Align Technology Inc (ALGN) — Q2 2016 Earnings Call Transcript

Good afternoon and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications & Investor Relations. Joining me for today's call is Joe Hogan, President & CEO; and David White, CFO. We issued second quarter 2016 financial results today via Marketwired, which is available on our website at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our website for approximately 12 months. A telephone replay will be available today by approximately 5:30 PM Eastern Time through 5:30 PM Eastern Time on August 11th. To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13640324 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 outlook and the expected financial results for the third quarter of 2016. These forward-looking statements are only predictions and involve risks and uncertainties that are set forth in more detail in our recent periodic reports filed with the Securities and Exchange Commission. Actual results may vary significantly and Align expresses no obligation to update any 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 webcast 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 & CEO, Joe Hogan. Joe?

Thanks, Shirley. Good afternoon and thanks for joining us. On our call today, I'll provide some financial highlights and then briefly discuss the performance of our two operating segments, Invisalign Clear Aligners and Scanners. David will provide more detail on our financials and discuss our outlook for the third quarter. Following that, I'll come back and summarize a few key points and open up the call to questions. Q2 was driven by better than expected revenue due to continued strong year-over-year Invisalign volume across our customer base and record utilization. With International case volume up 38.3% and North America up 15.3%. We also had continued strong demand for our iTero Element with record shipments this quarter, resulting in revenue growth of almost 200% year-over-year. For Q2 North America Clear Aligner volume was up 4% sequentially and 15% year-on-year on a sequential basis. Q2 growth was driven by both our orthodontist and GP customers. Utilization among our orthodontist customers continued to increase and we reached record levels in both ortho and GP channels for a total of 10.7 cases per doctor this quarter. On a year-over-year basis our Q2 volume growth rate continues to outpace our three-year average driven by increased ortho utilization, as well as expansion of our GP customer base. Q2 Invisalign volume for International doctors is up 17% sequentially and 38% year-over-year, continued strength reflects record International utilization driven by EMEA, as well as continued expansion of our customer base in APAC. We are seeing increased use of Invisalign G5 for deep bite in EMEA as well as in our Invisalign G6 for extraction cases in APAC, both showing momentum in the quarter and nearly equaling the overall growth rate for each respective region. In EMEA Q2 volume was up 37% year-over-year led by Spain, France, and the Netherlands. Smaller country markets such as the Nordics and Eastern Europe also had strong year-over-year growth, although off a smaller base. Execution of our high touch TSM program is expanding our focused approach across all our markets in Europe and starting to deliver stronger growth. Our low stage Lite denies seven products and continues to contribute incremental growth. In Asia Pacific, record shipments in Q2 resulted in 42% growth year-over-year, growth is very strong again in China, Japan, South Asia, and Taiwan. Q2 was a busy quarter for customer events, with more than 700 doctors and clinical staff attending our second annual Invisalign APAC Summit in Macao. In addition, we had more than 500 orthodontists attend our country-focused forum in China. We continue to ramp up doctor training in APAC with a particular focus on developing doctors in newer markets such as India, Korea, and Taiwan. In fact, more than 100 doctors in Taiwan were trained in June alone. In the important teen segment, the total number of Invisalign cases worldwide in Q2 increased 20% year-over-year reflecting continued adoption of Invisalign treatment for teenagers aged 11 to 19 years. We have definitely begun to see an increase in teen case starts in late Q2 as more teens go into treatment during the summer timeframe in North America. Teen volume grew 19% year-over-year among our North American orthodontists. In addition, we continue to make progress internationally among teenagers where we had 35% year-over-year growth. In Q2 in APAC, for example, we held a teen’s forum for the Australia and New Zealand markets where 200 doctors attended which was twice of what we expected. We also participated in a separate teen’s forum sponsored by the SWAN University. Over a 12-month period, 155,000 teens started orthodontic treatment with Invisalign with an average age of 15 years old. Our investments in the teen segment continue as discussed at our Investor Day last month. We are currently developing products that will expand Invisalign applicability over the next two or three years, enabling our doctors to treat more teen patients and address younger kids for the first time. Specifically, we will preview a mandibular repositioning product for teen Class II corrections as well as our prototype parallel expansion used for Phase 1 treatment. With these additional offerings and features we will give our doctors a complete set of clear and removable appliances capable of any orthodontic treatment for patients of all ages. Our integrated consumer marketing campaigns in North America, EMEA, and APAC leveraged traditional paid media, search digital marketing, 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 North America, a key focus area for Q2 was sharing the stories of real patients who have used Invisalign treatment to improve their smiles. These patient stories have driven high consumer engagement with 136,000 video views. New program launches included a partnership with Bravo TV on a network that reaches millions of women who could benefit from Invisalign treatment. The Bravo integration featured Invisalign treatment into the storyline of the hit show Odd Mom Out. In EMEA, we focused primarily on the real patient campaign which continues to drive interest in Invisalign treatment online, with web visits growing 112% compared to the same period last year. In Asia Pacific, new consumer campaigns kicked off in China and Australia and New Zealand, and programs continued in Hong Kong and Japan to drive consumer awareness and patient demand. In Q2, we are planning a big bang consumer campaign in China, which will leverage Paris