Align Technology, Inc. (ALGN) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Align Technology Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Shirley Stacy of Align Technology. Ms. Stacy, you may now begin.

Good afternoon and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communication and Investor Relations. Joining me today is Tom Prescott, President and CEO; and David White, CFO. We issued third quarter fiscal year 2013 financial results press release today via market wire, which is available on our website at investor.aligntech.com. Today's conference call is also being audio webcast and will be archived on our website for approximately 12 months. A telephone replay will be available today by approximately 5:30 p.m. Eastern time through 5:30 p.m. Eastern time on October 25, 2013. To access the telephone replay, domestic callers should dial (877) 660-6853, with conference number 421424 followed by pound. International callers should dial (201) 612-7415 with the same conference number. As a reminder, the information that the presenters discuss today will include forward-looking statements, including, without limitation, statements about Align's future events, product outlook and the executive financial results for the fourth quarter of the fiscal year 2013. These forward-looking statements are only predictions and involve risks and uncertainties, such that actual results may vary significantly. These and other results -- these and other risks are set forth in more detail in our Form 10-K for the fiscal year ended December 31, 2012. These forward-looking statements reflect beliefs, estimates and predictions as of today and Align expressly assumes no obligation to update any such forward-looking statements. During today's conference call, we will provide listeners with several financial metrics, determined on a non-GAAP basis for comparisons to previous quarters. These items, together with the corresponding GAAP numbers and the reconciliations to the comparable GAAP financial measures are contained in today's financial results press release, which we have posted on our website at investor.aligntech.com under Financial Releases and have been furnished to the SEC on Form 8-K. We encourage listeners to review these items. We've also posted a set of GAAP and non-GAAP 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, Tom Prescott. Tom?

Thanks, Shirley. Good afternoon, everyone and thank you, all, for joining us today. I'd like to personally welcome, David White, our new CFO, to Align. I'm excited to have him join our executive team. For those of you that haven't met David yet, he started the 1st week of August just after we reported Q2 results. He's hit the ground running and he's quickly coming up to speed in our business. On the call today, I'll provide some highlights from our third quarter results and briefly discuss the performance of our 2 operating segments, Invisalign Clear Aligners and iTero scanner and CAD/CAM services, including some color on our customer channels and geographies. David will share more detail on our Q3 financials, discuss our outlook for the fourth quarter and I'll come back and summarize a few key points and open up the call to questions. I'm pleased to report another very good quarter for Align, with revenue, gross margin and EPS higher than our outlook. Further, we achieved record levels of revenue, Invisalign case volume and North America iTero scanner volume, enabling us to reach the low end of our long-term model for our operating margin, while generating strong operating cash flow. The third quarter includes the seasonally slower period in Europe and North America for our GP dentists, along with the peak of the summer season for teenage orthodontic case starts. We're pleased that patient traffic appears to have remained solid for our North American ortho customers this summer, which resulted in strong sequential and year-over-year growth for Invisalign volume, especially in the important teenage patient segment. For Q3, total Invisalign case shipments increased to nearly 107,000 cases worldwide for the first time. Year-over-year growth was driven by continued expansion of our customer base, as well as increased Invisalign utilization. Improvements in product and technology over the past few years, including our new SmartTrack Aligner Material, are helping build even greater clinical confidence so our doctors will utilize Invisalign more often and on more complex cases. Doctors continue to give SmartTrack Aligner Material high marks on performance, with 78% of doctors surveyed agreeing that SmartTrack supports better clinical outcomes. SmartTrack Aligner Material also recently received the Top 100 Product accolades from Dentistry Today as the winner of the 2013 Pride best-in-class award, which will be presented at the upcoming ADA meeting in New Orleans in 2 weeks. Future results also reflect solid growth from iTero scanner and CAD/CAM services business. I'll start with a quick recap of a few key metrics for Invisalign, covering utilization, training and teenage ortho market penetration. But rather than going to a lot of detail here, I recommend that you reference our Q3 earnings slides posted on our website. For Q3, total Invisalign utilization was 4.3 cases per doctor, a slight decrease from Q2 at 4.4, which reflects an increase in utilization by North American orthodontists, offset by North American GPs and European doctors. This is consistent with the seasonally slower period for these customers and geographies. In Q3, we continue to expand our base of Invisalign providers, adding 90 North American orthodontists, 705 North American GP dentists and 840 international doctors for a total of 1,635 new Invisalign doctors. During the quarter, total teenagers treated with Invisalign increased to 28,900 and had a year-over-year increase of 18% and a sequential increase of 23%. For North American orthodontists, Q3 case volume of 41,600 cases increased 16% year-over-year and 5% sequentially, primarily reflecting continued increases in utilization, along with some contribution from new orthodontist submitters. These results reflect our continued focus on driving adoption and utilization of Invisalign into the very important teenage orthodontic market. While we are still assessing the market data from the summer teen season, we believe we gained some teen share of overall orthodontic case starts. For North American GP dentists, Q3 Invisalign case volume of 38,500 cases increased 11% year-over-year, primarily reflecting an expanding customer base, along with increased utilization. On a sequential basis, GP case volume was down slightly as expected given the seasonally slower summer period for most GP practices. For international doctors, Q3 Invisalign case volume of 26,800 cases increased 22% year-over-year and was down modestly from Q2 as expected, reflecting summer holidays for our customers, especially in the southern European countries. We continue to see strong volume growth for our Asia Pacific region, which was up sequentially and year-over-year. That strong volume growth in Asia-Pacific came from our traditional direct country markets of Japan and China, as well as our new direct country markets in Australia, New Zealand and Hong Kong. Collectively, this region continues to represent a great growth opportunity for Align. For Japan, Q3 was another record quarter for Invisalign volume. Strong growth was driven by the continued increase in the submitter base. We're also seeing positive trends in teen submissions, as a result of expanded training for Japanese doctors on the Invisalign teen product, which began in July. Product innovations like Invisalign G4 and SmartTrack really hit home in the market like Japan where the cases are very complex. For China, Q3 was also a record quarter, with strong sequential and year-over-year growth in Invisalign volume. These results reflect continued good execution of our strategic investments over the past few years. The China team continues to deliver outstanding clinical education, provide high-impact clinical and customer support and facilitate peer-to-peer advocacy, all of which support our strong progress. Much of this effort is being helped by key opinion leaders at the premiere government hospitals and orthodontic and dental schools. As the dental market evolves in China, access to dental care is expanding. Fueling part of that expansion is the increasing number of clinics serving the growing middle class. Align is now working closely with a number of these high-quality operators that are actively marketing Invisalign to consumers. These clinics understand the value of the Invisalign brand and are working to make Invisalign a significant part of their practice. On an overall basis, in our direct coverage Europe region, case shipments increased in this region by 20% year-over-year led by Spain, France, Italy and Germany. Across the region, we've seen an increase in clinical confidence in our product, along with further expansion of our customer base and increased demand for shorter, simpler treatments. These trends, combined with our continuous investment in education and customer experience improvements are contributing to great progress for Invisalign in Europe. All country markets demonstrated a strong year-over-year growth for Invisalign case shipments, with the exception of the U.K., which decreased slightly compared to Q3 last year. While our team in U.K. continues to work against some economic headwinds, we are seeing some initial signs of recovery among orthodontists in the UK. Turning to our consumer program, late in Q2, we launched a new fully-integrated consumer advertising campaign in North America and Q3 was the first full quarter in the market. The Better Smile Everyday campaign continues our focus on women and moms and teenagers and it's launch was timed to coincide with the busy teen orthodontic season, which runs from late spring to the start of the new school year. We're pleased with the strong early metrics from the campaign, which combines TV and digital advertising, with social media and traditional media relations. Web traffic at invisalign.com continues at an all-time high and that's a strong indicator of consumer awareness and interest in Invisalign. And as result of great editorial coverage in key outlets such as Lucky magazine, Marie Claire and Working Mother, our year-to-date print and online media impressions are at an all-time high. Over time, we expect to convert this awareness and interest into patient starts in our customers' practices. Let's now shift to our scanner and CAD/CAM services segment, where we had a record quarter for scanner shipments in North America. We're continuing to build our scanner installed base. And by our estimates, we are growing faster than our competitors. These results reflect the selling leverage we are gaining for major Invisalign customer events such as the Invisalign GP Summit held in July, as well as Invisalign orthodontic forums, a key clinical education event held throughout Q3. This progress and the feedback we continue to receive from iTero customers supports our belief that we have the best scanner with the greatest utility in the industry. An important part of our scanner business strategy is to improve the customer and patient Invisalign experience through the use of scanners to replace PVS impressions. We are definitely seeing leverage as our case submissions from digitally screened -- digitally scanned impressions continue to increase consistently. As of Q3, the percentage of Invisalign cases submitted with a digital scan rose to 25% in Q3 compared to 22% in Q2 and 13% in Q3 a year ago. Doctors, staff members and especially patients are all happy about this trend, as they see faster cycle times, better aligner fit and a far better experience. And with that, I'll now turn the call over to David for a review of our Q3 financial results. David?

