Align Technology Inc (ALGN) — Q3 2017 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 and CEO; and John Morici, CFO. We issued third quarter 2017 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 November 9. To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13671493 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 fourth quarter of 2017. These forward-looking statements are only predictions and involve risks and uncertainties that are set forth in more detail in our most recent periodic reports filed with the Securities and Exchange Commission. Actual results may vary significantly and Align expressly assumes no obligation to update any forward-looking statements. We've posted historical financial statements, including the corresponding reconciliations and our third quarter conference call slides on our website under Quarterly Results. Please refer to these files for more detailed information. With that, I'll turn the call over to Align Technology's President and CEO, Joe Hogan.

Thanks, Shirley. Good afternoon and thanks for joining us. On our call today, I'll provide some highlights on the quarter, and then briefly discuss the performance of our two operating segments, clear aligners and scanners. John will provide more detail on our financial results and discuss our outlook for the fourth quarter. Following that, I'll come back and summarize a few key points and open up the call to questions. I'm pleased to report another strong quarter and Q3 results that exceed our expectations across our key financial metrics including revenue, volumes, margins and EPS. Our Q3 revenues increased 38.3% year-over-year driven by increased Invisalign volumes across all of our geographies as well as strong growth from our scanners. Our strong Q2 results also reflect accelerated growth from teenagers in both North America and Asia Pacific with total Invisalign shipments to teens up 46.3% year-over-year and up 26.5% in Q2. On a sequential basis, revenues increased 8.1% driven by continued strength across Asia Pacific which offset expected seasonality in Europe as well as higher than expected revenues from shipments. For North America, Q3 Invisalign case volume was down 1.1% sequentially reflecting a decrease in the GP dentist channel due to less patient traffic and fewer days in the office from the summer holidays. In addition, as a result of the devastation caused by hurricanes Harvey and Irma, we estimate that our North American volumes are lower by approximately 1,500 cases in Q3, mostly adults. These declines were partially offset by strong growth from the ortho channel, especially from teens. On a year-over-year basis, North America was up 25% reflecting strong growth from the ortho channel, driven by an increase in teen patients and Invisalign express life products. Q3 Invisalign volume for international doctors is up 6.8% sequentially, driven primarily by the Asia Pacific region, which offset expected summer seasonality declines in EMEA. On a year-over-year basis, Invisalign volume was up 47.4% reflecting strong growth from both APAC and EMEA. In EMEA, Q3 volumes were up 37.6% year-over-year led by our core European markets, particularly Spain, UK and France. We also saw strong growth across all of our smaller expansion markets, including central and eastern Europe, Benelux, Middle East and Africa, the Nordics and Russia. In APAC, Q3 volumes were up 57.4% year-over-year with record Invisalign across all country markets led primarily by China. Q3 marked the first quarter in which China was our second largest market in the world behind the United States. Our customer base in APAC is almost triple year-over-year with over 1,500 doctors added in Q3, mostly within China. Turning to the teen market, over 698,000 teenagers started treatment with Invisalign clear aligners in Q3, up 26.5% sequentially and 46.3% year-over-year, reflecting a very strong summer teen season and accelerating growth rates. North American ortho teen cases increased 22.9% sequentially and 43.6% year-over-year reflecting our continued efforts to drive adoption of teenage patients through sales initiatives and our direct-to-consumer campaign emphasizing teens and moms. For international Q3 teen cases increased 36.7% sequentially and 65.7% year-over-year driven by accelerated growth across the APAC regions, primarily led by China. The introduction of Invisalign treatment with mandibular advancement is helping to raise visibility for Invisalign treatment of teenagers and contributed to some of the growth in the APAC region. We call the Invisalign treatment of mandibular advancement the first clear aligner solution for Class II correction that advances the mandibular while moving teeth at the same time. Mandibular advancement is critical to increasing teen adoption. Approximately 30% to 45% of teen cases globally need Class II correction. Based on early indications, we are seeing a positive correlation between those customers who use our mandibular advancement feature and the increased teen utilization. One example is Dr. Lethic in Canada, who has seen the benefits of switching from an analog to digital method of orthodontics, not just with mandibular advancement but with Invisalign treatment in general. With the launch of mandibular advancement and because of the renewed commitment to being fully digital and phasing out the use of metal braces, Dr. Lethic has started 162 patients in Invisalign treatment since Q2 '17. Of those, 120 were teenagers and 24 were treated with mandibular advancement features. This is compared to only 3 Invisalign patients in 2016 and only 1 Invisalign case in the first quarter of this year. That's an amazing transformation of Dr. Lethic’s business and speaks to the impact of digital growth for patients. Invisalign treatment with mandibular advancement is not available in the United States yet, as it's currently pending FDA approval. Our consumer marketing programs are continuing to increase demand for Invisalign treatment and are key to adoption in both the teen and adult segments. Each year we invest millions