Shirley Stacy - Align Technology, Inc. Joseph M. Hogan - Align Technology, Inc. John F. Morici - Align Technology, Inc..

Robert Patrick Jones - Goldman Sachs & Co. LLC Brandon Couillard - Jefferies LLC Jonathan David Block - Stifel, Nicolaus & Co., Inc. Elizabeth Anderson - Evercore ISI Steve Beuchaw - Morgan Stanley & Co. LLC John C. Kreger - William Blair & Co. LLC Matthew O'Brien - Piper Jaffray & Co.

Richard Newitter - Leerink Partners LLC Erin Wright - Credit Suisse Steven J. Valiquette - Barclays Capital, Inc. Jeff D. Johnson - Robert W. Baird & Co., Inc. Ravi Misra - Berenberg Capital Markets LLC Michael Ryskin - Bank of America Merrill Lynch Chris Cooley - Stephens, Inc..

Greetings and welcome to Align's Q3 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Shirley Stacy, VP of Corporate and Investor Communications..

Good afternoon, and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me for today's call is Joe Hogan, President and CEO; and John Morici, CFO. We issued third quarter 2018 financial results today via GlobeNewswire, 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 November 7.

To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13683414 followed by pound. International callers should dial 201-612-7415 with the same conference number.

As a reminder, the information that the presenters discuss today will include forward-looking statements, including statements about Align's future events, product outlook and the expected financial results for the fourth quarter of 2018.

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 statement.

We have posted historical financial statements, including the corresponding reconciliations and our third quarter conference call slides on our website under Quarterly Results. Please refer to these files for more detailed information. With that, I'll turn the call over to Align Technology's President and CEO, Joe Hogan. Joe? ..

Thanks, Shirley. Good afternoon, and thanks for joining us on our call today. I'll provide some highlights on the quarter and then briefly discuss the performance of our two operating segments, clear aligners and scanners. John will provide more detail on our financial results and discuss our outlook for the fourth quarter.

Following that, I'll come back and summarize a few key points and open up the call to questions. I'm pleased to report third quarter results with revenue and earnings above our outlook, driven by higher-than-expected Invisalign volume, offset somewhat by lower ASPs and foreign exchange. We also had another record quarter for iTero scanner business.

Q3 Invisalign volume increased 5.5% sequentially and up 35.3% year-over-year, reflecting strength across regions and customer channels as well as strong growth from both teen and adult patients.

From a product perspective, we saw strength across the Invisalign portfolio, with growth from both the comprehensive and non-comprehensive products, reflecting acceleration in the non-comprehensive category related to expansion of our product portfolio, as well as new sales programs and promotions intended to increase adoption and utilization.

We also saw continued strength from international regions, especially Asia-Pacific, which is our second largest region after the Americas in Q3.

Finally, during Q3, we trained another record 4,930 doctors, driven by APAC and Latin America, including Invisalign Go doctors, which represent continued expansion of our customer base, especially GP dentists. And Invisalign utilization increased overall to 6.1 cases per doctor, including another record for NA orthodontists.

Overall, while I'm pleased with the strong volume growth that we achieved this quarter, there were a couple of unexpected factors that impacted our results.

In Q3, Invisalign ASPs were down sequentially due to a combination of promotional programs, unfavorable foreign exchange and product mix shift, partially offset by price increases across all regions. John will provide more details on this in his commentary.

Now let's turn to the specifics around our third quarter results and let's start with the results of our America region.

For the Americas, Q3 Invisalign case volume was up 5.1% sequentially and 29.1% year-over-year, reflecting better-than-expected volume in both our orthodontist and GP dentist channels, driven by strong teenage case volume from orthodontists and adult patient growth across both customer channels.

For the Americas region, year-over-year growth was led by orthos, with another record quarter for North American ortho utilization at 17.4 cases per doctor. Q3 Invisalign utilization for North American GP dentists was up year-over-year at 3.5 cases per doctor, reflecting continued expansion of the GP customer base.

We also saw strong volume growth from the dental service organizations or DSOs channel, which increased over 40% year-over-year in Q3. In Q3, we trained over 2,000 new Invisalign doctors in the Americas region, of which 560 were in Latin America alone, primarily Brazil.

As the world's second largest market for cosmetic procedures, Brazil is estimated to have more than 1 million new orthodontic case starts each year.

In September, we hosted a grand opening event at our new office in São Paulo, Brazil with local doctors to thank them for their ongoing support in helping to build the clear aligner market in Brazil through Invisalign practices.

We also hosted the grand opening of our newest facilities in Costa Rica located at San Antonio business center, with plans to open another multimillion-dollar facility located at La Lima later this year. The new facilities will eventually house all of our Costa Rica employees, provide space to accommodate our long-term growth.

For international doctors, Q3 was another good quarter with Invisalign case volumes up 6.2% sequentially, reflecting a very strong quarter for APAC, offset by EMEA's seasonality, especially in Southern Europe markets which typically have extended summer holidays.

Year-over-year volume growth of 45.6% for international reflects increased utilization and continued expansion of our customer base. In APAC, Q3 was a strong quarter with Invisalign volumes up 56.4% year-over-year, with record shipments for all country markets except Korea.

Q3 results reflect record utilization for APAC driven by strong growth from teenage patients as well as growth in the GP dentists channel up 83.2% compared to last year. During Q3, we trained 1,730 new doctors in APAC, of which 310 were iGo doctors.

We also held several clinical education events across APAC designed to help increase doctor's confidence in and the adoption of Invisalign treatment, including how critical the iTero scanner is to practice growth. In China, we hosted the China Orthodontic Society, or COS, annual meeting with over 1,000 doctors.

