Shirley Stacy - Align Technology, Inc. Joseph M. Hogan - Align Technology, Inc. David L. White - Align Technology, Inc. Roger E. George - Align Technology, Inc..

Nathan A. Rich - Goldman Sachs & Co. Steve C. Beuchaw - Morgan Stanley & Co. LLC John C. Kreger - William Blair & Co. LLC Jeff D. Johnson - Robert W. Baird & Co., Inc. (Broker) Jon D. Block - Stifel, Nicolaus & Co., Inc. Chris Lewis - ROTH Capital Partners LLC.

Greetings and welcome to the Align Technology's Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. I would now like to turn the conference over to your host, Shirley Stacy. Thank you. You may now begin..

Good afternoon and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me today is Joe Hogan, President and CEO, and David White, CFO. We issued third quarter 2015 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 P.M. Eastern Time through 5:30 P.M. Eastern Time on October 30.

To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13621393 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 fourth quarter of 2015.

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 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, Joe Hogan.

Joe?.

Invisalign Clear Aligners and Scanner & Services. David will provide more detail on our financials and discuss our outlook for the fourth quarter. Q3 was another good quarter with revenue and EPS above the high end of our guidance.

Our results were driven by strong Invisalign case volume, up 2% sequentially and 23% year-over-year, with growth across all customer channels and geographies. North America volumes grew 18.6% year-over-year, and our international geographies were up 35% compared to last year.

This growth was driven by continued momentum in EMEA, in APAC, progress in North America, expansion in our low-stage product segment, and seasonally strong uptick in teenage patients. In North America, Invisalign volume was up both sequentially and year-over-year with the highest year-over-year growth rate for North America in three years.

Sequential growth was better than expected, driven by seasonally strong teenage demand in ortho channel, where we had another record quarter for utilization at 9.9 cases per doctor. This is the third consecutive record quarter.

On a year-over-year basis, growth was driven by both orthos and GPs, reflecting continued adoption of Invisalign by existing ortho customers and expansion of our GP dentist base. Our investments in sales force effectiveness are producing good results. We're pleased with the progress we see in North America.

Customers are responding positively to our new sales structure, and we expect to continue to make incremental investments in go-to-market, clinical education and customer support in this important market. Invisalign volume for international doctors was up sequentially and year-over-year.

Our international volume continues to be very strong across all countries in both EMEA and Asia-Pacific, which increased 31.5% and 41% respectively. The continued strong growth for international was driven by continued adoption of Invisalign in EMEA and expansion of our customer base in APAC.

On a sequential basis, Invisalign volume was better than expected and strong growth in APAC help offset the seasonally slower period in EMEA. In EMEA, our year-over-year growth continued across all major regions with strong performance by Spain, Portugal, France and the UK. Increased coverage and sales execution continues to build strong momentum.

We have a good balance of growth from newly-trained and existing customers. In September, we hosted our eighth EMEA summit, our largest to date with almost 500 doctors, including 75 from APAC, coming together for an intense clinical education and peer-to-peer networking conference for Invisalign providers.

The program focused on building clinical confidence and expanding early adoption of recent innovations like Invisalign G5 and Invisalign G6 and ClinCheck Pro. We were pleased to hear consistent and constant feedback throughout the summit that doctors are more confident using Invisalign for more complex cases.

In Asia-Pacific, Q3 was another record quarter in almost every major country, with China and Japan leading the growth. China now represents our sixth largest country market globally. Q3 utilization was consistent with the prior year and growth reflects continued expansion of our customer base in the region.

During the quarter, we continued commercialization activities for the Invisalign G6 across the region with numerous clinical education events in New Zealand, Hong Kong, Taiwan, Singapore, Japan and Thailand. And in cooperation with Sunny Dental, we helped open the first Invisalign-dedicated clinic in Beijing.

In the important teen segment, the total number of Invisalign cases in Q3 increased 22.3% year-over-year. This reflects continued adoption across our customer channels. On a 12-month basis, over 134,000 teenagers started treatment with Invisalign this past year.

Product innovation remains core to our long-term growth and ability to accelerate adoption of Invisalign treatment in both the adult and teenage segments.

The extensive new features and functionalities we have introduced over the past five years, including Invisalign G5 and Invisalign G6 as well as SmartTrack Material, have raised the bar for simple and comprehensive clear aligner treatments.

While Invisalign clear aligners are already recognized as very credible orthodontic appliances, we will increasingly focus our efforts on creating doctor advocacy for Invisalign clinical competencies. In Q3, our Scanner & Services business revenues were up sequentially from higher sales of iTero scanners.

On a year-over-year basis, revenue was down as expected and in line with our guidance as a result of the transition to the new iTero Element scanner. Since its introduction in March, interest and demand for the new iTero Element has been overwhelmingly positive.