in consumer advertising and social media campaigns to raise awareness, create preference, and help consumers find an Invisalign practice near them. In 2017, we increased our investment in consumer marketing by 60%, which we believe is contributing to our strong growth. But despite our efforts, most consumers interested in Invisalign treatment still end up with metal braces or don’t start any type of orthodontic treatment at all. This phenomenon isn't new, and we've been working for years to identify gaps like these and develop solutions that convert more consumers into Invisalign patients for our customers. In January, we launched a new consumer capture program with a Smile Concierge team enrolling with Carolina, whose goal is to reach more consumers one-on-one and ensure that anyone who contacts us directly has the best experience with the Invisalign brand from beginning to end. Our Smile Concierge service educates consumers on the benefits of Invisalign treatment, answers their questions and helps them schedule an appointment with Invisalign providers from our next-level partnerships listed as DIT on Invisalign.com locator. The team also follows up with consumers through digital apps and email to find out whether they keep their appointments and start Invisalign treatment. It's really exciting to see how something as simple as direct personal touch has resulted in such a positive response from our consumers and adopters. The team received incredible feedback from consumers every day, who appreciate the white glove service we provide which is translating into shorter research cycles for the average consumer interested in Invisalign treatment and a win-win for Align, our customers, and consumers. Over the past 10 months, our Smile Concierge team has contacted 50,000 consumers who took a smile assessment on Invisalign.com and scheduled 20,000 consultations with nearly 800 Invisalign practices across the U.S. Today, 5,000 have already started treatment within an Invisalign provider, which equates to millions of dollars in revenue through Invisalign practices and we're just getting started. Our new Smile Concierge service is not only helping turn more consumers into Invisalign patients, but we're also learning a lot about consumer conversion. For example, convenience and speed of contact are critical to conversion. If we can't schedule an appointment for consumers to see a doctor within 72 hours, meaning they can't get on to the doctor's schedule within three days, the likelihood of that consumer converting to an Invisalign patient drops by 40%. On top of that, for the consumers that get scheduled for a consultation, 65% of them cite financial concerns as the reason they don’t start treatment, with 25% of them stating that a high down payment in the practice is the main barrier to acceptance. With that in mind, as part of our Smile Concierge service, we just launched a patient financing pilot that addresses consumer financing concerns as well as insurance coverage for orthodontic treatment. In developing this project, it's important for us to provide solutions that offer consumers the ability to customize their own down payment, monthly payment, and interest rate in a way that can fit into any budget. Equally important is providing an end-to-end digital workflow for both the consumer and the doctor and with our new third-party finance partner, we’ve done just that. When consumers finance their treatment through us, Invisalign providers no longer pay Align; instead, they just receive payment for the treatment fee minus Align's lab fee. By changing the financial relationship between the patient, Align, and the provider, Invisalign treatment becomes a revenue source for the provider and eliminates the need for them to pass on the high down payments to patients. Finally, we've also learned what's important for consumers when it comes to choosing an Invisalign practice, and digital technology really matters. As part of the smile concierge referral process, consumers are offered the top three Invisalign practices in their areas and it turns out that the iTero scanner is one of the key influencers. While this isn’t surprising to us, it is important to be able to validate another example of digital technology, like our iTero intraoral scanner, replacing an old analog process like PVS impressions. With that, let’s review the results for the iTero business. Q3 was a strong quarter for iTero and better than expected with revenues up 25% year-over-year on record iTero scanner shipments. The iTero scanner is central to restore workflows and key to our GP strategy. In Q3, we saw a nice uptake by GP dentists with record contracts out of the GP summit in September. Q2 results also reflect the initial uptake of the iTero scanner from its first commercial availability in Japan as well as from our new distribution agreement with Patterson Dental in the United States and Canada. Use of the iTero scanners from Invisalign case submission in place of PVS impressions continues to expand and remains a positive catalyst for Invisalign utilization. For Q3, total Invisalign cases submitted with a digital scanner in North America increased to a record 61.9%, up from 48.8% in Q3 of last year. Overall, we continue to be excited about the long-term potential for the at-home doctor-directed market and are pleased with our equity investment and supply agreement with SmileDirectClub. For Q3 aligner shipments to SmileDirectClub or SDC were higher than expected and more than doubled sequentially reflecting continued strong volume growth as well as a shift to Align manufacturing more of SDC's aligners than what SDC internally produces. As SDC is an exclusive third-party supplier, this quarter we produced about two-thirds of the clear aligner volume as compared to only one-third in the prior two quarters. While this shift was not anticipated, our world-class manufacturing operations can accommodate changes in SDC's order flow easily. We are pleased that we are able to support their continued rapid growth. With that, I'll now turn it over to John.

