Align Technology Inc (ALGN) — Q2 2015 Earnings Call Transcript

Good afternoon. And thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me for today's call is Joe Hogan, President and CEO; and David White, CFO. We issued our second quarter 2015 financial results today, which are available on our website at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our website for approximately 12 months. A telephone replay will be available today by approximately 5:30 PM Eastern Time through 5:30 PM Eastern Time on July 30th. To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13612927 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 statements about Align's future events, product outlook, and the expected financial results for the third quarter 2015. These forward-looking statements are only predictions and involve risks and uncertainties that are set forth in more detail on 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 such forward-looking statements. We have posted a set of GAAP and non-GAAP historical financial statements including the corresponding reconciliations and our second quarter conference call slides on our website under quarterly results. Please refer to these files for more detailed information. With that, I'll turn the call over to Align Technology's President and CEO, Joe Hogan.

Thanks, Shirley. Good afternoon and thanks for joining us. It's a pleasure for me to be here today reporting my first quarter with Align. On our call today, I will provide some financial highlights and then briefly discuss the performance of our two operating segments; Invisalign Clear Aligners and Scanner & Services. Dave will provide more detail on our financials and discuss our outlook for the third quarter. Our second-quarter results were good, driven by strong Invisalign case volume up 10.5% sequentially and 21% year-over-year with growth across all customer channels and geographies. North America volumes grew 17% year-over-year and our international geographies were up 30% compared to last year. Revenue was near the high-end of our guidance reflecting better-than-expected volumes offset somewhat by lower ASPs. On a constant currency basis, total Q2 revenues were up 14.2% year-over-year and Clear Aligner revenues were up 17.5% year-over-year. In North America, Invisalign volume is driven by growth on both ortho and GP customers. We had another record quarter for North American ortho. Utilization was an increase to 9.5 cases per doctor. North American GP dentist utilization grew slightly to 3 cases per doctor in conjunction with the significant increase in the base of our GP dentist customers. We trained about 1000 doctors during Q2, one of our highest training quarters ever, and have more active GPs than ever. I will share a few highlights for North America. We are continuing to implement our sales expansion program and are making progress. Our new approach to customer segmentation and partnering with our customers' practices has been received very positively by our doctors including the addition of our strategic account manager role for high volume and multi-office customers. The increase in sales reps has increased doctor touch points in both numbers and frequency. Our Invisalign Express 5 promotion was well-received by customers and resulted in a better-than-expected uptake in volume and mix shift to the entry-level product this quarter. In Q3, we adjusted the E5 promotions to support the launch of our new single arch Aligners offering. Invisalign volumes for international doctors continue to be strong for both EMEA and Asia Pacific reflecting ongoing adoption and expansion of our customer base. We had record volume in most every major country in Europe as well as China, Japan, Southeast Asia, and Taiwan. A few highlights from EMEA, 27% year-over-year shipment growth driven by continued strong growth in Spain, France, U.K., and Italy. Our performance has been driven by a significant increase in utilization up 1.6 cases per doctor following the recent launches of Invisalign G5 and G6 as well as ClinCheck Pro. We continue to benefit strongly from our focus sales approach in each of our markets as well as from our newly integrated markets in Scandinavia and Eastern Europe, which are showing very good growth. A few highlights for Asia Pacific, 39% year-over-year shipment growth driven by China, Japan, Southeast Asia, and Taiwan, which is now a direct sales country for us. We ran a very successful Invisalign form in China with over 400 doctors from the private sector supporting our drive for broader penetration of the market. China is now our largest Invisalign market in Asia Pacific. In the important teen segment, the total number of Invisalign cases in Q2 increased 18% year-over-year reflecting a good start to the teen orthodontic season. We are looking forward to a busy summer especially in the North American ortho channel where teenage cases were up 22% year-over-year in Q2. Product innovation aims to create greater doctor preference for Invisalign by delivering new features and functionality to help doctors treat more patients and more complex cases with Invisalign. We continue to make progress with the launch of our Invisalign G6; that's our solution for the First Premolar Extraction cases. Early signs are very promising around the adoption of Invisalign G6, which is very important for the complex treatment needs in Asia and ClinCheck Pro, which has now been adopted by over 60% of our customers since its launch earlier this year. In Q2, our Scanner & Services business revenues were down sequentially as expected given the launch. Not yet available our next-generation iTero Element scanner, interest and demand for our new scanner has been very strong and we expect upcoming availability in shipping of the scanner in Q3 to help resume top-line growth. We first previewed the iTero Element at the IDS show in Germany this past March, then at the AAO in San Francisco in May and at our recent Invisalign GP summit in Las Vegas earlier this month. I have seen the iTero Element in action and the enthusiasm from our customers piloting it is contagious. Let me give you an example of how different the scanner is. At the GP summit, we had a scanning competition