During the quarter, we completed the initial market release of the iTero Element orthodontic scanner with shipments starting in September. To date, over 2,000 Invisalign cases have been initiated with the new iTero Element.

Customers tell us that the new design meets the high level of precision they expect from an iTero, with an Invisalign scan acceptance rate of 99.8%. We will expand the market release of our iTero Element to include restorative applications during Q4 this year.

For Q3, total Invisalign cases submitted with a digital scanner in North America was 40.5%, up from 39% last quarter and 34% the same quarter last year. In North America, our integrated consumer marketing approach continues to be highly impactful, with Q3 consumer search interest for Invisalign treatment up 20% year-over-year.

In addition, we had more than 1.3 million unique visitors to our invisalign.com website, and more than 112,000 potential patients search for an Invisalign practice on our doc locator.

Our multichannel marketing approach leverages national television, search, digital marketing, PR and social media and is designed to engage consumers throughout every point in the consumer purchase journey.

During Q3, we focused on reaching moms and teens during the key back-to-school season by continuing the Invisalign teen confidence campaign we launched in May. The campaign generated more than 385 million consumer impressions across 20 key markets and drove moms to the invisalign.com parent page, with unique visits up 102% during the campaign period.

In EMEA, our integrated consumer plan relies heavily on social media and online marketing in key markets. Even with the summer holidays across Europe and related seasonality, we saw great engagement with find-a-doctor searches increasing by 250% year-over-year and 200% growth in our EU social media community.

Before I turn the call over to David for a review of our financial performance, I want to comment on two recent litigation filings. This week we dismissed a California state lawsuit originally filed against ClearCorrect in 2011.

That suit alleged unlawful business practices regarding pricing and has no bearing on our outstanding patent infringement case against ClearCorrect through the International Trade Commission, ITC, who previously found ClearCorrect to infringe on our patents. ClearCorrect also dismissed a related cross-claim against us in California.

In the area of litigation, today we announced that we have filed an infringement and false advertising lawsuit against SmileCareClub, Sharper Image, and Brookstone, companies involved in the sale of do-it-yourself at-home clear aligner products sold directly to consumers.

The details related to our claims and specific patents in question are noted in the press release we issued.

However, it's worth mentioning here that while this is a new lawsuit, we believe ClearCorrect is treatment planning and manufacturing aligners for SmileCareClub using the same methods that the ITC previously found to infringe on Align's valid patents.

We anticipate that additional information regarding this relationship will come to light during discovery. SmileCareClub not only markets and sells its aligners directly to consumers, it also supplies aligners to resellers, Sharper Image and Brookstone stores, who are named in the lawsuit as retailers of the SmileCareClub system.

This situation is of particular concern in that it not only involves the marketing and sale of a product we believe infringes Align's patents, SmileCareClub also promotes a treatment option that seeks to eliminate the critical role played by the doctor in the patient's treatment.

Align has always believed that orthodontists and dentists play a critical role in successful orthodontic treatment using clear aligners, which is why the Invisalign system is so tightly integrated with the treating dental profession.

With over 640 patents worldwide, litigation is part of doing business as an innovative growth company and we will continue to assert and defend our intellectual property rights. The ITC has already found that ClearCorrect's product infringes Align's valid patents, and we are confident that the final outcome in both cases will be a win for Align.

I'll now turn the call over to David..

Thanks, Joe. Let's review our third quarter financial results. Revenue for the third quarter was $207.6 million, down 0.9% from the prior quarter and up 9.4% from the corresponding quarter a year ago. Third quarter revenues included a non-cash reduction of approximately $7 million related to our new Additional Aligners policy announced last quarter.

Third quarter aligner revenue of $198.3 million was down 1.3% sequentially and up 11.3% year-over-year. The sequential revenue decrease was primarily related to our new Additional Aligners policy as just mentioned.

Q3 ASPs were down sequentially about $45, which was almost entirely due to higher revenue deferrals from the new Additional Aligners policy. Excluding Additional Aligners, ASPs were otherwise flat quarter-over-quarter.

Our year-over-year revenue growth reflected Invisalign case volume growth across all customer channels, partially offset by lower ASPs, primarily related to foreign exchange rates and the higher revenue deferrals just mentioned.

For the third quarter, total Invisalign shipments of 147,500 cases were up 2.0% sequentially, reflecting growth from our North American orthodontic and international customers. Year-over-year case volume growth was 23.3%, driven by growth across all regions, with strength in international and continued progress in North America.

For North American orthodontists, Q3 Invisalign case volume was up 5.4% sequentially and up 21.4% year-over-year. For North American GP dentists, case volume was down 2.6% sequentially and up 15.3% year-over-year. For international doctors, Invisalign case volume was up 2.9% sequentially and 35.1% year-over-year.