Thanks, Joe. Now for our Q3 financial results. Total company revenue for the third quarter was a record $385.3 million, up 8.1% from the prior quarter and up 38.3% from the corresponding quarter a year ago. Clear aligner revenue of $341.6 million was up 6.4% sequentially, with higher than expected volume and favorable foreign exchange rates, as well as increased revenue from shipments to SDC. Year-over-year clear aligner revenue growth of 40.2% reflected strong Invisalign shipment growth across all customer channels and geographies, increased Invisalign prices, and revenue from shipments to SDC. Q3 Invisalign ASPs were up sequentially approximately $25 from Q2 to $1,310 reflecting favorable foreign exchange, a favorable shift in our product mix, and price increases partially offset by increased promotional discounts. On a year-over-year basis, Q3 Invisalign ASPs were also up $25, reflecting price increases, an increase in additional aligner revenue, and favorable foreign exchange partially offset by increased promotional discounts. For the third quarter, total Invisalign shipments of 236,100 cases were up 1.8% sequentially, driven primarily by our Asia Pacific doctors and North American orthodontists. Year-over-year Invisalign case volume growth was up 32.8%, driven by growth across all regions, as well as expansion of our customer base, primarily from Asia Pacific. For North American orthodontists, Q3 Invisalign case volume was up 1.8% sequentially and up 31.9% year-over-year. For North American GP dentists, Invisalign case volume was down 5.2% sequentially and up 15.9% year-over-year. For international doctors, Invisalign case volume was up 6.8% sequentially and up 47.4% year-over-year. Our Scanner & Services revenue for the third quarter was $43.7 million, up 23.2% sequentially and up 25% year-over-year, primarily due to our continued investment in go-to-market activities in APAC and EMEA, as well as the initial uptick of the iTero Scanner from its first commercial availability in Japan. Moving onto gross margin, third quarter overall gross margin was 75.9%, down 0.1 points sequentially and up 0.8 points year-over-year. Clear aligner gross margin for the third quarter was 77.9%, down 0.2 points sequentially, primarily due to an increase in aligners per case driven by additional aligners, partially offset by higher clear aligner ASPs. Clear aligner gross margin was up 0.2 year-over-year primarily due to leveraging our manufacturing costs over higher volumes. Scanner gross margin for the third quarter was 60%, up 3.3 points sequentially, primarily due to higher ASPs. Scanner segment gross margin was up 2.9 points year-over-year, primarily a result of lower service costs. Q3 operating expenses were $193.7 million, up sequentially by $6.4 million or 3.4%, primarily related to increased global headcount. On a year-over-year basis, Q3 operating expenses were up 31.7%, reflecting increased headcount and continued investment in our go-to-market activities critical to the growth of our business. Our third quarter operating margin was 25.6%, up 2.2 points sequentially and up 3.3 points year-over-year. The sequential increase in operating margin relates primarily to increased clear aligner volume. On a year-over-year basis, the increase in operating margin primarily reflects higher revenue and lower cost per case, partially offset by increased headcount and higher marketing expenses. With regards to our third quarter tax provision, our tax rate was 17.9%, which includes $1.7 million in excess tax benefit, and is down by approximately 0.5 points compared to 18.4% in the same quarter last year. Primarily due to the 2017 adoption of ASU 2016-9 which requires excess tax benefits related to stock-based compensation to be recognized as a reduction to tax expense, and certain one-time tax charges incurred in the prior year from implementing our new international corporate tax structure. The revenue and cost to supply aligners to SmileDirectClub are included in our operating profit and reported results. Additionally, we report our share of SmileDirectClub's losses below operating margin and our tax provision, which is titled Equity and