Fashion Week. In Q2, our scanners business revenues were up 36% sequentially and up nearly 200% year-over-year, reflecting a record number of units shipped in the quarter. Demand for the iTero Elements scanner continues to expand, fueled primarily by North American customers. This past March, we began shipping iTero Elements to restore workflows to customers who had pre-ordered and were awaiting the new iTero Element. In EMEA, we received a record number of iTero contracts. And in APAC, we received strong orders upon launching iTero Element at our Invisalign APAC Summit in May. We continue to work through the backlog of iTero Element Scanners, which remains at roughly six months lead time, as demand for our industry-leading intraoral scanners continues. Use of iTero Scanners for Invisalign case submissions in place of traditional impressions continue to expand. For Q2, total Invisalign cases submitted with the digital scanner worldwide increased 37.4%, which reflects a record 46.4% from North America and 20.5% from international doctors. While these scans are predominantly from our iTero Scanner, we are also seeing some uptake from 3M’s True Def and Sirona's Omnicam, the other two third-party digital scanners that are qualified for Invisalign case submission. Before I turn the call over to David for our financial review, I want to talk to you about a supplier agreement we announced today with SmileDirectClub for their doctor-directed at-home aligner program for minor tooth movement. It feels that orthodontics and dentistry has changed tremendously in a few decades since Align Technology was founded. Many of the greatest changes have been and continue to be driven by mass customized Clear Aligners, 3D treatment planning and restorations, digital photography, X-rays, scanning, laser therapy, practice management software, mobile devices, and this can go on-and-on. Technology has changed the demands of potential patients as well. With the internet, e-commerce, and social media, consumers access more information and more options for every type of treatment and procedure, including where and when they want it, at a much lower cost than traditional options. We have been watching the intersection of these technology advances and changes in consumer behavior, particularly as we have tracked different approaches to at-home teeth straightening with Clear Aligners. I am talking specifically about doctor-directed treatment, shipped directly to consumers. Not consumers trying to treat themselves in a do-it-yourself fashion. The at-home model follows an established trend of direct-to-consumer ship-to-home options for eyeglasses, contact lenses, hearing aids, and more. Logically, this type of at-home treatment in orthodontics is only possible with Clear Aligners. As the leader in Clear Aligner technology, we believe Align has to participate in and help shape this evolving market. The emerging leader in this market is now SmileDirectClub. It’s a privately owned business based in Nashville, Tennessee, they were founded in 2013 and are doing business in 49 out of 50 states so far. Potential patients can either visit a smile shop to get scanned, schedule an in-home scanning appointment or send them photos and impressions online to begin the evaluation process. SmileDirectClub offers an express class of many treatments that includes up to 20 stages, with no attachments and no interproximal reduction. Primarily catering to adults, it has a network of licensed orthodontists and general practitioner dentists to evaluate, review, and approve the patient treatment, and monitor progress of the case throughout treatment. In a separate release today we announced the supplier agreement with SmileDirectClub. Specifically, Align will provide a digital case setup which is made available on the SmileDirectClub smile check portal. A SmileDirectClub licensed orthodontist or a general dentist will review and approve the treatment, and Align will then manufacture aligners and ship them directly to SmileDirectClub. These aligners will be manufactured per SmileDirectClub specifications which do not include attachments and interproximal reduction. To be clear, this is not Invisalign; the Invisalign brand and system of Clear Aligners will not be used for this kind of direct-to-consumer market. The Invisalign system requires in-office doctor involvement throughout the course of treatment, and will only be available from an Invisalign provider. At Align, we are investing nearly $100 million in R&D and marketing to further advance the science and technology for the Invisalign brand, the most advanced Clear Aligners in the world. Our goal is to support our doctors in achieving outstanding outcomes for their patients. We will continue to drive the innovation we have delivered over the last 20 years as a reflection of the advancement in science and technology through our Invisalign doctors with new products such as Class III, Teen Class II morphine, and Phase 1 pilot expander that we indicated again recently in our 20-F, that will be available in 2017. These types of Invisalign advancements will significantly increase the applicability of Invisalign Clear Aligners to our in-office doctors. Our goal with the SmileDirectClub agreement is to help expand the market and opportunities for Invisalign doctors while supporting SmileDirectClub’s protocols as described. We expect there to be little cannibalization of existing markets. In addition, we are creating a new Invisalign doctor referral program similar to our Invisalign doctor locator that will ensure that the 30% of SmileDirectClub potential patients who do not fit these protocols and who are interested in straightening their teeth will be channeled back to existing Invisalign doctors. The process will work like this: beginning in October we will create a new Invisalign doctor referral program, much like our doctor locator works today. Consumers will request the smile check case assessment from SmileDirectClub, but whose case is outside of their treatment scope will be systematically referred to an Invisalign provider in the area. We believe this will provide incremental growth opportunities for Invisalign doctors by connecting them with new potential patients who would not have sought treatment otherwise. The at-home direct-to-consumer market is growing rapidly, and while still very small today, we believe the incremental growth potential that this huge market represents is compelling, as it provides consumers with access to more affordable treatment from the convenience of their own home, and will only expand the overall market for orthodontic treatment. With that, I'll now turn the call over to David.