Worldwide Invisalign utilization in Q3 was 4.7 cases per doctor, up slightly from 4.4 cases in Q3 last year. North America ortho utilization of 9.9 cases was a new record, increasing from 8.8 cases in the prior year. North America GP utilization was 2.9 cases, was up slightly from 2.8 cases in the prior year.

And international doctor utilization of 4.6 cases was up slightly from 4.3 cases in the prior year. In Q3 we added 2,260 new Invisalign doctors worldwide, 1,060 of which were new North American doctors and 1,200 of which were new international doctors. Q3 is seasonally a slower training quarter due to holidays and summer vacations.

So the number of Invisalign doctors trained was down approximately 8% sequentially. Our Scanner & Services revenues were up 7.8% sequentially and down 20.4% year-over-year, primarily as a result of the new iTero Element scanner, which didn't commence shipping until September.

Moving on to gross margin, third quarter overall gross margin was 75.9%, up sequentially 0.2 points and down 0.5 points year-over-year. Clear aligner gross margin for the third quarter was 78.8%, up 0.5 points sequentially and down 0.04 points year-over-year.

The sequential increase was primarily driven by lower freight costs and seasonally lower training activity, which was only partially offset by the impact of the Additional Aligners policy.

The year-over-year decrease in gross margin was primarily the result of lower ASPs, primarily attributable to currency exchange rates and the new Additional Aligners policy, which were partially offset by lower manufacturing costs.

Q3 gross margin for our Scanner segment was 14.7%, down 0.3 points sequentially and down 18.8 points year-over-year, both as a result of lower ASP due to a closeout incentive pricing program on our older iTero 2.9 scanner and lower production volumes.

Q3 operating expenses were $119.5 million, up sequentially by $3.2 million, primarily due to, first, increased investments to support our continued international growth and expansion and higher media spend. Secondly, costs primarily associated with severance costs for organizational changes previously announced.

And third, costs related to the termination of an agreement with a third-party company for product development in the obstructive sleep apnea area.

On this latter matter, while we continue to believe opportunities in the OSA market are potentially interesting, we've now decided to remain squarely focused on our core business and organic growth opportunities.

On a year-over-year basis, Q3 operating expenses were up $26 million, incidental to the growth of the business as well as our ERP implementation project. Our third quarter operating margin was 18.3%, down 1.9 points sequentially and down 8.8 points year-over-year.

The sequential decrease in operating margin relates primarily to the impact on revenue of the new Additional Aligners policy, which amounted to 2.6 points, partially offset by lower manufacturing costs.

The year-over-year impact relates primarily to these factors as well as foreign currency exchange rates and investments in the business related to sales expansion, R&D and ERP. With regards to our third quarter tax provision, our tax rate was 24.3%, down 1.9 points from our Q2 tax rate.

This is primarily due to a tax benefit as a result of the filing of our U.S. federal tax return this quarter. Third quarter diluted earnings per share was $0.34 compared to $0.39 reported in Q2 and $0.47 reported in the same quarter last year. Third quarter EPS was impacted by approximately $0.06 related to the company's new Additional Aligners policy.

Further, the year-over-year impact from foreign exchange as a result of the stronger U.S. dollar, including the decline on revenues, the benefit on our non-U.S. dollar operating expenses, together with currency exchange losses reported in other income and expense, was $0.04 per share.

Moving on to the balance sheet, capital expenditures for the third quarter were $10.5 million, primarily related to added equipment capacity to our second manufacturing facility in Juarez, Mexico as well as additional costs capitalized on our ERP project. Cash flow from operations for the third quarter was $60.1 million.

And free cash flow for the third quarter, defined as cash flow from operations less capital expenditures, amounted to $49.6 million. As a side note, on a trailing 12-month basis our free cash flow as a percentage of revenue was 22.7%, consistent with our long-term model target of 20% to 25%.

During the third quarter we repurchased 662,000 shares of stock, including 332,000 shares related to the completion of the company's previously announced $70 million accelerated stock repurchase and 330,000 shares, amounting to $18.8 million, in open market repurchases.

As another side note, our last 12 months of stock repurchases, together with cash used to pay employee taxes for the net settlement of vesting employee stock that otherwise would've been issued, amounted to 71% of our worldwide free cash flow.

We believe our free cash flow generation and these repurchases are consistent with our expressed capital allocation objectives of returning cash flow in excess of that needed to run and grow the business to our shareholders. Cash, cash equivalents and marketable securities, including both short- and long-term investments, were $630 million.

This compared to $602.6 million at the end of 2014, an increase of approximately $27.4 million. Of our $630 million of cash, cash equivalents and marketable securities, $213 million was held by the U.S. and $417 million held by our international entities.