Losses of Investee, net of tax. Our share of SmileDirectClub’s loss net of tax in Q3 was approximately $1.6 million, decreasing our diluted earnings per share by $0.02. Third quarter diluted earnings per share was $1.01, up 18.8% sequentially and up 60.3% compared to the prior year. Moving onto the balance sheet, as of the third quarter cash, cash equivalents and marketable securities, including both short and long-term investments, were $739.9 million. This compared to $676.6 million at the end of Q2, an increase of approximately $61.3 million, primarily related to earnings growth. Of our $739.9 million of cash, cash equivalents and marketable securities, $236.3 million was held by the U.S. and $501.6 million was held by our international entities. Q3 accounts receivable balance was $321.3 million, up approximately 10.2% sequentially. Our overall DSO was 75 days, up 1 day sequentially and down 3 days from 78 days in Q3 last year. We anticipate that our DSOs will continue to decline over the next few quarters. Cash flow from operations for the third quarter was $118.1 million, up $58.3 million compared to the prior year. Free cash flow for the second quarter, defined as cash flow from operations less capital expenditures, amounted to $70 million. Capital expenditures for the third quarter were $48.1 million, primarily relating to building improvements, purchases, and improvement equipment purchases for additional manufacturing capacity, as well as our global expansion efforts. During the third quarter, we concluded our previously announced $50 million accelerated stock repurchase. We received a total of 0.4 million shares under the ASR, at a weighted average share price of $146.48. We have $250 million for repurchases under the existing stock repurchase authorization. With that, let's turn to our Q4 outlook and the factors that inform our view, starting with the demand outlook. For our international market, we expect Invisalign volume to be up from Q3 as EMEA customers return from seasonally slower summer holidays, partially offset by a slight decrease in the APAC as the Greater China market observes the golden week holiday. For North America, we expect Invisalign volume to be up sequentially reflecting the seasonally stronger quarter, partially offset by some lingering effects of hurricanes Harvey and Irma. For our scanner business, we expect slight sequential increases, but in a typically strong end-of-the-year demand for capital equipment. Q4 sequential growth reflects the benefits from orders taken at our North America GP Summit in Q3 and global expansion. As Joe commented earlier, this quarter we produced two-thirds of SDC aligners. However, we expect our aligner shipments to SDC to be down sequentially in anticipation of a production shift back to their own internal manufacturing. With this as a backdrop, we expect the fourth quarter to shape up as follows: Invisalign case volume is expected to be in the range of 245,000 to 250,000 cases, up approximately 29% to 32% over the same period a year ago. We expect Q4 net revenues to be in the range of $391 million to $398 million, an increase of approximately 33% to 36% year-over-year. We expect Q4 gross margins to be in the range of 75% to 75.5%, reflecting higher ASPs, partially offset by higher expenses as we regionalize our treatment planning operations. We expect Q4 operating expenses to be in the range of $198 million to $202 million, up on a sequential basis to reflect our continued investments in go-to-market activities. Q4 operating margin should be in the range of 24.3% to 24.8%. Our effective tax rate, including an excess tax benefit of about $1 million, should be approximately 22%. We expect a $1.5 million loss related to our share of SmileDirectClub and diluted shares outstanding should be approximately 81.9 million, inclusive of any share repurchases. Taken together, we expect our Q4 diluted earnings per share to be in the range of $0.92 to $0.95. In addition, as we continue our operational expansion efforts, we expect CapEx for Q4 to be approximately $55 million to $60 million, and we expect depreciation and amortization to be $10.5 million to $11 million.