Thanks, Tom. I appreciate the warm welcome. It's great to be here at Align on my first earning -- quarterly earnings call, especially after such great results. Before I get into the details, I'd like to note that unless stated otherwise, all the financial information I'll discuss will be presented on a GAAP basis. Now with that, let's review our third quarter results. As Tom mentioned, our revenues for the third quarter amounted to $164.5 million, up slightly from the prior quarter and up 20.5% from the corresponding quarter a year ago. Third quarter clear aligner revenue of $153.5 million was relatively flat sequentially and was up 21.2% year-over-year. Sequential revenue growth was driven primarily by seasonal strength in the North American Ortho market, which reflects a 27% sequential increase in number of teenage cases in North America. This was offset somewhat by a decrease in international cases and lower international ASPs. North America ASPs were flat. Our year-over-year growth reflected higher Invisalign volumes across all geographies, channels and products. Turning to our third quarter scanner and CAD/CAM services segment. Revenue was $11 million, half of which related to scanners and the balance of which related to services. This represented a 4.1% sequential increase and a 12.1% increase year-over-year. Third quarter scanner volume was up 32% over the last quarter, which reflected record volumes in North America. Moving on to gross margin and operating expenses. Third quarter gross margin was 76.0%, up sequentially half of a point and up 2.4 points over a non-GAAP gross margin reported in the same quarter last year. Clear aligner gross margin for the third quarter was 79.9%. This was up 1.5 points sequentially and up 2.3 points when compared with gross margin reported in the same quarter last year. The sequential increase was a result of 2 primary factors: First, a more favorable product mix shift to higher-priced products; and secondly, as a result of updating our midcourse correction policy last quarter, we expensed a modest increase in mid-course correction cases and a corresponding reduction in our warranty claims. This necessitated a modest true-up of our revenue deferrals and warranty reserves, which actually resulted in a reduction in our overall gross profit of approximately $1.1 million. However, the impact on gross margin was favorable by about 0.7 points. The year-over-year increase in gross margins primarily reflects higher ASPs, resulting from our price increase, which was effective at the beginning of 2013 as well as the aforementioned impact from the change in our mid-course correction policy. Q3 gross margin for scanners and CAD/CAM services was 22.2%. This compares to 33.9% in Q2 and non-GAAP gross margin of 21.6% in the same quarter last year. The sequential decrease primarily reflects lower scanner ASPs as a result of a reduction in the list price of our current scanner, combined with the promotion to sell our older scanners, as well as higher manufacturing costs. Our year-over-year improvement in this segment -- segment's margins was primarily the result of lower manufacturing costs, which were partially offset by lower ASPs. Q3 operating expenses were $83.6 million. This was down $2.2 million sequentially as a result of fewer customer events in the quarter as well as less media cost. On a year-over-year basis, non-GAAP operating expenses were up $12.7 million, incidental to the growth of our business, as well as the impact of the medical device excise tax levied on our U.S. revenues. Our third quarter operating margin was 25.2%, up 2.1 points quarter-over-quarter and up 3.6 points when compared to a non-GAAP operating margin reported in the same quarter a year ago. With regards to our third quarter tax provision, results for the quarter benefited from a one-time tax credit of $1.3 million related to a true-up of our 2012 federal income taxes. Third quarter diluted earnings per share was $0.42 compared to $0.36 reported in the same -- in the prior quarter, and a non-GAAP diluted EPS of $0.26 reported in the same quarter last year. Moving on to the balance sheet. For the third quarter, accounts receivable was $109.2 million, down approximately 3% sequentially. Our overall DSO was 60 days, a 2-day improvement sequentially and a 10-day improvement over the same period a year ago. Capital expenditures for the quarter were $5.8 million. Cash flow from operations was $55.1 million. And free cash flow, defined as cash flow from operations, less capital expenditures amounted to $49.3 million. Our cash, cash equivalents and marketable securities, including both short and long-term investments, were $400.4 million. This compared to $356.1 million at the end of 2012. Now let's turn to our business outlook for the fourth quarter's and the factors that inform our view. While typically the third quarter reflects the peak season for teenage orthodontic case starts, the fourth quarter is often a slower period for North American orthos, as fewer teenagers start orthodontic treatment once the school year has started. As such, we expect North American orthos to be down sequentially in Q4. Offsetting this trend, our fourth quarter's historically been a stronger quarter for our international doctors and North American GPs as they rebound from a seasonally slower summer quarter. We expect volume for both international and North American GPs to be up sequentially in Q4. Our scanner business performed very well this past quarter despite an increasingly competitive environment and we expect our scanner volumes to remain consistent with third quarter performance. Our strong Q3 results reflect stable patient traffic in our customers' offices and our outlook for Q4 assumes this trend will continue. With this as a backdrop, we expect our fourth quarter to shape up as follows: Invisalign case volume is anticipated to be in the range of 109,700 to 112,100 cases, reflecting a 21% to 24% year-over-year growth. We expect revenues to be in the range of $169.1 million to $173.1 million. We expect gross margin to be in the range of 74.7% to 75.3%, which primarily reflects higher training costs and mixed shift to lower-priced Invisalign products, that is less Invisalign Teen and more Invisalign Express. We expect operating expenses to be in the range of $83.8 million to $85.4 million, which primarily reflects continued investment in products and technologies as well as continued market expansion. Our operating margin should be in the range of 25.2% to 26.0%. Our effective tax rate should be approximately 21% and diluted shares outstanding to be approximately 82.2 million. Taken together, we expect diluted EPS to be in the range of $0.41 to $0.43. With that, I'll now turn the call back over to Tom for his closing comments.

