume was up slightly, 0.9% sequentially, consistent with historical Q2 to Q3 norms, and up 14.5% year-over-year.

On a sequential basis, North American Ortho's were up, driven by teenage cases, which increased 20% from Q2, and contributing to another record quarter for Ortho utilization.

This was offset by North America GP volumes, which were down sequentially, primarily due to a seasonally slower period for GPs as well as weaker dental market.

The GP channel remains challenging, particularly among low-volume practices.

On a year-over-year basis, North American Ortho volume was strong and GP growth rate was solid, especially considering tougher 2015 comps.

We believe North America still has a lot of headroom for growth, as we continue to execute our strategic initiatives, including new products and technology innovation, evolving our go-to-market approach and leveraging the TFM model that has been so successful in EMEA, and rolling out new teen initiatives, including a new consumer campaign next year.

In the GP market specifically, we are working to scale two very successful practice development programs led by key opinion leaders, increasing our focus on DSOs and large group practices.

And in October, we began piloting Invisalign Go, our new product engineered specifically for GP dentists, with full commercial launches second half of 2017.

Q3 Invisalign volume for international doctors was roughly flat, 0.5% sequential, driven by strong growth in Asia-Pacific, offset by summer seasonality in EMEA, especially in Southern Europe, where doctors and their patients typically take extended holidays.

On a year-over-year basis, international Invisalign volume was up 33.8%, reflecting continued strong performance across both EMEA and APAC.

In EMEA, Q3 volume was up 27% year-over-year, reflecting continued adoption of Invisalign in core markets like Spain and France, as well as rapid growth from expansion into new country markets, including Eastern Europe, Benelux, and Nordic regions.

In Asia-Pacific, we had another record quarter, with volumes up sequentially and up 44.3% year-over-year, led by China and Japan.

Most APAC country markets have recorded shipments -- had record shipments, including China, Japan, Taiwan, Hong Kong and Southeast Asia markets.

In addition, we continue to see positive industry response at major events across the region, including the Guangdong Ortho Society meeting, one of the biggest in China.

During Q3, we announced multiple innovations that enhance Invisalign treatment planning and predictability of treatment outcome.

Invisalign G7, which we announced in October, built on earlier Invisalign G Series releases with new features to fine-tune certain tooth movement and deliver excellent treatment outcomes that doctors expect, especially with teens.

We also announced ClinCheck Pro 5.0, which has new features that deliver an exceptional user experience and new visuals along with increased control for doctors during treatment planning.

Finally, we were very excited to announce our new one-week wear recommendation for all Invisalign teen in full products.

Based on a predictability of the Invisalign system and our experience, as well as patient case data shared by our customers who have been prescribing weekly Aligner changes, we believe that, for most cases, one-week wear can deliver shorter treatment times for patients and greater efficiency for Invisalign practices.

Turning to the teen market, 162,000 teenagers started treatment with Invisalign over the past 12 months, an increase of 21% compared to the same 12-month period in 2015.

For Q3, the total number of teenagers using Invisalign increased 19% sequentially and up 17.4% year-over-year, driven by continued adoption worldwide.

In Q3, we saw a strong uptake among teenagers using Invisalign outside the United States, up 36% year-over-year, with strong growth, particularly from Asia-Pacific, which now accounts for 51% of the total international teen cases.

For North American Ortho's, Q3 teen volume increased about 14%, was lower than expected, and not as robust as Q3 last year when we ran several teen-specific promotions that drove incremental teen volume.

Q3 will serve as a good baseline as we head into next year, where we intend to launch a major teen program and a new direct-to-consumer campaign, with greater investment in targeting teenagers more directly than ever have before.

While we are pleased with our Q3 results, our incoming case receipts in North America were lower than expected.

We believe case receipts were impacted primarily due to a weaker dental market for GPs, as well as a lack of teen promotional activity for Europe orthos.

Today, with more than a month into Q4, I'm pleased to report that our North America case receipts have since improved and that demand outlook appears solid.

Dave will provide more details in his business outlook.

Our integrated consumer marketing campaigns in North America, EMEA, and APAC, leveraged traditional paid media, search, digital marketing, PR, and social media to engage consumers at every point in the consumer purchase journey.

Consumer interest and demand for Invisalign treatment continues to grow.

In Q3, we celebrated a major patient milestone, and launched a global social media and advertising campaign to promote the London-based 4 millionth Invisalign patient.

We promoted this milestone as a part of our partnership with Operation Smile, with Align Technology donating $1 to Operation Smile for every public share of a photo of a person's smile on Facebook, twitter, or Instagram, with the hashtag of #4millionsmiles for a total donation of up to $1 million.

The 4 Million Smiles campaign has been a great success in driving a reach and awareness of the Invisalign brand around the globe, and with this hashtag being seen over 51 million times around the world.