among practice staff where they competed for the fastest scan time. The winning time was 2 minutes and 16 seconds and all finalists were under 3 minutes. That's a big game changer in terms of efficiency of a patient appointment in the practice. Immediately after the contest was over, doctors placed orders for 35 scanners in total this summer; we took orders from more than 100 new iTero Element scanners. All attendees left the summit with a clear vision of what the future of iTero Element can offer and were highly motivated about what it can do in their practice. For Q2, total orders for iTero Element were about 700 scanners, double the total scanner orders a year ago. While this is my first Invisalign summit, our broader team and many of our attendees have remarked that it was the best GP summit ever in terms of doctor participation, energy, excitement, and commitment to do more. Many doctors expressed recognition of our North American go-to-market changes with a number of sales reps and the quality of the call, and they also recognized recent improvements to customer experience. Our teen message of Invisalign as everyday dentistry really resonated with them and they are beginning to see beyond just straightening teeth with the continuum of oral care and patient health with us. Consumer interest in the Invisalign brand continues to be strong in Q2 with over 1.3 million unique visitors to Invisalign.com. Doctor locator searches were up 26% year-over-year and consumer requests for more information were up 27% year-over-year in North America. We also saw increased awareness with over 534,000 people visiting EMEA websites in Q2 and 157,000 of them searching for an Invisalign provider, along with 3x growth in the Invisalign social media community over the last year and a half. Before I turn it over to David, I would like to share some of my initial observations and areas of focus over the next few months. I expect to pass the last six out of eight weeks visiting our key locations in North America, EMEA, and Israel, and I feel like I'm ramping up pretty quickly. The changes in our North American sales organization were absolutely needed. I like to relate that resources have been aligned and how we have sub-segmented the ortho and GP customers. In the second half, we will build out our North American team even further with the addition of an inside sales program to better support customers, particularly newly trained and lower volume doctors. Invisalign is not just a simple piece of plastic; I can't stress that enough. Our stereolithography manufacturing process creates 150,000 aligners each day, each one being unique along with our treatment planning technology represents one of the most automated processes I have ever seen. Together, these capabilities deliver very compelling treatment planning and manufacturing processes that predictively move teeth. Align has built a huge amount of accumulated know-how and IP that make me feel very confident in our competitive position going forward. International has experienced more direct competition in certain markets in North America. We have proven that we can be effective in diverse markets and maintain ASPs net of foreign exchange. I'm impressed with our company and the progress we continue to make globally. International growth and expansion have been tremendous and are the biggest opportunity for us as we go forward. For that reason, today we're now seeing changes to better support regional growth and priorities and to extend best practices across the company. Raphael Pascaud has done a terrific job leading the international organization and has delivered geographic expansion, adoption, and best practice across EMEA and APAC. He is now going to focus his attention and skills on our global marketing and business development efforts. With this change, all three sales regions, North America, EMEA, and APAC will now report directly to me. My experience tells me that this is the best way to stay in touch with the pulse of the business and to provide the inside direction each region needs to continue to grow. Finally, a focus on customers is not new to Align, or to most global companies; most successful organizations have recognized the strategic value that having a customer-centric focus has on growth and value creation. One of the key metrics used for measuring customer experience is Net Promoter Score or NPS. There is a high correlation between NPS and growth, both in terms of revenue and profitability. I introduced NPS in GE Healthcare and also ABB, so I'm pleased to see it at Align. We began our customer experience initiatives several years ago, and we are committed to delivering a better customer experience for our doctors and their patients. Our goal is to continue to improve how customers experience our products and services, our businesses, processes, and interactions with them in the Invisalign and iTero brands. Over the past two years, we've made improvements in each of these areas and as a result, our key customer experience measure for success, our Net Promoter Score has continued to rise. Our promoters do two extra cases than our detractors, and we believe that improving our customer experience and NPS will further increase volume over time. To that end, I'm pleased to announce that we recently implemented a new policy that closely aligns our business with the way our customers manage their practices and treat patients. The new policy is called Additional Aligners at No Charge, and it addresses our number one complaint from customers. We've historically charged customers for additional aligners ordered beyond those covered by the initial treatment plan. With this policy, Align will no longer distinguish between mid-course corrections and case refinements and will allow doctors to order additional aligners to address either treatment need at no charge. We expect this new policy will result in significant improvement in customer satisfaction and loyalty, which we believe will help increase Invisalign utilization and volume over time. David will walk you through the details of the new policy and the impact on our deferred revenues. And with that, I'll now turn it over to David for a review of our Q2 financial results.

