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ALGN > SEC Filings for ALGN > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for ALIGN TECHNOLOGY INC

Form 10-K for ALIGN TECHNOLOGY INC


28-Feb-2014

Annual Report


ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with "Selected Consolidated Financial Data" and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

Overview

Align Technology, Inc. is a global medical device company that advanced the invisible orthodontics market with the introduction of the Invisalign System in 1999. Today, we are focused on designing, manufacturing and marketing innovative technology-rich products to help dental professionals achieve the clinical results they expect and deliver effective, convenient cutting-edge dental treatment options to their patients. Align Technology was founded in March 1997 and is headquartered in San Jose, California with offices worldwide. Our international headquarters are located in Amsterdam, the Netherlands. We have two operating segments: (1) Clear Aligner, known as the Invisalign System; and (2) Scanner and CAD/CAM Services ("SCCS"), known as the iTero intra-oral scanners and OrthoCAD services.
We received FDA clearance in 1998 and began our first commercial sales of Invisalign to U.S. orthodontists in 1999 followed by U.S. General Practitioner Dentists (GPs) in 2002. Over the next decade, we introduced Invisalign to the European market and Japan, added distribution partners in Asia-Pacific, Latin America, and EMEA, and introduced a full range of treatment options including Invisalign Express 10, Invisalign Teen, Invisalign Assist, and Vivera Retainers. By 2011, we launched significant new aligner and software features across all Invisalign products that make it easier for doctors to use Invisalign on more complex cases, and introduced Invisalign to the People's Republic of China. In 2013, we launched SmartTrack, the next generation of Invisalign clear aligner material which became the new standard aligner material for Invisalign products. Most recently, we launched Invisalign G5 innovations, specifically designed for treatment of deep bite malocclusion as well as ClinCheck Pro, the next generation Invisalign treatment software tool, designed to help Invisalign providers achieve their treatment goals.
We also sell iTero intra-oral scanners and provide CAD/CAM services. Intra-oral scanners provide a dental "chair-side" platform for accessing valuable digital diagnosis and treatment tools, with potential for enhancing accuracy of records, treatment efficiency, and the overall patient experience. We believe there are numerous benefits for customers and the opportunity to accelerate the adoption of Invisalign through interoperability with our intra-oral scanners. The use of digital technologies such as CAD/CAM for restorative dentistry or in-office restorations has been growing rapidly and intra-oral scanning is a critical part of enabling these new digital technologies and procedures in dental practices. In late 2012, we commercially launched the Invisalign Outcome Simulator, the first Invisalign chair-side application powered by the iTero scanner. The interactive application provides dentists and orthodontists an enhanced platform for patient education and is designed to increase treatment acceptance by helping patients visualize the benefits possible with Invisalign treatment. In January 2014, we announced that the 3M True Definition scanner was qualified for use with Invisalign case submissions. This qualification enables Invisalign providers with a True Definition scanner to submit a digital impression in place of a


traditional PVS impression as part of the Invisalign case submission process. The 3M True Definition scanner is currently the only third-party scanner that has been qualified for use with Invisalign treatment. We continue to believe in an open systems approach to digital impressions, and are committed to working with other intra-oral scanning companies interested in developing interoperability for use with Invisalign treatment.
The Invisalign System is offered in more than 60 countries and has been used to treat more than 2.5 million patients. Our iTero intra-oral scanner, which is primarily sold in North America, provides dental professionals with an open choice to send digital impressions to any laboratory-based CAD/CAM system or to any of the more than 1,200 dental labs worldwide.
Our goal is to establish Invisalign clear aligners as the standard method for treating malocclusion and to establish the iTero intra-oral scanner as the preferred scanning protocol for 3D digital scans, ultimately driving increased product adoption by dental professionals. We intend to achieve this by continued focus and execution of our strategic growth drivers set forth in the Business Strategy section in this Annual Report on Form 10-K.
The successful execution of our business strategy and our results in 2014 and beyond may be affected by a number of other factors, which are described below:
New Products, Feature Enhancements and Technology Innovation. Product innovation drives greater treatment predictability and clinical applicability, and ease of use for our customers, which supports adoption of Invisalign in their practices. Increasing applicability and treating more complex cases requires that we move away from individual features to comprehensive solutions so that Invisalign providers can more predictably treat the whole case, such as with Invisalign G5 for deep bite treatment. Launched in February 2014, Invisalign G5 was engineered to treat deep bite malocclusion in its entirety, making it easier for our customers to treat one of the most common malocclusions. In addition, in February 2014, we launched ClinCheck Pro, the next generation Invisalign treatment software tool, designed to provide more precise control over final tooth position and to help Invisalign providers achieve their treatment goals. We believe that over the long-term, clinical solutions and treatment tools will increase adoption of Invisalign; however, it is difficult to predict the rate of adoption which may vary by region and channel.