North America, we saw positive gains in our consumer engagement and conversion metrics, including web traffic conversion, soft locator searches and consumer opting for more information on treatment.

In September, we partnered with the AAO at the start of the New York City Fashion Week to highlight the best fashion accessory ever, a great smile as a result of Invisalign treatment.

The Invisalign brand was a primary event sponsor, and created an Invisalign lounge experience to showcase the power of a confident smile through Invisalign patient testimonials, iTero scans, and consults with New York City area orthodontists.

In EMEA, our consumer outreach focused primarily on our 4 Million Smiles campaign and the launch of the Patient Experience Program in the UK market.

This program is aimed at helping Invisalign providers create an excellent patient experience, and includes learning modules aimed at practice staff to help them discuss Invisalign treatment with prospective new patients.

In Asia-Pacific, our consumer marketing campaigns are focused on demand generation in key markets, including China, Australia, New Zealand, Hong Kong, Japan.

In China, for example, our Big Bang Consumer Outreach Program has focused on consumer engagement through Invisalign providers and social media KOL's, or key opinion leaders.

This campaign delivered a 380% year-over-year increase in consumer web traffic, is on track to deliver 150,000 lead generations behind this campaign.

We will also continue to see traction in Australian teen campaign.

In Q3, our scanner business revenues were up 35% sequentially and up 274% year-over-year, reflecting a record number of units shipped in the quarter, primarily in North America.

Demand for the iTero element scanner has stabilized.

At the recent ADA meeting in Denver, we announced new software upgrades for our market-leading iTero Element intraoral scanner and Invisalign outcome simulator.

Only iTero scanners provide an optimized Invisalign scanning and treatment experience that includes the enhanced Invisalign outcome simulator 4.0 application, now with Invisalign 3-D progress tracking in patient simulation sharing.

The 3-D progress tracking feature gives Invisalign providers the ability to compare patients' new scan with a specific stage of ClinCheck Pro treatment plan to visually assess and communicate Invisalign treatment progress with an easy-to-read, color-coded tooth movement report that allows the doctors to know how each tooth is tracking.

Use of the iTero scanners for Invisalign case submissions in place of PVS impressions continues to expand.

The Q3 total Invisalign cases submitted with a digital scanner worldwide increased 39.6%, which reflects a record 48.4% from North America and 22% from international doctors.

While these scans are predominantly from our own iTero scanner, we are also seeing some uptake from 3M's True Def and Sirona's Omnicam scanners.

We also completed the final validation process for 3Shape's TRIOS scanner -- TRIOS Standard, TRIOS Color, and TRIOS 3, in which Invisalign providers with the TRIOS scanner can now submit digital scans as part of the Invisalign case submissions.

Now I'll turn to the supply agreement we announced in July with SmileDirectClub for the emerging Doctor-directed at-home aligner market.

Our agreement with SmileDirectClub is to manufacture non-Invisalign aligners for simple cases, which include up to 20 sets of aligners with no IPR attachments, and are produced with an off-the-shelf polymer material.

On October 15, we began accepting cases from SDC, and subsequently started manufacturing aligners.

We also recently implemented be Invisalign referral process for sending patients, whose case falls outside the scope of the agreed-upon SDC protocols, to Invisalign providers, and began scheduling Invisalign consultation appointments.

While this is still early, we are pleased with our initial progress, and remain excited about the untapped opportunity to help provide access to treatment for consumers who wouldn't otherwise seek orthodontic treatment.

With that, I will now turn the call over to David.

Thanks, Joe.

Let's review our third-quarter financial results.

Total company revenue for the third quarter was $278.6 million, up 3.4% from the prior quarter, and up 34.2% from the corresponding quarter a year ago.

Third-quarter Clear Aligner revenue of $243.7 million was flat sequentially, reflecting a slight increase in Clear Aligner volumes.

Our year-over-year revenue growth of 22.9% reflected Invisalign case volume growth across all customer channels and geographies, as well as our price increase in international markets.

Note that this past July marks a full year since we implemented the additional liner policy, and therefore, our year-over-year comparisons no longer reflects the impact from this policy change.

That said, our results still, however, reflect the impact from the grandfathered cases that were under the previous policy.

Q3 ASP's were flat from Q2 at about $1,285, reflecting a slightly higher mix of full and teen product, the partial impact of an international price increase, which were offset by several factors, including higher product discounts.

On a year-over-year basis, Q3 ASP's were up $26, primarily due to a price increase this year, partially offset by higher product discounts.

For the third quarter, total Invisalign shipments of [177,008] cases were flat sequentially, reflecting growth from our North American Ortho's and APAC region, offset by seasonally -- by seasonality across North American GPs and the EMEA region.

Year-over-year case volume growth was 20.5%, driven by growth across all regions.

For North American orthodontists, Q3 Invisalign case volumes was up 3.8% sequentially and up 18.2% year-over-year.