Thanks, David. There's a lot of good work going on by the Align Technology team, and I'm very pleased to see our strong results reflect that effort. We continue to deliver solid execution of our long-term strategic plan and expect to continue those key initiatives, which are at the core of our progress. Our results also reflect stable patient traffic in our customers' offices and their willingness to let us become a more significant part of their practices. Our goal is to become their best partner in practice, providing great opportunities for growth, with every potential patient asking for Invisalign by name. We look forward to seeing our investors during the busy time for conferences and industry trade shows as well as reporting back to you with our year-end results in January. And with that, let's go to the -- with the question and answer session, operator.

[Operator Instructions] Our first question comes from the line of Robert Jones from Goldman Sachs.

What a difference a year makes, Tom, David. Just looking at the ASPs, second straight quarter, where we saw some strong -- some support there on ASPs, actually some improvement across all the segments, I guess, could you talk a little bit more about the drivers of ASP and how we should be thinking about the pricing power going forward? Just really trying to figure out how much of this is a result of maybe comps versus an actual firming of pricing of your products in the market?

Hi, Robert, this is David. I'll see if I can't answer that for you. When you look at ASPs, as we publish on the website and so forth, those are an aggregate ASP for the entire company. And so one of the things that you don't necessarily see in there is what impact mix has on that. And so as you look at, if you look our business quarter-over-quarter, our Teen business is up very strongly sequentially and that came at the expense of some of the lower-end products that carry lower ASPs. And so those -- that tends to -- that mix shift there tends to cause the worldwide ASPs sometimes to look a little bit off. As it relates to your question about the purchasing price or the purchasing power of our product and competitive pressures on our product, as you know, we made a slight increase in prices of our product at the beginning of the year. Some of that was a result of the new medical device tax and so forth. But at this point in time, we haven't really made any further adjustments on pricing since then. So the effect that I think you're seeing, from an external standpoint, has really more to do with mix shift than anything.