         Invisalign Utilization rates.  Our goal is to establish Invisalign as
          the treatment of choice for treating malocclusion ultimately driving
          increased product adoption and frequency of use by dental
          professionals, also known as "utilization rates".  Our quarterly

utilization rates for the previous 12 quarters are as follows:

[[Image Removed]] * Invisalign Utilization rates = # of cases shipped divided by # of doctors cases were shipped to

Total utilization in the fourth quarter of 2013 was 4.4 cases per doctor a slight increase from 4.3 cases in the third quarter of 2013 driven primarily by the increase in utilization by our International customers offset by a decrease


in utilization by our North American orthodontic customers from 8.4 to 8.0 cases per doctor. This decrease by our North American orthodontic customers reflects a decline in the number of teen-aged cases shipped as summer is typically the busiest season for orthodontists with practices that have a high percentage of adolescent and teenage patients as many parents want to get their teenagers started in treatment before the start of the school year. On a year-over-year basis, total utilization of 4.4 cases per doctor in the fourth quarter of 2013 increased from 4.1 cases in the fourth quarter of 2012 cases, reflecting improvements in product and technology over the past year, including Invisalign G4 and SmartTrack aligner material, which continues to strengthen our doctors' clinical confidence in the use of Invisalign such that they now utilize Invisalign more often and on more complex cases. Although we expect that over the long-term our utilization rates will gradually improve, we expect that period over period comparisons of our utilization rates will fluctuate.

         Number of new Invisalign doctors trained.  We continue to expand our
          Invisalign customer base through the training of new doctors.  In 2013,
          Invisalign growth was driven primarily by increased utilization by our
          orthodontist customers as well as by the continued expansion of our
          customer base as we trained a total of 8,065 new Invisalign doctors.
          GPs are one of the keys to driving growth in the adult segment and in
          2014 we launched a new CE I training course, now called Invisalign
          Fundamentals, designed to improve practice integration and increase
          utilization for newly trained doctors. We are implementing this new
          Invisalign Fundamentals program across North America and will look for
          opportunities to adjust our international training programs as we work
          to help our GP practices worldwide more successfully adopt Invisalign
          into their practices. We believe that this new training approach will
          increase the number of doctors submitting cases 90-days post-training,
          as well as the number of cases submitted per doctor.



         International Clear Aligner. We will continue to focus our efforts
          towards increasing adoption of our products by dental professionals in
          our direct international markets. On a year over year basis,
          international volume increased 25%, driven primarily by growth in
          Europe as well as by strong performance in the Asia-Pacific region. In
          2014, we will continue to expand in our existing markets through
          targeted investments in sales coverage and professional marketing and
          education programs, along with consumer marketing in selected country
          markets. In addition, given the significant long term potential this
          extensive geography represents and the support we can now provide by
          utilizing our direct coverage model in Europe, beginning in February
          2014, we will transition a small number of those countries into direct
          sales regions. We expect to leverage our existing infrastructure and
          resources to bring sales coverage and customer support to these
          countries, most of which are adjacent to our directly covered European
          countries. Due to the small volume of business from our EMEA
          distributor, we do not anticipate that this transition will have a
          material effect on our financial results in the next several years.


         Foreign exchange rates. Although the U.S. dollar is our reporting
          currency, a portion of our net revenues and income are generated in
          foreign currencies. Net revenues and income generated by subsidiaries
          operating outside of the U.S. are translated into U.S. dollars using
          exchange rates effective during the respective period and as a result
          are affected by changes in exchange rates.  We have generally accepted
          the exposure to exchange rate movements without using derivative
          financial instruments to manage this risk; therefore, both positive and
          negative movements in currency exchange rates against the U.S. dollar
          will continue to affect the reported amount of net revenues and income
          in our consolidated financial statements.

Results of Operations

Net revenues by Reportable Segment Comparison for Years Ended December 31, 2013, 2012 and 2011:

We group our operations into two reportable segments: Clear Aligner segment and SCCS segment.

         Our Clear Aligner segment consists of our Invisalign System which
          includes Invisalign Full, Express/Lite, Teen, Assist, Vivera Retainers,
          along with our training and ancillary products for treating
          malocclusion.