For North American GP dentists, case volume was down 2.7% sequentially and up 9.8% year-over-year.

For international doctors, Invisalign case volume was down 0.5% sequentially and up 33.8% year-over-year, reflecting continued expansion of our customer base as well as increased utilization.

Worldwide Invisalign utilization in Q3 was 5.0 cases per doctor, up from 4.7 in Q3 last year.

North America Ortho utilization was a record 11.1, up from 9.9 in the prior year.

North America GP utilization was 3.0, slightly up from 2.9 in the prior year.

And international utilization was 4.9, up from 4.6 cases per doctor in Q3 last year, driven primarily by increased utilization in EMEA.

In Q3, we added 2,615 new Invisalign doctors worldwide, 1,300 of which were new North American doctors and 1,315 of which were new international doctors.

This compares to 2,885 in Q2 and 2,260 in the same quarter last year.

Our scanner and services revenues for the third quarter was $34.9 million, up 34.7% sequentially and up 273.7% year-over-year.

Moving on to gross margin, third-quarter overall gross margin was 75.1%, down 1.1 point sequentially and down 0.8 points year-over-year, both primarily attributable to a larger percentage of scanner and services revenue, which carries a lower margin than Clear Aligner.

Clear Aligner gross margin for the third quarter was 77.7%, down 0.9 points sequentially and down 1.1 point year-over-year.

The sequential decrease was primarily driven by a higher number of aligners per case, partially offset by seasonally lower training.

The year-over-year gross margin decrease was primarily driven by a higher number of aligners per case, partially offset by higher worldwide ASP.

Q3 gross margin for our scanner segment was a record 57.1%, up 3.5 points sequentially and 42.4 points year-over-year.

Both the sequential and year-over-year increases in gross margin were primarily a result of higher ASP's and the lower manufacturing costs of our iTero element scanner relative to its prior version.

Q3 operating expenses were $147.1 million, up sequentially by $7 million or 5%, primarily due to payroll and other costs related to increased headcount; higher depreciation, as we started to depreciate our newly implemented ERP system; as well as post-go-live support costs, but those should be decreasing over the short-term.

On a year-over-year basis, Q3 operating expenses were up $27.6 million or 23.1%, reflecting increased headcount and continued investment in our go-to-market activities incidental to the growth of the business.

Our third-quarter operating margin was 22.3%, down 1.9 points sequentially and up 4 points year-over-year.

The sequential decrease in operating margin relates primarily to slightly lower Clear Aligner gross margins; a higher mix of scanner revenue, which, while mentioned achieved record performance, carries a lower gross margin; as well as higher operating expenses.

On a year-over-year basis, increased operating margin primarily reflects lower operating expenses as a percentage of revenue, due to volume leverage achieved on our year-over-year growth.

With regards to our third-quarter tax provision, our tax rate was 18.4% compared to 23.2% in Q2 2016.

Our Q3 tax rate was lower by approximately 5 points due to a one-time benefit from our new international corporate structure, which we implemented in conjunction with our ERP.

Commencing in the third quarter, we also began including our relationship with SmileDirectClub in our reported results pure.

While we didn't actually commence shipping product to them until the current quarter, our equity investment in SDC requires that we report our proportionate share of their losses.

Our share of that loss is reported below operating margin and our tax provision, and is entitled Equity and Losses of Investee.

This Q3 loss, net of tax, was approximately $0.5 million.

Third-quarter diluted earnings-per-share was $0.63 compared to $0.62 reported in Q2, and $0.34 reported in the same quarter last year.

Moving on to the balance sheet.

For the third quarter, our Accounts Receivable balance was $245 million, up approximately 27% sequentially.

Our overall DSO was 78 days, up 14 days sequentially and year-over-year, as a result of our new ERP system and other related systems that impacted the timing of some of our customer collections.

We would anticipate that our DSOs will remain above our historical average for several quarters as we work through these changes.

Capital expenditures for the third quarter were $17.3 million, primarily related to equipment purchases to expand our manufacturing capacity in Juarez, Mexico and, to a lesser extent, our ERP implementation.

Cash flow from operations for the third quarter was $59.8 million, and free cash flow for the third quarter, defined as cash flow from operations less capital expenditures, amounted to $42.5 million.

During the quarter, we concluded our previously announced $50 million accelerated stock repurchase with final delivery of 143,310 shares, and purchased an additional 88,000 shares amounting to $8.2 million in open market repurchases.

These repurchases were collectively part of a three-year $300 million stock repurchase program announced on April 23, 2014.

In addition to the April 2014 repurchase plan, Align also announced on April 28 of this year a new plan to repurchase up to an additional $300 million of the Company stock.

There remains approximately $341.8 million available for repurchases under these two existing stock repurchase authorizations.

Cash, cash equivalents and marketable securities, including both short and long-term investments, were $675.8 million.

