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Edited Transcript of ALGN earnings conference call or presentation 27-Apr-17 8:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Align Technology Inc Earnings Call

San Jose May 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Align Technology Inc earnings conference call or presentation Thursday, April 27, 2017 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John F. Morici

Align Technology, Inc. - CFO

* Joseph M. Hogan

Align Technology, Inc. - CEO, President and Director

* Shirley Stacy

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Conference Call Participants

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* Jeffrey D. Johnson

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* John Charles Kreger

William Blair & Company L.L.C., Research Division - Partner and Healthcare Services Analyst

* Jonathan D. Block

Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst

* Richard Newitter

Leerink Partners LLC, Research Division - MD, Medical Supplies and Devices and Senior Analyst

* Robert Mcewen Willoughby

Crédit Suisse AG, Research Division - MD and Senior Research Analyst

* Robert Patrick Jones

Goldman Sachs Group Inc., Research Division - VP

* Samuel Brandon Couillard

Jefferies LLC, Research Division - Equity Analyst

* Stephen Christopher Beuchaw

Morgan Stanley, Research Division - Equity Analyst

* Steven J. James Valiquette

BofA Merrill Lynch, Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to the Align Technology First Quarter 2017 Earnings Call. (Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Shirley Stacy, VP of Corporate and Investor Communications. Thank you, Ms. Stacy. You may begin.

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Shirley Stacy, [2]

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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 first quarter 2017 financial results today via Marketwired, which is available in 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 May 11. To access the telephone replay, domestic callers should dial (877) 660-6853 with conference number 13658703, 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 second quarter of 2017. 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 expresses -- assumes no obligation to update any forward-looking statements. We've posted historical financial statements including the corresponding reconciliations and our first 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?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [3]

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Thanks, Shirley. Good afternoon, and thanks for joining us on our call today. I'll provide some highlights from the quarter and then briefly discuss the performance of our 2 operating segments, Clear Aligners and intra-oral scanners. John will provide more detail on our financial results and 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.

2017 is off to a great start with first quarter revenues, volumes, gross margin and EPS all above expectations. First quarter net revenues were up 30%, year-over-year driven by strong Invisalign case shipments of 27% year-over-year to a record 38.9 thousand doctors this quarter. These reflect growth from both our North American and international regions and higher-than-expected teenage cases across the board, which increased 32% year-over-year. iTero's scanner revenues increased 47% year-over-year, and were down sequentially as expected.

For Q1, North American Invisalign case volume was up 8.4% percent sequentially and 20.3% year-over-year driven primarily by North American orthodontists, with GP Dentist showing improving growth trends. Continued strength in North American ortho channel reflects another record quarter for Invisalign utilization, up 12.6 cases per quarter, which includes substantially higher use by teenager patients, a positive indication for market share gains for metal braces.

In Q1, we expand our adult focus media buying to target both men and women with specific segment focus. This new buying target built on the historical strength we have had with adult females, are also reaching adult males in a much more pointed way than ever before. We saw the results of this new media targeting come through in our sales as strength continued with adult females and also significant with adult males choosing it Invisalign treatment.

During the quarter we launched Invisalign Light in North America, which was at first introduced in EMEA, and includes up to 14 stages aligners. We also beginning piling Invisalign Go in North America in Q1 including with some of our Dental Service Organizations, or DSOs. iGo for short is an aesthetic solution designed to empower general dentists to treat more patients. iGo creates a simplified approach that guides dentists through identifying, planning and treating aesthetic cases.

On a year-over-year basis, shipment growth of 20.3% was driven by increased adoption of Invisalign by orthodontists and continued expansion of our GP customer base. We continue to make good progress with our DSOs, with Invisalign shipments up nearly 50% year-over-year in Q1, significantly higher than non-DSO practices. DSOs are our leaders in adopting new technology and innovation in dental industry. They were the first to consolidate practices, automate processes and drive greater efficiencies in order to scale their operations. The next phase in the DSO industry shift will be driven by the consumer and their preference for everything digital, which we have branded DSO 3.0 in our new marketing programs and collateral. Consumers today want digital experiences to provide them with more insight to their treatment and options, and what steps to take in order to achieve a healthy lifestyle. By leveraging our technologies, iTero scanning, Invisalign treatment plans, progress-tracking application, time lapse features, our DSOs will be able to collect data on their active patients and tailor dentistry and orthodontics the way their patients want to consume it digitally.

Working together with DSOs, we can help accelerate the industry shift to full digital practices much quicker and more effectively than with other companies.

As part of our newly-formed Americas region, in Q1, we completed the acquisition of our distributor in Brazil, which includes a small team of employees who will be based in our São Paulo offices in Latin America. Brazil is estimated to have approximately 1.4 million new orthodontic case starts each year and employs nearly 20% of the world's dentists. As the world's second largest market for cosmetic interventions, Brazil represents a tremendous growth potential for Align and this acquisition will help us establish our leadership position in Latin America and support our long-term growth strategy.

Q1 Invisalign volume for international doctors was up 11.4% sequentially and up 41.3% year-over-year. The better-than-expected sequential increase is driven by growth in both the EMEA and APAC regions.

In EMEA, Q1 volumes were up 38.8% year-over-year. We had record quarter of growth across nearly all country markets as our TFM model continues gaining traction across the ortho channel, with Spain, the U.K. and Germany leading the way.