Thanks, Joe. Let's review our second quarter financial results. Revenue for the second quarter was $269.4 million, up 12.8% from the prior quarter, and up 28.6% from the corresponding quarter a year ago. Second quarter Clear Aligner revenue of $243.4 million was up 10.8% sequentially, and up 21.2% year-over-year. The sequential revenue increase was primarily related to increased Clear Aligner volumes and to a lesser extent our price increase in North America. On a year-over-year comparative basis, the growth rate for both total revenue and Clear Aligner revenue was lower by approximately four points, related to the Additional Aligner policy change we implemented in July last year. Q2 ASPs were up sequentially from Q1, about $30, reflecting a price increase in the U.S. as well as favorable foreign exchange rates. Our year-over-year revenue growth reflected Invisalign case volume growth across all customer channels and geographies, as well as our price increase in North America and International. These increases were partially offset by lower ASPs, primarily related to the Additional Aligner policy change made last year. For the second quarter, total Invisalign shipments of 177,000 cases were up 8.1% sequentially, reflecting growth from both our international and North America customers. Year-over-year case volume growth was 22.4%, driven by growth across all regions. For North American orthodontists, Q2 Invisalign case volume was up 4.7% sequentially, reflecting higher adoption and utilization rates across the channel, and up 20% year-over-year. For North American GP dentists, case volume was up 3% sequentially and up roughly 10% year-over-year, reflecting continued solid performance from mid-high volume GPs offset somewhat by our large base of oral volume GPs. For international doctors, Invisalign case volume was up 16.8% sequentially and up 38.3% year-over-year, reflecting increased adaptations and utilization. Worldwide Invisalign utilization in Q2 was 5.1 cases per doctor, up from 4.6 in Q2 last year. North America ortho utilization was a record 10.7, up from 9.5 in the prior year. North America GP utilization was 3.1, up from 3.0 in the prior year. And international utilization was 5.0 also a record, up from 4.6 cases per doctor in Q2 last year, driven primarily by increased utilization in EMEA, which was a record 5.5 cases per doctor in Q2 compared to 4.8 cases a year ago. In Q2, we added 2,885 new Invisalign doctors worldwide, 1,125 of which were new North American doctors, and 1,760 of which were new international doctors. This compares to 2,470 in Q1 and 2,455 in the same quarter last year. Our Scanner & Services revenues for the second quarter were $26 million, up 36.3% sequentially and up almost 200% year-over-year. As Joe mentioned, we began shipping the iTero Element to restore workflows in Q2, and as a result, almost half of the scanners shipped were for our GP customers who have been patiently waiting for their new iTero Element. We are pleased that demand for scanners continues to be strong as we continue to keep pace with shipments. Moving on to gross margin, the second quarter overall gross margin was 76.2%, slightly better-than-expected, up 0.5 points sequentially and year-over-year. Clear Aligner gross margin for the second quarter was 78.6%, up 0.3 points both sequentially and year-over-year. The sequential increase was primarily driven by higher ASPs, partially offset by seasonally higher training activity. The year-over-year gross margin increase primarily reflects the benefit from leverage of our fixed costs over higher case volumes, partially offset by lower ASPs as a result of the additional Aligner policy. Q2 gross margin for our Scanner segment was a record 53.6%, up 8.6 points sequentially and 38.6 points year-over-year. Both the sequential and year-over-year increases in gross margin were primarily a result of higher ASPs and the lower manufacturing costs of our iTero Element scanner. Q2 operating expenses were $140.1 million, up sequentially by $12.8 million or 10%, primarily due to a full quarter of employee compensation-related costs such as annual wage increases, stock-based compensation awards, and new hires, as well as go-to-market investments. Q2 operating expenses were lower, however, than our outlook due primarily to slower hiring and investments in sales territory coverage, same go-to-market activities that were delayed in