This compares to $678.7 million at the end of 2015, a decrease of approximately $2.9 million.

Of our $675.8 million in cash, cash equivalents and marketable securities, $288.3 million was held by the US, and $387.5 million was held by our international entities.

Our US balances were up $107 million quarter-over-quarter, of which $147 million was contributed as a result of implementing our new international corporate structure, which was then reduced by our investment in SDC of about $47 million.

As of September 30, 2016, the balance of our equity method investments for SmileDirectClub was $46.3 million.

With that, let's now turn to our business outlook and the factors that inform our view, starting with the demand outlook.

As Joe mentioned in his comments, our incoming case receipts in North America in Q3 were slower than we had originally anticipated.

And given that our targeted turnaround time to our customers, we ship much of our backlog as of quarter-end.

Since then, our case receipts in North America have improved and returned to a year-over-year growth rate early in the quarter that is well ahead of both our second and third-quarter performance.

As such, for -- our outlook for Q4 appears solid.

However, lower Q3 case receipts and less backlog will dampen our Q4 shipment growth rate as our backlog begins to naturally return to normal levels.

As such, our Q4 guidance reflects this impact.

On a longer-term basis, we remain confident that our Invisalign revenue growth on a full-year basis will be within the upper half of our long-term model range of 15% to 25%.

With that backdrop, for our international markets, Invisalign demand remained strong, and we would expect Invisalign volume in Q4 to be up sequentially, driven by growth in EMEA coming off a seasonally slower summer period.

APAC is usually seasonally down sequentially coming off a strong summer.

For North America, we would expect North America Invisalign volumes in Q4 to be flat, primarily as a result of the factors I just described.

For our scanner business, we expect scanner shipments to be up sequentially as the iTero Element continues to penetrate the market.

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

Invisalign case volume is anticipated to be in the range of [182,500] to [184,500] cases, up approximately 15% over the same period a year ago, reflecting continued strong growth from international but muted by the factors just described.

We expect Q4 net revenues to be in the range of $289.2 million to $293.9 million, an increase of 27.6% year-over-year and well above our long-term target of 15% to 25%.

We expect Q4 gross margin to be in the range of 74.7% to 75.1%, essentially flat sequentially, primarily due to an increased mix of scanner business, and lower margins and slightly lower Clear Aligner ASP's.

We expect Q4 operating expenses to be in the range of $149.6 million to $150.6 million, up quarter-over-quarter, primarily due to increased headcount offset by seasonally less advertising and lower ERP post-go-live support costs.

Q4 operating margin should increase sequentially and be in the range of 23.0% to 23.9%.

Our effective tax rate should be approximately 22%.

We estimate the Q4 impact of the SmileDirectClub transaction will reduce diluted EPS by less than $0.01 per share, and diluted shares outstanding should be approximately [$81.5 million], exclusive of any share repurchases.

Taken together, we expect our Q4 diluted EPS to be in a range of $0.64 to $0.67.

Before I turn the call back over to Joe, I want to say a few things about my decision to retire and spend more time with my family.

This is something my wife Nikki and I have thought about and planned for some time and communicated to Joe.

This timing has afforded Joe and the Board time to find a replacement for me before I step down.

I want to thank many of you who I have worked with and come to know well over the past few years.

It has been a pleasure working for such a great Company, and I feel honored to have been a part of history in the making, as we transform and modernize the orthodontic industry.

But it's not time to say goodbye just yet.

Although John will start this week, and I will hand over formal CFO responsibilities immediately, I will work closely with him in the coming months, and you will see us together at upcoming financial conferences and industry meetings.

Until then, let's turn the time to Joe for his closing comments, and then open the call up for your questions.

Thanks, David.

Overall, I'm pleased with our Q3 results, especially the continued strength from our EMEA and APAC regions.

Notwithstanding weaker-than-expected North American case receipts in Q3, our business remains solid and on track.

Based on the high end of our Q4 guidance, the implied full-year results will be significantly higher than our original outlook provided in January, with 28% revenue growth, 20% Clear Aligner volume growth, and 23% operating margins.

We have a huge opportunity in front of us to replace wires and brackets and transform the orthodontic market.

As we continue to execute on our strategic plans, I'm confident in our ability to outpace the market and achieve revenue growth for 2016 and beyond at the upper end of our target of 15% to 25%.

Looking forward to following up with many of you in the coming weeks at various conference and industry meetings.

I'll now open the call to your questions.

Operator?

(Operator Instructions) Steve Beuchaw, Morgan Stanley.

This is Jack on for Steve.

Just a question looking at the trends in the business.

Clearly, the scanner business is doing very well.

The aligner franchise not going quite as strongly as we thought into 4Q, obviously, with some of the weakness in North America.

But I'm wondering if there's anything going on with the sales force, and if there is a bandwidth issue at all there, with scanners drawing so much attention?