With that, let's now turn to our business outlook for the fourth quarter and the factors that inform our view, starting with the demand outlook. For North America, we're encouraged by continued progress in North America, with Q3 volume growth rates above our three-year average.

While we continue to gain share in the important teen segment, the fourth quarter has historically been a seasonally slower quarter for ortho teen case starts. Notwithstanding the seasonal pattern, we expect North American Invisalign case volume to be up sequentially from Q3.

For international, Q4 has historically been a seasonally stronger quarter for EMEA and a seasonally slower to flat quarter for APAC. In total, we expect international volumes to also be up sequentially from Q3.

As a reminder, the changes for the new Additional Aligners policy applied to all new Invisalign Full, Teen and Assist products, our full product group, shipped worldwide after July 18, 2015 as well as any such open cases started prior to this product policy change.

As a result, beginning in Q3 our deferrals increased as a result of providing these Additional Aligners at no charge and the grandfathering of over 1 million open cases. The effect on our future revenue is two-fold. The first is an increase in the amount we defer for each new case we ship.

The second impact is that revenue recognized on each Additional Aligner shipment will be lower than the amounts we've historically recognized until these grandfathered cases are completed, which we anticipate will take approximately two years.

As a result of this policy change, we expect Q4 2015 to be lower than it otherwise would've been by approximately $7 million to $8 million. This is consistent with the guidance we gave in our Q2 earnings call. For 2016, we expect this impact to be between $25 million and $30 million in total.

Relative to our historical growth rates, we believe the current-year clear aligner volume growth will more than offset this impact on future revenues. With this as a backdrop, we expect the fourth quarter to shape up as follows.

Invisalign case volume is anticipated to be in the range of 154,900 cases to 157,400 cases, up approximately 22% to 24% over the same period a year ago. We expect Q4 net revenues to be in the range of $223 million to $227.9 million. We expect gross margin to be in the range of 75.7% to 76.2%.

We expect operating expenses to be in the range of $114.7 million to $116.3 million. Our operating margin should be in the range of 24.3% to 25.1%. Our effective tax rate should be approximately 24.5%. And diluted shares outstanding should be approximately 81.4 million, exclusive of any share repurchases.

Taken together, we expect diluted EPS to be in the range of $0.50 to $0.53. With that, I'll turn the call back over to Joe..

Thanks, David. I'm pleased with our Q3 results, which reflect stable patient traffic in our customers' offices and their confidence in using Invisalign on more patients and on more complex cases. Our goal is to be the best partner by providing great treatment experiences for our doctors and their patients.

Overall, we continue to see good momentum across our customers' channels and believe our investments in sales, marketing and R&D are helping to drive growth. Thank you for your time today. I look forward to updating you on our progress. With that, we'll open up the call to your questions.

Operator?.

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question comes from Robert Jones from Goldman Sachs..

Hi, this is Nathan Rich on for Bob this afternoon. A couple of questions on guidance. First, it looks like guidance implies that ASPs will be up sequentially in the fourth quarter versus the third, if I'm doing that math right. Just wondering if you could give us some more details on your expectations for both North America and international ASPs.

I think there are a decent amount of moving pieces just with the revenue recognition change, FX and case mix..

Hi, Nathan, it's David. Thanks for the question. As it relates to ASPs in the fourth quarter and the outlook as it relates there, too, we are expecting a modest increase in ASPs in Q4, not actually that substantial, primarily due to fewer promotions we run in Q4 versus what we typically do in third quarter.

The other piece of it is that we implemented a price increase internationally in July and it takes a while for that price increase to work its way through work-in-process and cases that are in various stages of submission. And so ,we only got a partial benefit of that last quarter. We expect to get full benefit of that this quarter.

So, those are the two things factoring from a positive standpoint. There is a little bit of FX headwind, but not very much, but a little bit positive on the ASP..

Okay, makes sense. And then, if I could just ask on the operating margin guidance as well. It looks like for the fourth quarter you are expecting a pretty big step up in EBIT margins.

Just wanted to get your sense of how much visibility you feel like you have here? Is it just a factor of sort of leveraging higher sales volumes? And maybe could you talk about the productivity of the sales people that you've brought on and how you feel about that return on investment?.

So, possibly two questions there. As it relates to operating margin, our Q4 visibility, if you kind of drill down a little bit into it, you'll see that our guidance for gross margin is pretty consistent with our actual results in Q3.

And where the uplift really in operating margin in Q4 comes from is the fact that our operating expenses are going down slightly quarter-over-quarter on higher revenue. And so that's the principal driver. I think it's about nine points of the operating margin increase quarter-over-quarter is that factor right there..

Great. Thank you..

Okay..

Thanks, Nathan.

Next question?.

Our next question comes from Steve Beuchaw from Morgan Stanley..

Hi, guys. Thanks for taking the questions.

