Align Technology, Inc. (ALGN) Q1 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the Align Technology First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I would now like to turn the conference over to Shirley Stacy, Vice President of Corporate Investor Communications. Thank you. You may begin.

Thank you. Good afternoon, and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Investor Communications. Joining me for today is Joe Hogan, President and CEO; and John Morici, CFO. We issued first quarter 2019 financial results today via GlobeNewswire, which is available on our website at investor.aligntech.com. Today's conference call is also being audio webcast and will be archived on our website for approximately 12 months. A telephone replay will be available today by approximately 5:30 p.m. Eastern time through 5:30 p.m. Eastern time May 08. To access the telephone replay, domestic callers should dial (877) 660-6853 with conference number 13689188 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 second quarter of 2019. 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 first quarter 2019 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 from the first quarter and briefly discuss the performance of our two operating segments, Clear aligners and intraoral scanners. John will provide more detail on our financial results, discuss our outlook for the second quarter. Following that, I'll come back and summarize a few key points and open up the call to questions. Our first quarter was a very good start to the year with revenues, volumes, gross margin in EPS all above our guidance. Record Q1 revenues and Invisalign volumes were up 25.6% and 28.3% year-over-year respectively. Reflecting continued strong growth across all geographies and customer channels as well as strong iTero Scanner and Services revenues, which are up 55.1% year-over-year. Q1 sequential growth was driven primarily by North America and EMEA volumes reflecting strength across the Invisalign product portfolio. We saw a nice uptick in adoption of Invisalign treatment with a record utilization overall as well as expansion of our customer base, which totaled 57,000 active doctors worldwide in Q1. Now let's turn to the specifics around our first quarter results starting with the Americas region. For the Americas region, Q1 was a solid quarter with Invisalign case volume up 7.1% sequentially and 21.8% year-over-year reflecting growth in both our orthodontic and GP Dentists channel. Q1 we trained 1,700 new Invisalign doctors in the Americas region of which 1,400 were North American doctors. On a sequential basis Q1 Invisalign volume growth reflects record utilization for the Americas region overall driven by North American Orthros at 18.3 cases per doctor with good initial adoption with Invisalign mandibular advancement in North America driven by the mid-Q4 launch in the U.S. We also had solid performance from GP Dentists with continued momentum from Invisalign Lite, Invisalign Go. Invisalign Go provides a simple pathway for dentists to integrate mild to moderate tooth movement and to comprehensive care. And it makes it easy for GPs to refer out more complex cases to orthodontics in the network. Year-over-year Q1 Invisalign volume growth in the Americas region was driven by continued strength in the Ortho channel, especially from our high volume doctors with 25.9% growth as well as an increase of 15.5% from the GP channel. In March, we announced the collaboration with Digital Smile Design or we call it DSD, a leader in holistic digital dentistry solutions for dental clinics, which features the Invisalign System and iTero element scanners as a digital solution of choice for tooth movement and scanning. As part of the cooperation Align and DSD will deliver dedicated education programs, enable simplified, streamlined integration of digital end-to-end workflows into GP practices and offer doctors more opportunities to learn about digital tools and treatment planning support. We also continue to make great progress in Latin America, led by Brazil. In Q1, Invisalign volume and Latin America was up significantly year-over-year reflecting our ongoing investments as we continue to build our business in the region. Training over 300 Invisalign doctors during the quarter. Next month I'll be in Brazil with the executive team hosting a major customer event with more than 200 doctors discussing the future of digital orthodontics including the science and technology behind both the Invisalign System as well as our iTero Scanners. We’ll also have local social media influences on hand as we kick off our very first Invisalign consumer campaign in Brazil and plan to live stream portions of the event to more than 500 doctors across the region. For our international business Q1 was another good quarter with strong Invisalign volume growth at 38.5% year-over-year reflecting increased Invisalign utilization and continued expansion of our customer base in both EMEA and Asia Pacific regions. On a sequential basis international volume was up slightly reflecting strong growth in the EMEA region and offset somewhat by seasonally lower period in Asia Pacific as expected. In Q1 we trained over 2,400 new Invisalign doctors internationally split roughly between each of the two regions. In EMEA Q1 was a strong quarter with volumes up 37.4% year-over-year driven by growth across the region with record Invisalign volumes in all but one country led by Iberia and France. We saw strength across the Invisalign product portfolio with continued momentum from Invisalign First and Invisalign Go. We also continue to see strong growth across our key expansion markets as well, led by the Nordics and Benelux. For APAC, Q1 Invisalign volume increased 40.4% year-over-year, reflecting continued strong growth from nearly all country markets, led by China, Japan, and ANZ. We also had a strong uptick in teenage patients in Q1, due in part to a teen promotion in China offered along with our Teen-edge sales program, intended to increase adoption of Invisalign treatment with teenagers. We also had strong growth from GP Dentists, which were up 63.5% year-over-year. On a sequential basis, Q1 was flat as expected, due primarily to a seasonally slower period with the lunar New Year holiday. During Q1, we trained nearly 1,100 new doctors in APAC, over half of which were in China, and we opened our second state-of-the-art training facility in China, located in Shanghai. Our new manufacturing facility in Ziyang, China is continuing to ramp, and while we are making good progress, we still expect it to take a couple of quarters to fully transition aligner fabrication from Juarez, Mexico to Ziyang, China to serve the Chinese market and expect manufacturing overhead in Ziyang to be underutilized during this transition period. Overall for the teen market, in Q1 nearly 100,000 teenagers started treatment with Invisalign clear aligners, an increase of 41.1% year-over-year driven by continued strong adoption across all major regions – especially in APAC and EMEA regions. For Q1, year-over-year Invisalign teen patient growth for North Americas Orthodontists increased 29.2% and International doctors were up 67.2%. Invisalign First and Invisalign treatment with Mandibular Advancement continue to ramp globally and are helping to increase our share of teenagers and younger patients worldwide. Overall, we’re very pleased to see that use of Invisalign treatment among teenagers continues to outpace adults and that Invisalign First is driving a really strong growth kid and tweens in the kid/tween segment. We’ll continue to drive utilization and growth in our Americas’ teen business this year with the first Invisalign Teen Summit in July. We know that Summits increase engagement and Invisalign adoption, so for the first time we’re focusing a Summit program completely on teen treatment and teen culture, including a tie-in to 2019 VidCon, the top teen culture and community event. Teen Summit is designed to turn low teen submitters into high teen submitters by combining Invisalign specific clinical and practice "how tos" with an immersive teen culture experience. Our consumer marketing efforts are designed to build the category and drive demand for Invisalign treatment through a doctor’s office. We invest over $100 million each year in consumer marketing programs including TV, digital and social media, PR, event marketing and our Patient Concierge service. Our goals are to make the Invisalign brand a household name worldwide and to motivate consumers to seek Invisalign treatment through a doctor’s office. In Q1, we continued to see strong digital engagement with consumers reaching nearly 4 million unique visitors on Invisalign.com sites worldwide for a total of 53 million visitors to date. Other key metrics show increased activity and engagement with the Invisalign brand and are included in our Q1 quarterly slides. In March, we launched a new online tool called SmileView at the International Dental Show IDS in Cologne, Germany. SmileView is designed to help prospective Invisalign patients visualize a new, straighter smile before they opt for Invisalign treatment. Within 60 seconds of taking a smile selfie using the SmileView online tool with their smartphone or tablet, prospective patients can see what their new smile and straighter teeth may look like, with their own facial features. SmileView