Thanks.

Hey, Jack, it's Joe.

I would say the definitive answer to your question is absolutely not.

I mean we obviously watch that closely to make sure that we primarily focus on where the focus needs to be by sales rep.

And I'd also just take a difference with your initial comment, is I think the overall liner market continues to be strong.

We had a little bit of a speed bump in third quarter from an orders standpoint.

It's mainly GP -- low submitting GPs that we've talked about before.

But overall, in the forecast that we've given you for fourth quarter, and fortunately, given the timing of the call today, we get a good clear October look.

We are very confident to be on the upper end of our 15% to 25% revenue growth that we've been indicating over the last 18 months or so.

Okay that's good.

And just on the one-week aligner policy that you introduced about a month ago, just curious what doctor uptake has been like so far?

And how quickly you might expect that to start to become the norm?

And I'll hop back into queue.

Thanks.

Well, you know, as we mentioned in the release, many doctors were already experimenting or were actually utilizing one-week wear, not just in North America, but all over the world.

So many have discontinued with what they were doing.

Overall, we've had a very positive response.

Again, this is -- we leave this in a doctor's hands.

There are some cases we don't think -- a majority of cases at all -- they might have to move to two weeks at some point in time.

But we feel, by far, the majority of our cases can go with one-week wear, with very -- a lot of confidence in the teens market also, in the sense that their dentition being looser and being able to be able to move more quickly.

So, I'm -- we're not predicting an immediate surge in orders based on one-week wear, but we think it's just another aspect of our go-to-market, it makes Invisalign very enticing for patients versus wire and brackets.

Okay, Jack?

That's perfect.

Yes.

Thanks.

Yes.

Thank you.

Steven Valiquette, Bank of America Merrill Lynch.

Congrats on these strong results.

Hey, so I guess just for us, the comment about the Q4 shipments, growth rate, and you are reflecting the backlog beginning to return to normal levels.

Just curious to make sure that that should work itself through in the fourth quarter such that if the strong volume you saw in October carries over into early next year, that we should mechanically then obviously see some improvement in the year-over-year growth as we go into early 2017.

Is that the right way to think about that?

Steve, just back up one.

Yes, we expect that to stabilize in the fourth quarter.

That's why we call the shipment rates that we've been calling for you too.

If I interpret the second part of your question is, as we move into 2017, should we be on a stronger footing in a sense of a backlog -- that's our plan.

Okay, so the backlog would not extend beyond one quarter basically, that's what I was trying to clarify.

So sorry for the poor wording the first time around.

Correct, Steve.

It will naturally return to its nominal levels this quarter as our case volumes recover, case receipt volumes recover, and as we are seeing early in the quarter so far.

Okay, got it.

Okay, all right, great.

Thanks.

Thanks, Steve.

Brandon Couillard, Jefferies.

Joe or David, as we think about the economic sensitivity of the Clear Aligner business, to what extent do you think we've seen any of that sort of lead over into the Ortho channel?

And not wanting to really split hairs here, but EMEA growth slowed a little bit sequentially.

To what extent, if at all, have you seen any, I guess, economic effects there in the core Western Europe market, if at all?

You know, I wouldn't -- I'll let David join in on this too -- I wouldn't call these any macroeconomic effects as far as what we are seeing right now.

Your comment about it bleeding over into Ortho, we had record utilization rates in Ortho, up significantly.

I think it's 9.9 to 11.1 in the quarter, so it shows terrific or continued growth in Ortho utilization with our product line.

So we feel broadly this is a GP blip.

This has been talked about in the marketplace in the third quarter that we saw in North America across the board, not just with Invisalign but with the dental market in general.

So -- but again, our October order rates indicate that we are on track with the kind of growth we experienced in the second quarter of this year.

And we think that will continue.

David, go ahead.

Yes, Brandon, just to add a little color to that, we -- when we look at our GP doctors by segment in terms of the case volume that they do, the doctors that are fully engaged with Invisalign, and have incorporated it into their practices, are typically less susceptible to softness in the market, because their practice has been built really around the -- or Invisalign has become such an integral part of their practice that they typically are on the offense in terms of business development.

It's really more the lower-tier doctors that are still quite dabbling in Invisalign, haven't quite changed their practice flows and so forth.

And so when we see an overall softening in the market, it tends to be those doctors that tend to be the first to pull back.

And when we look at the Q3, that's precisely where we saw it -- really those doctors that are at the lower volume levels.

Then one more for you, David.

In terms of the operating cash flow and the DSO build in the period, why would it necessarily take several quarters for that to normalize?

Well, I hope it won't.

You know, we had a very successful implementation in July.

We did have some delays in invoicing, a few customers, and we're working through those right now, and expect to have those worked out.

When we sell to 30,000-plus customers at a time, it doesn't take very many to create -- to influence that DSO.