And Robert, if I could just pile on, the slide that Shirley and the team have put in here, on the very last slide in our webcast slides really try to break out those effects net of mix. And if you look at that in general, I would say pricing is stable net of mix and other factors. And so it's not so much a comp issue. We're actually -- pricing is pretty stable.

Got it. And then if I could just move over to the case guide, the 3% to 5% increase sequentially, seems like a big guide up, especially in light of some of the uncertainties that seem to be surrounding the consumer as we sit here in October, maybe more of a qualitative question, but was just wondering if you could talk a little bit of how you're factoring in some of the uncertainty in the marketplace and some of the pressures around consumer sentiment into your fourth quarter outlook?

Let me maybe start and then may be a pull-up for David, since this is his first-cycle with us. I think his objective view might be useful here. But I guess what I'd first start with is that we have the same kind of visibility we always have in our business cycle, about 30 days or so. And what you're seeing is a fundamentally solid business today, with initiatives that are working for us. And I'd take you back to earlier in the year. We made investments exiting 2012 in headcount and coverage in our geographies: Europe, North America. We've made investments in new consumer programs. We spent a little more money. We've told our owners what we're doing purposely, our goal was to generate volume as we exit the year and we're starting to see that, so we're gratified by that. But it reflects what we're seeing in the business. And we're not smart enough to break apart all of the elements going on. But with that said, I think there's -- we've seen other data that patient traffic is stable to improving. Dental consumables are improving a bit. And when there's traffic in the offices, patients are willing to do a more expensive procedure, an implant, a restorative, then that means there that the road's wide open for us to get Invisalign growth. Maybe with that, I'll pivot -- let David build on his first-cycle here, preparing the guidance.

Thanks, Tom. Robert, I guess I would -- when I first joined the company, I would've thought that given 25,000 customers that we ship to in a quarter, that forecasting the business would lend itself to some econometric model. But as you kind of look under the hood, what you realize is we have a small number of doctors that have a very healthy practice with us that is fairly stable and relatively predictable. But on the other flipside of that, we have a lot of doctors that do a small amount of business with us, and that particular segment of our business tends to be more difficult to predict. So when I look at the process and so forth, we have a process that kind of does a bottoms up view from the field, in terms of where -- what our territory managers and so forth are seeing as they talk to their customers. We have a view from the tops down of the company, which takes a look at our own statistical correlation of trends and so forth. And then as Tom was saying, we also look at patient traffic and so forth and some of these other external data points, and we triangulate across all of those to come up with our best view of the world. It's -- from what I can tell and, I think, from what some of you have experienced, it's not perfect. We'd like it to get better. But I think what I can tell you, at least from what I've seen and observed and so forth, is I think we have a robust process. And I'd say it's representative of best practices across many industries.

All make sense. Just a last one David, I'd slide in just on the back of that. Any thoughts, I know kind of early days for you, but any thoughts about extending the outlook that you guys do provide? I know it's something that us on the sales side and I'm sure investors would appreciate very much.

Not at this point. We give a long-term operating model. I think our operating model is where we are steering the company towards and those are the results we're trying to head towards. So probably not at this point.

Our next question comes from John Kreger from William Blair. John Kreger - William Blair & Company L.L.C., Research Division: David, maybe just a quick follow-on to Bob's question. Any early thoughts on 2014? Obviously, you're not in the mode of providing full year guidance, but are there any kind of key issues that you think we ought to be thinking about that could be key swing factors, particularly around margins?

Well, John, a pleasure talking to you again. I guess what I would -- what I've observed and, I think, what you've observed as well is our business does have some degrees of cyclicality in it. Our business, certainly, from a revenue standpoint, has seasonality. Q3 perhaps being the largest manifestation of that. But further than that, there's other elements of our business that had cyclicality to it as well. Our media expenses, for example, might run counter seasonal. Then we make investments in the business that sometimes tend to be bulky and done on an as-needed basis and are not -- don't follow a pattern of repetition. So when you look at our Q3 performance that we've just announced and our Q4 guidance, I guess, the thing I would comment on is that I wouldn't use those 2 data points to extrapolate going forward. Because of that seasonality and because those 2 quarters alone do not manifest, I think, all the cyclicality that our business deals with. I think more representative of that -- of our business, however, there's our annual operating results. And I think that's probably the best guide because our annual results include -- incorporate all of those cycles in them. As you think about, going forward, as I said on the prior question, our targeted operating model is 25 to 30 points. And I think at some point, as we get to being able to consistently land within that operating model, at some point, we'll then update the model. But at this point, I think that the best guidance I can give you is the operating model we've already talked about. John Kreger - William Blair & Company L.L.C., Research Division: Just one last one and I'll stop. Could you give us an update on how realign is faring with the Henry Schein salesforce?