the second half of the year, and more ERP costs being capitalized than anticipated during the quarter. On a year-over-year basis, Q2 operating expenses were up $23.8 million or 20.4%, reflecting increased headcount and continued investment in our go-to-market activities incidental to the growth of our business as well as our ERP implementation project. Our second quarter operating margin was 24.2%, up 1.9 points sequentially and up 4 points year-over-year. The sequential increase in operating margin relates primarily to higher Clear Aligner volumes and higher gross margins overall. On a year-over-year basis, Q2 operating margin was impacted by 2.3 points from the Additional Aligner policy change. Regarding our second quarter tax provision, our tax rate was 23.2% compared to 23.4% in Q1 2016. Second quarter diluted earnings per share was $0.62 compared to $0.50 reported in Q1 and $0.39 reported in the same quarter last year. Moving on to the balance sheet, capital expenditures for the first quarter were $18.8 million, primarily relating to equipment purchases to expand our manufacturing capacity in Juarez, Mexico, and our ERP implementation. Cash flow from operations for the second quarter was $76.2 million and free cash flow for the second quarter, defined as cash flow from operations less capital expenditures, amounted to $57.3 million. During the quarter, as a part of our $300 million April 2014 stock repurchase program, we entered into an accelerated stock repurchase agreement, to purchase $50 million of our common stock, under which we paid $50 million and received the initial delivery of approximately 0.5 million shares based on current market prices. The final delivery of shares is scheduled for October and the number of shares will be based on our volume-weighted average stock price during the term of the ASR less an agreed-upon discount. Upon completion of the ASR, we will commence the repurchase of $50 million of our common stock on the open market. These two options together will complete our April 2014 stock repurchase program. Cash, cash equivalents, and marketable securities included both short and long-term investments were $685 million, compared to $678.7 million at the end of 2015, an increase of approximately $6.3 million. Lastly, I wanted to comment on our ERP implementation, which went live the first week of July. Over the last year, our team has worked very hard to ensure successful data migration and integration of new systems and processes. Overall, our implementation went very smoothly. Given the magnitude of this process and project, we are continuing to monitor and troubleshoot potential issues, but at this time believe we are past any potential for significant business disruption. We are pleased to have a foundation that enables new capabilities, improves our speed of execution, and will be used to improve our customers’ experience. As part of this implementation, we also implemented a legal restructuring of our subsidiary relationships, which will return in excess of $100 million of cash to the U.S. tax-free in Q3. As Joe mentioned earlier, in October we will begin supplying aligners to SmileDirectClub’s aligner program for minor tooth movements. As part of this transaction, Align acquired a 17% stake in SmileDirectClub for $46.7 million and gained a seat on SmileDirectClub’s Board of Directors. As a result of our equity holding in SmileDirectClub, Align is required to account for this investment under the equity method of accounting. Thus, Align will include a proportional share of SmileDirectClub’s earnings or losses in its financial statements beginning July 25, 2016. Our financial results will reflect two components, commencing in October when we begin to supply aligners: the sale of aligners to SmileDirectClub and the income derived from our supply agreement which will be reported in our Clear Aligner business segment. In Q3 and going forward, our portion of SmileDirectClub’s reported profits and/or losses will be included in our operating expenses. We are excited about this incremental new market opportunity and the potential for our Invisalign doctors to benefit from an untapped segment of consumers with minor malocclusion who want a better smile. We anticipate this relationship would be incremental to our top-line revenue and earnings in 2017. With that, let's now turn to our business outlook and the factors that inform our view.