In Japan, we held an Invisalign Forum with clinical speakers focused on teen treatment, including Invisalign First cases, adding iTero to their practice and Invisalign G6 innovation.

In ANZ, we launched Invisalign First clinical education events and practice marketing activity and received positive feedback with great uptake of Invisalign First cases.

In EMEA, Q3 was down sequentially due to expected seasonality up to 36.2% year-over-year, reflecting strong growth including the teen segment, which was up over 60% from the prior year. Year-over-year we saw strength across our core markets led by France, Iberia and the UK, as well as our key expansion markets led by Central and Eastern Europe.

We're also continuing to help expand the market for clear aligner treatment with approximately 1,100 newly trained doctors in EMEA, which include 485 iGo trained GP dentists. In Q3, we hosted a number of doctor-centered peer-to-peer events, including our first GP Growth Forum in Copenhagen.

We also hosted the grand opening of our new treatment planning facility in Madrid, Spain, which serves the Iberia market. Our Madrid facility aims to increase our commitment to Invisalign trained doctors in Spain and Portugal, and will play a key role in our strategy to be closer to our customers and support them in digital treatment planning.

In October, we hosted our first MEA or Middle East and Africa Forum in Dubai, highlighting the growth of the MEA orthodontic market, as well as showcasing our latest advances in digital dentistry that provides practice growth opportunities for dentists. Now, turning to the teen segment.

In Q3, 98,500 teenagers started treatment with Invisalign clear aligners, an increase of 25.6% sequentially and 41.1% year-over-year, driven by continued strong adoption across all major regions, led by North American orthodontists.

Q3 was the eighth consecutive quarter that Invisalign teen patient volumes grew faster than adults, reflecting a continued shift toward younger teens and tweens. The Q3 year-over-year Invisalign teen patient growth for North American orthos increased 32.8% and international doctors were up 60.9%.

In Q3, we launched an expanded Invisalign portfolio including Invisalign First for Phase 1 treatment of young patients age six and up. On July 1, we began offering Invisalign First to doctors in North America, EMEA, and ANZ and Japan. We shipped almost 2,000 cases to over 600 doctors during Q3.

Half of the cases were in North America, and nearly 60% of the Invisalign First patients were 8 or 9 years old. The Phase 1 segment of the market is really important for us because it's a large piece of the overall orthodontic cases. But it will also help us gain share in the teenage segment.

The Invisalign Experience program is a comprehensive way of describing all of Align's activities to engage consumers or potential patients through brand experiences in consumer-friendly settings and environments, including busy mall and lifestyle centers. We started out calling these locations stores.

We've realized this is confusing and concerning to some of our doctor customers. We're not selling Invisalign treatment to consumers in these locations.

Doctors have always been essential to Invisalign treatment, and a doctor's prescription based on an in-person examination remains the only way that Invisalign treatment can be delivered to a patient, even if a consumer learns about the Invisalign brand in new or different ways.

In late 2017, we launched the Invisalign store pilot program to create and test interactive Invisalign brand experiences in high traffic retail locations.

Our goal was to educate and engage consumers who might be interested in treatment but aren't showing up as typical consults in offices, and get them connected with an Invisalign doctor of their choice.

Based on what we have learned in last year and across the first four locations in this program, we are expanding this program and will open eight additional Invisalign Experience locations in the fourth quarter.

The first four Invisalign Experience locations have shown great progress since opening and have contributed to a significant influx of consumer interest in the orthodontic marketplace surrounding each location.

Key performance metrics suggest that the addition of an Invisalign Experience location can have a significant positive impact or halo effect on overall Invisalign patient growth in the surrounding area, even among doctors that are not directly participating in the Invisalign Experience program network.

It's a new way of creating awareness for brand, capturing someone else's attention when they're not even thinking about straightening their teeth, and it benefits all Invisalign practices in the market.

In Q4, under the Invisalign Experience umbrella, we're launching a major test of the program in New York City with a significant investment in media to reinforce the importance of doctor-led Invisalign treatment and a premium consumer experience to drive qualified consumers to partner doctor practices.

On November 5, we will launch a targeted media campaign in New York to take advantage of growing interest in the clear aligner category to capture and direct consumers to Invisalign-branded locations and pilot practices. This test includes an Invisalign-branded kiosk at the Oculus Center on November 17 as part of the Holiday Market.

Number two, piloting Invisalign Experience-branded doctor practices designed to attract prospective patients, connect them with the Invisalign brand and an Invisalign practice for treatment. And three, empower doctors with new tools, services and support to elevate the patient experience, amplify the message and grow their practice.

We're very excited about this program along with several other media campaigns kicking off in Q4 to put doctors at the center of everything we do. We've learned a lot from the Invisalign Experience locations and the doctors who have worked with us in the network to-date.

We're applying what we have learned and are constantly working to make the Invisalign Experience program better for consumers and better for the practices who opt-in to receive those leads.

One of the things we've learned from this and other initiatives is that a lot of Invisalign doctors want to do more in their own markets to connect with new consumers.

They want to create an Invisalign Experience in practice to connect with potential patients in new ways and want to leverage the total Invisalign iTero digital experience to make starting treatment easier and more convenient for them.

We want to help them to do just that, so under the Invisalign Experience program umbrella, we're working with a few doctors in select U.S. markets to explore what an Invisalign Experience looks like in wholly doctor-owned, consumer-focused environment.