I'll take that one, John. We're in very early days there. It is -- the Schein team and the Align team are working hard to ensure that the kind of the early customers and the field reps that are moving this have great experiences and we learn a lot from those cycles and make sure the product works perfectly for the patient. And Dr. Phil is creating the practice. So we kind of thought about the first year at startup. And we're right in the middle of that learning cycle, we're collectively about to head off to a trade show, the ADA, there's greater New York, there's some important cycles where Align will be out there in the market and Schein will be out there in the market, and we're going to have a chance to have that discussion with customers. So very early days, not going to be material for a significant amount of time, but way more strategic than kind of tactical. I don't know if that's what you're looking for. That's where I'll stop. John Kreger - William Blair & Company L.L.C., Research Division: And are you still comfortable, Tom, that the margins on that product can be consistent with the rest of the business?

Yes. Short answer is yes. When we -- if we stack up the take out in marketing, professional marketing demand creation, go-to-market, our contribution margins will be similar to, on a net basis, similar to, say, an Express product for example, where we got direct sales and marketing involved.

At the operating level.

At the operating margin level, below gross margin for sure, yes.

Our next question comes from Chris Lewis from Roth Capital Partners.

First, I guess, Tom, you mentioned the North American Ortho case volume strength was driven partially by new ortho submitters. So I guess, can you just talk a bit more about what's driving those new orthos coming on board?

It's really a couple of things. We've got more of those coming out of their graduate programs, maybe didn't get enough Invisalign in their program and as they're coming to a practice, they're very interested in, just trying to do Invisalign, that's 1. Two is we have some great established ortho practices that maybe got trained 10 or 12 years ago. I would say back in the early days, we weren't ready for prime time. They didn't have a great experience with the product. Couldn't address very complex needs. And as they've seen our progression, they have come to the view that they need to get on board. And so we've had a number of terrific kind of market-leading practices, want to reengage. In our mind, those are new practices, we haven't had business with them for years. And so that's the other part of the mix. Both are very positive, small numbers, but I think what's more important is what those kinds of practices represent over the next 3 to 5 years.

Okay. Great. And then, just on the gross margin side for the fourth quarter guidance, it's down sequentially. I think, you had mentioned some product mix, lower-priced products there, but can you just discuss a little further what other factors might be planned into that? And then, longer term, as we look on to 2014, how should we think about that gross margin trend unit?

Chris, let me see if I can give you a little color. As you look at our margins in the third quarter, they're, I think, almost a record, if they're not a record for the company, on the Invisalign side of the business. As we shift into Q4, however, though, we're going to see a lesser mix of you might say, the top end of our product line and that's going to get displaced with more volume in the lower end. So that mix shift is going to bring margins down to some extent. Then in my prepared comments, I made a comment that we had this mid-course correction that caused an adjustment to our deferrals, which is about 0.7 points of margin effect sequentially to Q3, but that's nonrecurring in Q4. And so we don't have the benefit of that in Q4. We also -- we'll have more training events this quarter. And when you -- we don't -- our training business is not an 80-point margin business. And so that will tend to drag the margins down a little bit as well. And offsetting those 3 is the fact that we -- is our scanner margins should improve quarter-over-quarter as well. And so the net of that is that margins should be down sequentially a little bit. As it relates to '14, again, I guess, the best guidance I could give you would be to look at the full year results, look at the trends, look at the -- and look at the operating margin, the targets or the business model that we talked about and I would plan off of those things.

Okay. Great. And if I could sneak one more in. Tom, just going back to the visibility into the business, I was hoping you could talk about how maybe that's evolved over the past, say, 12 months. Seems like, I think, you're talking about improving that visibility in recent quarters, some office surveys and other initiative to gauge more of a month-to-month trend in patient traffic and other market trends. So how has that evolved over the past year compared to third quarter of last year? And then, how that contributed in the fourth quarter guidance that was given today?

So I'll take my shot with -- while I'm knocking on wood, we're glad to have the positive results. I think, the starting point for all this is: A, we have the same kind of visibility we've always had in the core flow of the business; and then, B, our customers don't forecast, so asking them forecasting questions doesn't necessarily lead you to a factual framework you can count on. What is different, there are a few things different. The evolution of business this Q3 and Q4 from last year is fundamentally different. Patient traffic started declining in U.S. dentists office in the middle of Q2 last year, as we reconstructed all that. Procedures started falling with them, and mix shifted to lower value procedures, that really wasn't visible well into Q3 and we didn't really see it until summer didn't kind of bounce back. So that's different and that's why we keep stressing that stable to slightly improving patient traffic, mix in procedures is a really good thing for us. It's a good thing for everybody, but it's really good for Invisalign. To your second point about what we're doing differently, we do a lot more differently, a lot of things differently. When you get it wrong or you get humbled or you get surprised, you ask yourself a lot of questions about what can we do. Everything's on the table. We have instituted a whole series of what we internally call poll surveys. And it's not so much of forecasting, I just call it observational. We haven't been at that even a full year yet now in detail. And I would say we're far short of predictable kind of results. Our goal over time is going to be able to correlate some of that with other external factors like patient traffic. Empirical data we can observe. But boy, we're well short of what I'd call predictive capabilities. So what is reflected in our outlook, what is reflected in our results is good execution of business and everything we can control and a very solid environment out there in the countries that matter for us. And then, maybe the third fact is we have this very low penetration for Invisalign into a pretty big darn space and we still have a lot of headroom.

Our next question comes from Steve Beuchaw from Morgan Stanley.

I wonder, Tom, if we're far enough along that you could give us a little bit more granularity on what you're seeing with SmartTrack? Have you been able to get a view of what kind of impact that's having in practices that were maybe early adopters or beta testers, any discernible or hopefully quantifiable impact on how the mix of ortho cases there is impacted in terms of the percentage of cases that are going to Aligners in those practices?