Thanks, Joe. Let's review our second quarter financial results. Revenue for the second quarter was $209.5 million, up 5.8% from the prior quarter and up 8.8% from the corresponding quarter a year ago. On a constant currency basis, consolidated worldwide revenues were up 1.42% year-over-year. Second quarter Clear Aligner revenue of $200.8 million was up 7.4% sequentially and 11.7% year-over-year. On a constant currency basis, Clear Aligners revenues were up 17.5% year-over-year. The sequential revenue growth reflected higher volumes across all of our major geographies and channels offset by lower worldwide ASPs. Q2 ASPs were down sequentially about $35, which is primarily due to higher promotional discounts, higher revenue deferrals as we treat more complex cases, and foreign exchange. These costs were only partially mitigated by a price increase we implemented in North America. While that price increase took effect on April 1, 2015, it only had a partial impact on the quarter as we work through orders placed at the older price. The largest promotional impact on ASP was related to a new staff Aligner promotion launched in North America in February. This promotion allows active Invisalign trained doctors who met certain criteria to treat one staff member per year at a reduced price. The promotion is intended to increase practice utilization, especially among low volume customers, as staff members experience firsthand an Invisalign treatment and have the opportunity to share their experience with their patients. We ran a similar program across EMEA last year albeit on a much smaller scale. While it's still very early in terms of this promotion, the group participating EMEA doctors has grown 10% faster than non-participating doctors. Our year-over-year revenue growth reflected Invisalign case volume growth across all customer channels, partially offset by lower ASPs primarily relating to foreign exchange rates and higher revenue deferrals as just mentioned. For the second quarter, total Invisalign shipments of 144,600 cases were up 10.6% sequentially reflecting growth from our international and North American customers. Year-over-year case volume growth was 21.2% reflecting continued strength in international as well as growth from our North America orthodontists and to a lesser extent our North American GP dentists. For North American orthodontists, Q2 Invisalign cases were up 7.9% sequentially and up 21.6% year-over-year. For North American GP dentists, case volume was up 11.1% sequentially and 13% year-over-year. For international doctors, Invisalign case volume was up 13.3% sequentially and 30.4% year-over-year. Q2 marks the 7th consecutive quarter of greater than 25% growth from our international region. Worldwide Invisalign utilization in Q2 was 4.6 cases per doctor, up slightly from 4.4 in Q2 last year. In North America ortho, utilization of 9.5 was a new record increasing from 8.4 in the prior year. In North America GP, utilization of 3.0 was up slightly from 2.9 in the prior year. And international doctor utilization of 4.6 was up slightly from 4.5 in the prior year. In Q2, we added 2,555 new Invisalign doctors worldwide, 1,120 of which were new North American doctors and 1,335 of which were new international doctors. Our Scanner & Services segment was down sequentially as expected due primarily to the announcement of our next generation iTero Element Intraoral scanner in March. Second quarter revenue of $8.7 million equates to down 21.6% sequentially and down 32.2% year-over-year, reflecting reduced pricing for the current iTero scanner as well as lower scanner volumes as some customers delayed purchase decisions, and many others ordered our new iTero element which is expected to commence shipping in North America in the third quarter. Moving on to gross margin; second quarter overall gross margin was 75.7%, down sequentially 0.6 points and up 0.1 point year-over-year. Clear Aligner gross margin for the second quarter was 78.3%, down 0.8 points sequentially and down 0.5 points year-over-year. The sequential decrease was primarily the result of lower ASPs as previously discussed and increased training events which are only marginally profitable. Q2 gross margin for our scanner segment was 15%, down 13.3 points sequentially and down 14.5 points year-over-year both as a result of lower volumes and pricing on our iTero 2.9 scanner. Q2 operating expenses were $116.3 million, up sequentially by $14.1 million. This quarter-over-quarter increase reflects the impact of two items; first, Q1 operating expenses included a $6.8 million benefit for the refund of medical device excise taxes paid in 2013; and secondly, increased spending of $7.3 million related to sales force expansion and other investments. On a year-over-year basis, Q2 operating expenses were up $19.6 million which relates primarily to similar investments and our ERP implementation project, which were partially offset by the benefit from foreign exchange rates. Also, recall that Q2 2014 benefited from a medical device excise tax refund of $1.2 million. Our second quarter operating margin was 20.2%, down 4.5 points sequentially and down 5.1 points year-over-year. The sequential decrease in operating margin relates primarily to the medical device excise tax benefit recorded in the first quarter, which contributed 3.4 points. The balance of the sequential decrease was approximately split equally between lower gross margins and higher operating expenses. The year-over-year decrease is primarily the result of investments in the business related to sales expansion, R&D, and ERP as well as foreign exchange rates. With regard to our second quarter tax provision, our tax rate was 26.2%, up 2.4 points from our Q1 tax rate. This is primarily due to a higher percentage of certain non-deductible expenses. Second quarter diluted earnings per share were $0.39 compared to $0.44 in Q1 and $0.43 reported in the same quarter last year. Altogether, the year-over-year impact from foreign exchange has resulted in a stronger U.S. dollar including the decline on revenues, the benefit on our non-U.S. dollar operating expenses together with currency exchange losses reported in other income and expense was $0.03 per share. Moving on to the balance sheet; capital expenditures for the second quarter were $10.5 million, primarily relating to manufacturing equipment and fit-up costs for a second manufacturing facility in Juarez, Mexico for additional capacity, as well as additional costs capitalized on our ERP project. Cash flow from operations for the second quarter was $52.9 million and free cash flow for the second quarter, defined as cash flow