Thanks, David. Exciting time for Align Technology, as demand and adoption of our Invisalign system continues to expand across all of our regions, and with each new Invisalign innovation, doctors are doing more and more with Clear Aligners and growing their practices. Today we announced a supply agreement with SmileDirectClub, which will provide access to Clear Aligner treatment to more consumers than before while providing Align with an incremental revenue opportunity and helping us to connect Invisalign providers with a new base of potential patients. Thanks for your time today. I'll now open the call for your questions, operator?

Most of the metrics in the quarter were ahead of your own guidance and then ahead of our expectations. I guess one exception relative to us at least was North American cases and in particular case growth with GPs, so I guess I was just curious how does the 10% growth case in North American GPs compare with your own internal expectations? And then just related to that any view of what you can do or what you are doing that could reaccelerate growth in that group in the back half?

Yes, Bob, David. When we analyze our North American business, we see a significant improvement this year compared to the past few years, thanks to the investments we made starting last year. Both the orthodontic and general practitioner sectors are performing well, with record or nearly record utilization among those types of doctors. However, we do face challenges with low stage doctors, especially those general practitioners who engage with us one quarter and may not the next. This makes it difficult for us to consistently reach them, and we are continuing to invest in various strategies to engage them more effectively, but it does pose challenges for our forecasting. Additionally, when looking at our comparisons, particularly in the second quarter year-over-year, it’s important to note that last year we had specific promotions for E5 and E10 products that we are not running this year. Last year’s second quarter was particularly strong in terms of case launches due to those promotions and an additional aligner program that had more accessible qualification requirements for doctors. These factors significantly influenced our year-over-year volume, but had a lesser effect on revenue when comparing year-over-year figures.

Okay, that makes sense. And I guess just one on the SmileDirectClub agreement. And it sounds like you are saying it could be incremental to the P&L and in particular to the top line next year. Anyway we could put a little bit more numbers around that, maybe how many members they have today, how many do you anticipate will show up at Invisalign dentist offices, anything just directionally to help us as we think about layering that in, would be really helpful?

Hi Bob, it's Joe Hogan. You can tell by the announcement that that will start in October. We’ll start shipping then. It’s hard for us to really triangulate around what that might mean as we go into next year. But we’ll give you as much transparency as possible when we come back for the third-quarter earnings announcement.

Same line of questioning, I guess. Can you give us any sense of how much you think the SmileDirectClub deal expands your total addressable market here? This looks previously untapped. Do you have a size of the overall opportunity?

Yes, it's really hard for us to call the market. I mean when you look at the run rate right now of SmileDirectClub, it's in the $50 million range. It has really been accelerating significantly over the last six months. So it's really difficult to quantify this market. You can also see by the statistics that we threw out, this is the market that we really haven't serviced. It's less than 2% overlap with our current business. It's something we’re learning a lot from Doug and David, the two key leaders in the business who know exactly how this works. So we’re excited about it. We think we can help. We’ll make a good partnership. We’re also excited about how we feel it can help our business too in the sense of referrals back; they’re going through this protocol back to our Invisalign in-doc office business.

But again this is brand new. It's hard for us to call it. And we’ll give you more data as it becomes more apparent and as we move into the supply agreements in October. Maybe another factorial question around it though. If they’re kind of tracking along at a $50 million rate, I assume they’re losing a little bit of money on that. Is that a safe bet?

Yes right now, I think they’ll be cash flow positive next year sometime. So, this year they’ll still burn again.

Is there a liability if the treatment goes poorly that falls back on an orthodontist somewhere? That would not be your responsibility. Also, is there a bad debt figure related to SmileDirectClub's business?

I’ll take the later part. As it relates to the bad debt part, they have a very small cancellation rate amongst the people that are qualified. So, they go through a process where a person identifies themselves as having an interest in being treated. They are screened at multiple levels from both a photo standpoint as well as from a scan or an impression. And assuming the person passes their protocols and is capable of being treated, they have a very small cancellation at that point in time.

Rob, regarding your question about liability, we are the supplier of these aligners. SmileDirectClub sells them to the customers while we create the aligners according to their specifications. Our role is to manufacture the best possible aligners based on those specifications. SmileDirectClub handles the transfer, and while we do share some liability, we believe it is a collective responsibility. I’ll have Roger provide further comments on this.

Hi, it is Roger George, General Counsel. The doctor is writing the prescription and then treating the patient, so that is where they start. That's our common model.

Hi, it is Sachin in for Brandon. David, if we look back four years ago, 3Q12 was among the very few periods historically that Align has come short of its revenue guidance. At that time, you pointed to noise around the Olympics as well as the pullback in advertising activity because of the event, so I am curious did you apply an extra dose of conservatism or not with respect to your initial 3Q guidance with the upcoming Olympic and to what extent did you consider that factor if at all?