is available on line, or in GP practices in beta testing in the UK and the U.S. and we are getting really positive feedback. In North America, we continued to invest in strong digital plans for adults and teens. Our teen focused content developed by Awesomeness TV, the fastest growing youth channel and teen influencer program helps strengthen our brand presence among teens and parents, making Invisalign relevant and fun. During South by Southwest, we reached adult consumers with an immersive experience with a RealSelf House and Modern Beauty, where consumers can learn more about Invisalign and see a simulation of their future smile using Invisalign SmileView technology. And Invisalign was voted by consumers as a Most Worth It treatment, continuing to demonstrate continued strength of consumers. In EMEA, we held a recruitment drive for our Influencer Program called Invisalign Smile Squad generating over 100 plus new influencer applications and 350 plus doctor registrations to take part in the program. And our Parent of Teen campaign went live in UK and France – raising awareness amongst a new consumer audience. Q2 will see the launch of our revised patient journey with media campaign strategy for focused markets, better integrating new conversion tools like SmileView and Concierge into the journey. In APAC, we continued to build awareness for Invisalign treatment through use of paid media and our influencer campaign, including expansion of our influencer program in the region and a pilot Invisalign First social media campaign to target parents of younger children. To leverage increasing consumer awareness and demand, we also began to expand the Invisalign Concierge program that connects interested consumers with Invisalign doctors for treatment into new countries. Globally, in the second half of the year, we will launch a new consumer advertising campaign that emphasizes the importance of doctor led treatment with Invisalign clear aligners, while also differentiating our brand. On the professional marketing side, we recently launched two dedicated professional Invisalign brand campaigns that feature Orthodontists and GP Dentists. The Ortho as Hero campaign focuses on Invisalign orthodontists as critical leaders and the heroes of transformative, life-changing smiles, especially for teen and younger patients. The campaign showcases modern orthodontics practices that leverage digital approaches to treatment and are warm and inviting. The Go Beyond campaign is designed to celebrate dentists who go above and beyond every day to serve their patients. It also demonstrates the relevance of tooth movement to General Dentists and the importance of integrating Invisalign within comprehensive dentistry. This was launched in North America, and is now being rolled out in the EMEA and APAC regions. For iTero scanner and services business, iTero revenues increased 55.1% year-over-year, reflecting continued strength growth across all geographies and customer channels. On a sequential basis, revenues were down 9.8% sequentially, as expected, reflecting lower scanner sales following a strong Q4 and consistent with the seasonality in the capital equipment business partially offset by continued growth in services revenues due to the increasing install base. During the quarter, we launched the new iTero Element 5D Imaging System for comprehensive preventative and restorative oral care at the International Dental Show. The iTero Element 5D scanner is the first integrated dental imaging system that simultaneously records 3D, intra-oral color and NIRI images or near-infrared images and enables comparison over time using iTero TimeLapse. Integrated 3D, intra-oral color and NIRI technology of the new iTero 5D Imaging System aids in detection and monitoring of interproximal caries lesions above the gingiva without using harmful radiation. The iTero Element 5D scanner is available for sale in the majority of European and APAC countries, and is not yet available in the United States or Latin America. Cumulatively, 13.5 million orthodontic scans and 3.6 million restorative scans have started with iTero scanners. Use of the iTero scanners for Invisalign case submissions continues to grow and remains a positive catalyst for Invisalign utilization. For Q1, total Invisalign cases submitted with a digital scanner in the Americas increased to 76% from 67.3%. In Q1 last year, international scans increased to 59.3% up from 43.5% in the same quarter last year. Within the Americas, 91.2% of cases submitted by North American Orthos were submitted digitally. And China remains at 45% for the quarter. We continue to anticipate that in another year or two, nearly all Invisalign cases will be submitted digitally – primarily through an iTero scanner. Given our continued progress and increased use of digital scans for Invisalign case submission, we continue to get questions regarding interoperability with other third-party scanners. With recent product introductions, we want to make sure we are clear about which scanners are not qualified to submit Invisalign case submissions. We developed an interoperability matrix that has been distributed to our sales and customer facing teams to help inform doctors. It also included our Q1 2019 conference call slides. So please reference it for more detail. However, to ensure there is no confusion in the marketplace then I quickly reiterate our interoperability position on this call with two new scanners, the Trios 4 and Primescan. Regarding the Trios 4, Align will not qualify Trios 4, or any future 3Shape scanner product, for Invisalign interoperability in the U.S. or globally. Regarding Primescan, Align has received a request from Dentsply/Sirona to evaluate Primescan for Invisalign case submissions and we are considering that request. Until we make a decision to move forward and can conduct testing, Primescan is not qualified for Invisalign case submissions. Before I turn the call over to John, I want to update you on two other important topics. Our plans to reorganize Align’s corporate entity structure to better align with the growing international nature of our business, and the recent settlement agreement with Straumann. First, our plans to reorganize our corporate entity structure: Given the rapid expansion of our business globally, we must continue to scale and optimize our operations to help support our growth and financial profile. In March, we announced internally that we would be making changes to our EMEA headquarters located in Amsterdam, The Netherlands. Specifically, we will relocate our current EMEA Headquarters and move the majority of our corporate functions: Finance, IT, HR, Legal, and Regional EMEA Marketing from Amsterdam to Switzerland. We will begin the transition to the new headquarter location mid-year and expect to complete it in 2020 early. We will maintain an Amsterdam office to support local commercial operations. In addition, in August we will be relocating our current Order Acquisition or OA facility from Amsterdam to Poland to create a centralized operational hub for EMEA co-located with our new Treatment Planning facility that we just opened. This new hub in Poland will include iTero business operations, customer success and clinical support teams, and IT operations. As we evaluated our options, relocating our EMEA headquarters to Switzerland quickly became our top choice on many factors including: a more favorable and stable operating environment. An opportunity to accelerate our transition to a more decentralized commercial structure for EMEA that reflects the localization we’ve been working toward. A more centralized geographic location in Europe within EMEA’s largest potential market. An available talent pool to support key strategic roles required in the new EMEA headquarters. While we expect these proposed changes will allow us to obtain financial and operational efficiencies, it was a difficult decision to make and we are committed to supporting our impacted employees throughout this transition. Moving onto the settlement agreement with Straumann. On March 28, we announced a settlement with the Straumann Group to settle patent disputes with ClearCorrect, who was purchased by Straumann in 2017. As many of you know, for years Align has been engaged in complicated, multi-country, multi-court patent litigation with ClearCorrect. The settlement with Straumann ends all current and pending litigation and provides $35 million in settlement fees to Align. In addition, we have signed a non-binding letter of intent, LOI with Straumann for an iTero development and distribution agreement. If we reach an agreement, Straumann will purchase and distribute 5,000 iTero scanners over the next five years and co-fund development with us to integrate Straumann’s digital workflow into those scanners. The letter of intent we’ve signed is non-binding, which means either one of us can walk away from the LOI. However, if we don’t reach a development and distribution agreement with Straumann by early July, Straumann will pay us an additional $16 million, for a total of $51 million. We have always been passionate about defending our intellectual property and the hard work and innovation by the Align team that it represents. We’ll continue to do that and to protect our technology through all the ways that our legal system provides. With that, I'll now turn the call over to John.