Thanks, John. We're pleased with the performance of the business and feel good about the overall momentum and strength of aligner. With that, we will open up the call for any questions.

A very big step up in ASP. John, you touched on some of the factors that affect mixing and pricing increases, but it does look like that you're calling for this to be sustainable through the end of the year. So, I was maybe hoping if you could just talk about the drivers and, I guess, maybe specifically, mix and the pricing increases, where I will be most interested in what's driving that, why you think that looks like it will hold at least through the end of this year.

Good question. You're right, we did see some mix benefits with some volume that came through Asia, so that helps from an overall standpoint. We saw some FX favorability that came in this quarter. As you noted, we have price increases that are included in our numbers as well, partially offset by some discounting, so netted altogether, we feel that for the fourth quarter, we're flat to slightly down compared to Q3.

Okay, I got it. And then I guess just on the patient financing—interesting new wrinkle. Joe, was hoping maybe you could talk about the opportunity there. Any data or survey work you guys have done that might help us get a better understanding of how many people actually may go to the doc locator or go to see a doctor about pursuing Invisalign but ultimately don’t elect to do the treatment because of cost, might help us frame how this might help the opportunity there.

About two questions, we don’t have any real statistics to tell you how many people go to the doc locator, but we could tell you from our consumer capture efforts and we talked about this concierge service, this is one of the significant items that consumers have to deal with. Often orthodontists also ask for a large down payment upfront too; that even if a customer can avoid credit, it's still a pretty big hit from a cash standpoint upfront. We think this will be a good factor for us in helping to bring more consumers into Invisalign, but we don’t have any statistics right now to tell you exactly what that might be. I would say just stay with us, and as we go through this, we will be able to give you more and more specifics on it.

Two from me on the same basic concept, and it's about the trajectory of investment in the business. I have to imagine you feel happy on the marketing expense trajectory and on the efforts in Asia that these have paid off, as well as you give a couple of interesting statistics on, I think it was growth in marketing spend and something like a tripling of the customer base, and I believe that was a broader Asia. Could you talk about one, how you think about the growth of marketing spend and the commercial team from here and, then two, a similar question, more specific to Asia, how you think about the remaining runway for customer acquisition considering how much success you have and how much you probably learned about how things are working there?

Steve, so on the marketing spend, I would just say we just continue to do what we can in a sense of driving volume. There is no formal methodology we have here; I mean obviously we focused on teens in a big way. In North America, the look that we had— that spend also has been, I think, really refined in the sense of how much goes to social media, how much goes to some other segment and how much goes to the team that have done. So, I feel there is a lot of accuracy and sophistication in a sense of how we go about it. But we do know that we had a pretty big signal in the sense of being able to spend more in that channel and see an increase in orders, and we will keep spending where we can. I think a broader question and then I believe then your second one is how we do this overseas too. In North America, a lot of our marketing dollars, our teams were focused in the third quarter and the second quarter also. But we look at translating what we are learning here in the United States overseas, and we've had a pretty good response from a teen standpoint in China also, and now we have some restrictions in the sense of how you can advertise in certain geographies, and we have to be compliant in that sense, but we will be smart in the sense of how we use our advertising dollars. From an Asia runway standpoint, I mean we talk about going wide in the business. You saw we trained another 1,000 docs overall in China for the quarter. There is a direct correlation in the sense of being able to train those docs and we see the increase in orders going forward. Remember, our penetration rates in places like China are still relatively thin when you think about the available population, also India, we are really just getting started and Korea and Taiwan. In Australia, we saw terrific growth there too; that’s a market that we've had fairly good penetration rates in over the years, and so there are different formulas we have to use for different geographies in the sense of adding salespeople, adding docs. Like in Australia, it's a different deal in the sense of it is more like North America, where it's advertising and specificity where you spend from a sales standpoint that helps in that way. But I know I'm not helping you a lot, Steve, in the sense of being able to model that, but I tell you that we obviously watch as closely; we want to invest in the sense of where we get the biggest return, and we do watch that part also.