We're calling this pilot an Invisalign Experience branded practice and are working with participating doctors to apply some of the lessons and design elements from Invisalign Experience locations to their practices. Some of these pilots will be in markets where we have Invisalign Experience locations, but most will not.

Doctor-owned Invisalign Experience practices don't complete with Align. We're all working together to reach consumers in new ways. We'll share more progress with you and details on the different ways we're partnering with doctors under the Invisalign Experience umbrella in the coming quarter.

Our Smile Concierge program that we launched at the beginning of 2017 is continuing to help more consumers start Invisalign treatment by shortening their research cycle and connecting them with an active Invisalign doctor.

Year-to-date, we scheduled over 74,000 Invisalign consultations in the U.S., which equates to connecting hundreds of consumers to Invisalign doctors every day, providing leads they might not otherwise have had. The Smile Concierge service has also expanded outside the United States with teams in Singapore, Brazil, Australia and the UK.

And Q3 was a very strong quarter across the board for our iTero scanner and services business, with better than expected revenues which were up 37.2% sequentially and 79.1% year-over-year. Record Q3 results reflect commercialization of the iTero Element 2 and Element Flex scanners, especially for restorative GP dentists in North America.

Continued rollout with DSO partners and increased sales internationally including China, we have also begun to manufacture the iTero Element. Use of the iTero scanners for Invisalign case submissions in place of PVS impressions continues to grow and remains a positive catalyst for Invisalign utilization.

The Q3 total Invisalign cases submitted with a digital scanner in the Americas was essentially flat at 68.8%. International scans increased 51.6% of total Invisalign cases submitted in Q3.

We are very excited about the continued progress we have made with the iTero business and remain confident it will continue to help drive our overall growth and help increase adoption of Invisalign treatment.

Before I turn the call over to John, I want to share this important news with you today regarding our Chief Marketing Officer or CMO, Raph Pascaud. After more than eight years with Align, Raph has made a personal decision to reduce his responsibilities and transition to a part-time position in order to spend more time with his family.

As a result, we have begun an executive search for a Chief Marketing Officer, and will be working to find a replacement for Raph's marketing position over the coming months.

Once we've hired a new CMO, Raph will transition his marketing responsibilities to that leader, but he will continue to lead the business development and strategy for the company. Raph will also remain on the Executive Management Committee, reporting directly to me. Raph's contributions to Align have been significant.

He's held numerous leadership positions across the organization, including Head of International, Marketing, Product Portfolio and Business Development, as well as overseeing the iTero business.

We're fortunate that Raph will remain directly engaged in our strategy and overall business plans and will be able to help the new CMO come up to speed quickly. Until then, nothing changes and Raph remains Align's CMO and SVP, Product Portfolio and Business Development.

We're sharing this news with you today so we can openly recruit for a new CMO and so Raph can begin to develop a transition plan with his global marketing team. With that, I'll now turn the call over to John..

Invisalign case volume is expected to be in the range of 330,000 to 335,000 cases, up approximately 29.4% to 31.4% year-over-year.

We expect Q4 revenues to be in the range of $505 million to $515 million, an increase of approximately 20% to 22% year-over-year, reflecting strong growth for Invisalign volumes, offset by lower ASPs due primarily to ongoing promotional discounts, the effect of our new Advantage customer loyalty program, continued mix shift toward non-comprehensive products as well as foreign exchange.

We expect Q4 gross margin to be in the range of 72.3% to 73%, reflecting lower margins as we begin to produce clear aligners in our new manufacturing facility in Ziyang, China, where we will initially have higher fixed costs spread across very low volumes. We expect Q4 operating expenses to be in the range of $248 million to $253 million.

Q4 operating margin should be in the range of 23.2% to 23.9%. Our effective tax rate should be approximately 22.5%. We expect approximately $2 million equity loss related to our share of SmileDirectClub. And diluted shares outstanding should be approximately 81.3 million exclusive of any share repurchases.

Taken together, we expect our Q4 diluted earnings per share to be in the range of $1.10 to $1.15. In addition, as we continue our operational expansion efforts, we expect CapEx for Q4 to be approximately $50 million to $55 million. And we expect depreciation and amortization to be $15 million to $16 million.

Now let me turn to our view for the full-year 2018. Based on our Q4 guidance, we continue to expect 2018 total revenue growth rate to be above our long-term model and in the low-30s. We expect Invisalign revenue and volume growth to also be in the low-30s.

Taken together, we continue to expect operating margin for the full-year 2018 to be slightly up from 2017 operating margin of 24%. With that, I'll turn it back over to Joe for final comments.

Joe?.

Thanks, John. Overall, Q3 was another good quarter with strong growth for both the Invisalign and iTero businesses. Our performance reflects continued success in driving adoption and utilization across all region and customer channels, as well as an increased traction in new expansion markets with our DSO partners.

We have a huge market opportunity ahead to connect millions of consumers with Invisalign doctors for orthodontic treatment, and whether it's through traditional routes in a doctor's office or through new consumer-friendly approaches like the Invisalign Experience program, we are committed to a doctor in the center of everything we do.

Align is the best positioned company to help doctors successfully navigate the rapidly-changing dental market. We're excited to be guiding them through this digital transformation.

I look forward to following up with many of you in the coming weeks at various conferences and industry meetings, including the Invisalign Ortho Summit in Las Vegas next month where approximately 2,500 doctors and their staff will spend two days sharing Invisalign and iTero best practices, one of our most important peer-to-peer clinical education events.

With that, I'll turn the call over to the operator.

Operator?.