Thanks Joe. Now for our Q1 financial results. Total revenue for the first quarter was $549 million, up 2.8% from the prior quarter and up 25.6% from the corresponding quarter a year ago. Year-over-year revenue growth includes $16.5 million of unfavorable foreign exchange. For Clear aligners, Q1 revenue of $469.2 million was up 5.3% sequentially on strong Invisalign volume from North America and EMEA, and higher than expected Invisalign ASPs. Year-over-year clear aligner revenue growth of 21.7% reflected strong Invisalign shipment growth across all customer channels and geographies. Q1 Invisalign ASPs were up sequentially by approximately $10 to $1,245 reflecting favorable impacts from FX and product mix shift, partially offset by higher promotions. On a year-over-year basis, Q1 Invisalign ASPs were down $65 primarily reflecting promotional discounts, unfavorable foreign exchange and product mix shift, partially offset by price increases in July 2018. Total Q1 Invisalign shipments of 349,000.2 cases were up 4.6% sequentially and up 28.3% year-over-year. For Americas Orthodontists, Q1 Invisalign case volume was up 9.5% sequentially and up 25.9% year-over-year. For Americas GP Dentists, Invisalign case volume was up 3.5% sequentially and up 15.5% year-over-year. For international doctors, Invisalign case volume was up 1.3% sequentially and up 38.5% year-over-year. Our Scanner and Services revenue for the first quarter was $79.8 million, down 9.8% sequentially due to seasonality as Q4 is typically stronger due to end of the year capital equipment purchases. Year-over-year revenue was up 55.1%, primarily due to higher scanner units across regions and related service revenues. Moving on to gross margin. First quarter overall gross margin was 73.2%, up 1.5 points sequentially and down 1.7 points year-over-year. Clear aligner gross margin for the first quarter was 74.9%, up 0.8 points sequentially primarily due to improved manufacturing leverage, approximately $4 million of one-time benefits related to freight refunds and rebates, and seasonally lower training costs, partially offset by higher number of aligners per case. Clear aligner gross margin was down 2.1 points year-over-year primarily due to higher number of aligners per case, lower ASPs, partially offset by favorable manufacturing leverage, and one-time benefits related to freight refunds and rebates as described above, along with lower doctor training costs. Scanner gross margin for the first quarter was 63.6%, up 3.7 points sequentially and up 4.4 points year-over-year, primarily due to higher ASPs and one-time benefits related to freight refunds along with manufacturing efficiencies. Q1 operating expenses were $314.4 million, up sequentially 19.7% and up 37.2% year-over-year. The sequential increase in operating expenses reflects continued investment in sales and R&D activities, along with higher legal/consulting expenses, as well as increased compensation related expenses due to higher headcount and our planned annual increase in employee compensation programs, partially offset by seasonally lower advertising spending. Additionally, our Q1 operating expenses include impairments and other charges related to Invisalign Store closures of $29.8 million. Our first quarter operating income was $87.7 million, down 27.2% sequentially and down 10.7% year-over-year. The sequential decrease in operating income is primarily attributed to higher operating expenses offset in part by higher gross profit. On a year-over-year basis, the decrease in operating income primarily reflects higher operating expenses commensurate from growth, which includes charges related to our Invisalign Store closures. Our first quarter operating margin was 16%, down 6.6 points sequentially and down 6.5 points year-over-year. The sequential decrease in operating margin is primarily due to higher operating expenses and the Invisalign Store closure costs, partially offset by higher gross margin. The year-over-year decrease in operating margin is primarily due to higher operating expenses and Invisalign Store closure costs and lower gross margin. The Q1 operating margin impact from the store closures was approximately 540 basis points. With regards to first quarter tax provision, our tax rate was 10.4% which includes approximately $12 million of excess tax benefit related to stock-based compensation from restricted stock vesting during the quarter and approximately $8 million of discrete tax benefit related to the tax impact on the Invisalign Store closure costs. First quarter diluted earnings per share was $0.89, down $0.31 sequentially and down $0.28 compared to the prior year. Invisalign Store related closure costs, net of tax, impacted Q1 diluted EPS by approximately $0.28. Moving on to the balance sheet. As of March 31st, 2019, cash, cash equivalents, and marketable securities, including both short- and long-term investments were $732.5 million, a decrease of $11.9 million from the prior quarter which is primarily from $50 million used to repurchase approximately 205,000 shares of our stock. Of the $732.5 million of cash, cash equivalents and marketable securities, $372.6 million was held in the US and $359.9 million was held by our International entities. Q1 accounts receivable balance was $479.3 million, up approximately 9.2% sequentially. Our overall days sales outstanding was 78 days, up four days sequentially and up four days from Q1 last year. Cash flow from operations for the first quarter was $117.2 million, up $39.9 million compared to the prior year. Capital expenditures for the first quarter were $35.3 million, primarily related to our continued investment in increasing aligner capacity and facilities. Free cash flow for the first quarter, defined as cash flow from operations less capital expenditures, amounted to $81.9 million. During Q1, we've purchased on the open market approximately 200,000 shares of our common stock at an average price of $243.42 per share, including commission for an aggregate purchase price of approximately of $50 million. We have $450 million remaining available for repurchase under the May 2018 Repurchase Program. Also, during the first quarter, we adopted the new lease standard and now record operating leases – lease assets and related liabilities on our consolidated balance sheet, however, there was no significant impact to our operating results. With that, let's turn to our Q/Q outlook and the factors that inform our view, starting with the demand outlook. For International, we expect Q2 volumes to be up sequentially reflecting seasonally stronger periods for both EMEA and APAC regions. For the Americas, we expect Q2 volumes to be up sequentially reflecting growth across all key markets, as well as a seasonally stronger period for North America orthodontists with the beginning of the summer teen season. We expect our iTero business to be up sequentially coming off of a slower period for capital equipment in Q1. And, regarding Smile Direct Club, we expect almost no clear aligner volume from SDC in Q2. With this as a backdrop, we expect the second quarter to shape up as follows: Invisalign case volume is expected to be in the range of 380,000 to 385,000 cases, up approximately 26% to 27% year-over-year. We expect Q2 revenues to be in the range of $590 million to $600 million, up approximately 20% to 22% year-over-year. Our Q2 revenue outlook assumes almost no SDC volume compared to the same quarter a year ago, when aligners supplied to SDC contributed $8.6 million to revenue. We expect Q2 gross margin to be in the range of 71.5% to 72.5%. Q2 gross margin is sequentially lower than Q1 due to the one-time benefits of approximately 1% realized in Q1 that we do not expect to repeat. We expect Q2 operating expenses to be in the range of $277 million to $282 million, which includes a one-time benefit of approximately $30 million from our Straumann settlement gain, net of our estimated costs for the iTero development agreement. Q2 operating expenses reflect continued investments in sales, marketing and R&D including increased consumer media/advertising spend, as well as higher legal fees and costs related to our corporate structure reorganization announced last quarter. Q2 operating margin should be in a range of 24.5% to 25.4%, which includes the expected benefit from the Straumann settlement gain mentioned above and approximately 2% negative impact to operating margin due to higher legal fees and costs related to our corporate structure reorganization. Note, as we described on our Q4 earnings call in January, we expect the impact from higher legal and corporate structure reorganization costs to be about 1.5% to 2% for the full year. Our effective tax rate is expected to be approximately 24%. Diluted shares outstanding is expected to be approximately 80.6 million, exclusive of any share repurchases. Taken together, we expect our Q2 diluted earnings per share to be in a range of $1.47 to $1.54. Q2 diluted EPS guidance includes $0.28 gain from the Straumann settlement and $0.10 gain from the SDC equity settlement, net of the income tax effects, and approximately $0.09 expense related to the corporate structure reorganization costs and higher legal/litigation costs. In addition, as we continue our operational expansion efforts, we expect CapEx for Q2 to be approximately $85 million to $90 million, and we expect depreciation and amortization to be $20 million to $22 million. With that, I'll turn it back over to Joe for final comments. Joe?