So I'll ask two, one for Joe, and then, sorry, is Roger on the call as well?.

Yes..

Okay. So first for Joe. So, Joe, could you take a step back and just talk about the volumes and maybe rank-order what the drivers are? If you take a step back and say we have growth that's materially above 20%, you listed off quite a few items that the company did well during the quarter.

But if you had to look at one or two things and say, look, this is really what has sequentially come on and made the business grow faster here in 2015, what would those one or two things be and how do you see those evolving from here?.

I think versus last year is, first of all, you have to look at North America. I mean, it's the strongest comparison that we have year-over-year because they did have a poor 2014 then. And so if you look at, the growth has been there, the orthodontic sector has been terrific for us. You can see we have a penetration rate there that's a record at 9.9.

And so that's very significant. We are seeing growth again in the GP area and double-digit growth that we hadn't experienced in North America prior to that in the few previous years. So I think overall that's probably one of the biggest variance I'd say year-to-year.

What we had from a continuous standpoint, is you can see the terrific growth we have going on in EMEA right now in Europe and also the continued growth that we have in APAC also, which is very strong. And so, that's continued momentum and it's also on top of some pretty strong numbers from last year.

So, I think those four variables I would say, Steve, overall are the big drivers..

You haven't been, I'd, say wildly optimistic about GP.

I mean do you think the double-digit growth in GP is sustainable in North America?.

Well, I think there's an aspect of GP that we don't go deep in GP right now, we go wide. So you can see we have about 2.9 or 3 cases per GP unit versus 9.9 cases on ortho. As we add sales people, we know we get more sales in GP.

We have to work on and I think what you said, I haven't talked about that a lot, I'm not enthusiastic about it I think what your words were. I am, it's just we have to do better at penetration in that segment and that's what we really have to work on..

Okay. And then just one for Roger, I think, first of all, welcome back to the call, Roger..

Thanks, Steve..

I know this is your favorite part of the job. The SmileCareClub litigation was, I guess, a little surprising.

How big are they right now? Are they even 2% or 3% of the market? And I guess while we're on the legal topic, I mean, what do you think the timelines could be as it relates to some enforcement around ClearCorrect?.

Sure. So as far as the market size of SmileCareClub, it's negligible. We don't see them that much out there. As far as timing on ClearCorrect, the case at the ITC was appealed up through the federal courts, most recently at the Federal Circuit Court of Appeals, and oral arguments were held in August.

And we expect a written decision from the court sometime in the first quarter of next year..

Great. Thanks so much, everyone..

Thanks, Steve.

Next question?.

Thanks, Steve..

Our next question comes from John Kreger from William Blair..

Hi. Thanks very much. Joe, just to follow up on the last question about key growth drivers.

What's your assessment about the underlying market growth, particularly for orthodontists? Would you characterize it as stable or are you seeing any improvement there?.

You mean from a market overall, John, you mean outside of us or just the market itself?.

Yeah.

So in other words, looking at that 23% case growth, how much of that if any do you think is market?.

Well, I think we have a favorable market behind us, John, is the way that I'd answer that question. I mean, we don't have a down market behind us, and that kind of market momentum is really helpful.

To tell you how many points of growth that I think have to do with the market itself versus what we're driving from a penetration standpoint, I really don't have that kind of information. And so, I can't give you the specifics like that. But it's beneficial to have a market that's growing behind you..

And typically, John, as you know, the industry has typically grown in low single-digits. And so nothing substantial has changed in that standpoint..

Great. Okay.

And Joe, as you've had a bit more time to kick the tires, so to speak, around the world can you maybe comment on what your priorities are going to be over the next year?.

Well, I mean priority is obviously growth in profitability overall for the company from a growth standpoint, John, staying on your original question. The international part is a big part of our growth and where you're going to see us continue to invest heavily in that area to drive the growth that we think we can get there.

But that doesn't mean we'll negate North America. North America is a big market. There is kind of a lot of a law of large number issue in North America, we report lower percentages. But when you look at case volumes, they could be fairly close together.

And so you'll see us continue to invest pretty aggressively from a distribution standpoint in all three regions..

Okay. Thanks. And then one last one, now that you've had a few months to assess how clients are viewing the new policy about not charging for additional aligner refinements.

How is that impacting client behavior if at all, and are there sort of key regions where that has been a bigger driver than others?.

I think you can ask that question two ways, John. Is it a negative driver in the sense we see people trying to maybe take advantage of the policy? And then the other side of it is how comfortable does it make our customer base. We haven't seen any variant that would say that this is being abused in some way.

And really I've been personally amazed that a number of comments that I get really all over the world on that change. And there is no question it is exactly the way the team represented us before I got here is that this was the number one biggest attractor that we had in the marketplace regarding our product and our policies. I'll give you an example.