Our first question comes from the line of Robert Jones from Goldman Sachs. Please proceed with your question..

Great. Thanks, Joe and John, for the question. I guess just to start on the lower ASPs, which you guys provided some details around at least the areas that impacted it. And John, if I heard you correctly, it sounds like of the $85 sequential decline, if I remove FX, it would have been more like $60, $61 sequential decline.

So, of that decline, I was hoping maybe you could just break down how much of that came from promotions versus mix shift. And then I guess the follow-up would be, I don't necessarily remember you guys talking so much about the additional promotional program.

So, curious if there was something in the marketplace that kind of forced you to react to put the promotions in place, or if this was something that was always planned and maybe the uptake was just greater than you thought?.

Yeah. Hey, Bob. This is John. On the remaining piece that's left, about half of the drop in ASPs was due to mix. It was mix shift to the lower stage products. And about the other half or $30 or so was related to those promotions..

And Bob, it's Joe. Look, obviously on the Advantage Program and the special programs we ran for the quarter, we do this all the time. We're trying to encourage customer stickiness. We're checking out different segments of the marketplace. We do this all the time. But in this case, what happened is we incentivized the upper end of our customer segment.

We did not get the engagement in the lower end that we anticipated. And so, in that sense, we will shut that thing down. We won't repeat it again. We obviously learned from it and we move on..

And then I guess, Joe, just to follow-up on that then, as we think about ASPs for 4Q and then more importantly beyond 4Q, is it safe to assume that FX will be what it is but that at least the portion of the headwind from the promotion should normalize?.

Yeah, that's correct. Think about it as flat, Bob..

Got it. Thanks, guys..

Yes. Thank you..

Our next question comes from the line of Brandon Couillard from Jefferies. Please proceed with your question..

Thanks. Good afternoon.

Maybe, John, in terms of the aligner gross margins in the quarter, can you break out the impact of the manufacturing capacity expansions relative to ASPs? And as you look into 2019, given we're kind of bouncing along the low end of your three- to five-year model here at about 73%, would it be logical to expect year-over-year expansion in terms of the aligner margins as you start to soak up some of that new manufacturing capacity expansions?.

Yeah. You're right, Brandon. I mean, what we'll see initially because of the low volumes, we'll see more of that fixed cost over that low volume. So, that's a 0.5 to 1 point impact due to the manufacturing start-up. And then as we get more efficient, we should see some improvement as we go forward related to those manufacturing costs..

Thanks. And then one for Joe. The OpEx guidance for the fourth quarter implies the slowest year-over-year growth rate in a few years now.

To what extent are you beginning to see perhaps some diminishing returns from incremental investments, be it feet on the Street or marketing or otherwise, perhaps in some of the more international and emerging markets?.

Brandon, I think if you look at our growth, I mean our growth is above 30% right now. So we don't see any diminishing returns in that sense. Remember, we had a big third quarter when you look at our volume growth versus other years.

So the normal sequential kind of iteration that we go through between third and fourth quarters, we don't really believe it's going to be as dramatic as it has been in the past. And so this doesn't reflect anything from a market standpoint.

Remember, as you look at our performance overall, international market's performed extremely well, okay? We still had incredible shipments in North America from an Invisalign standpoint. We also had great iTero, too.

So, primarily what we're looking at is what we have with these promotions in the sense of the ASPs driven by them and the corrections we have to make as we go into the fourth quarter..

All right. Thank you..

All right, Brandon..

Our next question comes from the line of Jon Block from Stifel. Please proceed with your question..

Great. Thanks, guys. Good afternoon..

Hey, Jon..

Hey, Joe. First one, John, I think you mentioned flat scanner revs Q-over-Q and I've got to make some other assumptions. But I'm backing into around a $1,200 Invisalign ASP for 4Q 2018 based on your volume guidance. 3Q 2018 I believe was $1,230 on a worldwide basis. You mentioned some of the promotions that were run in 3Q will not be repeated.

So why the continued decline on the worldwide ASP into 4Q? And then do we think about extrapolating that $1,200 if I'm right out to 2019? And then I've got a follow-up..

Yeah, Jon, I would look at Q4 as continued mix effects that we have. So, as we are – the low stage that we've seen through Q3, some of the mix shift that's happening, that will continue into Q4. But like we had said, those promotions that we had, those specific promotions that were driving down some of the ASPs in Q3 will not continue into Q4. ..

Okay. And then, Joe, you may have answered this to Robert's question earlier, so I apologize if this is redundant. But I think it's important obviously with the focus on the promotion.

So, can you be a little bit more clear that the promotions that you ran in the quarter, you hear the word promotions at the same time that two or three comprehensive clear aligners were introduced in the market for the first time ever and that's going to freak a lot of people out, right? So the promotions that you mentioned, were those specific to express-type cases? Were they more specific to comprehensive? Any clarity you can give would be great.

Thanks, guys..

Yeah. Jon, to answer your question backwards is, these are comprehensive cases. From a competitive standpoint, look, we continue to monitor the competition in the marketplace. Ormco is still out in ANZ and not completely engaged. 3M has obviously hit the marketplace in the United States and we see it.

But these promotions were not geared toward trying to stop any competition that we're feeling right now. That wasn't the whole part of this promotional piece. Remember, third quarter's a big teen season. We had to make sure that we run the proper promotions going in there. This is a teen promotion and also an adult promotion too.

Again, we're just trying some things in the sense of incentivizing the marketplace and it just happened to engage the upper tier of our Advantage Program rather than a lower tier that we had hoped. And these go on all the time kind of under the radar screen, Jon, and we don't talk about them.