         Our SCCS segment consists of intra-oral scanning systems, and
          additional services available with the intra-oral scanners, that
          provide digital alternatives to the traditional cast models. This
          segment includes our iTero scanner and OrthoCAD services.


The below represents net revenues for our Clear Aligner segment by region, channel, and product and our SCCS segment by region and product for the year ended December 31, 2013, 2012 and 2011 as follows (in millions):

                                                      Year Ended December 31,
                                        Net          %                      Net          %
                           2013       Change      Change       2012       Change      Change       2011
Clear Aligner
Region and Channel
  North America
       Orthodontist      $ 203.9     $  31.4       18.2  %   $ 172.5     $  25.0       16.9  %   $ 147.5
       GP                  204.3        15.7        8.3  %     188.6        20.7       12.3  %     167.9
  Total North America      408.2        47.1       13.0  %     361.1        45.7       14.5  %     315.4
  International            161.7        36.9       29.6  %     124.8        13.3       11.9  %     111.5
  Invisalign non-case
net revenues                44.7        14.0       45.6  %      30.7         6.0       24.3  %      24.7
Total Clear Aligner net
revenues 1               $ 614.6     $  98.0       19.0  %   $ 516.6     $  65.0       14.4  %   $ 451.6
Product
  Invisalign Full        $ 382.0     $  43.4       12.8  %   $ 338.6     $  36.3       12.0  %   $ 302.3
  Invisalign
Express/Lite                72.4        20.9       40.6  %      51.5         8.9       20.9  %      42.6
  Invisalign Teen           84.9        17.8       26.5  %      67.1        12.6       23.1  %      54.5
  Invisalign Assist         30.6         1.9        6.6  %      28.7         1.3        4.7  %      27.4
  Invisalign non-case
net revenues                44.7        14.0       45.6  %      30.7         5.9       23.8  %      24.8
Total Clear Aligner net
revenues                 $ 614.6     $  98.0       19.0  %   $ 516.6     $  65.0       14.4  %   $ 451.6

SCCS Services 2:
Region
  North America          $  45.3     $   3.1        7.3  %   $  42.2     $  18.2       75.8  %   $  24.0
  International              0.3        (0.9 )    (75.0 )%       1.2        (2.9 )    (70.7 )%       4.1
Total SCCS net revenues  $  45.6     $   2.2        5.1  %   $  43.4     $  15.3       54.4  %   $  28.1
Product
  Scanners               $  23.7     $   3.7       18.5  %   $  20.0     $   6.7       50.4  %   $  13.3
  CAD/CAM Services          21.9        (1.5 )     (6.4 )%      23.4         8.6       58.1  %      14.8
Total SCCS net revenues  $  45.6     $   2.2        5.1  %   $  43.4     $  15.3       54.4  %   $  28.1
Total net revenues       $ 660.2     $ 100.2       17.9  %   $ 560.0     $  80.3       16.7  %   $ 479.7

1 In the fourth quarter of 2012, we identified an error that the actual case refinement usage rate was lower than our estimate and, as a result, we recorded a net revenue release of $4.9 million previously deferred for case refinement of which $5.2 million was a correction of an error of which $4.5 million related to the first three quarters for the fiscal year 2012 and $0.7 million related to the fiscal year 2011. The adjustment was not material to any quarter within 2012. The net amount of $4.9 million is not material to the results of operations for twelve months ended December 31, 2012.

2 As the acquisition of Cadent closed on April 29, 2011, the year ended December 31, 2011 balances for SCCS Services only reflect eight months of revenues.

Clear Aligner Case Volume by Channel and Product

Case volume data which represents Invisalign case shipments by channel and
product, for the year ended December 31, 2013, 2012 and 2011 as follows (in
thousands):

                                       36
--------------------------------------------------------------------------------


                                                    Year Ended December 31,
                                           Net        %                 Net        %
Region and Channel               2013    Change    Change     2012    Change    Change     2011
North America:
     Orthodontist               159.6     22.6     16.5  %   137.0      21.6     18.7 %   115.4
     GP                         154.3     14.6     10.5  %   139.7      16.5     13.4 %   123.2
Total North American Invisalign 313.9     37.2     13.4  %   276.7      38.1     16.0 %   238.6
International Invisalign        108.5     21.7     25.0  %    86.8      16.0     22.6 %    70.8
Total Invisalign case volume    422.4     58.9     16.2  %   363.5      54.1     17.5 %   309.4
Product
Invisalign Full                 262.4     27.4     11.7  %   235.0      28.7     13.9 %   206.3
Invisalign Express/Lite          79.0     20.3     34.6  %    58.7      14.5     32.8 %    44.2
Invisalign Teen                  59.6     11.3     23.4  %    48.3      10.3     27.1 %    38.0
Invisalign Assist                21.4     (0.1 )   (0.5 )%    21.5       0.6      2.9 %    20.9
Total Invisalign case volume    422.4     58.9     16.2  %   363.5      54.1     17.5 %   309.4

Fiscal Year 2013 compared to Fiscal Year 2012

Total net revenues increased by $100.2 million in 2013 as compared to 2012 primarily as a result of Invisalign case volume growth across all regions and products as well as increased Invisalign non-case revenue.