We talked about in our script about the Spain program that we had this year and that we just got back from. I had several doctors come up to me and just say, you know, Joe, it really increases my clinical confidence to have this policy changed. And they said because we feel like you have our back, if we run into an issue with something.

It's a difficult case in some way, we don't feel like we're stranded. And I never thought that that would be one of the side effects or secondary effects of making that kind of a change. So it's been overwhelmingly received in a very positive way.

And I think some of the surveys that I know you guys do and that I read, you can see a lot of the dentists that are surveyed on this will tell you that they feel happy about that and they'll be more aggressive about using Invisalign in the future, and that was the purpose of what we did..

Great. Thank you..

Okay, John. Thank you..

Thank you. Our next question comes from Richard Newitter from Leerink Partners..

Hi, good afternoon. This is Robbie actually in for Rich. Thank you for taking the questions. Actually, I had one follow-up on some of the doctor comments that you had made about GP adoption. Just curious in terms of, it sounds like you expect GP year-over-year growth to continue in that double-digit range.

In terms of the doctors that you guys trained in the quarter, do you give any breakout in terms of how many of those are GPs versus orthodontics?.

Okay..

We do have data to tell you how many. I think David will take you through that..

I think if you look at the website slides, we probably break it out..

And is that number like new doctors?.

North America total?.

North America total..

Yeah, total..

Yeah, but that doesn't break down....

Most of the doctors we train are GPs, right?.

Yes. Correct..

So if you guys recall historically and you can probably look at some of the historical data that we used to provide, but most of the doctors in North America are GPs..

And is that level increasing historically, or is it still – it's most and that's what we should expect going forward?.

No, you should expect that going forward most of the doctors we train will be GPs..

In the North America..

Yes, in North America..

Great, thanks. And then maybe one on litigation.

Is there any read-through on this California dismissal with ITC that both you guys have now dismissed that lawsuit against one another to a potential settlement with the ITC litigation?.

Can you repeat that, I didn't hear the first part of that..

Should we take the dismissal of the litigation in California by both parties as any sort of indication that there could be a settlement or are you just – should we just assume that you're willing to hear the ITC case play out?.

You should not assume there will be a settlement..

Okay. Great. And then maybe one more on the Scanners business, this came in a little bit lower than we had expected.

Any sort of – was that just seasonality or are you seeing any sort of capital challenges in that business there?.

So, (sic) Robbie, on the Scanner business it really has little to do I think with seasonality and everything to do with the cycle we're at in terms of transitioning from our historical Scanner, which we called 2.9, to our new scanner called Element.

And we began shipping that product in September and up until that point in time we had been winding down the sale of the older 2.9. So it's more a function of that than anything else..

Got it. Thank you very much..

Thank you. Our next question comes from Jeff Johnson from Robert W. Baird..

Thank you. Good afternoon, guys. Joe, I wanted to start with you maybe, strong fourth quarter guidance on the case shipments. So I think I know the answer to this already. But are you seeing any fade at all in China from a demand standpoint? In the U.S.

a little concern that maybe we started to see some consumer softening kind of in the September time period in that.

Are you seeing anything in your kind of month-to-month numbers that would worry you, either China or the U.S., at this point?.

The quick answer, Jeff, is no. China continues to be very strong. We had a good, strong September here in North America, too. I understand the basis of your question; I worry about it, too. What's the economic activity going on in those particular areas? But right now I'm not seeing any effect on the business in that sense..

Yeah, that's what your guidance would imply, too, so thanks. And then, David, maybe just a clarifying question for you on the Additional Aligner policy.

I'm going back to my notes here, but the guidance you gave for the revenue impact in 2016, the $25 million to $30 million, that's the total revenue drag from that policy in 2016 versus what looks like it's now going to be a $13 million or $14 million drag in 2015.

So the incremental drag, if you will, is only about $12 million to $15 million, is that the way to think about it?.

That's correct and that's primarily because it's only a six-month drag on 2015..

Yeah, yeah. Fair enough. I just wanted to make sure. And then my last question just I guess with Roger there I'll ask him, but I thought I remembered, guys, that with the ClearCorrect ITC ruling that even in appeals they could be risking some hefty day-to-day fines if they were still digitally treatment planning.

So wondering, one, am I right on that? And two, does that mean anything in conjunction with what you said about them potentially treatment planning the SmileCareClub cases, and just wondering if there is any impact to potential risk there from that standpoint for them?.

I don't remember specifically what the ruling is on damages in the interim, but it's continued infringement from our point of view. And it doesn't affect, I mean it's the same thing, whether they are doing it for themselves or whether they are doing it for SmileCareClub..

Okay, that's helpful. Maybe I'll ask a couple more offline on that later tonight. Thanks, guys..