Well, I wasn’t here four years ago, but I think that’s an interesting causal well I haven’t heard that one before since I have been here. I can tell you as it relates to our Q3 guidance that we have given today that didn’t enter into our thinking at all. And we basically approach our guidance the way we typically approach it, looking at the strength of the prior quarter, the doctor engagements, etc. And that particular factor wasn’t considered.

And also could you walk us through the impact of the anniversary of the aligner policy change in the second half on both the revenues and the P&L?

It continues to affect earnings and will do so for at least a couple of years as we address those grandfathered cases. However, starting in the third quarter, it won’t negatively impact year-over-year comparisons because Q3 2015 was when we first implemented that policy. While we may not discuss it much in year-over-year terms, it will still have some impact.

Just a couple of housekeeping items; the ERP, I mean once we get to the fourth quarter, can you give us a sense for what the swing is on OpEx between say Q3 and Q4 just for underlying purposes once we get past that ramp?

Yes. So, Steve, it’s going to be a little bit up in Q2, about a little bit less than a couple of million dollars, primarily as I indicated in my comments that, the stabilization phase is not capitalizable. So, that’s an uptick in Q3 and when we get to Q4, we would expect that principally to reverse itself almost dollar for dollar as those costs begin to drop off.

And then just one Joe sort of reflecting back on your prepared remarks, probably the most positive I have heard you in your tone around third-party scanners and their contribution. I wonder if you could just expand upon that, I mean what is it you're saying there that is incremental here and could you give us a sense for where you think volumes are headed there? Thanks.

Steve, I think my enthusiasm is around just the scanners in general when you see the percent of scanners are getting right now, they come into the organization approaching 50%. I mean it is a lot to us from a quality standpoint and how we can build our customer base, so I think I interpreted my enthusiasm more around just the scanning piece than it is third-party or whatever. Our scanning business obviously is having a really good year and we are expecting it to have a very strong this year too, and it's not just selling scanners, it's just what it does reinforces from a customer base standpoint, both through GPs and Orthos, and just makes things easier for us. It gives a wonderful platform in the sense to use that scanner for additional products, making things easier for our customer base. As far as the third-party piece, as shown in 3M or whatever, we're just seeing continued growth of those. There is nothing I would say that that's exotic about it. But it's just good strong linear growth going forward. And so that's helpful also.

I might have two or three. And numbers look really good. So I'm actually going to focus on the FCC deal that you announced. The first one Joe, I'm still a little confused. You mentioned 1% or 2% cannibalized, but when I look at your cases and sort of lean on the Analyst Day, the spread seems to be 15% plus. So can you sort of walk us through numbers or rectify them? Why Express 15 plus, you are cannibalizing one and two. Is that just because of the lack of attachments in the ITR?

Hi Jon, it is Joe. When you look at there is different protocols on this and so it's not just a number of aligners. It's what’s done. So just from an overall standpoint, remember there is no ITR as it's been on these; there are no attachments and obviously on E5 you wouldn’t have attachments, but E10 you do sometimes. Secondly, it's not directly it doesn’t move lower. They are basically moving so-so swiftly, and they’re moving with different velocity and different rates. And when you add that all up, it really comes after to as a very small overlap on that piece. Now your question has to do with our Express line. I think those overlaps are like 4% on E10, 8% on E5. When you are running against our whole portfolio, that's where you get less than 2% to the whole thing. So, we have tracked pretty well. We know this well. That's why we're confident about the minimum amount of cannibalization we would expect as we go into market.

Okay. And maybe can you give any details on what you are going to ship aligners to FCC in terms of the cost that they don’t pay on the revenue that you will recognize on those aligners?

So we have not disclosed, Jon, the pricing of those aligners. What we have disclosed is that the pricing is dependent upon volume discounts. And as their business ramps, they will earn lower pricing. But when you look at it on an incremental basis, we priced it basically on a pro-liner basis. We believe it's going to be accretive to the Company, both from a revenue standpoint as well as from an operating margin standpoint.

So, I get that, and accretive to you guys. But is it going to be dilutive to your customers, and that’s maybe my final question and then I have got more and I'll take them offline. But that's what I'm having a really hard time here with is. Joe you came in and you did such a great job, sort of walking off to the customers, shaking hands and eliminating the main point of friction with the additional aligner policy. And it seems like to me, is this a risk that you just sort of bring back in a main point of friction, because you are going to have a subset of docs who believe they are Express business in some other cases are now being pointed to that whole business? Thank you, guys.

