Greetings, and welcome to Align Technology Inc. Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Shirley Stacy, VP Corporate & Investor Communications. Please go ahead.

Good afternoon and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications & Investor Relations. Joining me for today's call is Joe Hogan, President & CEO; and David White, CFO. We issued second quarter 2016 financial results today via Marketwired, which is available on our Web site at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our Web site for approximately 12 months. A telephone replay will be available today by approximately 5:30 PM Eastern Time through 5:30 PM Eastern Time on August 11th. To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13640324 followed by #. International callers should dial 201-612-7415 with the same conference number. As a reminder, the information that the presenters discuss today will include forward-looking statements, including statements about Align's future events, product outlook and the expected financial results for the third quarter of 2016. These forward-looking statements are only predictions and involve risks and uncertainties that are set forth in more detail in our recent periodic reports filed with the Securities and Exchange Commission. Actual results may vary significantly and Align expresses no obligation to update any forward-looking statements. We have posted a set of GAAP and non-GAAP historical financial statements, including the corresponding reconciliations and our second quarter conference call slides on our webcast under Quarterly Results. Please refer to these files for more detailed information. With that, I'll turn the call over to Align Technology's President & CEO, Joe Hogan. Joe?

Thanks, Shirley. Good afternoon and thanks for joining us. On our call today, I'll provide some financial highlights and then briefly discuss the performance of our two operating segments, Invisalign Clear Aligners and Scanners. David will provide more detail on our financials and discuss our outlook for the third quarter. Following that, I'll come back and summarize a few key points and open up the call to questions. Q2 was driven by a better than expected revenue due to continued strong year-over-year Invisalign volume across our customer base and record utilization. With International case volume up 38.3% and North America up 15.3%. We also had a continued strong demand for our iTero Element with record shipments this quarter, resulting in revenue growth of almost 200% year-over-year. For Q2 North America Clear Aligner volume was up 4% sequentially and 15% year-on-year on a sequential basis Q2 growth was driven by both our orthodontist and GP customers. Utilization among our orthodontist customers continued to increase and we reached record levels in both ortho and GP channels for a total of 10.7 cases per doc this quarter. On a year-over-year basis our Q2 volume growth rate continues to outpace our three year average driven by an increased ortho utilization, as well as expansion of our GP customer base. Q2 Invisalign volume for International doctors is up 17% sequentially and 38% year-over-year, continued strength reflects record International utilization driven by EMEA, as well as continued expansion of our customer base in APAC. We are also seeing increased use of Invisalign G5 for deep bite in EMEA as well as in our Invisalign G6 for extraction cases in APAC, both showing momentum in the quarter and nearly equaling the overall growth rate for each respective region. In EMEA Q2 volume was up 37% year-over-year led…

Thanks, Joe. Let's review our second quarter financial results. Revenue for the second quarter was $269.4 million, up 12.8% from the prior quarter, and up 28.6% from the corresponding quarter a year-ago. Second quarter Clear Aligner revenue of $243.4 million was up 10.8% sequentially, and up 21.2% year-over-year. The sequential revenue increase was primarily related to increased Clear Aligner volumes and to a lesser extent our price increase in North America. On a year-over-year comparative basis, the growth rate for both total revenue and Clear Aligner revenue was lower by approximately four points, related to the Additional Aligner policy change we implemented in July last year. Q2 ASPs were up sequentially from Q1, about $30, reflecting a price increase in the U.S. as well as favorable foreign exchange rates. Our year-over-year revenue growth reflected Invisalign case volume growth across all customer channels and geographies, as well as our price increase in North America and International. These increases were partially offset by lower ASPs, primarily related to the Additional Aligner policy change made last year. For the second quarter, total Invisalign shipments of 177,000 cases were up 8.1% sequentially, reflecting growth from both our international and North America customers. Year-over-year case volume growth was 22.4%, driven by growth across all regions. For North American orthodontist, Q2 Invisalign case volume was up 4.7% sequentially, reflecting higher adoption and utilization rates across the channel, and up 20% year-over-year. For North American GP dentist, case volume was up 3% sequentially and up roughly 10% year-over-year, reflecting continued solid performance from mid high volume GPs offset somewhat by our large base of oral volume GPs. For international doctors, Invisalign case volume was up 16.8% sequentially and up 38.3% year-over-year, reflecting increased adaptors and utilization. Worldwide Invisalign utilization in Q2 was 5.1 cases per doctor, up…

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

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Your first question today comes from Robert Jones of Goldman Sachs. Please go ahead.