from operations less capital expenditures, amounted to $52.4 million. During the second quarter, we paid out $70 million under an accelerated stock repurchase plan, in which we received an initial delivery of approximately 824 shares of our common stock. Cash, cash equivalents, and marketable securities including both short and long-term investments were $596.7 million. This compared to $602.6 million at the end of 2014, a decrease of approximately $5.9 million. With that, let's now turn to our business outlook for the third quarter and the factors that inform our view. Starting with the demand outlook, we are pleased with our business especially continued growth from our international regions and progress in North America. For North America, most teen case starts occur in the summer months, and we expect to have a busy teen season with orthos in Q3. And virtually, Q3 is typically a seasonally slower quarter for our North American GPs. While we've made progress in North America with both orthos and GPs and expect to see some benefit from our investments in sales force expansion consistent with historical, seasonal trends, we are expecting North America volumes to be down slightly quarter-over-quarter. In our international markets, our European doctors typically spend fewer days in the office due to summer vacations and extended holidays. China, which has now become the largest Invisalign market in the Asia Pacific region, is beginning to offset some of the seasonality we typically experience in the Southern European countries. Notwithstanding this factor, however, we anticipate international Invisalign case shipments to be down to flat sequentially from Q2. We expect our Scanner & Services business to be up sequentially with commercial availability of our new iTero Element commencing in Q3. Before I turn to our outlook for Q3, I want to provide you with a financial implications of our new Additional Aligner policy beginning in Q3. These changes apply to all new Invisalign whole team and assisted products—our full product group shipped worldwide after July 18, 2015, as well as any open Invisalign whole team or assist cases started prior to this product policy change. As a result, beginning in Q3 2015, our deferrals will increase as we will now recognize lower revenue as a result of providing these additional aligners at no charge and the grandfathering of over 1 million open cases. The effect on our future revenues is two-fold. The first is an increase in the amount we defer for each new case we ship. The second impact is that revenue recognized on each additional aligner shipment will be lower than the amount we have historically recognized until these grandfathered cases complete. The revenue recognized for each additional aligner shipment, however, will not offset the higher deferrals for new cases for at least two years. As a result, we expect Invisalign Clear Aligner net revenues for Q3 2015 and Q4 2015 to be lower as a result of this change by approximately $6 million to $7 million and $7 million to $8 million respectively. One should note that we increased Invisalign prices in North America in Q2 and internationally in Q3 this year. While these price increases largely offset the economic cost of this policy change, they do not adequately cover the increase in deferred revenues due to grandfathered cases. While this policy change will slightly impact billed revenue because we will no longer charge for the additional aligners, the change is immaterial to our cash flows. And as Joe mentioned this new policy is very customer-friendly and we believe it will drive further adoption of Invisalign and increased volumes. 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 141.8 to 144.3 thousand cases, up approximately 18.5% to 20.6% over the same period a year ago. We expect Q3 net revenues to be in the range of $201.4 million to $205.7 million. On a comparative basis using constant currencies and normalizing for the impact of our new additional aligner policy, our Q3 revenue growth for Clear Aligners would be 13.9% to 16.5% when compared to the same quarter last year. We expect gross margin to be in the range of 74.5% to 75.1%, down only slightly quarter-to-quarter primarily as a result of additional aligner policy change and a higher mix of iTero Scanner business. We expect operating expenses to be in the range of $119.5 million to $120.9 million. A sequential increase in operating expenses reflects further investments to support our continued international growth and expansion. One-time costs of approximately $2 million primarily associated with severance costs for the organizational changes we announced earlier today. Our operating margin should be in the range of 15.1% to 16.4%. Our effective tax rate should be approximately 24% and diluted shares outstanding should be approximately $81.2 million. Taken together, we expect diluted EPS to be in a range of $0.28 to $0.31. Recognizing that there are a lot of moving parts, let me summarize how we see the year shaping up with these impacts included. First of all, from a volume standpoint, we see year-over-year Invisalign growth at slightly above the midpoint of our 15% to 25% long-term model for revenue. Our North America and international businesses are both responding to investments we've made, and we believe that they will respond to continued investment within our significant under-penetration of the market. As for revenue, however, 2015 has been impacted by significant currency movement when compared to last year. We've seen further weakening of the euro and other currencies since we first gave our 2015 preview during our Q4 earnings call in January. On top of this impact, our new additional aligner policy will impact 2015 revenue by approximately $13 to $15 million. We believe the added volumes we're seeing, however, will largely offset both of these factors. As such, on a net all-in basis, we believe our 2015 revenue growth will still be somewhere in the low double-digit range consistent with our comments in January and notwithstanding these impacts. From an operating margin standpoint, the incremental impact from FX, the impact from the new additional aligner policy as well as a one-point impact from higher costs with ERP will also be to some extent offset by higher volumes. As a result, we believe our 2015 operating margins will be on the order of 4 to 5 points below those reported in 2014. This too is largely consistent with our comments back in January. Notwithstanding these moving parts, 2015 is shaping up well, and our underlying demand for Invisalign remains very good. With that, I'll turn the time back to Joe.