In Q1, we introduced Invisalign Teen with mandibular advancement in certain country markets in EMEA and launched Invisalign Go in the U.K., France and Germany. We also completed the acquisition of our EMEA distributor, which includes opening our first office in the Middle East, which gives us direct access to customers and distribution partners across Russia, Commonwealth of Independent States, the Baltics, Turkey, Monaco, Israel, Cyprus, the Middle East and Africa.

In Asia Pacific, Q1 volumes were up 45.2% year-over-year led by China, Japan and Australia and New Zealand. In Q1, we launched Invisalign Teen with mandibular advancement in Australia, New Zealand, Hong Kong and South Asia and more than 800 doctors attending the peer-to-peer launch event. We also held a South Asia forum, with record 200 doctors and participated in New Zealand's Association of Orthodontist forum.

Finally, in South Korea, we transferred all Invisalign practices currently managed by our network partner to a direct coverage model. This gives us 100% direct coverage of the Korean market. It will enable our team to continue developing the market for clear aligners and help accelerate growth and adoption of Invisalign treatment.

Turning to Teen market. For Q1, 49,000 teenagers started treatment with Invisalign clear aligners, up 11.3% sequentially and 31.6% year-over-year. North America ortho shipment growth was well above the 3-year average both sequentially and year-over-year. International case shipments of teenage patients increased both sequentially and year-over-year as well, with Q1 teen shipments representing about 30% of total teenage cases.

In Q1, we introduced the first clear aligners solution for Class II correction in certain country markets in Canada, EMEA and APAC. Invisalign Teen with mandibular advancement combines the benefits of the most advanced clear aligner system in the world with features for moving the lower jaw forward while simultaneously, aligning the teeth. This new solution offers a simpler, more efficient and patient-friendly treatment option than functional appliances and without a need for elastics typically used to treat teen Class II patients. It's not available in U.S. yet. It's pending 510(k) approval from regulatory.

In Q1, we are excited to launch our new global Made to Move campaign. This is the first time we've had an integrated campaign approach for consumer and professional audience across all regions. The multichannel national consumer campaign will reach patients -- potential patients through TV and digital advertising, social media and PR programs. Launched first in North America, we'll begin to extend our Made to Move campaign in other key country markets beginning in May.

While it's still very early, our new campaign is already driving over 40% higher engagement in digital media versus prior media, and followers across Invisalign's social channels are up 13% this quarter. We're also seeing the effectiveness of the new target audience in the media planning. In Q2, we'll launch a significant push to drive consumer demand and conversion with moms and teenagers. We will dial-up our investment in marketing to moms with a the national multitouch campaign under the Made to Move campaign umbrella. And in mid-May, we'll launch our national campaign marketing to teenagers. The national campaign will utilize key social media platforms such as Instagram and SnapChat and YouTube to raise awareness of clear aligners, with custom programming for teens.

In Q1, our Scanner revenues increased 46.9% year-over-year and decreased 33% sequentially as expected. Given we worked through the backlog for iTero elements from the end of last year, these results are more reflective of a typical capital equipment buying cycle which is softer in Q1.

This past March, at the International Dental show, IDS we call it in Cologne, we had a greater presence and showcased iTero and Invisalign Go and the benefits of the combination with applications such as Invisalign progress tracking. We also previewed the time lapse application that provides dentists with the ability to compare scans over time to instantly visualize changes in patient's tooth wear, movement and gingival recession. Overall, positive interest as we continue to expand our presence among GPs and EMEA. Use of the iTero Scanners for Invisalign case submission and place of PVS impressions continues to expand and remains a positive catalyst for Invisalign utilization.

For Q1, total Invisalign case submitted with a digital scanner in North America increased to a record 54.4%, up over 10 percentage points from same quarter last year, which reflects an acceleration in case shipments with intra-oral scanners, especially by north American orthodontists.

Q1 was our first full quarter supplying clear aligners to SmileDirectClub and shipments to this new channel were solid. At the beginning of the year, SmileDirectClub launched a consumer advertising campaign that has performed well and is extending the message of treatment with clear aligners versus braces. They've also doubled their network of smile shops, where potential patients can schedule a scan or have 3D impressions and photos taken. Overall we remain excited about the long-term potential for the at-home doctor directed market and working with SmileDirectClub, to bring better smiles to more people.

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

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John F. Morici, Align Technology, Inc. - CFO [4]

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Thanks, Joe. Let's review our first quarter financial results. Total company revenue for the first quarter was a record $310.3 million, up 5.8% from the prior quarter and up 30% from the corresponding quarter a year ago. Clear aligner revenue of $282.4 million was up 12.3%, sequentially driven primarily by better-than-expected Invisalign shipments and higher Invisalign ASPs. Year-over-year Clear Aligner revenue growth of 28.5% reflected strong Invisalign shipment growth across all customer channels and geographies, partially offset by foreign exchange rates.

Q1 Invisalign ASPs were up sequentially approximately $40 from Q4 to $1,270, reflecting lower promotional activity. On a year-over-year basis, Q1 Invisalign ASPs were up approximately $15 primarily due to price increases, partially offset by increased promotional discounts, product shift to low-stage products and foreign-exchange.