This one in the sense of how it performed obviously affecting ASP, we just have to give you clarity on it. But, again, I want to re-emphasize, this is not based on anything competitively that we saw in the marketplace that we thought we had to move around..

Very helpful. Thanks, guys..

Our next question comes from the line of Elizabeth Anderson from Evercore ISI. Please proceed with your question..

Hi. Yeah. Thanks for the question. Speaking of what you were just talking about on sort of engagement in the lower end of the market, how are you sort of thinking about what you're going to shift going forward? That would be my first question.

And then could you sort of also talk about the typical GP path in that lower-end customer? Do they start with lower-priced products and then sort of move up, or do they sort of stay in that lower-level product mix shift? Any further color on that would be really helpful. Thanks..

Thanks. Actually can you repeat the first question? You're kind of light on the volume. We couldn't hear the first part of your question..

Oh, sorry about that.

Is that better?.

Yeah..

Yeah..

The first part of my question was, obviously, you said that you didn't get the engagement you were hoping for on the lower end of the market. And so I was just wondering sort of what you've learned from that and sort of how you're thinking about that engagement with that segment of the market going forward..

Yeah. On the lower end of the marketplace, it's just exactly how we target those incentives and how broad do we make them, okay? This was broad across all of our Advantage tiers. In the future, we'll just have to focus on the lower tiers in that sense in order to encourage that piece. I mean, it's that simple kind of feedback.

We thought it'd be more of a balanced response across the tiers and it wasn't. And now on the GP, I think your second question had to do with GP doctors and how they get engaged.

With iGo, as we start iGo, it's a mid-range product that we position with GPs that allow them to be able to do certain kinds of movements that we think are relatively simple to learn and for doctors to really start off the product line.

And so, as you see the iGo growth all around the world, that's predominantly what we'd call a mid-range product that we're positioning with GPs at the moment..

Okay. Thank you..

Does that help?.

Yeah. That was helpful..

Yeah. You're welcome..

And Elizabeth, I'm just going to add one other thing just in terms of what we're talking about with respect to ASP.

The other part of the conversation has to do around the new Advantage Program this year and how that has additional tiers, and intended obviously to incentivize doctors to move up in tiers, and what we saw was the higher volume doctors moving up in tiers more than the lower tiers. So, that's part of the impact as well..

Our next question comes from....

Question....

Sorry?.

Go ahead, Jeremy..

Our next question comes from the line of Steve Beuchaw from Morgan Stanley. Please proceed with your question..

Hey, Steve..

Hi, and thanks for the time here. I wonder if I could come back, Joe, to a point that you made earlier, maybe an intersection of a couple points. I mean, you talked about how doctors are thinking about an evolving environment.

I wonder is there something in the environment that is changing the way that clinicians respond to promotions or product line efforts or to the Advantage Program? Is there something different about it this time? I ask the question because historically the company has a lot of experience running these types of programs..

Yeah. Steve, I don't think the market is conditioned any differently than it's been before. The biggest change we've seen in the market is really just SDC in the United States marketplace. But that is a completely different segment since it's not through doctor's offices, and obviously that's not where the competition is right now.

I think if you look at this, Steve, I think with this new Advantage Program we launched in North America in 2018, it just has a different series of brackets, a different series of rewards, at different kind of bonus levels. We haven't really engaged promotions around those things before.

So it was a little bit of a learning curve in the sense of how those brackets, as Shirley talked about yesterday actually respond to these kinds of promotions. Don't look at this – I think I can understand your questions and the previous questions about, is there some external aspect that's really driving those things.

If there was an external some kind of catalyst in this sense, we'd tell you. I'd tell you, okay? That's not why we do these things. We do these things to encourage customer stickiness. We do these things to figure out what really works in the marketplace. Look, I've never been in a business that has price elasticity curves like this business.

And you really have to study those. We launch promotions, we do them at certain prices. We see what the uptakes are and we learn from those things. We're just launching this against a different type of an Advantage structured program and these tiers are different and this take-up was completely different than what we've seen before..

Okay. Got it.

And then just to follow-up on your point about SDC, I think I know the answer to this, but your view is still that any overlap between SDC cases and Align cases is low-single-digit percentage-wise, is that still correct?.

I think we've always said it's about – back when we were actually comparing data with these guys, back before our lawsuit, and it was about a 10% overlap is what we saw overall. We don't have any information that would change that at all at this point, Steve..

Okay. Perfect. Thank you very much..

Our next question comes from the line of John Kreger from William Blair. Please proceed with your question..

Hey. Thanks very much. Joe, any update on the timing for mandibular advancement in the U.S.

or the palate expansion product that you talked about at Investor Day?.

Yeah. Hey, John. We're expecting in the fourth quarter is what we said all along. Our communications with the FDA have been nothing bad or anything that would suggest that we're not on course. So I'd just say we're still sticking to our plan of being able to launch this product in the fourth quarter United States..

Okay.

And then how about the palate expander product?.

Palate expander, we're still working through that. When you think about it, our Invisalign First product is a palate expansion product but it's not a rapid palate expansion product. So we're digging into that six- to eight-year, nine year marketplace with Invisalign First.

We're still working through – in fact, I went through it this morning with a team. We're still working through the rapid palate expander and we'll give you an update on that as there's more to talk about. We're still thinking it's trialing in 2019 like we indicated at the most recent investors' conference..

Okay. Thanks.

And then maybe just, John, any kind of key puts or takes you want to call out as we start thinking more about the outlook for 2019? I assume FX will be a bigger factor in the coming year?.