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

Yes, Bob, David. So, if you look at our business in North America and you compare that growth relative to the last few years. If we feel like our North America business has really taken a nice uptick this year and starting last year with many of the investments we made, we think it's still strong on both the ortho and the GP side where we're continuing to see at record or near record utilization amongst those classes of doctors. We still are challenged when it comes to low stage doctors particularly the most emitting GPs who engage with us one quarter and then maybe don’t engage in the next quarter, and so we struggle at times trying to reach those doctors and we continue to invest in various to go market strategies that will build engage them more fully with us but it does represent a challenge for us in terms of how we forecast those doctors in any particular quarter. The other thing I would just mention is that when you look at our comps particularly in second quarter year-over-year you will remember that Q2 a year ago we had, we were running an E5 and E10 promotion at that point in time, which we’re not running this year. And so when you look at last year, Q2, we had a very strong quarter from a case launch standpoint because of those promotions on those low stage products, as well as the fact that we had additional aligner program that was -- you might say an easier qualification mark for the doctors to qualify for. And when you look at those two, they have a bigger impact on our year-over-year volume, but certainly a lesser impact on a year-over-year revenue basis.

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

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

Fair enough, thanks so much.

Okay.

The next question comes from the line of Robert Willoughby from Credit Suisse. Please go ahead.

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

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

But again this is brand new. It's hard for us to call it. And we’ll give you more data as it becomes more apparent and as we move into the supply agreements in October.

Maybe another factorial question around it though. If they’re kind of tracking along at a $50 million rate, I assume they’re losing a little bit of money on that. Is that a safe bet?

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

And just how worse -- is there a liability if the treatment goes bad, that goes back to an orthodontist somewhere, correct? That does not come to you. And just the last one on SmileClub is there a bad debt number associated with the business?

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

And Rob on the question as you had about, from a liability standpoint. Remember we’re the supplier of these aligners. We are -- FCC will sell them to the customer base. We do as per their specifications. Our job is to make the cleanest best aligners we can based on those specifications. FCC obviously makes the transfer, and something like that. We have liability. And we think we’re all doing a lot too there we have the deepest pockets they are going to have some issues too, but I think from a liability standpoint, I think it's shared in that sense that I'll ask Roger to make a comment on this.

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

The next question comes from Brandon Couillard of Jefferies. Please go ahead.

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

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

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

So, it continues to be a drag on earnings and it will be drag on earnings for as we said a year ago, for at least a couple of years as we work off those grandfathered cases. But starting in Q3, however, it won't be a drag on a year-over-year compare because Q3 2015 was the first quarter in which we actually implemented that policy. So, I think those -- we won't talk about it necessarily so much on a year-over-year basis, but it still will be a drag to some extent.

The next question comes from Steve Beuchaw of Morgan Stanley. Please go ahead.

Just a two couple of little household housekeeping items, the ERP, I mean once we get to fourth quarter, can you give us a sense for what the swing is on OpEx between say 3Q and 4Q just for underlying purposes once we get past that ramp?

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

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

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

Thanks everyone.

Your next question comes from Jon Block of Stifel. Please go ahead.

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

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

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

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

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

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

Alright. Thanks for your time guys.

Yes.

The next question comes from John Kreger of William Blair. Please go ahead.

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

So John, we have actually begun some of the activities incidental to expanding our pace of international operating activities. So as an example, we established in Europe a base where doctors who are submitting physical impressions, can send them to a European address to have them scanned. Those are sending them all the way to Juarez. So we have implemented that. And so you've seen, there has been some CapEx associated with that and there has been some operating expenses for starting that activity up. We have also begun looking at establishing some treat capacity in some of our regions and begun piloting some of that with small numbers of people and experimenting with how those work flows might work. As it relates to a bigger piece which would be doing Aligner Fabrication, that is still further add to the future, 2017 plus. And so, we will begin to see some of that now. And when you look at our gross margins actually for guidance in Q3, there is a little of an impact from that. As far as CapEx standpoint is concerned, STC won't really impact that very significantly. Their volume is relative to our, volumes are still very modest. And we wouldn’t expect the uptick to be meaningful. As it relates to the rest of our business, probably for the next two years or so, I think as that infrastructure begins getting placed geographically, we would probably see a little bit higher CapEx than what we normally experience. And that at which point as those operating are established and the brick and mortars up, we would probably expect CapEx return to kind of a nominal rate we saw historically.