For the first quarter, total Invisalign shipments of 208.1 thousand cases were up 9.5% sequentially, driven primarily by North American orthodontists and international doctors. Year-over-year Invisalign case growth volume was 27.1%, driven by growth across all regions as well as expansion of our customer base, predominantly from the Asia Pacific region.

For North American orthodontists, Q1 Invisalign case volume was up 13.6% sequentially, and up 27.5% year-over-year. For North American GP dentists, Invisalign case volume was up 2% sequentially and up 11.4% year-over-year.

For international doctors, Invisalign case volume was up 11.4% sequentially and 41.3% year-over-year. Worldwide Invisalign utilization in Q1 was a record 5.4 cases per doctor, up from 4.9 in Q1 last year. North America ortho utilization was a record 12.6, up from 10.4 the prior year. North America GP utilization was 3.1, up slightly from 3.0 the prior year. And international utilization was 5.0, up from 4.7 in Q1 last year, reflecting continued expansion of our customer base in Asia Pacific.

In Q1, we added 3,260 new Invisalign doctors worldwide, of which 980 were new North American doctors and 2,280 of which were new international doctors. This compared to 3,700 in Q4 and 2,480 total doctors trained in the same quarter last year.

Our Scanner and services revenue for the first quarter was $27.9 million, down 33% sequentially and up 46.9% year-over-year.

Moving on to gross margin. First quarter overall gross margin was 75.9%, up 0.8 points sequentially and 0.2 points year-over-year. Clear Aligner gross margin for the first quarter was 77.9%, up 0.4 points sequentially primarily due to leveraging our manufacturing costs over higher volumes, higher Invisalign ASPs and partially offset by increased aligners per case. Clear Aligner gross margins were down 0.4 points year-over-year, primarily due to increased aligners per case as we continue to treat more complex cases, partially offset by manufacturing efficiencies.

Scanner gross margin for the first quarter was 56.1%, down 4.9 points sequentially primarily due to a slight increase in excess and obsolescence reserves and higher freight cost.

Scanner segment gross margin was up 11.1 points year-over-year, primarily a result of higher ASPs and lower manufacturing and servicing costs of our iTero Element Scanner relative to our previous scanner.

Q1 operating expenses were $174 million, up sequentially by $22.1 million or 14.5% primarily related to increased employee headcount, commissions associated with higher volumes and marketing spend as a result of our investments in geographic expansion, our new advertising campaign and the commercialization of new products.

On a year-over-year basis, Q1 operating expenses were up 36.7%, reflecting the aforementioned investments.

Our first quarter operating margin was 19.9%, down 3.4 points sequentially and 2.4 points year-over-year. The sequential decrease in operating margin relates primarily due to increased headcount and marketing expenses as we continue to grow our business. On a year-over-year basis, decreased operating margin primarily reflects the higher operating expenses as we invest in headcount, geographic expansion and new products in order to increase the adoption and accelerate the growth of our business.

With regards to the first quarter tax provision. Our tax rate was minus 11.4%, which includes $21.3 million in excess tax benefits and is down by approximately 31.2 points compared to Q4 of '16.

In our first quarter of 2017, we adopted accounting standards update entitled improvements to employee share-based payment accounting. Under this new standard, excess tax benefits and deficiencies associated with employee share-based payments are no longer recognized as additional paid-in capital on the balance sheet but instead, recognized directly to income tax expense or benefit in the income statement for the reporting period in which they occur.

We also supply aligners to SmileDirectClub and therefore, revenue and cost for this activity are included in our operating profit and reported results. Although, they were immaterial to the company this quarter. Additionally, we also report our share of SmileDirectClub's losses below operating margin and our tax provision and is entitled equity and losses of investee net of tax. This Q1 loss net of tax was approximately $1.1 million or $0.01 per diluted share.

First quarter diluted earnings per share was $0.85 compared to $0.59 reported in Q4, and $0.50 reported in the same quarter last year. First quarter earnings per share included the benefit of $21.3 million or $0.26 per share from excess tax benefit on stock-based compensation in accordance with the new standard.

Moving on to the balance sheet. As of the first quarter, cash, cash equivalents and marketable securities including both short and long-term investments were $644.2 million. This compared to $700 million at the end of 2016, a decrease of approximately $56 million primarily related to the purchase of our new headquarters building.

Of the $644.2 million of cash, cash equivalents and marketable securities, $222.7 million was held by the U.S. and $421.5 million was held by our international entities.

Q1 accounts receivable balance was $267.1 million, up approximately 8% sequentially. Our overall DSO was 77 days, up 1 day sequentially and up 10 days year-over-year. The increase is a result of our ERP and other related systems implementation last July, which have impacted the timing of our customer collections. We anticipate that our DSOs will remain above our historical average for several more quarters as we work through these changes.

Cash flow from operations for the first quarter was $47.6 million. During the quarter, we used $36.5 million to pay employee taxes for the net settlement of vesting employee stock awards that otherwise would have been issued.

Capital expenditures for the first quarter were $59.6 million, primarily related to the purchase of our new facilities in San Jose, California, as well as equipment purchases for additional manufacturing capacity and building improvement.

During the first quarter, we repurchased approximately 40,000 shares of stock for $3.8 million, which completes the April 2014 repurchase plan. We have $300 million available for repurchase under the 2016 repurchase program that was announced on April 28, 2016.