Clear Aligner

Clear Aligner North America net revenues increased by $47.1 million or 13.0% in 2013 compared to 2012 primarily due to Invisalign case volume growth of approximately $48.5 million across all channels and products, offset in part, by lower average selling prices ("ASP") which decreased net revenues by approximately $1.4 million. The decrease in ASP was a result of product mix shift towards lower priced Invisalign Express products combined with the revenue deferral for free mid-course correction as a result of our policy change in June 2013. Beginning June 15, 2013, we included up to three free mid-course correction orders in our list prices for Invisalign Full and Invisalign Teen.

Clear Aligner international net revenues increased by $36.9 million or 29.6% in 2013 compared to 2012 primarily driven by Invisalign case volume growth of $31.1 million along with higher ASP, which resulted in approximately $5.8 million increase in net revenues. The increase in ASP was primarily due to the impact from acquiring our distributor in the APAC region on April 30, 2013, as well as a favorable impact of foreign exchange rates. By bringing the APAC region direct, we began to recognize direct sales of Invisalign products sold in that region at our full ASP rather than the discounted ASP under the distributor agreement. The increase in ASP was offset in part due to a product mix shift towards lower priced Invisalign Lite products.

Despite our recent product mix shift towards lower priced Invisalign products, we expect our worldwide ASP to trend upwards in the future as a result of higher growth rates in our international markets, which typically have higher ASP than North America.

Invisalign non-case net revenues, consisting of training fees and ancillary product revenues, increased 45.6% in 2013 as compared to 2012 primarily due to the consolidation of our Vivera product shipments in North America from four shipments per year to one shipment along with increased Vivera volume both in North America and international.

SCCS

SCCS net revenues increased 5.1% in 2013 compared to 2012 primarily due to an increase in scanner revenues, partially offset by a decrease in CAD/CAM services net revenues as a result of the discontinuation of the OrthoCAD iQ services during the fourth quarter of 2012. The increase in scanner revenues in 2013 was as a result of the increase in number of scanners sales recognized in 2013 as compared to 2012 as well as the release of $1.4 million of revenue previously reserved for the new iTero upgrade program which was completed in the first quarter of 2013.


Fiscal Year 2012 compared to Fiscal Year 2011

Total net revenues increased $80.3 million in 2012 primarily as a result of volume growth of 17.5% across all regions and customer channels in our Clear Aligner segment and the inclusion of a full year of Scanner and CAD/CAM Services (SCCS) segment activity in 2012 compared to eight months in 2011.

Clear Aligner

Revenue from our Clear Aligner segment, increased by 14.4% due to increased case volumes across all products which resulted in an increase in net revenues of approximately $74.8 million offset by lower ASP, which decreased net revenues by approximately $16.1 million. Additionally, in the fourth quarter of 2012, we determined that the actual case refinement usage rate was lower than our estimate and, as a result, Invisalign revenue includes the release of $4.9 million of revenue previously deferred for case refinement (refer to Item 8 on this Form 10-K for further discussion).

North American revenue growth of 14.5% was driven by increased volumes of 16% in the Ortho Channel and GP channels due to higher utilization and an increased number of doctors submitting cases which resulted in an increase in net revenues of approximately $50.4 million. Lower ASP contributed $5.0 million to a decrease in net revenues as a result of increased discounting from our volume rebate program and a product mix shift towards our lower priced products.

International revenue growth of 11.9% was mainly due to volume increases of 22.6% across all products which resulted in an increase in net revenues of approximately $25.3 million. This increase was offset in part by lower ASP which resulted in a decrease in net revenues of approximately $12.0 million primarily due to higher discounts, unfavorable foreign exchange rates and a product mix shift towards distributor sales and lower priced products.

Invisalign non-case revenues, consisting of training fees and sales of ancillary products, were higher in 2012 compared to 2011 primarily due to increased sales of our Vivera product and training.