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

Yes I think, at our Investors Meeting recently in New York, I think we laid that out pretty well. When you look at first of all from an R&D standpoint. China moved from a chronological standpoint backward to the pilot expansion and main digital expansion kind of devices that we announced that we'll have in the marketplace in 2017 is one part of that. Secondly is a sense of how we go to consumers and how we communicate Invisalign capability to the consumer base. Honestly, a lot of our approach to that marketplace over the years has been primarily through our results and that’s all demographic. And we feel pretty strongly as we move into next year, we’re going to have to - really there is two sides this equation. As you look at the three people involved normally in teens, you have a father, you have a mother, and then you’re going to have the teen and then you also have a doctor. We found that overtime you get to win two out of three. And I think often we win the one with teen we lose the mom, or we lose the doc. And so we’re working on both ends hard from an advertising standpoint to make sure we do better in working with our docs in the sense of our teen capability and expanding it coming forward. And then secondly is to get to the mom in a much better way, particularly around compliance, a lot of mothers or fathers have concerns of their teens really were aware of the amount of time that’s needed to properly move the teen. We found out through over the years that actually teens are more compliant than adults. And so we’re very confident. And frankly the dentition and teen are really helpful in the sense of how loose the dentition is and how fast we can actually move teen teeth. So, as we speak, we’re working hard in a sense of how we’re going to approach teens next year. It’s a great question, because it is obviously 75% of the marketplace, and it’s one that we have not obviously penetrated thoroughly. And I think we can make some really good progress in the next year.

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

Very helpful. Thanks.

[Operator Instructions] Our next question is from Richard Newitter of Leerink Partners. Please go ahead.

Hi thanks for taking the question. Just going back to the CDC, I’m curious if you could characterize for us the type of customer or consumer that just the lead generation aspect to the type of customer or consumer that’s going to SmileDirect and how will that compares to who is learning or coming to Fair Aligners through your Web site. Did you do any research, or do you have any information there about kind of the types, who were just getting this type of products versus traditionally who goes through the doc locater and traditionally on your align channel?

You know I could day that we don’t have exhaustive data on that. I mean what SmileDirectClub has shared with us. the demographic end tend to be heavily weighted toward women versus men, which we see in our demographics too. But these are people that are really often millennials. The convenience is really important to them. If they have a certain want, from a freedom standpoint as such that visiting doctors' offices, there is obviously a price point here too that's something simple in the sense of what they want to move from inclusion standpoint. So it's not necessarily a gender difference from what we've done or an age difference, but it's a preference difference in the sense of how people want to engage from what we can see so far.

Okay and then maybe just turning one financial one, on gross margin, I think you said that you have some manufacturing start up cost for you APAC kind of initiatives there bringing manufacturing closer to that part of the world, that's going to impact the step down in gross margin in third quarter. Can you just give us a sense as to whether or not that is kind of finite nature or should we kind of think of that as kind of a go forward kind of gross margin rate for future quarters modeling or how should we think about that? Thanks.

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

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

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

Thank you.

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

Okay, the last question today comes from Chris Lewis of ROTH Capital Partners. Please go ahead.

Hey guys thanks for squeezing me in.

Hi Chris.

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

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

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

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

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

So, I think one of the things we've been very fortunate where this that, demand that we saw and post the announcement of the product in March of 2015 has continued to almost outpace our ability to deliver. And so we’ve had a very good first half of the year with orders maintain that backlog in spite of our increased efforts to get ahead of it. We would expect that more nominal way to backlog would probably be somewhere in the half the levels that we have today. And we think that would be somewhere maybe towards the end of the year by the time we would catch up.

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

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

Okay, thanks for the time.

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

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.