Thanks John. Overall Q1 was another solid quarter and I'm pleased with the continued progress we're making and executing on our strategic growth drivers and I'm excited about the opportunity we have. Just want to highlight those four growth drivers here for the quarter. From an international expansion standpoint Invisalign volume was up 38.5%. On our Ortho/Teen Utilization our worldwide Invisalign Teen patients growth was over 41%. GP Treat and Refer, leading with iTero scanners, our worldwide GP volumes for Invisalign were up 27.3% and 15.5% for GPs in the Americas. And iTero scanner revenues were up 55.1%. Consumer and patient conversion with Invisalign treatment, we engaged with 4 million consumers globally in Q1 and are building the most recognized orthodontic brand in the industry. In Q2, we have a number of exciting programs and initiatives heading into the summer season kicking off with the AAO in early May, and the Invisalign Symposium on the Digital Practice in London, which is our first ever truly global event and designed to foster a global community of Invisalign doctors. The symposium will bring together 300 of the most experienced and most high volume Invisalign orthodontists from across the world to discuss the digital orthodontics and the challenges and opportunities digital transformation provides their practices. Finally, before I open the call up for questions, I want to take a minute to welcome Raj Pudipeddi who joined Align last month as Senior Vice President and Chief Marketing Officer, CMO, reporting to me. Raj joins us with more than 24 years of business leadership experience and brand building experience for companies including Procter & Gamble and Bharti Airtel, an Indian telecom leader. He has an outstanding track record of delivering results across the North America, Latin America and Asia Pacific regions. Raj also brings great consumer acumen and marketing expertise in terms of building brands, launching new products and accelerating digital businesses globally. His knowledge and understanding of how to leverage big data and consumer personalization will be instrumental as we continue to lead the transformation of digital orthodontics and dentistry and help millions of consumers get a smile they love with Invisalign doctors. Raj is a strong addition to our leadership team and I am thrilled to have him on board. With that, I want to thank you again for joining our call. I look forward to updating you on our progress as the year unfolds. We’ll see many of you at the American Association of Orthodontist Meeting in Los Angeles next month, as well as the upcoming financial conferences including BankAmerica Merrill Lynch, Northcoast, Stifel, Goldman Sachs and William Blair. Now I’ll turn the call over to the operator for questions. Operator?