Thanks, Jeff..

Next question, please..

Your next question comes from Jon Block from Stifel..

Great. Thanks, guys. Good afternoon. I'll focus on utilization. I guess the year-over-year GP utilization was up for the second straight quarter after being down every quarter in 2014.

So, Joe, can you talk about the sustainability here with that increase, with the greater sales rep count, and maybe where you are with the sales initiative in that really long GP tail? And then part two to that would be, in the ortho channel the utilization increases have been huge.

And can that continue with the current call it G portfolio or should we expect you'll need another iteration on that front?.

Hi, Jon, I think on the ortho channel side – I'll just start with that question before I back up what GP is. I think you'll see, just getting used to the statistics in this business, but I think you'll see that it normally goes down from third quarter to fourth quarter on the penetration rate.

And it has to do with the teen cases that tend to come in in the third quarter versus the fourth quarter. So I think what you might you see is a little lower penetration rate on the ortho side for North America as we go into the fourth quarter. But that's just statistical and based on year-to-year.

There is nothing in a sense of the demand pattern to think that we see any interest that we have in orthos on that. On the GP side, Jon, I'm just – again, my newness in this business makes me more cautious than I normally am.

But what the correlation I see right now on the GP side is you have to make sure that you continue to approach this market in the GP side with sales people, because it's hard for us to have any really meaningful increase when you look at the amount of utilization that's going on in that channel.

And so we've proven so far I think in 2015 is if you add sales people to this, there is a marketplace we can continue to get growth.

There are some sales models that we're transferring in from – in Europe from a penetration standpoint – that we're going to employ in North America next year as a trial to see if we can help with some of that penetration. That will apply both to ortho and GP, too.

Secondly is, and we talked to you before about the sales associates that we've added recently, which are basically what I would say back office support that actually make phone calls and all to customers andnot direct.

We've seen some success with that model, too, and I think that might help us on the GP sector also in the sense of how do we go about that, how do we really – I've talked about this before too, Jon – how do we really segment that marketplace to see where we think we can get further penetration with doctors that are truly interested and taking Invisalign to another level, versus doctors that might just be curious on it and wanting to work with it, not necessarily in the in-depth way that we would want..

Okay. Perfect. Very helpful. And then....

And that's a lot....

It's a lot, but it's all very helpful. So I appreciate that. And then, David, just to shift gears for a second, you got the question earlier on leverage and your commentary was, well, revenues are up and OpEx is down and that doesn't happen too frequently.

And I'm not asking for a 2016 guidance, but I just want to make sure, we've had situations before where your 4Q to 1Q, your leverage is usually down pretty dramatically because you've got some one-time expenses that sort of get re-upped.

Can you give any color around leverage as we look out, exiting sort of 2015 into 2016, maybe near-term, long-term? Because again, the move from 3Q to 4Q is just tremendous. Is there anything that comes back into play on the OpEx front once we enter 2016? Thanks, guys..

So, to the first part of that that you asked as it relates to some of the seasonality you might see in our performance, financially and so forth, you're right to call that Q1 typically is down for us. And largely, for things that are external to the company like the fact that payroll taxes start over. We have a lot of employees here in the U.S.

whose payroll taxes start over and our portion of that that we have to pay. At the same time, we have internal items that influence that, such as we have focal salary reviews and increases – performance reviews and increases at that point in time. So those all put pressure, you might say, on operating expense uplift in Q1.

And then, when you add to that the fact that, when we go through our annual operating plan cycle, we go through a process that looks at basically our baseline organic business in terms of what do we think our business can sustain without any additional resources, and then we look at that relative to where do we have investment opportunities and how would those investment opportunities drive both short-term as well as long-term growth of the top line and penetration into the business.

And a lot of times, those investments all get made early in the beginning of the year as well, and this last year – this year that we're currently in is a case in point.

We made investments in all three of our regions at the beginning of the year to begin driving further penetration within existing doctors and bringing new doctors into the family, so to speak. So there is that piece of it.

I think you should anticipate that we will, as our historical pattern has shown, that we'll be making large investments, incremental investments as we move into 2016 and that that will create some downward pressure on Q1.

And hopefully by the time we get to the end of the year, we begin seeing a lot of uplift to our business as we're seeing this year.

Longer-term than that, Joe mentioned the fact that we see a pretty good correlation between our investments that we make in the field and investments that we make in products, one driving adoption, the other driving doctor coverage and so forth. I think that will be our business for a while.

I think our challenge long-term is finding the right balance between the investments that we believe we can execute on, and at the same time, be good caretakers of being financially responsible for finding that right balance between our short-term performance and our long-term performance.

So our long-term model that we've talked about historically, we still believe that's the right model for us, and that's where we'll continue to strive the business..

Perfect. All right. Thanks, guys..