With that, let's turn to our business outlook and the factors that inform our view. Starting with the demand outlook. For our international markets, expect seasonally higher period for APAC and EMEA. For North America, seasonally up for orthos and GP dentists. For our Scanner business, Q2 equipment purchases are seasonally higher. With this as a backdrop, we expect the second quarter to shape up as follows: Invisalign case volume is anticipated to be in the range of 221,000 to 224,000 cases, up approximately 25% to 27% over the same period a year ago, reflecting continued strong demand across all channels and regions; we expect Q2 net revenues to be in the range of $340 million to $345 million, an increase of 26% to 28% year-over-year; we expect Q2 gross margins to be in the range of 74% to 75%, reflecting a higher mix of iTero business and aligned manufacturing expansion in Asia Pacific; we expect Q2 operating expenses to be in the range of $180 million to $184 million, up quarter-over-quarter primarily due to increased headcount, increased marketing expenses related to our new Invisalign brand and teen campaigns; Q2 operating margin should be in the range of 21% to 22%; our effective tax rate including a windfall benefit of $2 million to $3 million should be approximately 21%; we estimate that Q2 impact of the SmileDirectClub transaction to not significantly impact EPS; and diluted shares outstanding should be approximately 81.6 million, exclusive of any share repurchases.

Taken together, we expect our Q2 diluted earnings per share to be in the range of $0.71 to $0.74, which includes approximately $0.03 of excess tax benefit.

In addition, as we continue to operational -- continue our operational expansion efforts, we expect CapEx for Q2 to be approximately $30 million to $35 million.

Now, let me turn to our view of 2017. Given the stronger-than-expected results we've seen to-date, we now anticipate 2017 total revenue to be at the high-end of our long-term operating model range of 15% to 25%.

We also expect Invisalign revenue and volume growth to be at the high-end of that model. Notwithstanding continued investments in our strategic growth drivers, we remain comfortable with the operating margin for the full year to be flat to slightly up from 2016 operating margin of 23%.

With that, I'll turn it back over to Joe for final comments. Joe?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [5]

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Thanks, John. In closing, I'm pleased with our continued progress and execution of our strategic growth drivers. The dental industry remains healthy and our customers continue to report solid patient traffic in their offices. I just returned from the AAO meeting in San Diego this week and was excited to see the level of activity in our booth and the interest level in our products, especially for teenagers as we kick off the summer teen season with our new teen-focused campaign. We had 2,000 doctors and their staff visit our booth and 300 attendees participated in our iTero, our record scanning challenge, wherein an iTero scan was completed in under 1 minute for the first time in competition.

We will be in Dubai in May, hosting our EMEA summit with over 400 customers attending the 2-day peer-to-peer event.

We've got a lot going on in Q2 and I look forward to sharing more with you at the upcoming financial conference and meetings.

I'll now open the call to questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first person comes from the line of Robert Jones of Goldman Sachs.

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Robert Patrick Jones, Goldman Sachs Group Inc., Research Division - VP [2]

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I guess, just looking at the significant step up in case growth for ortho in North America. And in particular, Joe, you highlighted, a couple times on the call that the impressive teen growth, which accelerated materially. I'm curious, you had a few initiatives at play in the quarter. Anything you can share on how much of the teen growth, specifically within ortho North America, was because of things like the teen challenge versus some of the more tactical changes you had within the sales force? And I'm thinking about doc locator and things of that nature.

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [3]

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Bob, it's a good question and we've asked ourselves this question during the quarter too, as unfortunately, we don't do single, variable equations around here. We have a number of things we've done with teens. And again, we'll make it more complicated as we get into more intense advertising in the second quarter. But you mentioned teen challenge. We think it certainly, had an impact in this sense, I think, some of the changes we've made on doc locator and the sense of specificity of the patient directive into accounts, was is part of that also. Also, our next level partnership parts with customers which basically takes customers to another level depending upon the share of business that we receive or the accelerated growth level that they can provide to us. Remember, when you go back about 75% of the normal orthodontic cases in the United States are teen-based. So if you want to do more Invisalign, it's going to be hard to just dip into adults, if you really want to increase in that sense and you have to look at your teen business too. So I'd say those 3 major variables is what really we -- what drove, from a North American standpoint, the teen growth in the first quarter.

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Robert Patrick Jones, Goldman Sachs Group Inc., Research Division - VP [4]

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Got it. So no one stood out more than other?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [5]

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No, couldn't separate it.

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Robert Patrick Jones, Goldman Sachs Group Inc., Research Division - VP [6]

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And then I guess, just my follow-up on the early recently launched products that you mentioned, like Invisalign Lite, Invisalign Go, mandibular advancement. Given those are still relatively new within the case numbers that you're sharing, how should we think about these products helping accelerate or play into case growth as we move throughout the year?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [7]

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I can't give you -- John can help you on the dimensions of it. But I'd say, when you talk about the mandibular advancement, which is completely different animal than the -- like the 15 stage we have for Lite, the Lite product fits really well when you think about E5, E10 and now E15. Customers can understand it, they can integrate it. We saw really rapid uptake with that product line. When you come up with new products in this business like mandibular advancement, the infusion rate into the marketplace is slow. You really -- you have dentists and orthodontists who want to try the product, they want to see how it works. They're just cautious on the front-end until they gain confidence with it. So I mean, mandibular advancement, remember we don't have a 510(k) in United States yet. We have to -- that will occur later this year, we hope so. But we will launch it the rest of the way, around the world. And that product is truly a breakthrough. We'll have to work hard from a peer-to-peer standpoint to help to promote it, whatever. But it gives us more credibility again, in that teen market than we had before. But I wouldn't look at significant -- I wouldn't look at material numbers from mandibular advancement in 2017, in any way. It will be as how fast we can infuse that product in the marketplace.