Thank you. [Operator Instructions] Our first question is from Erin Wright With Credit Suisse. Please proceed. Erin?

Hi, Erin, are you there?

Please check as if your line is mute.

Apologies. Can you hear me now?

Yes.

Hi, Erin.

Hi, Erin.

Hi. So on the gross margin, how should we be thinking about the run rate for the remainder of the year? I understand there was an onetime factors in freight refunds, rebates. Are there other moving parts we should be thinking about in the second quarter from a gross margin perspective? And more broadly, can you characterize how we should be thinking about that longer-term leverage to that metric over the next few years? Thanks.

Hi, Erin, this is John. Yes, what we saw – in Q1, we saw good improvement in our gross margin, we talked about 4 million of some of the unusual, you strip that out. What we expect as we go forward in our Q2 guidance is that progression, we're going to continue to improve our gross margin, some of that comes to some of the operational efficiencies in China and other places that we'll see as the year progresses.

Okay, great. And then can you speak to some of the incremental cost and opportunities associated with this reorganization of your corporate entity structure? Are there incremental costs there from what you said in the fourth quarter? And what are those longer-term financial efficiencies that this can generate from a tax perspective or from an operational perspective as well?

Yeah, Erin, this is John again. So no additional than what we had talked about. We laid out from a reorganization standpoint about 1% in total for the year. And that'll really progress with Q2 on, but really what we see is a more agile organization and one, that can accommodate changes to any global changes that might come up around taxes or anything else. So that's really the benefits that we have. EMEA is growing so much as centralized as that location, but it also gives us an operating structure that we can use in the future.

Okay. Great. Thank you.

Our next question is from Jeff Johnson with Baird. Please proceed with your question.

Hi, Jeff.

Thank you. Good afternoon guys, can you hear me okay? Hey Joe, how are you?

Great.

Let me start with you and then – Hey, all. So let me start with you, Joe, and then I have a question for John as well on the margin front. But Joe, with the store shut down here in April, I guess, what are you seeing impact wise on volumes maybe in the near-term, whether that's 2Q or over the next couple quarters? And then how might that impact how you allocate some expenses this year? Is there some way you can reallocate those expenses into other kind of growth initiatives, whether that's with DSO or other private docs or what have you?

Hey Jeff, first of all, I mean I think we – when we announced this issue with SDC having to close the stores, they just said it wasn't going to be material from a revenue standpoint and what we – for the year and so we're sticking with that overall. I mean, obviously there'll be some case loss from a store standpoint. The other part of your question is we shift some of that spend back into advertising back into other activities that we have going on to help to drive that demand. So we are – we will reallocate that expense, it's reallocated into marketing and sales and be able to do that. And we expect to have good results from that too. We have I think good experience and understanding what that investment return rate is.

All right, that's helpful. Thanks. And then John on the margin front, I mean if I exclude some of the onetime costs in the 1Q, it seems like your operating margin probably would have beaten by maybe 500 basis points or so relative to your guidance. And then if I take into account the gains in 2Q, it seems like margins are going to be down 400 basis points, 500 basis points year-over-year, and the 2Q, which is kind of worse than we were thinking. So I guess I'm just trying to get my arms around kind of volatility around margins. Is there more volatility x the noise in the base business going on right now? Is there just conservatism in your base business guidance for 2Q? How should we think about kind of recent and future margin trends?

Yes, so from a – you’re talking about specific gross margin, when you look at that, we're seeing good improvement from some of the manufacturing efficiencies and things that happened in the first quarter. We expect that to continue, we saw ASPs up $10 in Q1, which helps contribute to that. But this is about being able to continue to leverage the manufacturing and the other operations that we have. And that should continue to get better as the year progresses. And so that's similar to what we talked about at the end of Q4 as well. This is something that we – we’ll get those efficiencies as the year progresses.

Well, let me just clarify, I guess that question and focus just on the first quarter x the charges in the 1Q, it seems like your margin probably beat even at the operating line by almost 500 basis points relative to your guidance because I think your guidance did not anticipate these onetime store closure costs in that. So what drove that upside and how did you get the 500 basis points of upside in the quarter?

Yes. So really when we saw, as we looked through it Jeff, we saw like I said some improvement on the gross margin standpoint, some of the OpEx leverage that we are able to achieve in the first quarter as well and that started our year in a very strong position from an operating margin standpoint. And then as we go through the year as we've talked about, there'll be some litigation and some reorganization costs that we've been calling out, as we go through. But it was really a strong start to the year from a gross margin standpoint and then managing the op-Expenditures and we saw that leverage really show up in Q1.

Thank you.

Thanks Jeff.

Our next question is from Jon Block with Stifel. Please proceed with your question.

Hey, Jon.

Great. Thanks guys, good afternoon. I'm also going to ask a margin related question, and then on pivot. But just John big normalized EPS be it for 1Q, obviously there's been sort of no shortage of news flow over the past couple of months. So I just wanted to check in, I'm going to drill down or make sure that I'm clear on the op margins. In other words, if I were to check it on the 2H 2019 op margin, should I get back to the 25% to 30% OM range, that you will alluded to last quarter? That's sort of part A of number one. And then part B would be, your 2Q revenue guidance, the revs are slightly ahead with the cases of smidge below. So do we assume a sort of flattish 1Q to 2Q ASP? And then I'll ask my second one.

Okay. Yes, from an op margin standpoint and what we tried to do is lay that out a little bit in the slides for you, Jon, but when we look at as we've reported on a gap basis, just talk to the high guide of 25.4% from a guidance standpoint. And we're staying within there because that's GAAP, within there is a Straumann settlement of approximately 5 points. And then we have some of the corporate structure and reorganization costs, as well as the legal cost. And you back out or add back a couple of points to that. So that gets you to 22.5% or so from an op margin standpoint in Q2 on an operational basis.