Yeah. We're not giving the 2019 guidance, as you know, John. But FX is a piece of it. We call it out. It is what it is. And then everything else is on our operational performance. But we'll give a good update on 2019 at the next call..

Great. Thank you..

Yeah. You're welcome, John..

Our next question comes from the line of Matthew O'Brien from Piper Jaffray. Please go ahead..

Afternoon. Thanks for taking the questions. So, if I look at your slides that you provided, slide 30 specifically, you can see a step-down Q3 to Q4 on the pricing side both worldwide and internationally. Were you running some kind of program similar to this back then? And then we saw recovery over the next several quarters.

Is that something kind of like what we should expect this time around?.

Yeah. I mean, what we see, Matt, that comes through some of those slides and trends is FX effect. So, if there's foreign exchange that comes through there, it shows up as well. So, some of that, especially when you look on the international side, you can see some of the FX effects there..

Sure. Just to punch a little bit further on that question specifically though, the moderation that you should get from the promotion going away, maybe some more mix benefits going forward. This should be kind of the low watermark maybe here in Q3 for the ASPs with the gradual increase over the next several quarters.

Is that fair?.

Yeah. I think what we're expecting is kind of the Q4 ASPs that we're kind of calling should be that low point and that's how you should think about things going forward..

Okay. And then as the follow-up question and actually to talk about something positive in the quarter, even though there was a lot positive. On the scanner side specifically, can you parse out a little bit where that performance came from? Because that should be a pretty good leading indicator for the business going forward.

DSOs, international, et cetera, would you mind just providing a little more color there?.

Yeah. Matt, it's Joe. When you look at it, every region we had a lot of strength in iTero. You start with we have now major penetration into China and great uptake there. Last year, we were approved in Japan and that's been good too. So, really all up and down Asia it's been strong.

In North America, it's been strong across our individual doctor base but also, as you mentioned, the DSOs have been very strong also. And then also in the quarter, we did see increasing momentum with iTero scanners over in Europe too, which is our most difficult competitive market. We have good momentum there too.

The launch of the Flex product line and iTero 2 were really great launches. Customers loved the product too so the response has been terrific. So, everything has been working extremely well with that business. But remember, that's just a wonderful footprint for us for future Invisalign business once we have those scanners in place..

Got it. Thank you..

All right, Matt. Thank you..

Our next question comes from the line of Richard Newitter from Leerink Partners. Please go ahead..

Hi. Thanks. I wanted to just clarify. I think you had said you're still expecting mandibular expansion – I'm sorry, the mandibular product in the fourth quarter, best of your ability to predict the FDA.

Is it right that that's not factored into your Invisalign case volume guidance or your 4Q guidance?.

Yeah. We don't factor it in, but honestly within one quarter of the launch of that, we wouldn't expect anything material, Richard, to report in that sense. And that's not anything to do with mandibular advancement. It's just the way things work around here in the sense of doctors will try this, they'll do a few cases, they'll get used to it.

And then, as we move into 2019, we'll give you some idea of what we think mandibular advancement United States uptake would be..

Okay. That's helpful. And just maybe one other one. I noticed that the percentage of cases submitted with a digital scanner in the Americas was flat and it's been increasing almost every quarter for quite some time.

I'm just wondering if that's somehow linked to some of the kind of anomalies that we saw around trends with ASPs or if there's any other explanation there?.

No, Richard, there's no correlation with the ASP side. Remember, last year, we ceased allowing 3Shape to be able to submit scans. And so those doctors would have to go back to PVS impressions, and we think that's pretty much what drove that. Obviously, our scanner sales have been really strong in United States.

So we think that's just basically a re-submittal because of the situation we have with 3Shape right now..

Okay. Thanks a lot. And then maybe just one last one. You said that you didn't get an expected kind of reaction in the marketplace from kind of the promotions across kind of both parts of the market, complex and simple.

I guess what's your hypothesis as to why it didn't work on the low end of the market? Or do you have kind of a running assumption as to what maybe you got wrong or why it didn't work?.

Yeah. I think, Richard, first of all, it's not low end, it's low tier. So we have an Advantage Program. An Advantage Program has several tiers.

It starts at Bronze, it goes all the way up to Double Diamond, okay? And so, when we talk about that, these are still broadly their comprehensive cases, okay? When you put these promotions in place, you want to make sure you're sensitive in the sense of who you're incentivizing across these brackets, right? What we're saying is we didn't have strong enough incentives on what we'd say the lower end of our Advantage tier program.

And, obviously, that'd be the change we'd make going forward.

Makes sense, Richard?.

Yeah. Thanks..

I thought we lost you..

All right. Our next question comes from the line of Erin Wright from Credit Suisse. Please proceed with your question..

Great. Thanks. I won't ask about ASPs, but the Invisalign Experience locations, could you provide any sort of new metrics around in terms of conversion rate or traction or any sort of key performance kind of metrics there. And how will the economics work for the doctor-led Invisalign Experience locations with the rebranding and all? Thanks..

Erin we haven't given any statistics yet on our Experience centers. And we only had four stores, and now we're expanding the other eight stores right now. As we move into 2019, we'll be more transparent with that information. The doctors can engage in several ways. The doctors are actually engaged with the store.

These products have a certain premium assigned to them, because we actually attract the patients and send the scans to the doctors or whatever. So, depending on what it is, Signature, Signature Plus or Deluxe, there's obviously a lab fee for the aligners but there's also a certain fee for those types of products.