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Operator [8]

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Our next question comes from the line of Steve Beuchaw of Morgan Stanley.

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Stephen Christopher Beuchaw, Morgan Stanley, Research Division - Equity Analyst [9]

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Yes, so I've never been someone who congratulated a company on a great quarter, and I'm not going to do that here but you know it was a great quarter. But I'm going to be the first to congratulate you on joining the $10 billion market cap club here in the aftermarket.

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [10]

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Thanks, Steve. That's great.

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Stephen Christopher Beuchaw, Morgan Stanley, Research Division - Equity Analyst [11]

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So I -- hopefully, I was first in the queue on that one. Just a couple for me. And I completely agree, of course, with Bob that when you look at the quarter, you have to take a step back and say, wow, this is the fastest growth I've seen in -- certainly, in my model, it's fairly remarkable to step up. Teen really jumps out. I wonder if you could sort of hypothesize for me about how important the one-week aligner changeout was, specifically? I know you called it out briefly but could you just dive a little bit deeper there? And could you give us a sense for -- specifically, in the U.S., because a lot of investors really like to focus on this point. Just how much faster teen growth was relative to the '16 trend? You mentioned it was faster but could you give us any more granularity there?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [12]

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I'll take the first one. I'll give John the second one on this one, Steve. On growth trial on one-week wear piece, again, it's hard to pull that signal out from the volume noise, I'd call it but what we see is, we're seeing a rapid uptake by our orthodontists and GPs on moving to 7-day kind of aligner wear. We're also getting good feedback in a sense that helps them in a close cycle with patients to know that those particular episodes are going to last some sometimes -- half the time of what another one was. So it becomes another item in that discussion that's really helpful. So it's certainly helping us again, but I can't quantify to the extent of what it is. As far as the U.S. and the faster piece that you mentioned before, John will do it, Steve.

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John F. Morici, Align Technology, Inc. - CFO [13]

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Steve, was your question specifically, on teen growth in the U.S.? Or with ...

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Stephen Christopher Beuchaw, Morgan Stanley, Research Division - Equity Analyst [14]

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Exactly.

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John F. Morici, Align Technology, Inc. - CFO [15]

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Yes, I mean, teen growth -- we have an overall growth model built in. This is definitely faster than we had built in initially and that's what led to some of our upside that we saw in the first quarter. So teen was definitely stronger than and we would've modeled out so far this year.

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Shirley Stacy, [16]

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Yes, and I think -- just adding to what John said, Steve, the comment that we made about teen -- North American ortho teen growth being faster than the last 3-year average. That gives you a couple of things to look at.

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Stephen Christopher Beuchaw, Morgan Stanley, Research Division - Equity Analyst [17]

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Got it. As I was at the Align booth at IDS, I thought the message that I'm getting here from the teen is very clearly that this just almost isn't an orthodontics company anymore. This is a company that wants to and has now taken a big step towards becoming a bigger part of the doc office, is sort of consumer brand. And I understand that your ambitions are to become a true consumer power, maybe the Nike of oral health care. Joe, it would be really helpful now that you've seen some of the progress with these initiatives. And some of the progress with SDC, for that matter, if you could just sort of refresh us on your thinking on the path there and how this plays into your thinking about the 15% to 25% range with the business really sitting at the high-end?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [18]

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Steve, first of all, you saw our presence at IDS. We had a strong presence down at the AAO in San Diego. But when I hear your comments like that, one thing I want to make sure is that we're not looking at ourselves as a general dentistry company. We do clear aligner systems and we do scanners and we don't have the kind of penetration in the marketplace we think we should have, here and anywhere in the world. And so we'll stay focused on those items. So don't -- I don't want anyone to think that we're trying to broaden our wins to become a more of a general dentistry company. It's not what is kind of in the cards. I think, what you -- when you -- Steve, you look at the Google searches that have really rocketed for Clear Aligners over the last quarter or so, some heavy investing by SDC and also, having an investing by us, it's generating a lot of interest from a consumer standpoint in the marketplace. More and more, we know we have a strong consumer brand and we'll reach out to consumers to try to drive that. But again, I want to emphasize, we are doctor-directed kind of a product line and we work through our docs to get these things done and we do want to establish a strong brand identity with consumers as they turn into patients but at the same time, we don't have a direct-to-consumer kind of model that we're pushing at the moment. We -- that's exercised through SDC and are supplied for those kinds of things. I hope -- does that help, Steve? Does that make sense to you?

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Stephen Christopher Beuchaw, Morgan Stanley, Research Division - Equity Analyst [19]

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Right, it's loud and clear.

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Operator [20]

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

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Richard Newitter, Leerink Partners LLC, Research Division - MD, Medical Supplies and Devices and Senior Analyst [21]

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And I will congratulate on the quarter -- on a great quarter because it really was. The first question I just had on SmileDirectClub. In the past, we've heard some discussion from orthodontists who are a little nervous with what this might mean for their practice. I'm just wondering, can you update us on where the conversations have been at their respective conferences you've attended so far? Clearly, some of the initiatives you have in place from an advertising standpoint, they must be drawing in new patients. So I'm assuming orthodontists are getting comfortable that it's not going to cannibalize their business. But any update there? And then, I have a follow-up.

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [22]

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Yes, Rich, you know I'd say, we announced July, last year the SDC relationship that we have. There is a lot of constant turmoil in the industry in a sense of what we did and why we did it. We continue to explain to our customer base and sense of the logic behind that. Their business continues to expand and the market continues to expand. So I think there -- I can't tell you that this will ever go away. There's -- still I would quantify it as a large amount of anxiety in the marketplace. I don't think that will change. What I do find though, Rich, is that customers that do a significant amount in Invisalign and then have a good relationship with Align, tend to understand this more or accept it more. Ones that haven't and ones that stay more in the metals and brackets, I think have been more boisterous or more concerned in some of our -- now that's empirical. I can't give you any statistics specifically on our customer base on that but it's what I feel. But I -- overall, I think as time goes on and the orthodontic market continues to expand as well as the consumer market continues to expand, and the -- I think it generates, as we said before, a huge amount of business goes to the GPs and the orthos that use Invisalign and we'll continue to recycle patients that don't fit the protocols that SDC has into the current consumer -- customer base that we have. So I'd just say, we have to keep working it, Rich. If we're not out of the woods in the sense of the discomfort of our customers. But we'll keep driving the same message, we'll keep bringing business into those accounts to help those accounts grow and hopefully, they'll reach a higher comfort level over time.

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Richard Newitter, Leerink Partners LLC, Research Division - MD, Medical Supplies and Devices and Senior Analyst [23]

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Okay, that's helpful. And then just one follow-up. On the distributor acquisitions you're doing internationally, wondering if you could just quantify the contribution that you saw in the quarter and what we should think going forward? And also, are there are additional ones we should expect in future quarters, aside from the ones you executed in 1Q? And if you could talk to the gross margin impact as well?

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John F. Morici, Align Technology, Inc. - CFO [24]

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Yes, I'll take that one, Rich. This is John. The impact is very, very small. We just closed those deals in the first quarter, so there's really not much of a material effect that we saw. But it is in line with our overall strategy where we want to be able to have our own sales team, go to -- work in those markets and try to grow faster. So it continues and it's part of our strategy but there really is, a really small effect to start in the first quarter.

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Operator [25]

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Our next question comes from line of Steven Valiquette of Bank of America Merrill Lynch.

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Steven J. James Valiquette, BofA Merrill Lynch, Research Division - MD [26]

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I'll also congratulate you guys. Those are some pretty strong results.

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [27]

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Thanks, Steve.

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Steven J. James Valiquette, BofA Merrill Lynch, Research Division - MD [28]

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So the average selling price number looks pretty solid and probably reflects at least -- the other price increase you took several months ago. But just on pricing in the market, and we did notice that ClearCorrect, you announced the shift in their pricing at AAO over the weekend where now practitioners can pay per aligner. It's probably only have impact maybe on the low-end of the market but just curious if you have any thoughts about their pricing change and whether it really matters for Align overall?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [29]

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Yes, Steve. I think, I mean, I saw that too. It was pretty well presented by ClearCorrect. I think if you have the kind of product that they have, that's a pretty simple way to go to marketplace. And so we don't see that changing our strategy because when you look at the sophistication of our product line and how it is directed towards certain malocclusions and the number aligners associated with it, our pricing makes sense in that way. But if you're ClearCorrect, you know I'd say that, that was a simple way to go about it. And I think it makes sense in that end of the marketplace.

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Operator [30]

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Our next question comes from the line of Jon Block of Stifel.

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Jonathan D. Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst [31]

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I'll limit myself to 2 questions. First one is just international, I mean big, big numbers, diverse growth. EMEA was up 38%, Joe. A big acceleration from the 4Q '16 number of up 20%. And I know 4Q '16 had some sort of EMEA backlog moving parts, if you would. So just maybe your thoughts on how that market is growing? Is the best to look at it, I guess, what I'm asking is somewhere in between that 20% deceleration that we saw exiting '16 and the big 38% number that you put up in 1Q '17?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [32]

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You know, John, that's a great question. They came back very strong and I'd say that, in this case, we continue to do incredibly well in Spain. You see us in the U.K., both from a GP standpoint, orthodontic standpoint continues to grow and we're seeing great strength out of Germany also, France. So by country, when I look at that, and given -- I spent a lot of years over in Europe too, all those countries are so different when you see that kind of acceleration and growth across each one of those countries, you know the team is executing well on the strategy across all the different cultures. I honestly would say, it's hard to explain exactly what happened in the fourth quarter in EMEA. I would tell you that internally, we probably did not guess the vacation schedule as well as what happened in Europe. And we had some bleed over, obviously, from a case shipment standpoint. And I'd say in general, we, as a company, we haven't anticipated well the turndown in the holidays in Europe and how that can affect case growth. So I think behind your question, John, there's -- we're executing well over there, we're excited about it. Obviously, there's this expansion that we've done in the Middle East and Russia with this next distributor acquisition is something we know how to do. We've proven, we really can grow from that. I'm confident we can continue to drive some pretty impressive numbers out of Europe as the team continues to execute there.

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Jonathan D. Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst [33]

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Okay, very helpful. And then the other one just specific to SDC, it seems that the cases that you guys were providing them are sort of in an infancy stage. But Joe, I'd love your thoughts on how that -- you came with the agreement 9 months ago or so. How that doctor-directed at-home market has progressed and are they cannibalizing a ton of Align cases? I guess, what I'm trying to figure out, is there a component in this where you have another player out there talking about Clear Aligners, spending marketing dollars? Is that helping to sort of stimulate the entire market, which could be a precursor for what happens when some of the other big ortho companies, if they do come out with their Clear Aligner products?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [34]

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Yes, John -- you know John, I -- we think that this is helping to stimulate the whole Clear Aligners category. SDCs, they are spending a lot of money, they're very good in a sense of how they advertise. We see that as we go to marketplace too. So I do think that's a component in the growth of the marketplace right now. I'd also caution you, John. As the other Clear Aligner companies come in, I don't expect big consumer spends. These are companies that you normally just sell to orthodontists through their channels or through distribution channels. They're not used to massive consumer advertising campaigns and the associated expenses associated with that. So I'm not so sure that the next list of competitors, and you can reel them off as much as I can, are going to come into the marketplace with that kind of gunpowder to go directly-to-consumer. I don't think the SDC and our model will be broadly duplicated with the next round of competition.

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Operator [35]

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Our next mission comes from the line of Jeff Johnson of Robert W. Baird.

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Jeffrey D. Johnson, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [36]

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Let me ask maybe 2 revenue questions, and then I have a margin question as well. But Joe, on the revenue, the guidance you're giving for second quarter and then for the full year, it would seem to imply a slowdown in the second half to maybe 20% revenue growth. And given the strength this quarter, it's almost hard to imagine, which just a couple of quarters ago, that would've been a good number. And so just trying to figure out if there's just conservatism in there? What kind of -- how you're thinking about the second half playing out? And then on the international side. For a long time, we've kind of heard the story that you need to continue to invest in the international markets to really kind of sustain 30% growth. You'd tick up to 40% this quarter, is that kind of -- should we be thinking about sustainability now above 30% in the international markets at least in the near-term?

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John F. Morici, Align Technology, Inc. - CFO [37]

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Okay, Jeff. This is John. I'll take the question. On revenue, what we've seen in the first half is you saw great performance in the first quarter. We continue to see that as we head into the second quarter. Strong performance and we're guiding to the high side of what we had in our long-term model of case shipments on our high set of 27%. Our strategies are playing out. We're seeing that in what we've seen in volume and that's why we felt comfortable of taking this to the high-end of our guidance to closer to that 25% for the year. And as we get through this quarter and the second quarter, we'll revisit that if that volume continues, to where we see it. So right now it's not being conservative, we're just kind of calling what we see. And then in terms of the growth that you saw -- that you were talking about, was it specifically for international? Or are you -- was it...

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [38]

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EMEA or APAC or...

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Jeffrey D. Johnson, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [39]

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Yes, and pretty much just rolling international up all together. We've kind of long thought of that as the sustainable 30% or 25% to 30% and you have to keep investing to maintain that kind of number. And now we see it up to 40%. Just wondering how sustainable is that here going forward?

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John F. Morici, Align Technology, Inc. - CFO [40]

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Yes, so we definitely still have volume opportunities in these developing countries. So that is growth opportunities for us. We've mentioned on the earlier part of this call about some of the distributor deals and some of the things that we're going direct. That should help us with some of the volume. But we're still seeing a lot of growth and a lot of opportunities in places like China and parts of EMEA and so on. And we're going to continue to push for that growth where we can and we expect it to continue to keep growing like it has.

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Jeffrey D. Johnson, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [41]

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Fair enough. And then just on the margin side. A couple of quarters, your margins have been down. Your guidance -- for the full year, obviously, flat to up slightly. So many initiatives going on at this point that's really helping support that top line. I guess, what gives you the confidence? And where does the margin improvement come from, I guess, going forward with all this investment that you've got going on at this point?

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John F. Morici, Align Technology, Inc. - CFO [42]

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Yes. I mean what we've seen, Jeff, so far is we've invested as we have, really last year and now into this year up front, with a lot of our sales initiatives and our marketing expenses, up front we're seeing that volume come through and that's happened in the first quarter and expect it to continue into the year. And that's what gives us confidence in holding our margin rate flat to slightly up from last year.

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Operator [43]

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Our next question comes from the line of Robert Willoughby of Crédit Suisse.

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Robert Mcewen Willoughby, Crédit Suisse AG, Research Division - MD and Senior Research Analyst [44]

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You mentioned the ERP process is keep -- is driving that DSO number higher. You say it's kind of a several quarter phenomena but can you give us any granularity around that? That's -- it's getting to be a larger number. So when's a reasonable timeframe to see that number turn over and see the cash start to improve?

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John F. Morici, Align Technology, Inc. - CFO [45]

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Yes, Robert. It's up to them. We've worked on -- we've worked hard within the company to try to improve. It's not -- the big ERP implementation we had was last July. But we've also been putting on additional entities and going live on our new ERP. And that has caused us to struggle a little bit in terms of getting some of those collections and moving from one system to another, getting customers and our collectors to kind of be in sync. We expect that it's going to start to come down as we go through this year. And some of the initiatives that we have that to be -- we're really focused on those collections and also, work on our ERP to make sure that we're able to fix some of these issues that we have. But we expect it to start coming down.

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Robert Mcewen Willoughby, Crédit Suisse AG, Research Division - MD and Senior Research Analyst [46]

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Okay, and there's no bad debt experience of consequence?

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John F. Morici, Align Technology, Inc. - CFO [47]

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No, what we've seen is as we've tested and has gone through, it's just taking longer for us to collect but it's not turning into bad debt. It's just a slower paying that we normally experience. But the bad debt has not increased.

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Shirley Stacy, [48]

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Thanks, Rob. One last question, please?

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Operator [49]

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Our next question comes from the line of Brandon Couillard of Jefferies.

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Samuel Brandon Couillard, Jefferies LLC, Research Division - Equity Analyst [50]

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Not to disparage the results at all but I'm curious if the North American GP experience in the first quarter was in line or maybe better than your plan? It seems that it was more in line if I suppose with typical seasonality whereas, we saw the rest of the business really pick up in the first quarter versus historical trend. Just your thoughts there?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [51]

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Hi, Brandon. It's Joe. I'd say it's in line to trending up. Maybe, slightly stronger than what we thought. I'd say it straight -- it probably came from, like we mentioned, DSOs more than anything and our work with them. So we felt good about the quarter in that sense. And not dramatic but I'd say, it's turning up.

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Samuel Brandon Couillard, Jefferies LLC, Research Division - Equity Analyst [52]

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Okay then, one more. I'm curious if you have any data or you even track this, in terms of like the new iTero shipments last year was a big year in terms of how many of those go to non-Invisalign docs? And kind of what the uptake trajectory or trend might be from doc to get one of the new scanners through the -- translating those into pull through for new case starts?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [53]

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That's always kind of a magic question around the table here. It's -- we do know that we do see an uptick in uses of Invisalign when we sell Invisalign to an account. Usually, that account has already been associated with Invisalign in some way, Brandon. But we haven't been able to quantify that. Sometimes, it's a blip, sometimes it's bigger. It -- sometimes it tends to kind of fall back down to the initial line as an Invisalign customer at some point. But we certainly know that once a customer does get an Invisalign scanner, they tend to do more Invisalign cases. And frankly, we can bring more power to that customer in the sense of the software and the ease of the use of the product line that we really start to build in with the iTero scanner. As far as how many we sell to non-Invisalign accounts, I really don't have that data and I don't think we have kept track of that data at all.

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Shirley Stacy, [54]

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Operator, we'll take one more question, please?

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Operator [55]

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Our last question will come from the line of John Kreger of William Blair.

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John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner and Healthcare Services Analyst [56]

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Joe, given the nice uptick in growth, what is your sense about the underlying market on the ortho side? Are your customers reporting any changes in their sort of typical case start growth? Or is this all share gains on your part?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [57]

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Well, I mean, we're seeing an increase of orthodontic patients through the orthodontists that we track and we talk to. So we do have a healthy orthodontic market behind us, there's no doubt. I think our teen expansion shows that we have taken significant share in that area too. So look, it's wonderful to have a good -- a stronger market behind you like that, but this is a story of a strong market and a share shift at the same time.

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John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner and Healthcare Services Analyst [58]

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And what do you view as the underlying market growth? We'd sort of put it maybe at about 4% on a unit basis. Would that be in sync with what you hear from your customers?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [59]

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Yes, right on.

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John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner and Healthcare Services Analyst [60]

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Okay, great. And then one other one. The very good growth in DSOs, I assume that's primarily in North America. Can you just talk a little bit about what your strategy has been to drive that? Or has it really been just as those entities get bigger, they viewed Invisalign as a good same-store growth driver? Just curious what you're seeing?

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Joseph M. Hogan, Align Technology, Inc. - CEO, President and Director [61]

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Look, it kind of -- John, you've led the question really well, I mean it's kind of a story at a DSO level. As soon as you join the DSO, it's all about growth, right? And we're trying to transfer best practices on growth and efficiency across all the different units that they have. Invisalign's a great story because you can attract more patients with Invisalign, you have a different revenue source and you tend those patients to attract with Invisalign. You tend to keep them over time, too. And so you know, we incentivize these customers, we train them as much as we possibly can. We work to make it as easy to use Invisalign, as possible. And it's worked out well. Obviously, Heartland's been a good partner for us and so were other DSOs that we have out there. And it's a good business partnership in that sense but from all the work we have to do to work together to get the right advertising in place, demographics from a patient identification standpoint, the training is necessary for each one of those. But DSOs can really help to facilitate that based on the kind of organization that they are.

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Operator [62]

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There are no further questions over the audio portion of the conference. I would like to turn the conference back over to management for closing remarks.

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Shirley Stacy, [63]

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Well thank you, everyone, for joining us today. This concludes our conference call. If you have any follow up questions, please contact Investor Relations. Have a great day.

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Operator [64]

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This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.