Thanks, David. Overall, I'm pleased with the Q2 volume growth and continued strength in our international business. We're making progress and we have a lot of positive momentum. One of my priorities for the first few months is to get direct feedback from our customers, gain insight into their practices, and understand how we can better serve their needs. Still coming up to speed on many things, I believe that I have a good understanding of our business and believe that we have many of the key drivers to further our success. As we scale our business, international is a key driver of that growth; the best person to create a unified marketing strategy for the company that leverages opportunities, resources, and best practices globally is Raphael. He understands our business and customer dynamics and international markets and will quickly get up to speed in North America. He also has a real passion for improving customer experience, which is in line with the goals of our company. In summary, we're making positive and forward-looking changes for the company. We just reported a solid quarter of growth, and we're making measurable progress in improving our customer experience worldwide. We talk about our opportunities because we have a lot of them, simplifying and unifying our sales and marketing across all regions is an important part of seeing and seizing these opportunities while delivering the best products and experiences for our customers and their patients. I'm confident that these changes will help accelerate our progress and continued success. Thank you for your time today. I look forward to meeting our shareholders and analysts over the coming month. With that, I'll now open the call to your questions.

Thank you for the questions and welcome, Joe. I have a couple of inquiries regarding case growth for the year. It appears that you should anticipate case growth around 20% based on your year-to-date performance and the guidance for Q3. It seems that for Q4, you are actually planning for a significant acceleration, likely well above 20%. I'm curious, is that the correct way to understand your expectations for the latter half of the year in terms of case growth? Also, do you have any additional insights that provide clearer visibility into Q4 compared to where we currently stand in the year?

Hi, Robert. First of all, your assessment is correct in the sense we're looking at a pretty big outlook in the second quarter versus the first half. There is positive momentum we talked about on the case growth side. You could see that; you could see international is very strong. You could see that the ortho side in the United States has been strong too. As far as the clarity of it, it's based on that momentum, some historical presence that we have. And also relying on the investments we've made particularly in the North American market and internationally for increased resources to help drive that.

That makes sense, and then I guess David if I could just follow up on the policy change, anything you can share on what you'd expect the eventual increase to be? I'm just trying to get a sense of how big of a barrier to growth had this been that you guys obviously felt the need to put in place this new policy?

Well, see if I can answer a couple of ways here. When we looked and pulled customers as to their Invisalign experience and how we can improve upon that experience, this particular policy change has been the number one item they've asked for. When we look at those customers who are promoters and we compare their growth rates against detractors, we know that whenever we can move a customer who is a detractor or even a passive into a position where they are a promoter, we see a significant uptick in volumes as a result. So the policy change is related to that and trying to capture additional opportunities to improve their growth. The unfortunate consequence of it is that it requires us to change our deferral and the estimates that we use for deferrals. And so when we look at our results going forward, the year-over-year comparisons are going to be a little tough to make until that kind of normalizes out, and that will take at least one year for the year-over-year comps to normalize out and probably a couple of years before all those grandfathered cases work them out and when we actually get back to a more normalized operating model.

That's helpful. Thanks.

Thanks, Bob.

Hi, and thanks for taking the questions everyone. First, my first question is actually on the experience you've had, Joe, as you've been out talking to customers over the last, I don't know if it's six months or so. One of the things that I've heard from customers that I thought you might want to touch on here, and not necessarily the initial days, but within your first 12 to 18 months, how the company thinks about using data and how the company thinks about interacting with the consumer and also the patient. I wonder as you look at how the company has positioned itself with social media and outreach, and how another company has used information that it has obtained from customers, say visiting the website. What do you think about how you are going to use that data more powerfully going forward? And then I have a follow-up.

