ALGN-2014.3.31-Q1
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________ 
FORM 10-Q
____________________________ 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2014
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to
Commission file number: 0-32259 
____________________________
ALIGN TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
____________________________ 
Delaware
94-3267295
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
2560 Orchard Parkway
San Jose, California 95131
(Address of principal executive offices)
(408) 470-1000
(Registrant’s telephone number, including area code)
 ____________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
The number of shares outstanding of the registrant’s Common Stock, $0.0001 par value, as of April 25, 2014 was 81,635,404.

 


Table of Contents

ALIGN TECHNOLOGY, INC.
INDEX
 
 
 
 
PART I
ITEM 1.
 
 
 
 
 
ITEM 2.
ITEM 3.
ITEM 4.
PART II
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
Invisalign, Align, ClinCheck, Invisalign Assist, Invisalign Teen, Vivera, SmartForce, SmartTrack, Power Ridge, iTero, Orthocad, iCast and iRecord, among others, are trademarks and/or service marks of Align Technology, Inc. or one of its subsidiaries or affiliated companies and may be registered in the United States and/or other countries.



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Table of Contents

PART I—FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
         
 
Three Months Ended
 
 
March 31,
 
 
2014
 
2013
 
Net revenues
$
180,646

 
$
153,580

 
Cost of net revenues
43,395

 
40,731

 
Gross profit
137,251

 
112,849

 
Operating expenses:
 
 
 
 
Sales and marketing
52,888

 
42,281

 
General and administrative
29,179

 
30,348

 
Research and development
13,380

 
11,282

 
Impairment of goodwill

 
40,693

 
Impairment of long-lived assets

 
26,320

 
Total operating expenses
95,447

 
150,924

 
Operating profit (loss)
41,804

 
(38,075
)
 
Interest and other income (expenses), net
601

 
(988
)
 
Net income (loss) before provision for income taxes
42,405

 
(39,063
)
 
Provision for income taxes
9,961

 
2,920

 
Net income (loss)
$
32,444

 
$
(41,983
)
 
 
 
 
 
 
Net income (loss) per share:
 
 
 
 
Basic
$
0.40

 
$
(0.52
)
 
Diluted
$
0.39

 
$
(0.52
)
 
Shares used in computing net income (loss) per share:
 
 
 
 
Basic
81,120

 
81,248

 
Diluted
82,817

 
81,248

 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
 
 
Three Months Ended
 
 
March 31,
 
 
2014
 
2013
 
Net income (loss)
$
32,444

 
$
(41,983
)
 
Net change in cumulative translation adjustment
106

 
(55
)
 
Change in unrealized gains on available-for-sale securities, net of tax
42

 
3

 
Other comprehensive income (loss)
148

 
(52
)
 
Comprehensive income (loss)
$
32,592

 
$
(42,035
)
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)

 
 
March 31,
2014
 
December 31,
2013
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
182,766

 
$
242,953

Marketable securities, short-term
183,677

 
127,040

Accounts receivable, net of allowances for doubtful accounts and returns of $1,798 and $1,733, respectively
126,183

 
113,250

Inventories
15,840

 
13,968

Prepaid expenses and other current assets
43,711

 
47,465

Total current assets
552,177

 
544,676

Marketable securities, long-term
138,929

 
101,978

Property, plant and equipment, net
79,093

 
75,743

Goodwill and intangible assets, net
84,388

 
85,362

Deferred tax assets
22,739

 
15,766

Other assets
8,315

 
8,622

Total assets
$
885,641

 
$
832,147

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
18,506

 
$
17,718

Accrued liabilities
71,349

 
80,345

Deferred revenues
81,000

 
77,275

Total current liabilities
170,855

 
175,338

Other long-term liabilities
18,033

 
22,839

Total liabilities
188,888

 
198,177

Commitments and contingencies (Note 8)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.0001 par value (5,000 shares authorized; none issued)

 

Common stock, $0.0001 par value (200,000 shares authorized; 81,632 and 80,583 issued and outstanding at 2014 and 2013, respectively)
8

 
8

Additional paid-in capital
759,768

 
729,578

Accumulated other comprehensive income
442

 
294

Accumulated deficit
(63,465
)
 