Jon, it's a fair question. And obviously it was something we strategically had to wrestle with inside the Company as we work with SmileDirectClub. But I think you can see that as we work through this, when you looked at, we keep the Invisalign product within SmartTrack, SmartStage, all the pieces of that, Invisalign brand name, all that stages at doctor's office. And also see this is EX30; it is basic dental materials that’s been out there for years. There is no ginger of a cut straight rail system it's going to a group where we feel demographics that are a lot more concerned with convenience and cost. And then when we ran those protocols that we just talked about, we showed the less than 2% would be an issue for us from a cannibalization standpoint. And I make that stat Jon honestly with when you look at what's going on overall in the marketplace right now with direct to consumer, you just saw the thing with Dollar Shave Club and what Unilever had to pay for that company, because they were late to that game. I really felt that for a lot of reasons, both from an offensive standpoint and a new market standpoint, that this would be balanced well with concerns from a customer base. And we will do our best to ensure our customer base if this isn’t intended that way. And we'll work as best to connect to the demographic that they have been targeting and being successful with.

Hi thanks very much, I had a CapEx question. I think at Analyst Day you talked about over the next few years moving both planning and our fabrication to Europe and Asia, can you just remind us the timing of that and if we should assume any sort of a step up in CapEx to do it and when you layer the volume of SmileDirect on, will that prompt any sort of retrofitting anywhere else?

So John, we have actually begun some of the activities incidental to expanding our pace of international operating activities. For example, we established in Europe a base where doctors who are submitting physical impressions can send them to a European address to have them scanned. Those are sending them all the way to Juarez. So we have implemented that. So you've seen, there has been some CapEx associated with that and there has been some operating expenses for starting that activity up. We have also begun looking at establishing some treatment capacity in some of our regions and begun piloting some of that with small numbers of people and experimenting with how those workflows might work. As it relates to a bigger piece that would be doing Aligner Fabrication, that is still further down the future, 2017 plus. And so, we will begin to see some of that now. When you look at our gross margins actually for guidance in Q3, there is a little of an impact from that. As far as any CapEx standpoint is concerned, SmileDirectClub won't really impact that very significantly. Their volume is relative to our volumes is still very modest. We wouldn’t expect the uptick to be meaningful.

Great thanks and just one more, Joe, stepping back if you think about your opportunity with that Clear Aligners, the bigger opportunity which seems to be teens, but that tends to have a little bit lower volume growth for you. What do you think you need to do to get teen growth equal to or outpacing your adult case lines?

Yes, I think at our Investors Meeting recently in New York, I think we laid that out pretty well. When you look at first of all from an R&D standpoint. China moved from a chronological standpoint backward to the pilot expansion and main digital expansion kind of devices that we announced that we'll have in the marketplace in 2017 is one part of that. Secondly, is a sense of how we go to consumers and how we communicate Invisalign capability to the consumer base. Honestly, a lot of our approach to that marketplace over the years has been primarily through our results and that’s all demographic. We feel pretty strongly as we move into next year; we’re going to have to really focus on two sides of this equation. As you look at the three people involved normally in teens, you have the father, you have the mother, and then you’re going to have the teen, and then you also have a doctor. We found that over time, you typically get to win two out of three. I think often we win with the teen but we lose the mom, or we lose the doctor. So we’re working hard on both ends from an advertising standpoint to improve our messaging around our teen capability while expanding it moving forward. Additionally, to reach the mothers effectively, particularly around compliance—the concern many parents have regarding their teens adhering to the treatment's requirements. We’ve established that teens are often more compliant than adults, and we’re very confident. The dentition in teens is often more accommodating in that teeth are generally looser, which allows us to move them more rapidly. As we speak, we're working hard on how we're going to approach teens next year. It’s a great question because it's obviously 75% of the marketplace, and it’s one that we have not thoroughly penetrated. I believe we can make excellent progress in the next year.

Hi John, just to add a little bit of color to Joe’s comments there. If you look at our teen growth, our teen growth is still north of 20% year-over-year, which we think is really outstanding in a market that’s only growing 3% to 4%. You know that share that we’re taking away from larger competitors. When you look at the 20% growth, it may lag our overall growth as a company by maybe a point or two, but I think some of that is largely attributable to our international business growing faster than what we’re growing here in North America. Their business is more dominated by treatment of adults. As our international business has been growing at those faster rates, it had somewhat of a dilutive impact on our overall teen growth because our teen business is more concentrated here in the U.S. So, we still feel like the teen business is growing great and still feel like we’ve got plenty of opportunities ahead of us.