Steve, I have been impressed since I have been here. Look, my experience has always been with B2B businesses, and obviously, we have both here. I call B2B as moving into the ortho or dentistry side and B2C is what we are doing to consumers. If I look at work on consumers, I see it's very well balanced. I think, in a sense of using social media using print media, and there is a lot of experience here over the years in the sense of what's effective and what's not effective in essence and spend. I'm amazed we could see the statistics I referenced in the opening in the sense of the 27% increase overall in web business, the conversion of web business into actual unit volume going on the doc locator. So I feel good about that, and I hope I'm answering your question. Secondly, when I see customers, I get two comments all the time. One is, 'I don't like where I am on doc locator,' okay? And that means a lot to me; that means they watch that. It means a whole lot they know generating demand for them. And really the best businesses I have ever been in is when we had customers that looked at the business for demand generation and our customers certainly do that and we do that to our consumer efforts. Secondly, the question that I heard about were the issues with Aligners and having mid-course corrections or whatever. I know it's another thing we want to emphasize in a sense of our customer NPS growth that was really the number one reason, and I almost never got out of a doctor's office without that being mentioned. So we are trying to improve that customer experience both in consumer standpoint and also B2B standpoint, and from what I have seen, I think we are making great strides here over the last year.

Okay. Then my follow-up is related to volume growth. So you guys are taking the volume growth expectations to essentially 20% or better. I think that figure previously was somewhat lower, say north of 15%, but less than 20%. I mean, if you have to pick one thing that you have seen incrementally to get you more comfortable with the outlook, what might that be? And as a corollary to that, can you comment on not necessarily for 2015, but how you think about over the next year the interoperability arrangement that you have with Sirona contributing to the growth story? Thanks so much.

Steve, I will let David answer that. I think he can be more specific than I can with this point.

Yes. Steve, I think as we look at our first quarter performance and we look at our second quarter performance and we measure that against historical patterns here in the company, second quarter in particular we began to see a significant divergence between year-over-year case volume growth and what we have experienced historically when we look at Q2 over Q2 and 2011, 2012, 2013, and 2014. We are seeing a gap widening there. And that gap is partly what is giving us confidence that we are going to see a stronger second half. So that's the analytical side of it, and it’s clearly more behind that. But at the highest level, that's probably the analytical side of it. But on the other piece of it, which is more qualitative, is the fact that we have been doing this for a long time in terms of making investments in our go-to-market coverage and geographies we are expanding into and so forth. And what we know is that when we invest directly in go-to-market, we see a response. We made the largest step up in investment, I think in the history of the company, starting in January and particularly targeted North America, but not discriminating against the international side of it as well. And we are seeing a response to that. And so we are trying to invest into it and keep the growth of the company moving forward and testing just how we continue to grow the markets and invest and what works and what doesn't. We try different promotions. And all these things play together collectively to tell us that we are seeing some traction. On the Sirona question, while we qualified the scanner, their software updates are still going through testing at this point in time and final qualification. It's supposed to be released later this year; I don't know what the specific date is. You might have to find something on their website in that regard from them. But, it's moving forward. But when you look at the uplift, I think we talked about this perhaps in another analyst meeting or earnings call, is the fact when you looked at where most of their install base is particularly on the scanner that we are qualifying, most of it is overseas, a lot of it is in GP practice. Most of our effort internationally is on the ortho side. So what we think is important and why we think it will play to our strategy of continuing to become more relevant in the GP practice, we don't see it creating an immediate type of uplift in our business. And we think it's going to be a longer journey before we will actually see a blip in the radar on it.

Thanks, Steve.

Thanks for all the color, guys.

You bet.

Great. Thanks. And good afternoon, guys. Joe, maybe the first one for you. In EMEA, you guys have reaccelerated the growth and pretty handily, you caught markets like Spain, France, Italy. I mean, not really the strongest collection of economies in. I know slightly lower penetration over there, but can you talk to what's allowed the reacceleration the 25% to 30% growth? Maybe if you can address the sustainability of that number one? And number two, is there anything you are doing differently over there? I mean, any secret sauce in how you are attacking those markets that arguably could be transferable to the North American market?

Jon, that's a good question. When I arrived here, I visited Israel to assess the scanner and then went to Amsterdam to engage with customers and review our team's progress. It’s interesting to see how Europe operates, given that each country has distinct economies and industry drivers. Ralph and the team have excelled in determining which strategies work for market penetration in specific countries. For instance, in Spain, despite the country's challenges, they achieved remarkable penetration in a short time by strategically focusing resources on customers to quickly enhance their effectiveness. This builds confidence that we can move teeth reliably, and that success encourages others to strive for similar achievements. In contrast, the U.K. has seen less emphasis on orthodontics, focusing more on general practice, which requires a different approach. Overall, we’ve gained valuable insights from our experiences there, and Raphael and the team have implemented them successfully. Additionally, there are lessons we can apply back in North America to enhance our efforts as we target various market segments.

Okay, great. Thanks for that. And just a follow-up maybe, Joe, if you can touch on why now for the additional Aligners at no charge. I mean, what you are hearing from the field, why is the proper time now? And then David, to your earlier remarks, I mean, obviously, people don't want to pay extra; I get it, but what's interesting here is that at the same time, you are also hitting them with a list increase price yet. You say you are increasing the goodwill. So can you talk about those dynamics, I guess? What do they want? They want predictability; they are willing to pay a little bit more unless, but sort of be assured that they are not going to have additional out-of-pocket expenses as the case progresses, if you can talk to those dynamics? Thanks, guys.