John, I'm sure if I could jump in there really quick. I didn't mean 2Q, I meant 2H, last quarter you talked about 2H 2019 op margins falling back in your long-term guidance range of 25% to 30%, here we are today. Do you still have high conviction in 2H 2019 the op margins are 25% to 30%.

Yes, sorry, Jon, yes. In the second half the conviction that we have and what we expect to have in the second half is consistent, it's the 25% range in the second half of the year.

Okay. And then the implied ASPs for 2Q flattish with 1Q, is that the quick ballpark demand?

That – there is a little bit of FX from 1Q to Q2, but essentially flat.

Okay, great. And then for 1Q 2019, Simon EMEA growth rate is now within 300 bips relative to Julie's, which I view as a good thing from a diversification standpoint and congrats to Simon, who I know has been chasing Julie for several years. But I'm just curious how we should think about that going forward, especially with the scanner that's technically newer in China. And Joe, you talked about the teen opportunity in China. Do we think that, call it closer to parity Joe is here to stay? Or is there anything unique in one market or the other, teen I go scanner that can cause APAC to sort of separate again. Thanks.

Hey, Jon, I think first of all you've got to take cyclicality into – in fact when you look at China and APAC versus EMEA, EMEA goes around the dark side of the moon right after the second quarter, China has really strong third quarter like they always do, get to Lunar New Year in the fourth quarter, you got a stronger EMEA in the first quarter. So I think you can't do this kind of an apples-to-oranges comparison when you look at what Simon did this quarter. So what I would take away from this one is you got a continuing growth rate in EMEA and continuing penetration rates there that are terrific. We still have a great business in APAC from a growth standpoint overall. So I love the competition between those two. I'm cheering for them both, Jon.

Okay, fair enough. Thanks guys.

Our next question is from Robert Jones with Goldman Sachs. Please proceed.

Hi, this is Nathan Rich on for Bob this evening. Maybe just going back to ASPs, it looks like you saw a pretty nice step up sequentially in the quarter mostly on the international side. Could you maybe just talk about what came in better than expectations in the quarter? And then you kind of talked about the 2Q guidance for ASPs to be flat, but it does seem like you're seeing some nice progression there relative to your kind of full year guidance for ASPs to be flat to 4Q of last year. So how should we think about the progression of ASPs going forward over the balance of the year?

Hey Nate, this is John. Similar to what we've said in the past where we see better comprehensive cases like we saw I think compared to what we had expected, driven by mandibular advancement and other products that we have, that was in the teen growth that we saw, the 41%. That all contributes to higher ASP that showed up in Q1. And when we think about – as we're looking forward, take FX out of that, we think that the – it's pretty balanced. We'll have that – overall, we'll have a good international growth, we have that growth in the comprehensive cases with teens, but then we have the low stage mix shift that we see, where the low stage is growing faster than our comprehensive cases. But in balance, we think it's – it balances out.

Okay. That makes sense. And then, Joe, maybe one for you. The ortho utilization in the quarter was very impressive. Can you maybe just talk to kind of what's resonating in the market and where you think this could go? It seems like you should still have a lot of traction with some of the recent launches, like MA and the marketing initiatives that you guys talked about. So just curious to get your thoughts on where you think this could ultimately end up?

Nathan, overall, when you look at what's going on, I'd say there's two prime drivers in that ortho segment. One is what you mentioned is you have our MAF product now that was qualified in November of last year, you have our Invisalign teen product, which we're doing a lot of cases, seven-year old patients, eight-year old patients that we really never touched before. So that's obviously a big driver from an increased utilization standpoint. Secondly, I think it's just increasing awareness of the preference of consumers for clear aligners and I think orthodontists know that and we see more and more orthodontists really adopting that. Thirdly, when you think about the segment overall is – from a long-term standpoint, like we talk about, that's our second strategic imperative, is we see a lot of runway in teens. And that's why we're having our Teen Summit coming up this year, we'll have a lot of focus on our top 300 in London this year also on teens and we see more and more uptake on that as we work with orthos on the teens and we go directly to consumers and parents about it.

Great, thank you.

Nate, thanks. Next question, please.

Yes. Thanks.

Our next question is from Glen Santangelo with Guggenheim Securities. Please proceed.

Thanks and good evening. Joe, I just want to follow up on the previous sort of ASP question because I almost look out a little bit differently, right. I mean, you clearly had a decent uptick on an international basis and your worldwide ASP was up slightly. Does that kind of imply that North America might have been flat or even maybe down? And I know there's a lot of moving parts and I think, John, you talked about some of those like mix and promotional discounts and FX. Could you just peel back the onion a little bit on North American ASPs and give us a sense because I think it's important, given the market's focus on the competitive landscape? So just give us a sense for what's going on there.

Yes. Glen, when we look at the ASPs, totally like you said, up about $10 on a worldwide basis. In North America, slightly down from Q4, but from a standpoint of – really coming from a mix standpoint, it's just a matter of how and what type of cases the doctors are taking on, whether it's more comprehensive or some of the low-stage. And remember from a low-stage standpoint, those are some of our highest margin rate products. So when we look at that in total, we'll go to where the volume is and what makes sense for our business.

Maybe I'll just ask one follow-up question on your utilization. Within North American orthodontists, you saw a healthy sequential uptick in the number of cases, maybe – any idea what drove that and maybe could you give us a better sense for where maybe market penetration stands now for clear tray aligner and maybe what your market share numbers might look like to give us a sense for how much runway there maybe to go?

Hey, Glen. It's Joe. On the utilization for orthos, think about two big vectors there, it's just our product line in teens, MAF and our Invisalign First product line. It really brings us into, what is about 25% to 30% of the teen market that we couldn't access before, before we had those products. Overall, I just think we have good momentum in that sense and we're going to continue to see continued increase in utilization as more and more doctors gain confidence in those products.

Thanks, Glen. Next question, please?

Our next question is from Ravi Misra with Berenberg Capital Markets. Please proceed.