And then we're talking about the halo effect too. The halo effect, sometimes it's the doctors who aren't even associated with the program at all, we're still seeing a significant increase in Invisalign sales to those doctors just because of just the raising the awareness of Invisalign and doctors in that specific geographical area.

And those are areas of anywhere between 10, 25, up to 50 miles we start to see that kind of response..

Okay. Great. And then you've previously alluded to financing initiatives for customers that seems to make sense here, but I don't really hear you speak much about it. I guess where does that stand today on that effort? And that remains purely a third-party relationship today? Thanks..

Hi, Erin. Yeah. This is John. Yeah, the financing, it continues. It's primarily in the U.S. and it's something where it's financing that's not on our balance sheet's third-party company that we work with. And really we're just trying to find easier ways for our end consumers to be able to use Invisalign and make things easier for them.

So we continue to do it. It's part of the conversion that we try to use. And it's been rolled out across the U.S. for a few quarters now..

Okay. Great. Thank you..

Welcome..

Our next question comes from the line of Steven Valiquette from Barclays. Please proceed with your question..

Thanks. Good afternoon. So I guess for the 35% case growth in the quarter, which obviously accelerated pretty nicely. I'm just curious if there's any color on how much of that volume growth was maybe tied to what we'll call the overly enhanced promotional activity.

Or are you more of the mindset that maybe you would have had essentially the same case volume growth overall if there were no alterations to the loyalty program? Thanks..

Yeah. Steve, we can't nail it exactly, but we can tell you it's 1% to 2% on the North America volume..

Okay.

One other quick one – again, if you're slightly off on where you want to be on your ASPs because of this activity, just kind of thinking out loud without giving anything away for next year, just curious if you also think you could potentially increase list prices maybe a bit more than normal to get you where you want to be on ASPs for 2019, just as another lever that you could pull if you wanted to when thinking about optimizing price..

Well, you don't want to comment on price going into a year. We never do that, Steve. But we have raised price every year in the last three years. Obviously we raised price in this quarter, too. And it's been part of our strategy. It fuels a lot of the things we would do.

We talk about Invisalign Experience and our marketing campaign and driving customers' adopters, also all the technology we invest into. So it's been a pretty large part of our strategic plan. But I don't want to comment on 2019 in that sense..

Okay. All right. Got it. Thanks..

Our next question comes from the line of Jeff Johnson from Robert Baird and Company. Please proceed with your question..

Thank you. Good evening, guys..

Hey, Jeff..

Hey, Joe. So let me start just on the Invisalign Experience. It sounds like you're moving that into some private practitioners or some other offices here in the fourth quarter.

Any discussions on moving that into the DSO channel where you could almost supercharge that or really get into 600, 800 offices at a time? And in those cases, I think you alluded to it, Joe, a little bit in your comments just a second ago.

But my sense, at least from the conversations I've had is that the gross margins are actually accretive in cases that come through that kind of channel because you're kind of doing some of the work to get the patient into that office.

Is that a fair way to look at that?.

Yeah. Jeff, it's a really fair way to look at it. I mean, we talked about Aspen last quarter. I mean, the whole idea of the Aspen piece and their uptake of iTero scanners was to put what we used to call a store in store. We now call it an Invisalign Experience thing in the doctors' offices within Aspen.

And part of what we've done in the stores is we've created obviously consumer material. We've created a lot of things. From a customer engagement standpoint, turning customers into patients, we put those in place and we'll be able to employ in those DSO stores too.

So, that's been a big part of our strategy and it's one of the reasons you see such a big uptake in the DSOs that we've been selling to and reporting..

Yeah. Fair enough. And then, again, there hasn't been enough ASP questions here tonight but I just want to understand, John, your comments. You get some of the promotional activities right-sized in the fourth quarter. Currency probably is a little bit bigger of an impact going forward.

So, fourth quarter you would expect ASP to be down sequentially a bit versus 3Q, is that right? And then we kind of see a recovery throughout 2019 or at least a little bit trending up in 2019, as some of those currency headwinds in the back half come off and maybe some of the promotional activity headwinds do as well?.

Jeff, what we would see is – you're right, on the FX, you see it come down a little bit from an ASP standpoint in the fourth quarter. But then from the fourth quarter, we expect it to be about flat, just given the mix and other things that we've talked about in terms of what we see in the business..

Okay.

And just to clarify that, so whatever our fourth quarter ASP, wherever that ends up, that you would expect holding flat, then moving throughout 2019 sequentially?.

Yes. That's how we would look at it..

All right. Thanks, guys..

Yeah. Thanks, Jeff..

Our next question comes from the line of Ravi Misra form Berenberg Capital Markets. Please proceed with your question..

Hi. Thank you for taking the question. Just a couple based on the margin outlook for the business. So, just working through that flat pricing outlook, how do we think about the gross margin implication on the aligner business. I mean, you have these plants coming online.

Is it similar type of kind of ramp that we look at a step-down from 3Q in the aligner gross model and that kind of remains flat or slightly increases going forward into 2019? And then, just a question on the marketing strategy, as kind of Raph steps aside, you have a number of new programs going on here. You have a new marketing leader coming in.

You have an orthodontic summit in a month.

How do you kind of like look at your dental segment and your customer base, the orthodontists here? Are we in a world where you're trying to get greater productivity from your top dentists and let the less productive guys I guess to call it less of a focus on that? Or is there room for everyone here? How are you looking to approach that? Thank you..

Ravi, I'll take the gross margin question. Yeah, as we said, coming online with some of the manufacturing, it's at certain amount of costs that we need some of the volume now to be able to spread those costs over. So we guided in Q4 to reflect that.