Hi thanks for taking the question. Just going back to the CDC, I’m curious if you could characterize for us the type of customer or consumer that just the lead generation aspect to the type of customer or consumer that’s going to SmileDirect and how would that compare to who is learning or coming to Fair Aligners through your website. Did you do any research, or do you have any information there about the types of consumers being treated versus who traditionally comes through the doc locator and the standards in your align channel?

You know I could say that we don’t have exhaustive data on that. I mean what SmileDirectClub has shared with us, the demographic tend to be heavily weighted toward women versus men, which we see in our demographics too. But these are people that are really often millennials. The convenience is really important to them. If they have a certain interest in freedom standing such that visiting doctors' offices is less appealing, there is obviously a price point here too that resonates with those looking for a more straightforward solution to their needs from a dental perspective. So it's not necessarily a gender or age difference from what we've done or in our pool, but it's a difference in preferences in the sense of how people want to engage from what we can see so far from data.

Okay and then maybe just turning one financial question, on gross margin, I think you said that you have some manufacturing start-up costs for your APAC initiatives there bringing manufacturing closer to that part of the world, that's going to impact the step down in gross margin in the third quarter. Can you just give us a sense as to whether that is finite in nature or should we consider that as kind of a go-forward gross margin rate for future quarters modeling or how should we think about that? Thanks.

Yes, I would say it's probably more of a go-forward rate, but let me give you a little bit more color to that, because I was answering that question in the context of a CapEx discussion. When you actually look at the biggest impact on gross margins, the fact that they are declining just slightly quarter-over-quarter, the biggest impact is from our scanner business, which has a gross margin that is in the low 50s. As that business is growing more than doubling on a year-over-year basis, it's having a little bit more of a dilutive impact on overall gross margins. I would say that the guidance we've given for Q3 is probably the best guidance we could give you on a more going-forward basis.

Okay, thanks. And if I could squeeze one more in. I believe you said you had the G6 product launching in the U.S. So you had anticipated that, I was just wondering any initial feedback there and how that launch is going assuming it's already happened?

We've launched G6 in the U.S. G6 functions well. I mean we have good feedback on it, but honestly when you look at the demographics again of this, it moves to Asia as extraction cases in Asia are way overboard in the sense of number of cases they see. So it's being used in North America, it's been successful in that sense and growing, but predominantly it's been an APAC product.

Thanks Rich. Operator, we will take one last question, please.

Hey guys, thanks for squeezing me in.

Hi Chris.

I guess first just on the North American price increase, can you quantify what the increase was on the timing of that and the rest of just what you've seen since you've implemented that pricing strategy?

Yes, the price increase was effective April 1, so we saw just a partial impact of that in the second quarter. The magnitude of the price increase varied depending upon the products that are primarily applied to our full-stage products and varied anywhere from $50 to I think $70 to $80.

Okay, got it, so it's reasonable to assume that at least in North America ASP trends up in the third quarter from the second quarter?

From a revenue standpoint, yes. There are other factors, however, when you go into the third quarter, because typically we have more promotional activity going on in the third quarter particularly for teens, but holding that aside, you are right.

Understood, and then just turning to the iTero element, it understands it's going to increase sequentially. Are you still working through the backlog there and if so when do you think that will be normalized? I guess I'm looking beyond the third quarter and just kind of trying to gauge where sales go post-3Q? Thanks.

I think one of the things we've been very fortunate where this that, demand that we saw and post the announcement of the product in March of 2015 has continued to almost outpace our ability to deliver. And so we’ve had a very good first half of the year with orders maintaining that backlog in spite of our increased efforts to get ahead of it. We would expect that more nominally, the backlog would probably normalize somewhere by the end of the year.

Okay great and then just one more from me, as we think of that full list of new scanners being placed, it sounds like mostly in the GP channel. When do you think that will really start to translate into utilization? And do you think is there an immediate pick up, uptick in utilization, once the GP receives that scanner or is there a bit of a lag effect there? Thanks.

We still wrestle with that question. Honestly, Chris, I think obviously there is an immediate pick up if they are a user today, from an Invisalign standpoint, they turn all the impressions over to iTero, and you see it immediately. But as far as they actually keep doing more and more cases, we have more and more data to say that’s true. We can't quantify exactly right now how true that is and to what degree it occurs.

Okay, thanks for the time.

Thank you everyone - sorry operator. I’ll go ahead and close. Thank you everyone for joining us today. We appreciate your time. If you have any follow-up questions, please contact Align Investor Relations.