If I could just sneak one housekeeping item, I wonder if you have any updates on timelines in the U.S. for mandibular advancement and for iGo?

We expect to receive feedback from the FDA regarding mandibular advancement in December, and that’s all the information we have at the moment. After submitting our data, the FDA reviews it internally, and we believe we have provided strong data, so we will see what transpires in December. Regarding iGo, we maintain higher ratings for it across various areas and markets, which reflects positively on the product and its interactions with both doctors and patients. We have been performing well with this product line, and you can expect more detailed information on iGo's success when we report our fourth-quarter results next year.

Joe, obviously the year split are very, very well in terms of volumes. Can you just talk about how the infrastructure is holding up? Are you starting to see any bottlenecks or choke points that could be challenges if the demand continues to be this strong?

Obviously when you start to grow at this rate above what we've predicted, we've been able to stay ahead from the manufacturing standpoint. We always go to a certain amount of buffer capacity so we cover things like this. Initially we had a little bit of trouble in the sense of clean check, and our people did actually do the clean check pieces, but we experienced that back actually in January or so; we adjusted to give us extra capacity for the year. Right now, we're in good shape; it's a good thing about this business in the sense we can adjust capacity pretty quickly within a certain number of weeks and months when we have this kind of things. But we're trying to anticipate and lay resources ahead of these things, so we don't get into a situation where we can't handle demand.

Great, thank you. And then, maybe any early thoughts on 2018 and sort of key puts and takes? For example, should we think about the storms here in North America as maybe causing you to start more slowly, or maybe giving you a little bit of pent-up demand as you move into next year?

I wouldn’t call the storms material at all; I probably wouldn’t even consider that in your accusations. And right now, we kind of talk about this; we anticipate there will be 2018 questions, but we have good momentum now; you can see us going into the fourth quarter. And I think John has given you some really strong indications of where the fourth quarter is going to be, and so we try to be as specific as we could to help in that sense, but we are really not ready to get into conjecture on 2018 at this point.

May just a first one, the international case volume there was tremendous, notably APAC. You mentioned the trained docs, and that was certainly big, but is some of that growth also due to the local treatment planning facility that just opened up or is arguably that even too soon to be yielding benefits in that it might be on the come in subsequent quarters?

I would say that I won’t associate any extra volume with those right now. We were in Germany last week to check on our facility in Cologne, and it's just beginning to ramp up. The initial signs, similar to what we saw in China, are very promising. They connect well with customers, and the teams there are enthusiastic about their potential. Being closer to those customers, both culturally and in terms of timing, is crucial. So, this hasn’t affected volume yet, but we will provide an update as we move into next year and as this matures. We included this in our projections because we believe it will drive volume for us in the mid to long term.

Got it, actually you just answered the question with the very last statement. That’s perfect. And then just to shift gears, patient financing pilot, I want to make sure I got my arms on this correctly, so the doc gets the treatment fees, less Align's lab fee. So are you guys the ones taking on the financing risk? If so, should we think about it as a potential long-term tailwind to sort of your realized ASP offset by what could be sort of the theoretical bad debt expense on the consumer? Maybe if you can just talk through that. Thanks, guys.

No, it’s a third party that would take on any of the financing sort of bad debt or anything that comes with this; it would be third party, it would not be associated with us at all.

Okay, so zero impact to your ASP.