And then, as we get more efficient related to that manufacturing, both the manufacturing and the treatment planning that we have kind of globally, we'll start to see some of the efficiencies related to that manufacturing and treatment planning that will affect our gross margins..

And Ravi, it's Joe. Your question on the segment and top dentists versus – or top orthos versus lower brackets, I'd just end it by saying there's room for everyone. You have to segment this market always between general dentistry as we call GPs and also orthodontists.

But when we talked about at Investors Day, we see a market that we used to measure as 12 million case starts a year as potentially 300 million.

But what we specifically talk about with our doctors, particularly on the ortho side, is this is a massive what we call analog to digital conversion, right? If you really want to get the productivity of a digital-based orthodontic system that ends up in plastic, and that's what our process is, is you really have to do predominantly a majority of your business has to be in digital.

And those doctors that walk forward that want to go through that journey with us, we have a number of programs to take them through from financing to how you encourage more consumers, how you set up your practice, all those things, so you can make it as efficient as possible.

On the general dentistry side, we often work from a restorative standpoint to make sure that we can work within those restorative workflows and make sure that it's profitable for those docs and they understand how to use these things. Ravi, one thing I want to make certain, and maybe it's just me being overly sensitive.

Don't take Raph's announcement in any way as any indication that he had some responsibility for this promotional aspect for what went on. Raph's been tremendous for us. After running our international business, coming in and running marketing and strategic development and also business development, he's been critical to this business.

This is not some kind of smoke and mirrors. This is Raph making the decision from a family standpoint that he's had issues with that he has to deal with right now. We support Raph in that from a family standpoint. This has nothing to do with him..

Thanks. Next question, please..

Our next question comes from the line of Michael Ryskin from Bank of America Merrill Lynch..

Hey, guys. Thanks for squeezing me in. A lot of questions have been taken but I just want to follow-up on a couple points.

One is, are you getting any sense that the pretty substantial price difference in the quarter, the discounts, are they being passed onto customers by the dentists? I know it's tough to measure those channels sometimes and it's aggregated, but are you getting any sense that the dentists themselves are being squeezed on pricing by the end customer and they have to do something to adjust?.

We don't have any data, Michael, to hold up with that. I'd say, remember there's a million points of light in this business too because there's so many doctors overall involved. But I don't feel this has to do with having these promotions actually in some way and have that passed onto consumers.

It's just not the feedback we get or what we think is going on..

All right. And then a follow-up just real quick on the DSOs. I think you mentioned 40% growth in the quarter as a customer grouping.

And the mix is shifting, still a small part of the overall business, but is there anything that's different there in terms of how much price you're able to get with those customers versus some of the stand-alone docs?.

From a DSO standpoint, obviously these are large contracts we put in place. And there's significant price discounts in the sense for the volumes that the DSOs offer. So, when we talk about mix, there's a certain amount of mix associated with DSOs.

When you see these kind of growth rates, 40%, it's obviously some aspect of the mix that we're talking about. So, when you think about that too, Michael, is that we don't have to spend as much OpEx on the DSOs. And it's really important to understand. A lot of them since they're general dentists, they use their own patients to generate their demand.

The normal GP dentists would have 1,500 to 2,000 patients per office. We could help them mine those patients to understand which ones would want orthodontic treatment or could stand for orthodontic treatment or not. We don't have to have the amount of sales coverage that we'd have with individual doctors.

So you're going to have a lower overall ASP on those businesses, but we feel that from an OpEx standpoint we're not spending as much money too. So, from a gross margin standpoint, it's still positive for us..

All right. Thanks..

Yes. You're welcome..

Our next question comes from the line of Chris Cooley from Stephens. Please proceed with your question..

Good evening, and thanks for letting me just hop in here at the end. Just two quick ones for me. Maybe, Joe, to start with, you mentioned in one of the prior questions price elasticity curves for the market.

Could you maybe just give us your views, as the market continues to evolve, what level of margin you think that your higher echelon volume providers expect to maintain and maybe how that differs versus the lower tier provider as these markets evolve, just in terms of profitability by caseload? And then, just from a clarification standpoint, John, if I'm doing the math right, just kind of doing the puts and takes on the one-timers there on the tax rate in the quarter, am I right in that it's about $0.05 to the positive when we look at the net effect there for the 3Q? Thanks..

Yeah, just on the tax, we just gave kind of the highlights of the overall that affected tax. We had guided 21% and ended up at 19.5%. So you can pretty much say that it's 1.5% of our tax was a few things that came in a little bit favorable compared to what we guide. But those two were just kind of the big puts and takes for the quarter..

Understood. Thanks..

As far as the price elasticity curves by docs going forward or whatever, I don't have any comments on that or really any projections of what that's going to be. When we talk about those things, we talk about segments. It would be lower segments or comprehensive segments or teen segments and those kinds of things.

But we don't necessarily have that data by doctor or doctor tiers and where it's going to. And if we did have them, not so sure we'd share that anyhow. We just like to keep it at high level.

But I'll just tell you that we're aware of these price elasticity curves from a specific – not just demographic, but a specific area of the marketplace all over the world. And we'd have to do promotions and things to test those. And obviously, we respond to those either favorably or not depending on what signals we get.

It's an important part of why we do these programs..

That's helpful. Thank you..

Thanks, Chris. Well, thank you, everyone. That concludes our conference call today. If you have any further questions, please contact Investor Relations. And we look forward to seeing you at the upcoming conferences and at the Invisalign Ortho Summit next month. Have a great day..

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