Jon, let me start off, then I will turn it over to David because David has more experience in this than I do. I think as you get into the business and you look at this again, the customer calls and stuff I have made just initially; you hear about this additional aligner thing, it's incredible. It's a lot of reason, but it creates uncertainty. And I think we are working with doctors; doctors want more certainty and patients want more certainty. And we feel like this – gives them that kind of control or feeling what that certainty is. And so I think this is as much subjective as it is objective. It's something that has been around a long time. And as I talk to the Align personnel, many of them say we should have done this years ago because we know what the issue is and really haven't addressed it. It wasn't until MPS correcting came in. And we could really weigh what that's meant to our business. But I think it gave us the determination to take the next steps and make change. David?

I want to address your question about the timing of our decision. This wasn't made overnight or recently; we've been working on the necessary mechanisms for a few years now. There's a significant amount of infrastructure involved. While it may seem like a straightforward change, it comes with numerous nuanced requirements that involved IT development and other adjustments, which took time to build, test, and implement. This decision has been in the works for a long time. Regarding the price increase you mentioned, we've typically raised prices modestly every couple of years, though North America and international pricing haven’t always aligned. We believe that the value we provide to doctors and patients justifies the timing of this price increase, which is about two years after the last one. We've heard from doctors about challenges they face when patients go off to school during treatment and return later, creating urgency for them when it comes to costs. Various personal circumstances can disrupt patients’ treatment, and our previous policy didn't address these well. Doctors quote a price at the beginning of treatment, and patients expect that price to remain consistent, regardless of any delays—however, in our case, those delays could lead to increased costs for the doctor. This change aligns our business practice more closely with how doctors engage with their patients, as Joe noted in his remarks.

And Jon, I had one more thing on the price question too; we put a lot of technology in the market over the last few years, and when we think about G4, G5, and now G6, we need a certain amount of payback for that investment also. And so there is kind of price increases reporting value in a marketplace. To emphasize what David said, we look at it; we're creating value for customers, and we feel that we should be paid for that also, and that's part of the thought process for the price increase.

Perfect. Thank you, guys.

Thanks, Jon. Next question.

Great, thanks very much. David, maybe could you just give us a little bit more numbers on the new strategy around additional alignments? Can you talk about what's the percentage of cases that actually end up ordering it and how many are we talking about? Any numbers you could give us there?

Well, we don't typically disclose what percentage of cases require refinements. It varies when you actually kind of dig down into it; it's varied by geography. We see more case refinements and so forth internationally than we do domestically. Some of that is driven by the fact that they are treating more complex cases in some of those geographies, and particularly when we get to APAC, we see that. And so as we've looked at the incidence you might say of refinements and so forth, our trend has been going up over time, and it seems to correlate very closely with the degree and complexity of the cases that we're beginning to treat. And so those are the kind of the trend lines, and this policy will just simply make it easier for the doctors to do that without creating additional friction for doing what's right for the patients.

Great, thanks. And then as a follow-up, Joe, you said I know you've spent a lot of your initial days talking to customers. Beyond their experience with Invisalign, what else are they telling? Just curious how are they feeling about their practice? Is their business getting better or worse given the economy? And are you seeing any interesting changes on the competitive front kind of in the lower complexity end of your market?

John, I think it's right in line with what I think the statistics you see in the dental market right now. Most of the people out there are experiencing growth year-over-year, and this year looks very strong. The strongest year they've had. So overall, I mean, there is a difference between the primary care side and the ortho side, but both of them are reporting that it's really a pretty good business environment out there as mostly as things are going through. As far as what customers are thinking and talking about also from an Align standpoint and how we interface with them, when you talk to them, I'm asking a lot of the detailed questions about customers and how the technology works and what's happening over the years. And you see a lot of enthusiasm for the product. I think not being here three or four years ago, I think there was a lot of skepticism in the marketplace if we can move teeth predictably and then finish cases as well. You see many of the doctors I talked to, in fact, all of them, none of them doubt that we can do the things we're doing; they get excited about new products like G5 and G6 and the complexity cases that David talked about too. So overall, these have been good conversations outside of some areas that we need to address like we have from a customer engagement standpoint and customer satisfaction standpoint, but overall it’s a pretty good marketplace and we have a lot of people feeling good about Align and our technology.

Great, thank you.

Shawn, next question please.

Thank you. Good afternoon, Joe. I wanted to ask about the policy on extra or additional aligners. How much of that is aimed at attracting competitive accounts? Some doctors we've spoken to have used one or two of your competitors, particularly one you've had legal issues with, and recently we've heard that some doctors appreciate their policy. Is this approach meant to specifically target that? Additionally, you've made some personnel changes that seem to address a primary customer concern, which are the first two visible moves we've seen. Should we expect any other changes in the next three to six months, or are these the main significant developments for the near term?