Scanner and CAD/CAM Services
Revenue from our Scanner and CAD/CAM Services segment, consisting of scanner and CAD/CAM services, increased by $15.3 million as a result of $18.2 million increase in North America revenue related to higher scanner volume from a full year of activity in 2012 compared to eight months in 2011. This is partially offset by a $2.9 million decrease in international revenue due to lower scanner volumes as a result of the termination of our exclusive distribution agreement with Straumann for iTero intra-oral scanners. The financial results of Cadent have been included in this segment since the acquisition date on April 29, 2011.

Cost of net revenues and gross profit (in millions):

                                                Year Ended December 31,
                                  2013       Change      2012       Change      2011
Clear Aligner
Cost of revenues                $ 129.8     $ 19.4     $ 110.6     $  13.5    $  97.1
% of net segment revenues          21.1 %                 21.4 %                 21.5 %
Gross profit                    $ 484.8     $ 78.8     $ 406.0     $  51.3    $ 354.7
Gross margin %                     78.9 %                 78.6 %                 78.5 %
Scanners and CAD/CAM Services 1
Cost of revenues                $  32.3     $ (0.7 )   $  33.0     $  11.6    $  21.4
% of net segment revenues          70.9 %                 75.9 %                 76.3 %
Gross profit                    $  13.3     $  2.9     $  10.4     $   3.9    $   6.5
Gross margin %                     29.1 %                 24.1 %                 23.7 %
Total cost of revenues          $ 162.1     $ 18.5     $ 143.6     $  25.1    $ 118.5
% of net revenues                  24.6 %                 25.7 %                 24.7 %
Gross profit                    $ 498.1     $ 81.7     $ 416.4     $  55.2    $ 361.2
Gross margin %                     75.4 %                 74.3 %                 75.3 %

1 The Scanners and CAD/CAM services segment was created as a result of our acquisition of Cadent on April 29, 2011 and the financial results for that segment reflect the activity since that date.


Cost of net revenues for our Clear Aligner and SCCS includes salaries for staff involved in the production process, the cost of materials, packaging, shipping costs, depreciation on capital equipment used in the production process, amortization of acquired intangible assets from Cadent, training costs and stock-based compensation expense.

Fiscal Year 2013 compared to Fiscal Year 2012

Clear Aligner

Gross margin improved slightly in 2013 compared to 2012 due to lower warranty costs as a result of reduced warranty claims corresponding with the change in our mid-course correction policy in June 2013. This gross margin improvement was partially offset by increased material costs, primarily related to our new SmartTrack material. In addition, we incurred higher inventory reserves for our prior aligner material which has been substantially replaced by our new SmartTrack aligner material.

Scanner and CAD/CAM Services

Gross margin increased in 2013 compared to 2012 primarily as a result of the release of revenue for amounts previously reserved in 2012 for the new 2.9 iTero scanner upgrade program which was completed in the first quarter of 2013. In addition, we had lower manufacturing costs as a result of the closure of our New Jersey facility, which was completed by October 2012, and a reduction in training costs; however, these savings were partially offset by higher third party labor service costs and lower manufacturing cost absorption.

Fiscal Year 2012 compared to Fiscal Year 2011

Clear Aligner

Gross margin remained fairly consistent in 2012 compared to 2011 largely benefiting from higher sales volume that resulted in a decrease in cost per case offset by lower ASP.

Scanner and CAD/CAM Services

Gross margin improved slightly in 2012 compared to 2011 primarily resulting from
lower acquisition, integration, and exit costs partially offset by lower scanner
ASP as well as higher training costs.
Sales and marketing (in millions):

                                    Year Ended December 31,
                      2013       Change      2012       Change       2011
Sales and marketing $ 180.0     $  28.0    $ 152.0     $    9.8    $ 142.2
% of net revenues      27.3 %                 27.1 %                  29.6 %

Sales and marketing expense primarily includes sales force and marketing compensation costs including commissions and stock-based compensation expense, media and advertising, travel and expense related costs, clinical education, product marketing, expenses for trade shows and industry events and allocations of corporate overhead expenses including facilities, IT and human resource costs.

Sales and marketing expense increased in 2013 compared to 2012 due primarily to higher compensation costs of $16.4 million largely related to increased headcount, including additional employees as a result of the acquisition of our APAC distributor, higher sales commissions and stock-based compensation. In addition, we incurred higher advertising and media costs primarily related to network and television media campaigns.

Sales and marketing expense increased in 2012 compared to 2011 due primarily to higher compensation costs of approximately $5.0 million which was largely attributable to the inclusion of Cadent's headcount for the full twelve months of 2012 as compared to only eight months in 2011. We also incurred higher costs . . .

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