Sure. Simple answer is for the most frequent users of Invisalign, including some of those that were in the pilots, even a year before we released, and others that just see, most quickly see the benefits, they have virtually all expanded case complexity and gotten most of the benefit out of it. We are still, I would say, working through our complete customer base. For a customer that does, even a great orthodontist that's only doing 10 or 15 a year, it's taking them longer to see the benefits because they generally are treating simpler cases. And they're just -- they don't have the at-bats that a high-volume doc doing 200 or 300 Invisalign cases a year would. But on those higher volume practices that are -- their progression has been towards greater complexity and earning a bigger part of their practice. And they say kind of yes to Invisalign more often when that patient asks, that's the short answer.

Is there a case for 5 points of mix shift over some horizon, can you quantify any of this for us?

It's not -- I wish it was as simple as that. We actually have some internal ways we measure it. And we look at the kind of the incidences, what presents with a -- at an average orthodontist or dentist office for the malocclusion and put them into categories, and then we look at what that incidence is and then what they treat against that mix. That same chart varies widely by the practice and how much they've adopted Invisalign. So we have 2 things. In our most ardent supporters, we get the biggest chunk of their Class 1 crowding cases, adult and even teens. And again, teens are harder cases to fill because everybody's aiming for absolutely perfect. And if they think they're making any clinical tradeoffs, they're going to be more resistant using Invisalign. But at least for adults, we're doing very well there. As you get over towards more straightforward Class 2 or even hard Class 3, the doctors that have got the greatest confidence and have had the greatest results with Invisalign are much more comfortable offering that to an adult patient. So there's a temporal framework that goes along that opportunity. The least frequent users are the least penetrated to those indications would be most around Class 1. And the most frequent users who have the greatest confidence are doing it on much more complex cases. So it's not as simple, I'm sorry to say, I wish it was, to say there's a projection of growth or share, but both are being driven by evolutions like SmartTrack and G4 that give us both greater confidence and because they're getting better results with those tools.

Got it. And then, as my follow-up, I wonder if you could give us an update on your thinking around partnerships in the world of inter-oral scanners. I wonder if there's any new thinking there? And I wonder, now that you have a relationship with Henry Schein that's expanded, if that might be a gateway, if some of the Henry Schein partnerships might be more logical for you? And then, I'll drop.

Sure. Thanks, Steve. The update is when there's news to talk about for interoperability, we will be happy to do so. We think it's strategically valuable. You saw we keep going up around 250 to 300 basis points quarter-over-quarter in cases coming, just with the iTero base among our customers. And we know there's interest out there. So it's in our best strategic interest to have those partnerships and you ought to assume that we're interested in doing that. But until we get there and can actually validate appropriate high quality scanners, I don't want to project.

Our next question comes from Chris Cooley from Stephens.

Could you help us think more towards gross margins and specifically, when we think about the contribution of fourth quarter and out in the '14 for more value-oriented product offerings like Express 5, how do we think about that in combination with the ramp of Realine, which I realize is still in early days right now, but assuming it has to become a bigger part of the mix, how do we kind of weigh that when we kind of think forward on the gross margin guidance? And I have a quick follow-up.

Yes. Again, we've had a few questions about 2014, and I guess, it's not surprising given our results in Q3 and Q4. As Tom said earlier, as it relates to Realine, it's really too early to call, to put a vector on that and to give any guidance as it relates to how that product will impact overall mix. As it relates to gross margins, we've continued to comment, I think, that as we look over the long term, that the percentage of cases that we treat, particularly for simple cases with adults and so forth will increase, and that will potentially drive down margins -- drive down ASPs, I should say. And clearly, our margins are influenced by product mix. But given that we're still growing well into double-digits year-over-year, while that may have some bearing on the directional indicators for margins, these gross margins, I don't think they'll necessarily have an indication of an effect, I guess, on operating margins. So going back to, I guess, the comments I made before, I think the best guidance for '14 is, again, going to be our operating model that we talked about.

Fair enough. And then, maybe just as a quick follow-up. When we think about the scanner business, 22.2%, I believe, the gross for the quarter, could you give us a feel there in terms of the mix, what's being placed versus what's actually being sold into the channel and how that may or may not be changing?

I'll see if I can take that one, and David can pile on if he wants to. First of all, the reported gross margins are nowhere near where we want them to be or where we expect to get them over time. If I understood your question, in terms of new systems going in versus services stream, was that the question?

Yes.

I think, we spoke about roughly half and half in terms of the mix of services against new scanner placements.

I would just add to that, as our scanners -- as we continue to penetrate the market with more and more scanners, that mix should go more favorably towards the service and licensing sides of that over time.

With higher margins.

Over time with higher margins.

If I could, Tom, just to follow on or to clarify that, when the actual system is placed, is the system sold outright or they placed early on, on a volume commitment, I'm just trying to tease out why the margin's at 22%?

Well, the margin's at 22% because our build material and cost of goods, we have the best scanner in the market and we don't make money on them. We -- and with pricing that has come down over the last 1.5 years, 2 years, with a lot of competitive entries, we've met that pricing, pricing is actually stabilizing a bit in the scanner market, have raised -- coming up a little bit. And we do think scanners will be ubiquitous. We think it's critically important for us to be at chair-side in the middle of a clinical discussion with the patient right there, and then, creating advantages for our Invisalign franchise and other things we intend to do over the long term. So with that said, the gross margins aren't anywhere near where we want them on the scanner. We intend to fix that over time. The services stream is better and we think we've actually got some strategic advantage there over time. But it's just the build material that's expensive, and it's the best scanner in the market, which is a kick, but we'll fix that over time.