Hi, thank you for taking the questions. So I guess, just following up on that, Joe. Can we just talk a little bit about how the Invisalign First and mandibular advancement are contributing to that growth rate in that kind of teen, the strong teen growth number that you put there? And a little bit related, can you maybe touch upon what you're seeing out there with the competition and how your strategy is evolving now that the store closure has become underway? Thanks.

First of all, Ravi, I'll just say, again, the utilization rates that you referenced and all and for teens, again, it's new product. We feel we're still having underutilization in teens. I mean, we're still in the United States, 9%, 10% from a teen standpoint. I'd say from a clinical standpoint, we can handle 80% to 90% of those cases, depending on how you want to rate them. Many of our Invisalign docs say they can do anything in teen than they can in Invisalign. So we have a long way to go from a growth standpoint. From a competitive standpoint, we really have no competitors in those kind of products. Okay, those are highly proprietary products that – it just take a lot of history and knowledge to be able to make them and have them function well in the marketplace. As far as how we're competing out there with Invisalign stores or whatever, look, Invisalign stores or what they always have been was how do you drive more demand for our product line, it was way instead of – we've been advertising consumers for years. This was a way of just taking those advertisement kind of capabilities and bring them in the store and exciting patients, moving those patients to doctors. It was nothing different in our business model. I mean, it's a shame in the sense of what the arbitrator ruled, but look, we respect that decision and we'll move on in the sense of continuing to generate demand the way we know how to generate demand. From a competitive standpoint, SDC is a different kind of competitor. Obviously, they have high growth rates, we have high growth rates too, we show we can mutually co-exist in the marketplace and we continue to both grow.

Great, thanks.

Thanks, Ravi. Next question, please?

Our next question is from John Kreger with William Blair. Please proceed.

Hey, John.

Hey, how are you?

Good.

So I'd like to go back to China. Can you just talk about the next steps there? What do you have to do to continue growing as quickly as you have? We noticed that the number of doctors trained in APAC and China declined a little bit compared to where it was at the end of 2018. Is that in any way related to the slowing economic outlook in your opinion or is that seasonality? And can you just talk about how you expect the competitive dynamics in China to change, now that Straumann is making an entrance via a partnership there?

Hey. Look, it's – you're back to Joe here. Look, China is great growth market for us, we have – we're manufacturing in China now. We've put treatment planning in Chengdu. We handle all of our Chinese doctors right now out of China itself. We have two wonderful training centers, one in Shanghai, one in Chengdu. We feel very capable in China, we lead in China. Straumann's move with a third or fourth tier player from a clear aligner standpoint, I don't see that as a dramatic effect on this market now or in the immediate future at all.

Okay, great. And then just one quick clarifying question on operating margin. So if you strip out the one-time gains and losses that you've discussed, does your full year outlook that you discussed a quarter ago for operating margin that's below the long-term outlook, does that still hold?

Yes. Yes, it does.

Okay, thank you.

You're welcome.

Our next question is from Brandon Couillard with Jefferies. Please proceed.

Thanks, good afternoon. Joe, two part question on the scanner business. First, would like to get your perspective on how you sort of see the competitive landscape developing, number of new launches, all the ideas? And do you anticipate any stepped up level in just noise or evaluations as customers kind of digest these new intros? And then secondly, could you give us a sense of the relative growth rates in the scanner business between O-U.S. and North America? And then I guess, thirdly, any help you can give us in terms of the expected timing of the U.S. approval for the new iTero 5D?

Starting with your broader question on the scanner business is – look, we feel really good about our scanner. I mean, 5D leads, I mean, obviously, you see the 3Shape product came out, but you got two separate scans that kind of use the near-infrared. And I mean, we're so focused on workflow of GPs, we just known over the years that, goodness, GP's time is such an important commodity in that sense and you want to do things as fast as you possibly can. So combining the near-infrared together for caries detection and tooth cracking together with just a normal digital scan is a big breakthrough for us in the industry. And we've gotten great feedback. Obviously, they're starting off well. From a standpoint of U.S. approval, it's the FDA. Right. I won't talk too much about it, but there are some issues in the sense of how the FDA wants this one to be designed from a disease control standpoint. But we have a good vector on what needs to be done, it's going to take a little bit longer, just like our MAF product did, but we're confident. And I would say late fourth quarter early first quarter next year, we'll be able to get approval.

Thanks. And a couple for John, housekeeping items. First, could you quantify the impact of the China facility on gross margins in the first quarter? Secondly, were there any legal or corporate expense or corporate reorg expenses absorbed in the first quarter? And then lastly, the $0.10 SDC equity gain in 2Q, just confirm, is that below the line?

Well, I can answer that one first. Yes, that's below the line. That's the equity gain that we will have. And then the corporate restructuring costs, very small amount in Q1, it really started in Q2 and handles the rest of the rest of the year. And then in terms of the China gross margin or the impact on costs, I mean, we saw higher utilization in those plants, drives efficiencies and we see that come through to our bottom line. So as we described earlier, it starts in Q1 and it progresses through the year.

Thanks, Brandon. Next question, please?

Our next question is from Elizabeth Anderson with Evercore. Please proceed.

Hi, good afternoon. Could you talk a little bit about the feedback that you guys have received on the doctor-owned experience centers, now they're sort of switching over more to that strategy?

Elizabeth, it’s Joe. We have about two of those out there right now. Feedback is good. I mean, we've had Invisalign stores out there for years, basically, and these are ones just dedicated Invisalign stores with brand and all. And feedback has been terrific, uptick has been good. So overall, it's a good place for us to invest.

Okay. And if you, the new plan for sort of that growth going forward there, you don't anticipate sort of any major changes versus what you've been sort of seeing recently with those?

No, I think we'll just – we will continue with the pace that we've been going and there's a lot of interest out there. We're just working through it right now. But overall, the interest from an orthodontic standpoint has been extremely good and also from the GP practices.

Okay, perfect. Thank you.

Our next question is from Steven Valiquette with Barclays. Please proceed.

Hi. Thanks, good afternoon. So I just have a question here around the Straumann settlement. The $35 million initial payment, I mean, that seems pretty straightforward. But for the extra non-binding part of the agreement, seems like the potential for Straumann to sell 5,000 extra iTero scanners would be much more positive for Align versus just receiving an extra $16 million from them. So I guess the questions are, first, do you agree or disagree with that? But then also, secondarily, just from the Straumann perspective, what would be the incentives for them to sell iTero instead of just paying you the $16 million? So just curious to get more color around this. Thanks.