Good afternoon team, this is Kevin on for Matt today. Thanks for taking the time. I wanted to take a moment on iTero which seems to be the focus for this year and beyond. With record shipments, I'm just curious how you're looking at the trends for case submissions and the broader strategy on the ground for iTero. It seems like a bigger piece than we previously anticipated. I know you mentioned the lower patient traffic in summer holidays; just wanted to reconcile the sales effort on the scanners and the GP offices and how does that relate to the lower volume in the quarter? It seems a bit of a mismatch.

You remember last year Tim we were shipping a lot from backlog on the volume piece. What you are seeing this year is a pure demand signal; there is nothing really coming out of backlog. So, I think if you are talking about that discrepancy, that's the one I'd point out. On your broader question on the volume of the business, I think it's important for you to understand that when we talk about sales last year of iTero, it's broadly a North American business. What we're seeing now is an increase uptick in Europe. We just approved in Japan; we had significant shipments in Japan in the third quarter also, and we'll move into Asia broadly into more next year. I say the business is just getting broader internationally and that adds to the volume also. But in the United States, I hear in your comments that I think you understand that we've had a really good amount of orthodontic penetration with iTero, and more and more of our sales are moving into GPs. That's one of the reasons we put together the Patterson Dental distribution agreement because of their strong position with GPs and helps us through, so we have some work to do on restore the workflow in areas like that to be more viable in that channel but we've got a really good pickup and we are enthusiastic about the future in the North American channel for GPs too.

I mean the second question kind of comes from China. I think a few folks touched on this; I just wanted to discuss just the utilization trends in that market and the strategy that's being done differently there that you would highlight versus the rest of the international markets. Is there anything on the ground that I am missing driving this, or is it just continued adoption training and utilization as you would expect?

Continual adoption, training and utilization just as you described it, Kevin. I wish I could make it sound harder and more sophisticated, but it's about getting resources in place and moving it through. Now, you know we just put up a treatment planning facility in China and that's really—they are ramping up well we are getting good customer feedback, and so you know we will continue to do more and more resources to enhance that position in China in the future.

Just as a follow-up on the scanners. I guess what sort of traction are you seeing for kind of standalone, I guess, versus sort of the closed architecture systems just given sort of the distribution shift that we've been seeing kind of in the U.S.? And are there stocking dynamics that we should be considering here in the near term? Thanks.

I missed that question; can you rephrase the question?

iTero.

Yes, I know that’s iTero, but it was underneath that.

What do you mean by closed systems?

Like closed architecture systems involving like scanners.

You mean like a Scarano system. But Scarano is capable of doing a scan and sending it to us, and you can bypass them and impress them with a Scarano Scanner. You can't necessarily get stimulation and visualization and the features that we offer on the iTero side. Does that answer your question about capacity on iTero or...

Yes, or any sort of stocking with just your relationships there that we should be….

I understand what you mean. No, nothing like the Patterson, Scarano thing, don’t worry about any kind of stocking things affecting our numbers in a material way.

Okay, great. And then can you give us an update on this SmileDirectClub and how's that sort of resonating with customers and how you weigh sort of that direct to consumer relationship with all those practitioners as well?

I mean, our relationship with SmileDirectClub is good; we value, I think we’re very synergistic in the sense of how we work with one another. Remember, those are SmileDirect customers; we don’t see them, we don’t really experience them; we just do what SmileDirectClub asks us to do it. Obviously, part of your question is a lot of consternation in the orthodontic channel about doctor-directed and kind of systems that will be more of a digital dentistry; remote kinds of things where it's not involved in the doctor's office. Again, that’s not us; we’re not part of that. SmileDirectClub really controls that and holds it. I mean, there is a market for this and SmileDirectClub continues to do a great job in marketing and growing pretty substantially, but it would be stupid to ignore that there is a certain amount of consternation in the marketplace and a pushback, but I think SDC continues to do a great job out there.