Yes, and just to add to that, as I said earlier, just to make it maybe clearly, state it more clearly, that service element should grow against -- it's in proportion with the install base, and not in proportion to the number of systems we're selling in any particular quarter. The other thing, as you talk about the 22% gross margins in the second -- in the third quarter, some of that was also the result of the fact that we were selling, under promotional programs, some of our older scanners. So that had -- that promotion to kind of move some of that inventory had a dampening effect on margins in the third quarter and that's one of the reasons why the margins in that business should be up in the fourth.

Chris, I just realized, I didn't answer a part of your question. You were theorizing maybe there was placements instead of sales, we really don't do that. So those are all sales. Whether there was a financing involved, we don't finance either, but whether it was financed for us, it was a net sale, period.

Our next question comes from Jeff Johnson from Robert W. Baird. Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division: All of my questions have largely been answered here, let me just ask one, Tom. I want to make sure I understand the timing comments on the DTC, I was surprised, your DTC spending may be down this quarter, I know it had kind of flared up in the second quarter as you launched some of these new programs. And so is that just kind of a normal kind of ebb and flow of that spending? How are you thinking about maybe DTC spending given that it seems to be generating some nice top line, how are you thinking about that spending over the next several quarters to couple of years?

Sure. I think, as David was talking about, the broader issue of the timing and mix of spending isn't always in the same cycle with volume expansion given cyclicality, seasonality et cetera. And the example, I believe, was summertime is typically our strongest media, traditional media, digital media, everything else. And it's often a softer quarter, given the seasonality, people out on holiday in Europe, and certainly in North America, where we advertise most. So in general, there is a general consistency to our program spending on consumer and that is light in Q1, heavier exiting Q1, stronger into Q2, setting up for the summer season, heaviest spending exiting Q2 into the summer, and then pretty strong through all the summer, slowing as we exit Q3 into Q4. And you probably shouldn't see us by the time Christmas advertising is on in general just because there's so much noise. That is -- and now there's a whole -- there's a parallel mix of digital PR. Again, this integrated campaign, if you see for every TV commercial that you might see on one of the -- Bravo or one of the channels we work with, there's probably 10x that activity through multiple other platforms, whether it's Pandora for radio, whether it's gaming and other things. So that's the visible part in traditional media on TV. But again, there is generally the same profile for that spending in North America. Does that get at your question? Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division: Yes, that does. And I guess, last year, you had obviously some timing shifts or some fall off probably to that normal cyclicality, just given the Olympics and that, but I would assume, looking forward, nothing on the horizon we need to be thinking about that might shift that timing, at least in the near intermediate term?

The Winter Olympics is nowhere near the media frenzy of Summer Olympics. We don't have an election year. There's a lot of things that you have to engineer around in the media world. This should -- I don't know what normal is in the dental industry but if we had to imagine a normal, this feels like more of a normal. Now the second thing is we were off the air a bit more exiting '12 because we were getting ready to launch a whole new campaign. And I think, when we spoke about our guidance in January for the year, we were talking about investing in new assets, a creation of new creative and materials and all the associated elements that go along on the digital side and everything else. So all that, that's where the spending was, it wasn't necessarily visible media that was part of the first half year -- first half of the year profile in greater spending. So again -- but in general, you should expect stepwise expansion investment and the same kind of impact that we expect to get for payback year-to-year.

Operator, we'll take one more question, please -- we'll take 2 more questions, we've got time for 2.

Our next question comes from Brandon Couillard from Jefferies.

David, just curious if you could give us an update on where we stand on the NOLs and when you expect to have to begin paying cash taxes, whether that's anytime soon?

So I'll say, we do pay -- I'll be clear here, we do pay some cash taxes. Typically, those are in foreign jurisdictions and in states here in the U.S.. As far as our U.S. federal return is concerned, we do have NOL carryforwards. And currently, today, obviously, we're making money here in the U.S.. Those taxes, however -- that income, however, though, the taxes on net income, we do have the benefit of R&D tax credit, which offsets that to some degree, we also have the benefit of stock exercises and the ability to deduct some of that off of it. And so it means that we use up less of our NOL than what we might have otherwise in the absence of those credits. Altogether, our estimation is that our NOLs will probably run sometime into or through around 2015.

Great. And then, just one more for you, given this is your first conference call as the new CFO, I would be curious to hear your view around how you think about capital allocation and share repurchase in general with cash building on the balance sheet pretty substantially here?

Well, I guess, I would say, philosophically, that if a company is accumulating cash and doesn't have a need for that cash to either grow its business and just to run the business, then at some point, there should be a plan to figure out how to return that to shareholders. That said, we just finished here in line, as I'm sure you know, $150 million stock repurchase plan in the June quarter. 95 -- $93 million of which was spent in that quarter. And so we just completed one of those plans. We haven't really quite come up for air yet. I would tell you that as we kind of look at our annual plan for next year and our 5-year strategic plan, we are right now pulling together what we think our investment requirements are going to be for the company. And clearly, those investments will, at some point, are going to mean added manufacturing capacity, market expansions, we're going to have both domestic needs, as well as international needs. And at this point, we haven't really assimilated how all that's going to fit together. But at some point, we will in the not-too-distant future here. And to the extent we come to a conclusion, at least with the board, that we have excess cash that we don't need as a company. We'll figure out what plan we're going to do with it. But right now, as of today, we're just not ready to declare what that next step will be. But I think, if you can be patient with us, we'll probably have more to say about that in the not-too-distant future.