(95,910
)
Total stockholders’ equity
696,753

 
633,970

Total liabilities and stockholders’ equity
$
885,641

 
$
832,147

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Three Months Ended
 
March 31,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
32,444

 
$
(41,983
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Deferred taxes
12,769

 
931

Depreciation and amortization
4,776

 
4,944

Stock-based compensation
9,132

 
6,410

Excess tax benefit from share-based payment arrangements
(13,568
)
 
(7,739
)
Impairment of goodwill

 
40,693

Impairment of long-lived assets

 
26,320

Other non-cash operating activities
1,977

 
(444
)
Changes in assets and liabilities:

 
 
 
Accounts receivable
(13,939
)
 
(10,002
)
Inventories
(1,870
)
 
(320
)
Prepaid expenses and other assets
(1,790
)
 
(586
)
Accounts payable
265

 
1,611

Accrued and other long-term liabilities
(15,286
)
 
(7,941
)
Deferred revenues
3,083

 
(1,476
)
Net cash provided by operating activities
17,993

 
10,418

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of property, plant and equipment
(4,996
)
 
(5,608
)
Purchase of marketable securities
(157,919
)
 
(3,282
)
Proceeds from maturities of marketable securities
53,137

 
4,366

Proceeds from sales of marketable securities
10,564

 

Other investing activities
(133
)
 
1,079

Net cash used in investing activities
(99,347
)
 
(3,445
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock
11,946

 
13,268

Common stock repurchases

 
(2,438
)
Excess tax benefit from share-based payment arrangements
13,568

 
7,739

Employees’ taxes paid upon the vesting of restricted stock units
(4,453
)
 
(3,141
)
Other financing activities

 
(5
)
Net cash provided by financing activities
21,061

 
15,423

Effect of foreign exchange rate changes on cash and cash equivalents
106

 
(37
)
Net (decrease) increase in cash and cash equivalents
(60,187
)
 
22,359

Cash and cash equivalents, beginning of the period
242,953

 
306,386

Cash and cash equivalents, end of the period
$
182,766

 
$
328,745

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


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ALIGN TECHNOLOGY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Summary of Significant Accounting Policies

Basis of presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared by Align Technology, Inc. (“we”, “our”, or “Align”) in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") and contain all adjustments, including normal recurring adjustments, necessary to present fairly our results of operations for the three months ended March 31, 2014 and 2013, our comprehensive income (loss) for the three months ended March 31, 2014 and 2013, our financial position as of March 31, 2014 and our cash flows for the three months ended March 31, 2014 and 2013. The Condensed Consolidated Balance Sheet as of December 31, 2013 was derived from the December 31, 2013 audited financial statements. Net revenues by geographic area for prior period amounts in Note 12 have been reclassified to conform with the current period presentation. These reclassifications had no impact on our financial position for the three months ended March 31, 2014 and 2013.

The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 or any other future period, and we make no representations related thereto. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A and 8, respectively, in our Annual Report on Form 10-K for the year ended December 31, 2013.

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") in the United States of America (“U.S.”) requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, we evaluate our estimates, including those related to the fair values of financial instruments, long-lived assets and goodwill, useful lives of intangible assets and property and equipment, stock-based compensation, income taxes, and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Recent Accounting Pronouncements

In July 2013, Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, "Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)." The amendments in this ASU provide guidance on the financial statements presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward with certain exceptions, in which case such an unrecognized tax benefit should be presented in the financial statements as a liability. The amendments in this ASU do not require new recurring disclosures and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this standard in the first quarter of 2014 had the effect of reducing our accruals for uncertain tax positions by $8.4 million, with an offsetting reduction in our long term deferred tax assets, but had no effect on net income.



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Note 2. Marketable Securities and Fair Value Measurements

As of March 31, 2014 and December 31, 2013, the estimated fair value of our short-term and long-term marketable securities, classified as available for sale, are as follows (in thousands):

Short-term
March 31, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Commercial paper
$
67,332

 
$
10

 
$
(1
)
 
$
67,341

Corporate bonds
59,282

 
42

 
(14
)
 
59,310

U.S. government agency bonds
22,794

 
17

 
(6
)
 
22,805

Asset-backed securities
13,934

 
8

 
(1
)
 
13,941

Municipal securities
9,613

 
13

 

 
9,626

U.S. dollar dominated foreign corporate bonds
8,102

 
8

 
(2
)
 