Thanks, John.

Next question?.

Our next question comes from Chris Lewis from ROTH Capital Partners. Mr. Lewis, your line is live..

Chris, are you there?.

Hey, guys, can you hear me all right?.

Hey, there you are. Yeah, we can hear you fine..

Sorry about that. Good afternoon. Thanks for taking the questions. I wanted to start on the fourth quarter gross margin guidance. When I think about ASPs ticking up sequentially along with the strong implied sequential case volume growth, midpoint of the fourth quarter gross margin guidance implies a flattish level from the third quarter.

So can you just walk us through the factors that are layering into that outlook, despite the sequential ASP and volume pick up?.

Well, we do have some ASP uplift. But we also have a higher training volume during this quarter, which typically is with lower gross margin. So that tends to hold some of that uplift back as a result.

The other piece of it is that we are shipping our Element product this quarter, and Element, although it is a much better business model, you might say, for our company in many respects and I think also for the doctor and it does have a higher gross margin than the older version, it is still below our clear aligner overall gross margin.

And so as that Element business picks up, that also puts some downward pressure, you might say, on the gross margin, just from a mix standpoint..

Then on the OSA market opportunity, can you talk about that decision and potentially quantify the impact that will have on R&D spend going forward? Thanks..

I'll let David do the quantification, Chris. I'd say that when you look at that, it's not that we didn't that OSA was a good market. In fact, it might be a good market for some company at some point in time in the sense of how that can compete against other kinds of opportunities out there.

But from us, we have I feel much better places in our core market to invest that money right now and that's what we're going to do in the future is just stay focused..

And back to your question about impact, we gave some guidance at the beginning of the year that we thought OSA would be somewhere around a 1 point cost on revenue. And you'll see in the slides that we've provided on the webcast in the quarter the wind-down cost on that was about $0.02 a share..

Okay. Thanks for the time..

Yeah. Thanks, Chris. See you..

Thanks, Chris..

Thank you. Our next question is a follow-up coming from Richard Newitter from Leerink Partners..

Hey, Rich?.

Hi, thanks. It's actually Robbie. Thanks for taking the follow-up again..

Oh, sorry. Hi, Robbie..

No problem. I have a question maybe on ASPs for sort of by product segment, the Express and Light segment. It looks like it's stepped down a little bit again sequentially.

How should we think about that going forward in terms of is this the new normal or should we continue to expect price declines from this area?.

So, Robbie, as we've talked about in the past, there's a lot of variables that make up our ASP. And they come down – if I summarize them at the highest level, they come down to product mix, doctor mix, and – let me focus on those two for a second.

So when you look at product mix, certainly lower-stage products and so forth are going to drive down – all other things being equal, a richer mix of lower-stage products will obviously bring ASPs down. And from time to time you're going to see us running promotions and so forth to incent doctors to give those low-stage cases, prize and so forth.

But ultimately an objective for many doctors is to treat those and to get them to not only treat the simple cases but get them to build their clinical confidence on those simple cases and begin adopting full cases, where they feel they're capable and confident that they can do so. So you're going to see some ups and downs on product mix.

And as we introduce new products in the future and so forth, I think you can anticipate that most of our R&D effort is focused on improving the clinical efficacy in those more complex cases. I think you'll see pressure from a product mix standpoint going in the other direction.

So I wouldn't be too fixated I think on the last quarter or so as we ran some promotions on that case. We've said over time that over the long period we think ASPs can be relatively stable, plus or minus. And the other piece that kind of enters into it, the second piece I forgot to mention is when you look at the types of doctors we're bringing in.

So as we dabble and penetrate and so forth the GP market, those doctors that are submitting lower cases are typically paying higher prices for those cases. As those doctors get engaged, whether they're GPs or orthos, they have an opportunity to participate in volume discounts.

And so as we improve utilization in either the GP channel or in the ortho channel, we basically share, you might say, with those doctors some of the economic benefits of that adoption from the standpoint they get higher discounts and of course we're getting more volume as a result.

And depending upon how that mix is from one quarter to the next, you're going to see some volatility, you might say, in ASPs. So for example in Q3 we know it's a heavy quarter for teens, particularly here in North America, and that typically goes to orthos.

And when you look at ortho adoption, our ortho doctors are typically the ones that participate more regularly in those advantage pricing tiers and so forth. So I wouldn't get too fixated with some ups and downs that you're going to see quarter-to-quarter. And as I said a minute ago, over the long term we think ASPs will be stable, plus or minus..

Great. Thank you for the very detailed response. Appreciate it..

Thanks, (sic) Robbie. Well, everyone, I think this concludes our call today. We appreciate your time and look forward to seeing you at upcoming conferences and industry meetings. If you have any follow-up questions, please contact Investor Relations. Have a great day..

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation..