Align Technology (ALGN) Joe Hogan on Q4 2015 Results - Earnings Call Transcript

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Align Technology, Inc. (NASDAQ:ALGN) Q4 2015 Results Earnings Conference Call January 28, 2016 5:00 PM ET


Shirley Stacy - VP, Corporate Communications and IR

Joe Hogan - President and CEO

David White - CFO


Robert Jones - Goldman Sachs Group, Inc

Jonathan Block - Stifel, Nicolaus & Company

Steve Beuchaw - Morgan Stanley & Company

John Kreger - William Blair & Company, L.L.C.

Richard Newitter - Leerink Partners

Chris Lewis - Roth Capital Partners

Brandon Couillard - Jefferies & Company, Inc.

Jeff Matthews - Ram Partners, LP


Greetings and welcome to the Align Technology Fourth Quarter and Year End 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

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

Shirley Stacy

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 David White, CFO.

We issued fourth-quarter and fiscal 2015 financial results today via Marketwire, which is available on our website at 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 PM Eastern Time through 5:30 PM Eastern time on February 11th. To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 13627358 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 first quarter and full year 2016.

These forward-looking statements are only predictions and involve risks and uncertainties such that are set forth in more detail in our most recent periodic reports filed with the Securities and Exchange Commission. Actual results may vary significantly and Align expressly assumes no obligation to update any forward-looking statements.

We have posted a set of GAAP and non-GAAP historical financial statements, including the corresponding reconciliations and our fourth 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?

Joe Hogan

Thanks, Shirley. Good afternoon and thanks for joining us. On our call today, I'll provide some financial highlights and then briefly discuss the performance of our two operating segments, Invisalign Clear Aligners and Scanners.

David will provide more detail on our financials and discuss our outlook for the first quarter, including some commentary on our view for 2016. Following that, I'll come back and summarize a few key points and open up the call to questions.

Q4 was a strong finish to another record year for Align. Better than expected revenue and earnings were driven by record Invisalign volume, which is up 26% year-over-year. These results reflect strong growth across our customer base and geographies from both an increase in the number of submitters, as well as cases per doctor.

In addition, scanner revenue strong of 33% year-over-year exceeded expectations as shipments of our new iTero Element began ramping up this quarter, resulting in record scanner shipments.

For the full year of 2015, over 0.5 million patients started orthodontic treatment with Invisalign, an increase of 22% compared to 13% last year. Our increased growth reflects continued adoption and utilization from international doctors and a solid rebound in North America, both driven by investments in territory coverage and sales and marketing programs, including clinical education.

Product and technology innovation is also a key growth driver for the company and as a result in 2015, we continue to see increased clinical confidence in Invisalign treatment for our customers worldwide.

For Q4, North America Clear Aligner volume was both sequentially and year-over-year up, reflecting record Invisalign utilization and a record number of submitting doctors. Sequential growth was driven by North American GP dentists with an increase in both the number of submitters and cases per doctor.

North American ortho volume also increased sequentially, although less so given Q4 is a seasonally slower for teenage orthodontic case starts. On a year-over-year basis, Q4 North America volume growth was driven by both orthos and GPs, reflecting increased utilization of Invisalign and expansion of our customer base.

For the full year, North America volume increased 18% compared to 8% last year and a three-year average of 12% reflecting the positive impact of our sales force expansion and go-to-market changes we announced on our earnings call last January.

We're very pleased with the acceleration in growth rate and believe that we will see further progress in North America as we continue to drive greater adoption and utilization, and the ortho channel increased our share of the team market and improved patient conversion.

Q4 Invisalign volume for international doctors was up 17% sequentially and 35% year-on-year. Our international business continues to be very strong across all countries, driven by both an increase in the number of submitters and in cases per doctors in EMEA and continued expansion of our customer base in APAC.

In EMEA, Q4 volume was up 34% year-over-year and we had a record quarter across all markets. We continue to see strong performance in our five core country markets and are building momentum in our new geographies.

For the full year 2015, EMEA volume growth of 30% was balanced across both ortho and GP channels. We also saw strong growth in Spain, the U.K. and the Mediterranean country markets, using our new selling process, which helps accelerate clinical confidence.

In addition, newly integrated country markets previously indirect in the Nordics, Eastern Europe and Benelux are showing very good growth in their first full year of our direct focus.

In Asia-Pacific, our Q4 volume reflected strong year-over-year growth of 37%, notwithstanding a seasonally slower period coming off a strong summer quarter.

During the quarter, we celebrated our 10th anniversary in Japan with a full day customer forum with over 200 Japanese doctors. We also participated in the China Annual Orthodontic Society meeting with nearly 400 doctors, and in December we attended our first Indian orthodontic congress in India where we are beginning to invest in trained orthodontists in a three key cities: Mumbai, New Delhi, and Pune.

For the full year, Clear Aligner volume in APAC increased by 39%, reflecting both expansion of our customer base, as well as an increased utilization. In China, Invisalign volumes doubled over the prior year and Japan grew more than 50% for the third consecutive year.

In the important teen segment, the total number of Invisalign cases worldwide in Q4 increased 24% year over year. This reflects continued adoption across our customer channels, but more pronounced in North America where we have the greatest sales and marketing focus on teens.

For the full year, over 141,000 teenagers started treatment with Invisalign, reflecting 21% growth compared to 16% growth in 2014. In North America, the growth rate of our teenage cases continues to outpace adult cases.

Our integrated consumer marketing campaigns in North America, EMEA and APAC combine traditional paid media, search, digital marketing, PROFITABILITY, and social media to engage customers at every point in the consumer purchasing journey.

Consumer interest in demand for Invisalign treatment continues to grow as we can see from increases in key program metrics worldwide. For example, social media engagement and lead generation increased across all regions in 2015 and more than 8 million consumers visited one of our Invisalign consumer websites and almost 1.3 million of those visitors searched for an Invisalign provider on our site, up nicely from the prior year.

In Q4, our Scanner Sales & Services business revenues were up 74% sequentially and up 33% year-over-year due to the introduction of our new iTero Element scanner, which has been received very enthusiastically by our customers.

For Q4, total Invisalign cases submitted with digital scanners in North America were flat from last quarter at 40%. We believe due in part to fewer scanner sales in Q3 as we transition to our new iTero Element scanner.

While we are talking about our Scanner business, I want to mention someone who has been an important part of the iTero's growth and success. Tim Mack, Vice President Scanner & Services, will be retiring in March after 25 years in the medical device industry.

Tim joined the management team at Align when we acquired Cadent and he has been instrumental in integrating the Scanner business into the company and bringing new innovations to market like iTero Element scanner.

Over the next two months, Tim will transition his responsibility for our Scanner & Services business to Raph Pascaud, the Chief Marketing Portfolio and Business Development Officer, who will assume the role of General Manager for our Scanner business. We're going to miss Tim, but I know he is going to enjoy having a personal life again after some very busy years.

Now, I'll turn it over to David.

David White

Thanks, Joe. Let's review our fourth quarter financial results. Revenue for the fourth quarter was $230.3 million, up 10.9% from the prior quarter and up 15.9% from the corresponding quarter a year ago.

On a year-over-year comparative basis, our fourth quarter revenue growth rate was lower by approximately eight points related to the Additional Aligner Policy we implemented last July and the impact of foreign exchange rates.

Fourth quarter Clear Aligner revenue of $214.0 million was up 7.9% sequentially and up 14.8% year-over-year. The sequential revenue increase was primarily related to increased Clear Aligner volumes.

Q4 ASPs were slightly down, slightly sequentially, about $5, due to foreign exchange rates, as well as a small shift in product mix towards our low end products. Our year-over-year revenue growth reflected Invisalign case volume growth across all customer channels and geographies, partially offset by lower ASPs, primarily to the Additional Aligner Policy change and foreign currency exchange rates.

For the fourth quarter, total Invisalign shipments of 160.4 thousand cases were up 8.8% sequentially, reflecting growth from our international North American customers. Year-over-year case volume growth was 26.4%, driven by growth across all regions.

For North America orthodontists, Q4 Invisalign case volume was up 1.5% sequentially, reflecting higher adoption and utilization rates across the channel, and up 24.5% year-over-year.

For North American GP dentists, case volume increased 9.4% sequentially and was up 20.3% year-over-year. For international doctors, Invisalign case volume was up 16.8% sequentially and 34.8% year-over-year.

Worldwide Invisalign utilization in Q4 was a record 4.9 cases per doctor, up from 4.4% in Q4 last year. North America ortho utilization was 9.9, up from 8.6 in the prior year. North America GP utilization was a record 3.1, up from 2.9 in the prior year.

And international utilization was also a record at 5.0, up from 4.5 cases per doctor in Q4 last year. For the full year 2015, we achieved record Invisalign utilization across all three customer channels.

In Q4, we added 2,670 new Invisalign doctors worldwide, 1,270 of which were new North American doctors and 1,400 of which were new international doctors. This is consistent with the same quarter a year ago. For the full year, an additional 9,795 doctors became Invisalign providers, reflecting continued expansion of our customer base, especially outside the U.S.

Our Scanner & Services revenues for the fourth quarter were $16.2 million, up 73.7% sequentially and 33.4% year-over-year. We're excited to be ramping up production and shipping the new iTero Element scanners to our customer practices given the high volume of preorders we have received since its announcement in March.

Moving on to gross margin. Fourth quarter overall gross margin was 75.0%, down 0.9 points both sequentially and year-over-year. The year-over-year decrease in gross margin was primarily the result of lower ASPs from currency, which amounted to approximately 0.9 points, as well as the Additional Aligner Policy change by about 0.7 points, which was partially offset by lower costs per unit.

Clear Aligner gross margin for the fourth quarter was 77.9%, also down 0.9 points, both sequentially and year-over-year. The sequential decrease was primarily driven by higher freight costs and increased trading activity, which carries a lower margin.

Q4 gross margin for our Scanner segment was 37.7%, up 23 points sequentially as a result of higher scanner ASPs and lower manufacturing costs associated with the new iTero Element.

On a year-over-year basis, Q4 gross margin was up 7.5% as a result of product mix shift to the lower-cost iTero Element, coupled with reduced service costs.

Q4 operating expenses were $113.5 million, down sequentially by $6.1 million, primarily due to lower marketing and media spend. Recall also that in Q3 we incurred severance costs for organizational changes, as well as costs related to the termination of product development efforts targeting for the obstructive sleep apnea market, which contributed to the sequential decline as well.

On a year-over-year basis, Q4 operating expenses were up $14.3 million, or 14.4%, as a result of our sales expansion efforts, as well as our European implementation project.

Our fourth quarter operating margin was 25.8%, up 7.5 points sequentially and approximately flat year-over-year. The sequential increase in operating margin relates primarily to increased Clear Aligner volume and lower expenses.

On a year-over-year basis, Q4 operating margin was impacted by approximately three points from foreign currency and the Additional Aligner Policy.

With regards to our fourth quarter tax provision, our tax rate of 18.1% was down 6.3 points from our Q3 tax rate. This was primarily the result of a more favorable mix of earnings and lower tax geographies, lower tax expenses realized upon the filing of certain tax returns, and to a lesser extent, the renewal of the U.S. R&D tax credit. These items together amounted to about an incremental $0.04 benefit in earnings per share in the quarter.

Fourth quarter diluted earnings per share was $0.60 compared to $0.34 reported in Q3 and $0.48 reported in the same quarter last year. Fourth quarter EPS was impacted by approximately $0.07 related to the company's new Additional Aligners Policy.

Finally, the year-over-year impact on the fourth quarter from the Additional Aligner Policy change as well as assuming constant year-over-year foreign currency exchange rates, was approximately $0.11 per share.

Moving to the balance sheet. Capital expenditures for the fourth quarter were $16.8 million, primarily relating to equipment purchases to expand our manufacturing capacity in Juarez, Mexico, as well as our ERP implementation.

Cash flow from operations for the fourth quarter was $79.4 million and free cash flow for the fourth quarter, defined as cash flow from operations, less capital expenditures, amounted to $62.6 million. During the fourth quarter, we repurchased 179,000 shares of stock, amounting to $11.2 million in open market repurchases.

As a side note, our last 12 months of stock repurchases, together with cash used to pay employee taxes for the net settlement of investing employee stock awards that otherwise would have been issued, amounted to 66% of our worldwide free cash flow.

We believe our free cash flow generation and these repurchases are consistent with our express capital allocation objectives returning cash flow in excess of that needed to run and grow the business to our shareholders.

Cash, cash equivalents and marketable securities, including both short and long-term investments were $679 million. This compared to $603 million at the end of 2014, an increase of approximately $76 million.

Of our $670 million of cash, cash equivalents, and marketable securities, $236 million was held by the U.S., and $443 million was held by our international entities.

Before we move to the Q1 outlook, I would like to make a few comments on our full year 2015 results. In 2015, we shipped a record 583.2 thousand Invisalign cases, up 22%. This reflects 32.5% volume growth from international doctors and 17.7% volume growth from our North American doctors.

Revenue was a record $845.5 million, up 11% year-over-year, including the impact of foreign exchange and the Additional Aligners policy. Full year operating income of $188.6 million or 22.3% of revenue, which included 1.6 points of impact from additional aligners and foreign exchange rates on a constant currency basis.

Our operating results also included approximately $12 million of costs related to ERP and a one-time refund of $6.8 million for medical device excise tax refund, which will not recur in 2016.

Free cash flow was $184.5 million or 22% of revenue, consistent with our long-term model target of 20% to 25%. For the year, we repurchased 1.7 million shares of Align stock for $101.8 million. 2015 diluted EPS was $1.77.

To recap, 2015 was a strong year for Align, and despite several headwinds, including foreign exchange rates, as well as the impact of our new policy -- Additional Aligner policy, we did better than planned across the Board. Strong Invisalign growth offset much of these headwinds, enabled us to achieve revenue growth in operating margins above our original outlook.

With that, let's now turn to our business outlook for the first quarter and the factors that inform our view. Starting with the demand outlook. Consistent with current demand trends, we expect North America volume to be up sequentially in Q1, primarily driven by the ortho channel.

For our international business, while we expect continued strong year-over-year growth, Q1 is a seasonally slower period in Europe due to winter holidays, and notwithstanding sequential growth expected from APAC, we anticipate total international volume to be down sequentially.

As for our scanner business, demand for our new iTero Element scanner has been strong. As a result, we expect Q1 scanner shipments to be up significantly sequentially. With this as a backdrop, we expect the first quarter to shape up as follows.

Invisalign case volume is anticipated to be in the range of 161.3 thousand to 163.7 thousand cases, up approximately 23.4% to 25.2% over the same period a year ago. We expect Q1 net revenues to be in the range of $232.5 million to $236.6 million.

We expect Q1 gross margin to be in the range of 73.5% to 74.1%, slightly down sequentially, primarily due to a higher mix of our scanner business which carries lower gross margins. We expect Q1 operating expenses to be in the range of $130.9 million to $132.4 million.

Typical of prior years, Q1 operating expenses will increase quarter-over-quarter, based on several factors. First of all, employee compensation related costs will increase in Q1 due to our annual cycle of employee compensation reviews, which include salary increases and promotions, as well as annual stock grants and employer paid payroll taxes such as Social Security taxes in the U.S. that we had set with the start of each new calendar year.

Second, incremental investments and sales territory coverage, go-to-market and product development activities will increase operating expenses as we add additional resources, much of which is front-end loaded in the year.

And, finally, we're entering the last stages of our European implementation program and will not be able to capitalize as much of our total program costs as compared to the earlier stages of the program.

Our Q1 operating margin should be in the range of 17.2% to 18.2%. On a quarter-over-quarter basis, this is relatively consistent with historical Q4 to Q1 trends if you exclude ERP investments and the impact from a higher mix of our Scanner business.

Our effective tax rate should be approximately 25% and diluted shares outstanding should be approximately $81.1 million, exclusive of any share repurchases. Taken together, we expect our Q1 diluted EPS to be in the range of $0.37 to $0.40.

Let me now provide some directional comments with respect to the full year 2016. From a total revenue standpoint, we anticipate year-over-year growth to be in the low to mid 20s% and somewhere in the upper half of our long-term operating model.

From a volume perspective, we expect continued strong growth in Invisalign case shipments. For Scanners, based on current backlog and demand for our new iTero Element, we expect Scanner revenue to be approximately double that of 2015.

Notwithstanding higher topline growth in 2016, we believe 2016 operating margins will be relatively consistent with our 2015 results for the following reasons. First of all, 2016 will bear the full year impact of the Additional Aligner policy, which we anticipate will impact revenues by approximately $25 million to $30 million.

Secondly, we anticipate higher overall mix of iTero scanner revenue in 2016. And while the new iTero Element scanner is more profitable than the older version, it still carries lower gross margins than Invisalign Clear Aligners and, therefore, will somewhat dampen total margins.

Finally, while we expect to complete most of the implementation of our new ERP system by midyear, the smaller percentage of these program costs can be capitalized in these later stages, meaning more of these costs will now be included in operating expense.

For the full year, we expect ERP implementation expenses to be relatively consistent with 2015. We believe these investments are key to continued customer adoption and accelerating our growth. Similar to last year, many of these investments will take time before they realize meaningful returns.

All included, we expect our earnings power in the second half of the year to be stronger than the first half with second half operating profits to account for somewhere in the range of 55% to 60% of our full year results.

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

Joe Hogan

Thanks, David. As you have seen from our record 2015 results, the investments we made in the onset of the year have helped us accelerate growth and increase adoption of Invisalign globally. These results reaffirm our confidence in and commitment to new investments in 2016.

This year, we will continue to invest in international expansion in new country markets like India and Korea, sales in customer support resources, as well as product and technology innovation to address such things as treatment times, indication unique to teens and predictability.

In addition, we will establish our first order acquisition and treatment planning facilities in international regions, so we can be closer to our customers, improve our operational efficiency, and provide doctors with the great experience to further improve their confidence in using Invisalign to treat more patients, more often. All told, we believe these investments will further extend our competitive advantage and leadership in the market.

Thank you for your time today. I look forward to sharing more details with you as the year unfolds. I'll now open the call to your questions. Operator?

Question-and-Answer Session


At this time we will be conducting a question-and-answer session. [Operator Instructions]

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

Robert Jones

Great. Thanks. Just on the revenue outlook for the year, based on the full year outlook and the doubling of the scanners, it looks like you are implying high teens Invisalign revenue growth. I was just hoping maybe you can share a little bit more around the assumptions behind that, both from a volume versus pricing perspective.

And then, if you could, share anything on geographically how you are thinking about the year, specifically curious about APAC, just given some of the concerns out there and the strong growth you've seen. Just anything you can share behind the what seems to be very healthy Invisalign revenue growth would be helpful.

David White

Yeah, Rob, David. So, I'll give you a couple of pieces. Let me kind of start with the scanners since that's where you started from. We announced the iTero Element scanner back in March of last year and really only began shipping that product back in September.

And during that interim period, we were actively promoting the product and selling it and generating interest at all kinds of conferences and so forth and taking orders for the product at that point in time.

And so since September to December, which we just began shipping that product, we have accumulated some backlog, and we've shipped what we had supply capabilities of. And we were starting the year with a very healthy demand profile for the product that is really driving the comment I made about we are expecting that revenue to double year-over-year.

We wouldn't expect it to double in 2017, although we'd love to have that high quality problem. But that's kind of how we are looking at 2016 as it relates to the scanner business.

When you look at the Clear Aligner business, the only color I'll give you as it relates to volumes and so forth is that you can see by the slides and our commentary and so forth, our international business is growing at a faster rate than what North America is, notwithstanding the fact that we got a great rebound in North America.

Our EMEA business is growing in 2015, grew roughly at the same rate as APAC did, although a few points behind but pretty close. And we expect to continue to see strong growth in each of those international regions as we continue to make investments in expanding our territory coverage. And as Joe mentioned in his comments, actually entering into some new geographies.

When you look at North America, like I said, we had a great rebound. We're expecting that to continue. We have continued to add territory coverage here in the U.S. And we have seen the results, I think, of some of that manifest in not only volumes, but higher utilization rates in both channels in North America.

So, when you net all that together, we're seeing 2016 from a revenue standpoint being somewhere, as I indicated, the growth being in the mid to low 20s%. And I don't know if that gives you enough color there or not.

Robert Jones

No, no, that's helpful. I guess just to move away from revenue, it seems like obviously there's a lot of momentum there. But in the operating profit side, if I look at the 1Q guidance and then the outlook, even with the second half operating profits to account for 55% to 60%, it still seems like even with that back half ramp, you are expecting the year to be below those three to five-year long-term targets.

So, either one of you, but maybe Joe, curious now that you have had a little more time with the business, is that 25% to 30% operating profit margin range, is that still the right metric to represent the profit profile for the company, or is it something different, in your mind?

Joe Hogan

Rob, I think it's still the right profile. If you take our end of the year operating profit, you add for Additional Aligners and you add for FX, we're right at the bottom part of that range right now. So, I mean I don't see any reason to change it at all.

Robert Jones

Got it. Thanks.

Shirley Stacy

Thanks Bob. Next question?


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

Joe Hogan

Hey Jon.

Jonathan Block

Great. Thank. Good afternoon. One really high-level one, maybe for you, Joe, and then some specific annoying ones for David on the guide. So, Joe, it's going to sound like a little bit of a suck up question, but, really, you have got a base that is maybe 3X what it was back in 2007. You've got a product that is really not recurring, and yet you are recapturing the growth rate.

And so can you just talk to us at a high level, what is allowing you to recapture this level of maybe 20%-plus Clear Aligner growth, and then how many more investments do you need to layer on from, call it, exiting 2016 from that level if you would going forward?

Joe Hogan

Jon, I'd just say the growth is deep and wide in a broad sense. And so, if you look at our utilization levels across the Board, you see them going up even in GP and ortho, substantially.

Secondly, from a breadth standpoint, where you look internationally, the growth from an international standpoint, it is in new markets, but also there is some depth in new markets, too, like we're seeing in Spain and with TFM and things we have talked to you about before.

I think there is also -- there is an adoption profile for plastic aligners versus metals and brackets that's starting to be accepted on a wider sense, and there is a lot more confidence out there in the sense of the use for it.

I mean we see that in our discussions with orthodontists and doctors around the world, too and people that have been with us for 11 years and people that have been with us for three or four.

If I go off and I talk about the investment aspects, I mean, this is -- it's a high-growth business. It requires continuing investments in order to do that. I think a lot of what you have seen, Jon, we're doing this from a non-dilutive standpoint if you take out an additional aligner policy and you pull away some of the ERP.

But these are investments. You take a look at the ERP, we need that. I can't tell you how much this business needs an ERP platform in order to grow in the future. We basically juggle this business on Excel spreadsheets in a way that's just not a good long-term way to conduct this business.

There's so many things we do that are a lot of arms and legs around here that we should be used for really interpreting information rather than generating it at times. And I could go on and on about that.

Secondly, to go into Korea, to go into Taiwan, to move into India, those aren't just salespeople. There is certain infrastructure, certain compliance, certain things that you just need to invest in to ensure that you adequately go into those markets and we will continue to do that.

But hopefully, Jon, and you know us well, you see that we're doing that in a sense of not telling you to hang on for three years. We're getting good returns on those investments. And what David and I are projecting right now, we'll see the same thing in 2016.

Jonathan Block

Okay. That was very helpful. And then, it dovetails well into the next question for you, David, or just sort of three quick little parts. You mentioned flat operations margins year-over-year, but I do think you have roughly an additional or an incremental 12 or 13 from the Additional Aligner program -- full year versus six months.

So, should I think about it on a non-GAAP basis the op margins are up maybe roughly 100 bps year-over-year? And then you mentioned the ERP expense. What is that that is similar to 2015?

And then, finally, just the tax rate -- R&D tax credit, it looks like we have going forward, so does the tax rate going forward look like it was for full year 2015? Thanks, guys.

David White

So flat on the operating margins and your question in that regard. If you look, again, back to what Joe just iterated, if you pull out FX, you pull out Clear Aligner and you pull out the portion of ERP that we would not expect to be recurring on a long-term basis, we're in the range of our long-term model.

When we gave guidance for 2015 you will recall a year ago, we were facing a lot of FX headwinds at that point in time and we articulated that our strategy was that we would grow our way out of the FX challenge. And I think if you look at our results this last year, we largely succeeded in reclaiming a lot of that headwind.

Now, since then, the dollars continued to strengthen, so we are still chasing a little bit of it. So, it's not quite -- we're not anticipating this to be as big of an impact in 2016 as what it was in 2015. But if I neutralize for that, we're inside the long-term model and it is a modest improvement, as you articulated, over 2015 when you look at it apples-to-apples.

On the tax rate question you had, one of the -- our guidance for Q1 was 25% or you saw that our rate last year was 22 point something I think was the effective rate. Part of one of the things that's driving it -- in fact, probably the largest thing that is actually driving that is the growth of our Scanner business.

And those sales are largely being made here in the United States where they are taxed at the -- our U.S. federal and state tax rates. And that is driving some pressure on the tax rate as it currently stands. So my best guidance for you at this point would be somewhere in that ballpark. I haven't got a better number than that.

Jonathan Block

Okay, perfect. Works for me. Thanks guys.

Shirley Stacy

Thanks Jon.

Joe Hogan

Thank you, Jon.


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

Steve Beuchaw

Well, thanks for taking the questions. And thank you operator, that was the best pronunciation of my last name I've ever heard. First question is actually on Element gross margins, you mentioned that they are likely to be higher relative to the prior iteration of iTero. My sense is that what we saw in this quarter is probably not a great barometer for how high they can go as you are still -- is that a fair assessment?

Joe Hogan

It would be, Steve. Given that we're just starting to ramp the product and so forth, we still have a learning curve that we're going down. We're still or were still experiencing a yield ramp on the product. So, we're expecting it to be reasonably better in 2016 than in 2015.

Steve Beuchaw

Okay. Got it. And then two quick ones for Joe. One is on expansion of the commercial force. Can you speak to the magnitude of ads in 2016, how they might compare to what you did in 2015, appreciating that 2015 was a big year?

And then, normally, in January as you think about working with Align over the years, normally in January we hear a little bit about product launches, plans for innovation, it wasn't as big a focus. Could we see something interesting at, say, the AAO, or is this maybe a quieter year on the product launch front? Thanks.

Joe Hogan

Steve, first of all, from kind of a commercial investment standpoint as the basis of your question, I'd say very similar to 2015, but you would say more up in international and a little bit less in North America from a ratio standpoint.

I think that expansion is something we just need to do. We know we get a decent return on it, as I mentioned before and we don't see it as being dilutive. I don't think we see it as being expansive. And Steve your second question was?

Steve Beuchaw

The question is about [Technical Difficulty] for product launches, innovation cadence in 2016.

Joe Hogan

Yeah. We'll have some announcements on product launches and some things that we think will be pretty exciting for the industry. In that sense, I can't necessarily talk about that now. We're still moving through different clinicals and things that exist out there.

But I think from a broader standpoint too Steve -- not think I know, we continue to focus a huge amount on engineering. We see so many additional malocclusions that we can address through our technology. We'll continue to invest that way going forward so we can capture a larger and larger percentage of the market. But we'll have some exciting announcements in 2016.

Steve Beuchaw

Well, looking forward to it. Thanks for all the comments.

Joe Hogan

Yeah, thanks Steve.


[Operator Instructions]

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

John Kreger

Hi, thanks very much. Joe, I know sometimes it can be hard for you guys to give a -- get a good market assessment, given all those share gains you have gotten, but what is your view, if you go around the horn, the U.S. orthodontic market, GP, and then Asia and Europe, does the market feel to you like it's getting better or worse based upon feedback you are getting from your sales reps?

Joe Hogan

John, my comment would be that it seems to be stable. I think we saw an uptick in the market in 2015, and you go through the statistics and you can see it. Fortunately, we just traveled around the world for sales kickoff meetings from North America, Pacific and also Europe. In each one of those cases, we talk about a market that's pretty much stable from year-to-year, in that sense. I wouldn't count on a big market uplift. So what we're basically expressing here in our 2016 forecast is continued penetration in those markets.

John Kreger

Great. Thanks. And then, maybe just to expand a little bit more about what you're hearing out of China, given some of the headlines in that region. How comfortable are you that the really strong growth that you guys have seen in the last year can hold up as we move through 2016?

Joe Hogan

China is really interesting in this sense. We saw we doubled our growth last year. We spent a lot of focus in resources on China. The quick answer to your question is that we feel good about China growth next year.

We -- just a week ago, we were together with that team. That team is very excited about it as we move into 2016. They are not feeling a lot of what we see and get concerned with from a Western standpoint with what's going on with the Chinese GDP figures and also some of the industrial investment that is going on there.

Look, John, I'm long enough in business to always be on my toes in this sense, that something might change, but from what we see right now and what we hear from our sales team from a customer base is we're looking for China demand volume to be equivalent to what we saw in 2015 in the sense of continued growth.

John Kreger

Great. Thanks. And then one last one. Are you seeing any uptick in electronic case receipts for Clear Aligners from any of your partner scanner companies or is it pretty much all still coming in through iTero?

Joe Hogan

It's pretty much all through iTero. We're seeing a little bit right now, but we're just on the beginning edge of the qualifications of those. So specifically Serono. You know that is done. There's a qualification aspect that they are going through with their customers to make that work, but there is nothing that I would say is material and meaningful yet.

John Kreger

Great. Thank you.

Joe Hogan



Our next question comes from the line of Richard Newitter of Leerink Partners. Please proceed with your question Richard.

Richard Newitter

Hi, thanks for taking the questions. I had two. One, first, just on the ASP. I caught some of the company-comments that I'm not sure I heard. Can you just go over again what the mix shift was with respect -- I think you said in 4Q in particular that you had a shift towards less complicated cases.

And I just wondered, one, was that correct? And then, two, does that have anything to do with just the strength that we're seeing and the pickup in GP utilization? And is that that they are intending to use lower kind of -- or do less complicated cases?

David White

Yeah, Rich. This is David. We announced back in June or July -- I can't remember a specific date on it, a single arch option for both our Express 5 and i7 product, which is our lightest stage internationally and domestically as well as the E10 and light product, which is the 10 stage and 14 stage, respectively -- respective products.

And those products have -- and part of the objective of that was to satisfy a need that doctors had in treating people who only had one arch to be treated. Historically, when doctors needed to use an Invisalign product to treat a single arch, they had to pay for the price of both.

So, we bundled a -- we debundled that and gave them basically the option to divide a single arch. And we've seen -- if you look at the growth of that product or that class of products in the fourth quarter relative to the rest of our business, they are going at roughly a 50% faster rate than our full cases.

And we don't think that rate will necessarily continue, but that in and of itself drove some shift in our overall ASP mix to those lower side products and put some pressure on ASPs as a result.

Now, two things about that. One is, when we look at the data from -- the demand from that, we certainly know how many single -- we certainly know how many dual cases we were selling previously where the doctor only wanted to treat one arch.

And we can look at how the adoption of that single arch product has accelerated doctors actually using the Invisalign product relative to what they were doing previously. And so we believe we've gotten a lot of incremental volume at the low end for that and so incremental income on the margin from that at the same time.

Richard Newitter

Got it. Thank you. Very helpful. And then, Joe, just with respect to some of the investments that you were talking about, we've heard you in China and getting closer to the customer, we've heard kind of some explanation around the initiatives there that you want to implement.

Can you tell us kind of which ones in particular are the top priority as we move into first half of this year and what kind of the payoff landscape or timeline might be for those? Thanks.

Joe Hogan

Our top focus right now is APAC. That's where we have the most diversity in the sense of a customer base and I think the most lag time lag just from a distance standpoint and with our current operations. We move over order acquisition, which is basically when someone takes an impression, we do a CT scan and then lower it to a digital file. We move that over, getting it close to the customer who will allow us to improve that part.

And then we move treatment planning treatment, which I think is the biggest customer satisfier that we can move with quickly. And we will move that over to different parts of Asia as we go through 2016 and we'll begin probably with EMEA also to begin the foundation of that.

Our resources are somewhat limited at times. So, we have to get started in APAC and we will figure out how much residual capacity we have from movement over to Europe on the treatment piece. But we'll move forward with both of those.

Richard Newitter

Thank you.

Joe Hogan

Yeah, Rich.


Our next question comes from the line of Chris Lewis of Roth Capital Partners. Please proceed with your questions.

Chris Lewis

Hi, guys. Thanks for taking the questions. I wanted to start on the teen segment. You had a nice quarter there. You pointed out the continued strength in North America. Joe, I was hoping you could spend a minute or two just talking about where teen is internationally at this point? And what's the strategy there over the next call it one to three years to really start driving teen in international markets?

Joe Hogan

It's a good question, Chris. I mean I'll just stand on North America for a second. We saw good results this year and even though they are good results, it's still 75% of the marketplace and we're not even near the penetration rate that I feel our product deserves in the sense of that particular demographic.

Taking what we have learned from a promotional standpoint a clinical confidence standpoint with customers are moving it overseas. There are parts overseas where we do see better teen engagement, in different parts of APAC and some parts of Europe. But to tell you that there's a magic formula for North America that's transportable to these other markets, it's not.

It's very similar to what I had in GD [ph] Healthcare too. When you start to move into these markets, they all have their different idiosyncrasies, so we're going to have to look at each one of the large ones and make sure that we bring our teen product forward in the sense that our customer base is comfortable with it and we're right kind of clinical information that supports that.

So, we known in North America we can do that, we’re confident we'll do it around the world and we can make those kind of progress we saw in North America this year. But there's going to be a lot of work year-in and year out both from a clinical standpoint and also from a sales standpoint and a channel standpoint in order to continue to penetrate that base.

Chris Lewis

Got it. And you talked -- you continue to carve the important of the clinical confidence. I was hoping you could elaborate on that. How are the strategies you've implemented here so far progressing per your expectations? And what types of strategies are you implementing for this year to continue that?

Joe Hogan

Chris, I'd say, starting in Europe, it has gone really well with the TFM process that we use, which is, I think you know, is it's our focused touch point strategy that we have with customers to bring them up the learning curve as quickly as possible. I digress one minute, if you think about what are we doing here in this business, we're taking customers from an analog process to a digital process.

And, frankly, it's not easy. I mean, if you take a E5 or E10 case, it might be easy, but as you go up the scale and you start doing different kinds of malocclusions, it gets pretty complicated. And we have to be able to work through -- get customers up that learning curve as quickly as possible in that clinical piece.

But also the business piece, too, because cash flow and different things that they associate with their analog business changes pretty dramatically as you move into a digitized business, also.

So, from a clinic -- back to the major point that you're making from a clinical piece is doctors want that confidence that they start a case that they can be confident they're going to finish it. They are not embarrassed in front of their customer. They have to call them back in a lot of times.

And TFM and those kinds of processes we are putting in place. And frankly, some other things that we're working on inside the company we think are going to be able to improve that clinical competence piece as we go forward.

Chris Lewis

Appreciate it. And then, David, maybe just one more. In terms of Invisalign ASPs, you talked about that shift towards the lower end products. Just looking out in the guidance, it looks like maybe ASPs are down slightly sequentially in the first quarter. I guess first, is that correct?

And then, second, any color you can provide on just how we should think about ASPs trending throughout the year in 2016, both in North America along with international markets? Thanks.

David White

So to your point on Q1 ASPs and so forth, when you look at -- as our business grows, there's a number of things that impact the ASPs, as I talked about previously, any product mix shift from full cases to light cases.

Any shift from doctors that are high volume doctors to doctors that are less volume-driven doctors can have an impact on it because of our Advantage program, which incentivized doctors to go deep into their practices.

And so when we look at those influences going over into 2016, we do have a little bit of ASP pressure on Q1, not very much. Consistent with what we saw in Q4, which was I think $5 I mentioned in my script. And over the course of the year, we would -- as our utilization rates go up, we would expect to see that doctor engagement create some ASP pressure as well.

But generally speaking, we would look at ASPs over the course of the year for other factors that we're working on that I won't go into the details on would offset some of those impacts.

And so right now, I think we would continue to say holding FX aside and Additional Aligner policy aside and so forth, I think we would say that our ASPs would still be in the flattish type of directional indication.

Chris Lewis

All right.

Shirley Stacy

Thanks Chris. Next question please.


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

Brandon Couillard

Thanks. Most of my questions have been addressed, but a couple of bookkeeping items for you, David. As far as the ERP program goes, should we expect that $12 million roughly of spend that is being absorbed in the P&L to go away in 2017? And could you sort of describe some of the benefits you anticipate on the other side of this?

David White

Yeah. The vast majority of that $12 million we would expect to go away in 2017. We will be -- we do have built into 2016 a portion of operating costs associated with the new platform and so forth. So, you won't get all the benefit of the $12 million, but you get the vast majority of it.

In terms of benefits, there's a number of them, and I think the ones that we're probably most excited about from a business standpoint have to do with our ability to offer products and services to our customers today -- tomorrow that are very difficult for us to offer to them today because of some system limitations.

And so we have a number of ideas that we have not announced at this point that we're actually working on that we hope to be able to launch not far after the date we go live on our new ERP system.

And so we think our doctors are going to appreciate some of those changes. We think it will drive improvements in their customer experience. We think it will allow us to get our business more closely aligned with their business model at the same time so that we practice our relationship with them more closely approximates the type of relationship they have with their patients. And I won't go into more details than that, but we think that the customer experience will be greatly enhanced.

And then the other thing is from an internal standpoint, when we launch new programs here in the company, there is a significant amount of heavy lifting that has to be done even to announce and launch a new promotion.

And when you consider that we have got a number of systems that all have to be updated, they have got to be tested before we can go live on them, et cetera, we believe that having one consistent platform for the company is going to improve our agility as a company, will allow us to be much more responsive to opportunities that we see in the marketplace, as well as our time to launch new initiatives and so forth.

Brandon Couillard

And then last one, can you give us a sense of what we should be embedding for the currency headwind on revenues next year and then any sense of CapEx full spend for the full year?

David White

When you say headwinds in 2016 for FX, right now we are accounting zero because we gave our guidance for the year based at today's current rates. And I don't know what their euro is at right now, but $1.08, $1.09, something like that and all the other currencies roughly at those rates.

On the CapEx side, I think our guidance for the quarter was -- is in the press release, like $20 million, $25 million. And I think for the year, it's somewhere going to be in about the $60 million range. Most of that will be spent on manufacturing capacity additions.

Brandon Couillard

Thank you.

Shirley Stacy

Operator, we'll take one last question please.


Our last and final question comes from the line of Jeff Matthews of Ram Partners. Mr. Matthews please proceed with your question.

Jeff Matthews

Hi, thanks very much. Can you hear me?

Shirley Stacy

Yeah. Hi, Jeff.

Joe Hogan

Clearly hi.

Jeff Matthews

I have two questions. One is a follow-up on Brandon's ERP question. You don't seem to be having the cost overruns and glitches that many other companies do when they get into this. Is that accurate? And is the timetables for going live roughly the same as it was when you started?

David White

So, to your first part of that question, it is a -- I think for any company a change of an ERP system is a significant undertaking. We have a lot of people engaged in doing this. A lot of energy and momentum behind it. So, I wouldn't say it has been easy, but we're making great progress.

And when we announced the program a year ago in the same call at the end of Q4 of 2014, we expect it to be going live somewhere around midyear 2016, and we are still on that plan.

Jeff Matthews

Great. Thanks. And then, what I'm really interested in is India and coming on the heels of just marking your 10th year in Japan, because I know you spend a lot of time in Japan working through case complexities before you go into China and I'm just wondering how you view the potential in India relative to what you have seen in China, and is there anything that makes long-term potential there markedly different positively or negatively? Thanks.

Joe Hogan

Hey, Jeff, I have been doing business in China and India for 15, 20 years and I think they are always in jeopardy of comparing those two markets and trying to make them similar. They are just night and day. I think India has a good opportunity for us. You can see we're going into Tier 1 kind of cities that we will start in. There is a good number of orthodontic case starts that are similar to China, but the similarity really stops there.

And so we expect good growth, but I don't expect a lot of what we're doing in China to be transferable to India in the sense from a commercial standpoint. And we're going to have to get into each one of those cities and learn and adapt properly as we move forward. But it is a focus for us. We're going to have to be successful there. But we're going to take it -- we're going to start one step at a time, and 2016 will be a foundational year for us.

Jeff Matthews

Understood. Thanks very much Joe.

Shirley Stacy

Thanks Jeff. Well, thank you everyone for joining us today. We look forward to seeing you at upcoming conferences and industry events, including the Chicago Midwinter Meeting at the end of February.

We also hope you'll join us for our Financial Analyst Meeting, which is scheduled for Thursday, June 2nd, in New York City. More details will follow, but for now please hold that date on your calendars. If you have any questions, please contact Align Investor Relations. Have a great day.


This concludes today's teleconference. You may disconnect your lines at this time. And have a wonderful rest of your day.

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