And one of the things with most customers is when a sales tax rate or a VAT rate is incorrect, you typically wind up having to rebuild the customer at the correct VAT rate or sales tax rate, and then the clock starts all over again.

And so, we are generally up against that issue right there.

And we think over the next couple of quarters, it will be behind us.

Thanks.

Jon Block, Stifel.

Two questions.

The first one has got two parts, just one for Joe and David.

So just to begin SDC, Joe, maybe if you can tell us what has been sort of the Invisalign provider reaction to date?

Anything surprise you on either the positive or negative side?

And the second part to that question is for David.

Anything in the 4Q 2016 revenue guidance on SDC?

Since I believe, as you mentioned, they will be shipping cases for the vast majority of the quarter.

And then I've just got a quick follow-up.

Thanks.

Hey, Jon, it's Joe.

Look, I think the provider -- honestly, the provider reaction to this was anticipated.

I think you picked it up in your analysis too with the 100 or so that you do.

Many orthodontists aren't happy with this.

Many of them understand why we did it.

I think they feel good about it not being Invisalign, that it is a -- it's the X-30 and it's a lift-row kind of a system and not a gingerbread cut.

But it's just really a complete offtake of what the product that they were using before.

So I think overall, I haven't been surprised with the reaction.

We haven't seen a response in the market that would be negative in some way.

We're sitting here at the Ortho Summit, so we'll get an on-the-ground feel here this week.

But I would say overall good, because I think, frankly, there is an understanding in the marketplace of what we did and how we did this.

That doesn't mean there's not a lot of passion about a doctor-directed kind of virtual model that exists out there.

But we feel the response has been in line with what we had anticipated.

And John, to your second part of the question, really SDC didn't really impact any of our thinking as it relates to the Q4 guidance.

When you look at our year-over-year growth that we're -- that has been baked into our guidance, it really comes to two factors -- one, which has to do with a renormalization of our backlog, if you call it that, coming off of Q3, a weaker case in receipts.

And then secondly, when you look at a year ago, Q4 of 2015, that quarter was up 25% year-over-year and up 9% quarter-over-quarter.

And so it was a very -- it was just a rock solid quarter for us.

And so I think when you look at the compare quarter-over-quarter, I think you are seeing a comp there that's also having some bearing on it.

Okay.

I'll follow-up with you off-line on that one, David.

I guess I'm just wondering if you are recognizing revenue from shipping out the aligners.

But I'll follow up with you off-line on that one.

The other one, I just hate to burn one on Cadent, but I do think it's important just for 2017, Joe, how do we think about the scanner?

And I'm just asking because it's a very different business than Invisalign.

It's capital and you're coming off of a big upgrade with Element.

So just when we look at 2017, up, down, flat, specific to the Cadent business.

Thanks, guys.

You know, 2017, John, just to be clear, up.

I'm not going to give you a percentage, but it will be up.

I think you can see with our announcement with our simulator product and things we've been putting together, the scanner is really important for us in the sense of how we go to market with the Ortho's but particularly with GPs also.

So think about that scanner business is going up.

Don't think of the margin being as dilutive as what we talked about before, as you put that in the model.

Just think of it being almost equal to Invisalign in that sense.

I'm going to let David backtrack here on the SDC fourth-quarter piece and next year, so we can just clear that up now with you, John.

Yes.

So back to that question, Jon, on SDC.

Very minimal revenue in our outlook this quarter for SDC.

We really just got off started in the middle of October.

We are taking this very slowly as we integrate into their practice.

So, really a minimal consideration in the revenue guidance we gave for Q4.

Very small.

Going back to the scanner, I just want to highlight one other thing about our scanner business.

You know, here's two components to that business, one of which has to do with the sale of the hardware itself, the equipment.

But then secondly, the ongoing support that we -- revenue that we recognize associated with maintenance and subscriptions and so forth, that revenue grows in proportion to our installed base.

And as you've seen this year, our scanner growth rate from a unit standpoint is quite significant.

So the installed base is building actually quite nicely.

And so that's going to be -- form a nice foundation, I think, for the scanner business going into 2017.

Great.

Thank you, guys.

All right, Jon.

John Kreger, William Blair.

Joe, maybe following up on Jon's question, any other 2017 comments that you'd care to give us?

You are certainly coming up against some very tough comps in terms of the Invisalign unit growth.

Thanks.

John, no, I'd prefer not to give any more 2017 comments, but I think you can tell from my comments we are optimistic about 2017, and believe this year -- I mean, obviously above guidance of what we gave you in 2016.

Our international growth has been tremendous.

Our Ortho utilization numbers are good.

To come out next year, we have several programs with GP in North America that we think will address some the weakness that we've experienced.

Invisalign Go that we've put in place is a big one.

Some of our key opinion leaders and how they go about the Ortho market -- I mean, the GP market right now has really been incredibly successful.