Our last question comes from the line of John Block from Stifel Nicolaus. Jonathan D. Block - Stifel, Nicolaus & Co., Inc., Research Division: Maybe I can just slip in 2 or 3 questions. I guess, the first one, on the investment side, and I'm also guessing people are going to stop asking if you're staying by your long-term margin guidance, on the investment side, you've done a ton in the past 12 months, APAC, you've added North American reps, you did some work in the international side, and then you're starting to obviously post a leverage. I think, in the past, the spend has been very lumpy. And so, Tom, can you just speak broadly about incremental investments from here, maybe not detailing what exactly they're going to be, but again, will you pull back at all, will they be as lumpy as they've been in the past? Any color would be great.

I guess, I have to start with the word lumpy. From our perspective, the business cycle itself here in the dental industry is cyclical. Maybe use that instead of lumpy. And in many areas, these investments, it doesn't make sense to line up investment choices that are multiyear in nature and have a strategic value to fit them perfectly, maybe fit them generally, yes, but not fit them perfectly into that kind of annual cycle we see. Q3 being a great example of one that's softer. So where we choose to make investments that during a quarter or 2 would take operating margins down a little bit, as we did in Q1 when -- or into Q2 as well where we talked about it with the yearend results in January of this year, we also made the commitment that we expected to be able to generate volume growth. And I think, David said it well earlier, we think looking at the model, in terms of our annual performance is the right way to look, and so the question is going to be we know that's not how you have to model on a quarterly basis and the reports you put out, but from our perspective, we're trying to deliver an annual result with the quarters that make sense, and some of the spending, an example is consumer is going to be in advance of that volume step up. And in this case, this year, it was also on top of substantial headcount investment that we had all completed by end of Q1. All that headcount was in North American sales force on an incremental basis. And you had virtually none of the volume was coming in yet. We had a new media camp, a new consumer campaign going on yet, with very little impact felt yet. So that's great examples of where it's the right thing to do and the timing is better to get at it quickly and get it in. So simply stated, I think, we will continue to be a little more cyclical in our total operating margin profile. But where we are on the lower side of that, I believe we'll continue to articulate what the spending is going towards so that our owners can understand that the kinds of things we're investing in, we have high confidence will lead to either increased earnings, in the case of the right kind of factory, or increasing volume, and ultimately, operating margins on an annual basis. Jonathan D. Block - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then, just shifting gears over to teen, it was up 18% year-over-year and it looks like some of that was a little bit lower on teen growth from GPs. It's certainly good numbers, but it's a second quarter in a row where you sort of had a decel into the mid to high-teen level, and then it goes mid-20s in 2012. So I'm just trying to find something to pick on. I mean, what do you think about growth in teen going forward? You mentioned, hey, they're looking for perfection. Is SmartTrack starting to give them better conviction that they can get there with Invisalign? Again, any thoughts would be great.

Sure. If this is the only thing we've given you to pick on, I'm really happy as CEO. Look, first of all, we're thrilled with the progress we're making. We've said for a long time that earning that marginal teen case is the hardest case to wrestle away from brackets and wires, which is still standard of care. So we have to be better than brackets and wires in many ways. And we're getting there. Now I think it was a question earlier that I answered, that was comparing where each practices and their adoption and their clinical confidence, a practice that uses a lot of Invisalign in adults and teens doesn't seem to worry about it. They'll lead with Invisalign. A practice that's more conservative that is just now maybe starting to get SmartTrack is just now starting to get more complex crowding cases on adults. And so our goal is over time, is to move practice by practice, this progression through and have them see that experience firsthand, have the patients be thrilled, get those great results. And that just reinforces their own journey. So it's literally that practice by practice process that we're encouraging. On a numbers basis, we get big enough. The denominator gets tougher, 18%, 21%. We're in the right neighborhood and we're thrilled with the process. SmartTrack is a big part of that, G4, all the rest of it. We can't do enough consumer advertising if the product -- if they're not confident the product doesn't work. So the right coverage in clinical education and clinical support, the right product evolution and the right consumer, those 3 legs of the stool go together really well for the teen market and we're very confident over the mid to longer-term, our goal is frankly to become standard of care in orthodontics. The teen market is the last place, we'll get there. Jonathan D. Block - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And last question, if I can just jump in there David, this might be for you. International ASP, and those slides are helpful, but international ASP looked like it was down sequentially despite what I believe was an extra month from APAC in a euro that went in your favor. So what am I missing on why international ASP would just be down Q over Q?

Well, you're right to pick up on foreign exchange. I mean, that was a benefit to us, about $1 million in the quarter. But again, back to the comment I made before, when you look at these ASPs, it's an average across the mix of products that we're selling. And so, when that mix changes, the ASP can come down, even though -- you can point to examples where the price on every single product could go up quarter-over-quarter, but if the mix changes, the overall could look like it's going down. So there's really no trend there that I think you should be concerned about. It's really more of a mix shift than anything else, I believe.

Well, operator, that concludes our formal comments today. We thank you for joining us and look forward to seeing you at upcoming financial conferences and interesting meetings. If you have any further comments or questions, please contact Investor Relations.

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