Well hey, Steve, it's Joe. First of all when you look at Straumann, they have their own internal scanner, but it really doesn't fit the broad application base that you need for both clear aligners and also for the restorative aspect of GP. So they primarily use 3Shape for those kind of scans today. So your comment about which is better, the $60 million or this. It's a good question. I mean, you have to assume with the 5,000 that they would sell will be 5,000 we can't sell. And, I mean, that's not necessarily true or a discrete variable in this whole equation. So, look, ideally, I think having the scanner sold by Straumann and having a good restorative workflow together would be helpful. But I wouldn't, it's not a live or die proposition. I feel we have good distribution in the marketplace. We have good coverage in three different regions and we'll be able to function well in either scenario.

Okay. Got it. Thanks.

Yes.

Our next question is from Matt O'Brien with Piper Jaffray. Please proceed.

Thanks for squeezing me in. This is Kevin on for Matt today. First one just quickly on iTero. Assume the seasonality in Q1, likely the low watermark there and assume the outlook for the sequential increase in Q2 that you provided, but can you put any numbers or a trend around the iTero growth for the second half of the year? The comps there are obviously difficult, but I assume you have a bigger specialized sales force just on that and then you're lapping some DSO partnerships.

Yeah. Kevin, this is John. So good growth in Q1. What we expect is to be able to continue to, globally, be able to have more and more iTeros sold. We think it's a great scanner, new 5D and so on really contributes to that growth. But we've seen good growth so far. Really no change in what – in how we think about it for the total year, but it's going to continue to expand and work through as many doctors as possible.

Okay, sounds great. If I could squeeze one more in for Joe. It seems like the initiatives in Brazil are continuing to ramp up with those 3,000 docs trained and you've obviously been highly under index there historically as a percentage of Americas, despite it being a big market. Can you frame up that opportunity a little bit and talk about the type of revenue contribution you can get this year and in the coming years from that region? Is it upside to the plan? How do you think about that region? Thank you.

Well, I mean, I think it's in our plan for 2019 is already baked in there from a Brazil and Latin America standpoint. I could tell by your question, you do recognize the opportunity that we have in Latin America and also Brazil, given the focus on orthodontics in both of those regions. And look, your comment also, we were late to the game there. And that's why you see us making significant investments now in the sense of training doctors, putting people in place and building infrastructure there. So, we haven't broken out those numbers yet. When they really become material to the business, we will do that. But right now, we're not making any projections or specifics about it. But rest assured, as you know, this is a big opportunity for us, it's a good product at the right time and we feel we have good leadership there and good momentum.

Thanks very much. Next question, please?

Our next question is from Michael Ryskin with Bank of America. Please proceed.

Thanks for squeezing me in guys. Just two real quick ones. One on the mandibular advancement, it's been a few months now since it's been out in the States. And you mentioned that you saw a positive adoption response in 1Q. Could you go a little bit deeper? Did it show up materially in the numbers? Do you think it contributed and sort of how does it feel going into the ramp for the rest of the year?

Hey, Mike. This is John. It certainly helps. It's a slow adoption. I mean, these are doctors that they just started trying some of these cases, they want to see and experience it for themselves to be able to see that it works in the way they want. So it's a slow rollout and adoption, but it gets that some of the key parts of our business that we want to grow, which is teen.

Got it. I was just trying to get if that contributed to the North American ortho boost in the quarter. And then a quick follow on. The China fabrication facility you mentioned is still being underutilized, continues to ramp. Any thoughts for when you think you could hit full ramp or close to it? Is it later this year? Is it early 2020 just to give us a sense for how that moves through?

Yes, Mike. This is John again. So we will see a progression and we saw a good improvement in Q1 and it will continue to improve as you utilize that facility more and more, but that will take the rest of this year.

Thanks, Mike. Next question, please?

Our next question is from Richard Newitter with SVB Leerink. Please proceed.

Hi, this is Jaime on for Rich. Thanks for squeezing me in. I just wanted to circle back on competition. I know some of your competitors have recently launched more price favorable lines geared towards the GP channel. So I was wondering, if you're seeing – or running a little bit more in that channel? And then also just kind of a sense of the ortho channel as well as you're now several quarters into seeing some competition. Thanks.

Hey, Jaime, it's Joe. Just a quick question for you, would you tell me who that competitor is with the price favorable lines of GP?

I believe Henry Schein had been – they had launched a new product, geared...

Yes. We haven't really seen Schein, felt Schein in the marketplace at all. And we don't even know what their pricing is frankly. And so we really haven't had to respond to that piece. I think if you look at the marketplace, you'd say that ClearCorrect traditionally has been in that GP segment. They're obviously owned by Straumann now. Straumann has been taking them throughout that channel. But we really haven't felt a higher degree of competitive pressure since it is a piece either. So I just find your question interesting. I know there's a lot of speculation out there right now, but we don't necessarily feel that. And remember, ClearCorrect always had a price favorable line from a GP standpoint. And we're basically being able to fight that with technology and coverage in the marketplace.

Thanks for your question. We'll take one last question, operator.

Our last question is from Kevin Caliendo with UBS Investment Bank. Please proceed.

Hi, thanks for taking one last question. Appreciate it. Just any color around the doctors trained in the quarter? Noticed a sequential decline. There's always some seasonality to this, but just the number of docs trained was pretty meaningfully lower both O-US and in the Americas. Just any color around that.

Hey Kevin, this is John. From a doctor's standpoint, Q1 is typically lower from a training standpoint. So things build as you go through the year and we saw that from Q4 to Q1, but nothing more. We want to work with doctors that want to come with cases and really get into being able to use more and more Invisalign. So, some of it's just the timing of making that all happen, but nothing more than that.

Great, thank you very much.

Well, thank you, everyone. This wraps up our first quarter conference call. If you have any follow-up questions, please follow up with Investor Relations. We hope you have a great day. We look forward to seeing you at future meetings.

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