I'll answer your last question first. These are the biggest moves I foresee making. There isn't currently a competitor strong enough to compel us to change our approach with additional aligners. We compete on various fronts both domestically and internationally, but that hasn't driven our decisions. Our key focus is our relationship with our customers, which guided our recent actions. While the competitive landscape may shift in five or six years, it hasn't influenced our current decisions. At present, competition is primarily within the lower-end segment, dealing with simpler cases. This situation doesn't necessitate immediate competitive actions on our part in the marketplace. We're aware of the competition both in the U.S. and overseas, and while we anticipate that it will increase in the coming years, it pertains to easier cases rather than our more complex offerings. Lastly, it's worth noting that we recently launched a lower arch aligner, which we developed based on customer requests to purchase aligners for that specific arch. We believe this will not only meet customer needs but also enhance our competitiveness moving forward.

Okay, understood. And that was actually going to be my follow-up question on the lower arch. You had mentioned at least in the prepared remarks the single arch, so we'll assume that's that lower arch. Are you saying that you're going to price that kind of the Express 5 level? Is that what I'm hearing? And then David, I thought the Express 5 promotion was going to end in July. It sounds like maybe in your remarks that's going to be extended, is that correct in North America, that discounted price that went into effect over the last four or five months?

Yes. Jeff, first of all, when you look at those product lines, we had to reposition the Express 5 pricing to really allow the single arch to have that price point and then we moved up our E5 price, and David you give the specifics of what those numbers were.

Yes, Jeff, I don't think we've formally announced it, but I have been informed that we have.

Thanks so much.

Thanks, Jon.

Yes. Thanks. And good evening. I just want to talk a little bit about ASPs and margins. I think I understand the commentary this quarter; ASPs were impacted by some of the promotional activity, maybe some higher revenue deferral and FX. But if we kind of look at ASPs in terms of what you're implying next quarter based on the revenue guidance, it looks like ASPs tick down again a fair amount sequentially. Is that all attributable to the new deferral arrangement or is there some other promotional activity in Q3 that's kind of worth calling out?

Most of that, Glen, is related to the additional aligners; in fact, the vast majority of it is. You can compute back into our ASPs probably half of our guidance.

Okay. That's helpful. And David, may if I could expand the conversation into margins. It sounds like you are modeling fiscal 2015 without margins down 400 to 500 basis points. But, Joe, maybe is a good question for you. On last quarter's call, Tom talked about investment in a new ERP system. He talked about making sleep apnea investment. Now you kind of have the new sort of deferral arrangement. You got FX kind of playing a role in there. So I'm trying to think about fiscal 2016 margins, and I know you don't want to guide on that. But, should I think about or just stay on your margins for the full two years until you sort of work your way or through all the grandfathered cases before we sort of get to a cleaner run rate a couple of years from now? I'm just trying to think about how we should think about the margin progression just kind of knowing the information that you gave us tonight.

I first start off my answer with our goal here to be between 25% and 30% operating margin. This team knows it. I know that. The Board knows it. We want you guys to know that too. This is an unusual year and quarter because just what you mentioned there is ERP, sleep apnea, you have foreign exchange really weighing on year-to-year, it's not going to be quarter-to-quarter; but it's year-to-year right now. And so it's a lot of static in this quarter. And obviously, we prepare to try to make this as clean as possible for you to understand what's going on. There is also behind this whole thing is a significant volume left; we are seeing that now. We feel good about that volume piece and I'm not ready to declare anything for 2016, but you want to see that kind of volume that go into 2016. And we have built the particular operating model around 2016. We are not done with that yet that helps us to go for the goals that we are striving for between 25% and 30% operating margin. David, do you want to add anything?

I think Glen, your comment about the change will take probably a couple of years for that to work its way out. So we are going to have that little bit of a drag on operating margins for that time period. But once like Joe said, we expect to be driving the business towards that long-term model. We have hit that long-term model before. We did in 2014. And we are committed to doing it prospectively going forward. And I will just add – I will just add one other thing as you think about 2016; you realize when we gave our guidance for this year and actually even the comments I made in my remarks today, ERP is a drag on margins of a little over a point right now. And that should fall off mid-year next year. And so there is at least that piece of it should get better.

And could you maybe just give us any color on the sleep apnea investment, how big it is and when that should – when we should anniversary that; did that roll off?

Glen, I think the much as I can say about this right now is we are still working that.

Okay.

And determining exactly what it means; we are still in the beginning phases I would say, we might have been a little bit early in mentioning that to you. And as far as we are working through that in subsequent quarterly reports we will bring you up to date.

Okay. Thanks for the details.

Thanks, Glenn. And thank you everyone for joining us today. This completes our conference call. If you have any further questions, please contact Investor Relations. Have a great day.