I just wanted to start, your growth trajectory continues to accelerate, you're at a level, there are some pretty enormous year-over-year numbers here, and I was just wondering if you could reflect a little bit upon the age-old question we always ask you: balancing driving future growth through investment and dropping to the bottom line. And as we kind of think about, some of these marketing initiatives that are clearly paying off, it sounds like you guys are probably at a point where the team's inflecting and you might want to dial back some of these initiatives, and is that the way to think about it, you could be at a tipping point here, inflection point in adoption, and you guys are going to put the gap total expense, or how should we think about your growth for all the investment.

I'll just turn your attention to how underpenetrated we're in this marketplace. I mean it's incredible, right? Globally we can do 60% to 70% of the orthodontic cases out there today, we have 8%. And so, a lot of the investment and things that we make, whether it's recruiting new doctors in China or it's targeting moms and teens here in the United States, it's about really driving the penetration that there is an entitlement in this business we should have based on what patients want and based on what our technology can deliver. I know there are always questions on leverage out there; our operating profits are over 25%, obviously held by SDC this quarter, and it's significant, but we've shown good leverages this quarter despite exchange and despite what I call unusual from an SDC standpoint. So, I would say we're getting some leverage in this business, but I don’t expect kind of the material change in this sense of the input, output ratio of this business. We have to continue to invest aggressively in forward sales forces and marketing, especially in technology to stay ahead and penetrate more of the marketplace. We’ve always said that our goal is 25% to 30% operating profit in this business. We could do that tomorrow if we wanted to; you wouldn't like the growth numbers. Now we're getting close to that lower end and we keep working that piece, and we feel good about the tradeoffs that we are actually administrating right now between volume and margin. Does that make sense, Richard?

It makes a lot of sense, and I think a number of investors would agree to it, that are striking the right balance and the trade-off there. My second question is just on teens; can you break out a little bit of the continued acceleration that we're seeing in that category? I get a lot of it was held outside the U.S., but in North America, what kind of attraction are you getting with the GP channel in the teen? Obviously, your orthodontic channels are a little more dominant there, but are you starting to see some inflection on the GP side with that segment?

With the GP segment in general, I would say no, honestly. I would say iGo is helping us understand that more, and I can tell you the GP segment in the U.S. is certainly different than the segment in Germany, than it is in Japan, than it is in China. Each one of these countries has a different solution that we have to work through, whether it's workflow or preferences, whatever. So, I will not say we are in an inflection point in all the GPs; I would say we have a lot of growth. Teen growth for GPs is not where they are focused, and so a lot of GPs only touch a teen; they are worried about working with teens. When we talk about teens, we are really talking about all ortho channel utilization in the end.

I'll try to be quick here as the last question. So Joe, I guess the first question just why did we see the increase in SDC volumes in the third quarter? Was there a driver of that? Was there a reason behind that, and why does it revert in the fourth quarter? Do we just kind of live with a little bit of volatility here going forward?

I'll answer your last question first; you live with the volatility going forward, Jeff, okay? We don’t control SmileDirectClub's decision-making process. I'm not quite sure exactly why we received that much more of SDC's volume, but I don’t count on that going forward, and that's basically John's comments where in his opening remark. So, I wish I could be more specific about it, Jeff, but I can't, and it's just…

Should we at all bring that as a demand spike in the third quarter, like all of the sudden volume came in stronger than they expected in the third quarter? Or do you think it was just them putting out some volume on you?

Well, they continue to grow but I would say it's a combination of both, but it's not driven discreetly by volume; I would say.

Yes. Okay, and my last question just on the fusion, the iTero fusion program, you know you're locking GPs and it's some higher implied volumes there with that program. Just what's been the response to that program? Has that program taken off or is it taking off, and how should we think about the implications for the GP numbers from that program going forward?

I think again, I have to move outside of North America in general; the biggest uptick in segments for fusion has been outside of North America, and it's been received extremely well. In North America right now, we're really just getting cracked up on the fusion piece, and we'll have more for you in the fourth quarter results, Jeff.

Well, thank you, everyone. This concludes our conference call for today. We look forward to seeing you at upcoming financial conferences and industry meetings. If you have any other questions, please contact Investor Relations. Have a great day.