Our TFM model that we are implying here in the United States, not just in the Ortho channel but the GP channel also, also gives us confidence that we can maintain that kind of momentum.

But outside of that, I don't care to talk about any numbers and specifics, John.

Okay, great.

And then just one other follow-up in terms of your comments about the slower incoming case receipts.

When did you start to see that?

We've heard other dental providers talking about slowdowns as early as June.

Was that strictly in September?

Or did you see it start earlier in the summer?

So, John, it really began showing itself up in early July.

And at the time when we were seeing it, we were thinking it just might be early seasonality.

You know, we do -- even though we know that Q3 is a seasonally weaker quarter for GPs; a seasonally stronger quarter for Ortho, particularly teens; weaker seasonally EMEA, et cetera, that seasonality is not just -- it tends to move.

And so sometimes it will show up earlier or later.

And so in early July, we thought it was more just simply an earlier seasonality.

And what wound up happening was it wound up being more seasonally weak, you might say, across almost the entire quarter.

Great, thanks.

Thanks, John.

Richard Newitter, Leerink Partners.

Thank you for taking the questions.

Joe, just maybe one more kind of on a go-forward view without maybe giving specific additional guidance on 2017.

Can you give us a little more color or at least some of the things we should be thinking about as we refine our models for 2017 on -- what puts and takes should we be considering on the cost side, whether it's mix shift, just things to bear in mind as you anniversary the ERP?

Can you walk us through some of the things just to think about there?

No, not really.

(laughter) No, Richard, we -- no, we appreciate you wanting to fill out your spreadsheet for next year.

We're trying to give you as broad a guidance and positive a guidance as we can, but to really start to nail those specifics wouldn't be in line with the kind of information we normally divulge.

Yes.

When we get to the January earnings call for reporting year-end results, we'll be glad to throw some meat on the bones, so to speak, to kind of describe our outlook into the year.

But suffice it to say, at this point, I think Joe's comments earlier about revenue growth and so forth in our -- above our long-term range, et cetera, should suffice.

Got it.

And then maybe just to -- you put out there a confidence level to get to the kind of the upper part of your long-term range of 15% to 25%.

Is that really just kind of the GP initiatives?

Obviously some of the backlog normalizes, works itself out, but you are up against top comps.

So should we just be thinking about that as really these initiatives around kind of the GP segment?

And then kind of marketing and new direct-to-consumer and teen, that are really kind of what give you the confidence there?

Or is there something else?

Thanks.

Well, I mean, we didn't have easy comps this year when you look at -- we had easy comps on 2015 versus 2014.

But this year we had, you know, Richard, pretty difficult comp, even what David just referenced in the fourth quarter last year, what a tough time we had.

So, look, I think when we talk about or when I talk about the GP focus that we are going to have, the international growth, the focus on teens next year, all those things are just to focus in areas where we develop products and systems over the course of the last 18 months that go after those areas that historically have been some soft areas for us, and maybe more predictable than they should have been.

The rest of this business, you know the international parts, the Ortho utilization piece, those things are going really well.

Did we lose you -- hey, Richard, are you there?

Sorry, I was on mute.

Yes.

No.

Thanks.

That's very helpful.

And just maybe one last one.

The difference between -- what does GP Go do for you that kind of prior initiatives haven't in the past?

And maybe just elaborate on that a little bit.

Thank you.

You know, Richard, basically GPs don't want to be Ortho's.

They haven't been trained in tooth movements.

And when you look at products like we have, like ClinCheck and our full case assessments and those things, they are -- as much as we want to make them simple, they are very sophisticated products.

It's almost like using 90% of PowerPoint, which most people can't, right?

And so with GPs, what we have to do is build their confidence in the sense that they can look at a case and quickly say, I can do this case and I can do it well for my patient or I can't.

And just in a short kind of a statement, that's what Invisalign Go is.

You can scan that patient or take a photo of that patient.

We'll quickly assess that, and we'll tell that particular GP if they can actually handle that case.

If they can, we can quickly work up a case assessment and give it to the customer while they're in the chair.

It's a substantial difference than trying to, in two days, teach an Ortho -- I mean a GP how to do Ortho work, which is very difficult.

We feel we can really integrate into a GP practice much more simply by making less complexity in a sense the way we do case assessments, and the burden it would place on a GP to take that kind of burden.

I hope that makes sense.

That does.

Thank you.

Jeff Johnson, Robert W. Baird.

Let me start just by saying, David, best of luck in retirement.

It's been great working with you for the last three years or so.

So, best of luck going forward.

Yes, thank you, Jeff.

Appreciate that.

Yes.

Yes, great.

So, Joe, let me ask a couple of questions here.

I mean, again, kind of like John, I hate to burn a question on the scanner business, but it's been so strong here.

You know you mentioned kind of that being up next year.

If I look at your second-half numbers here, what's kind of implied in fourth-quarter guidance and the third-quarter's strong results, it looks like you are up 50-some-percent sequentially even first half to second half of this year.

So, not to paint you in a corner, but kind of up year-over-year based off the 2016 base?

Or do we keep seeing growth even off these low $30 million numbers, which are just well above what I think any of us were probably thinking they would be at this point?

I mean growth over the 2016 base, Jeff.

2016 base.

Yes.

No, that's helpful.

And then, David, maybe a clarifying question on the margin side.

You made comments in your prepared remarks about margins.

I think you said gross margins is down a little bit year-over-year next quarter, and you said that aligner ASP is down.

You kind of made reference to some bigger promotions here in this quarter.

I guess I'm trying to figure out why aligner ASP's would be down in the fourth quarter if you anniversary through the additional aligner thing, now you've got price increases?

You also have the positive mix.

If the backlog on North America is a little lower than the OUS backlog, I would think -- or the OUS growth -- I would think would be helping ASP's next quarter.

So just trying to reconcile margins being down next quarter -- gross margins.

So -- okay.

So, for a couple things.

One, as it relates to Clear Aligner, you know our -- well, more about ASP's, which will impact that.

ASP's are affected by product mix.

And our low stage products are very heavily concentrated, or more so concentrated, you might say, from a mix standpoint in our EMEA region than the rest of our business.

And so, since Q3 was a seasonally weaker quarter for EMEA and Q4 is a seasonally stronger, that mix of low stage product is going to enter into the equation and is going to influence the ASP's this next year.

It will go up -- that mix is going to go up by one-plus points quarter-over-quarter.

And that will have some bearing on it.

And then secondly, you've got doctors -- this is the end of the advantage period for many of our doctors.

And so as those doctors begin to get close to or approximate the next tier of their pricing, they will begin to see lower prices even this year early, as they are running towards that December 31 date.

So those two things right there are bringing down the ASP and bringing down very, very modestly the gross margin at the same time.

All right, that's helpful.

And Joe, last question for me.

I just want to make sure I understand clearly your comment on being in the upper half of that 15% to 25% range.

I think you were talking Clear Aligners.

And you were saying get back to that by first quarter of 2017?

Or is that just kind of a general comment, getting back to that over the next few quarters?

Well, I, from an order rate standpoint, you know, Jeff, we feel we'll be in that range in the fourth quarter.

So as we move into the first quarter of next year, we feel that way.

And that is -- I'm quoting, as you mentioned, Clear Aligners.

This is not mixing Clear Aligners with the scanner business.

Yes.

That's helpful.

Thanks guys, appreciate it.

All right, Jeff.

See you.

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

Our final question comes from the line of Robert Jones of Goldman Sachs.

Please proceed with your question, Mr. Jones.

Thanks for the questions.

And, David, yes, congratulations on the retirement.

John, look forward to working with you.

I guess, Joe, just wanted to go back to something you had said about what you're seeing in case receipts quarter-to-date.

Wanted to make sure I heard you correctly.

It sounded like you are saying, based on what you are seeing to date, you do expect a return to the type of growth -- case growth that is that we saw in 2Q as we move into next year.

Wanted to be clear that, A, I heard you correctly, and B, are you talking specifically about North American GPs?

Or was that a reference to overall North American expectation for case growth?

The 20% that we're talking about is overall for the Clear Aligner business, is what we see right now in October for the entire business.

We are seeing better North American performance than what we saw in the third quarter.

I haven't specifically referenced if that was GP or Ortho.

And better than Q2 as well.

Yes, better than Q2.

Better than 2Q.

Okay, got it.

And then I guess just on the international side, it does look like the 4Q guidance for international cases seems to imply a bit of a slowdown there on a year-over-year basis.

Just wanted to see if you could comment on some of the factors at play.

Do you feel like you are reaching any kind of capacity constraints?

Anything else as far as how quickly you can go after that big international opportunity?

So, Bob, our factory basically fabricates aligners on a first-in/first-out basis and without really much respect for where those aligners come from.

And so, when we talk about our case receipts increasing this quarter, and our backlog and factory WHIP returning to a more normalized level, that cuts across both -- you know, all regions of our business.

And so, it has a -- whatever dampening effect it has, it is -- it's across all regions.

And so, that's part of the reason.

Okay.

The case -- on a case receipts side, though, international is very strong and it continues to be strong.

Nothing's really changed there on the case receipts side.

Okay, that's helpful.

Thanks, guys.

Thank you, Bob.

Thanks, Bob.

There are no further questions over the audio portion of the conference.

I would now like to turn the conference back over to management for closing remarks.

Thank you, operator.

And thank you, everyone, for joining us today.

We appreciate your time.

If you have any follow-up questions, please contact Investor Relations.

This concludes today's conference.

Thank you for your participation.

You may disconnect your lines at this time, and have a wonderful rest of your day.