8,108

U.S. government treasury bonds
2,546

 

 

 
2,546

Total Marketable Securities, Short-Term
$
183,603

 
$
98

 
$
(24
)
 
$
183,677


Long-term
March 31, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Corporate bonds
$
45,844

 
$
41

 
$
(49
)
 
$
45,836

U.S. government agency bonds
31,077

 
11

 
(4
)
 
31,084

Asset-backed securities
20,501

 
5

 
(5
)
 
20,501

U.S. government treasury bonds
20,598

 
15

 
(1
)
 
20,612

U.S. dollar dominated foreign corporate bonds
13,783

 
2

 
(17
)
 
13,768

Municipal securities
7,114

 
15

 
(1
)
 
7,128

Total Marketable Securities, Long-Term
$
138,917

 
$
89

 
$
(77
)
 
$
138,929


Short-term
December 31, 2013
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Corporate bonds
$
29,079

 
$
10

 
$
(4
)
 
$
29,085

Commercial paper
54,318

 
10

 

 
54,328

U.S. government agency bonds
16,693

 
10

 

 
16,703

U.S. dollar dominated foreign corporate bonds
13,959

 
12

 

 
13,971

Municipal securities
7,006

 
11

 
(3
)
 
7,014

Asset-backed securities
5,937

 
2

 

 
5,939

Total Marketable Securities, Short-Term
$
126,992

 
$
55

 
$
(7
)
 
$
127,040

Long-term 
December 31, 2013
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
U.S. government agency bonds
$
38,138

 
$
1

 
$
(21
)
 
$
38,118

Corporate bonds
23,308

 
14

 
(9
)
 
23,313

U.S. dollar dominated foreign corporate bonds
19,485

 
27

 
(17
)
 
19,495

Municipal securities
8,326

 
13

 
(8
)
 
8,331

U.S. government treasury bonds
6,916

 
3

 

 
6,919

Asset-backed securities
5,800

 
4

 
(2
)
 
5,802

Total Marketable Securities, Long-Term
$
101,973

 
$
62

 
$
(57
)
 
$
101,978


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 For the three months ended March 31, 2014 and 2013, realized gains were immaterial. Unrealized gains and losses for our available for sale securities as of March 31, 2014 and December 31, 2013 were also immaterial. Cash and cash equivalents are not included in the table above as the gross unrealized gains and losses are not material. We have no material short-term or long-term investments that have been in a continuous unrealized loss position for greater than twelve months as of March 31, 2014 and December 31, 2013. Amounts reclassified to earnings from accumulated other comprehensive income related to unrealized gain or losses were immaterial for the three months ended March 31, 2014 and 2013.

Our fixed-income securities investment portfolio consists of corporate bonds, U.S. dollar dominated foreign corporate bonds, commercial paper, municipal securities, U.S. government agency bonds and asset-backed securities that have a maximum maturity of two years. The securities that we invest in are generally deemed to be low risk based on their credit ratings from the major rating agencies. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As interest rates increase, those securities purchased at a lower yield show a mark-to-market unrealized loss. The unrealized losses are due primarily to changes in credit spreads and interest rates. We expect to realize the full value of all these investments upon maturity or sale. The weighted average remaining duration of these securities was approximately 11 months and 10 months as of March 31, 2014 and December 31, 2013, respectively.

As the carrying value approximates the fair value for our short-term and long-term marketable securities shown in the tables above, the following table summarizes the fair value of our short-term and long-term marketable securities classified by maturity as of March 31, 2014 and December 31, 2013 (in thousands):

 
March 31,
 
December 31,
 
2014
 
2013
Due in one year or less
$
183,677

 
$
127,040

Due in one year to 27 months
138,929

 
101,978

Total available for sale short-term and long-term marketable securities
$
322,606

 
$
229,018


Fair Value Measurements

We measure the fair value of our cash equivalents and marketable securities as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We use the GAAP fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value:

Level 1 — Quoted (unadjusted) prices in active markets for identical assets or liabilities.

Our Level 1 assets consist of money market funds and U.S. government treasury bonds. We did not hold any Level 1 liabilities as of March 31, 2014 or December 31, 2013.

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Our Level 2 assets consist of commercial paper, corporate bonds, U.S. dollar dominated foreign corporate bonds, U.S. government agency bonds, municipal securities, asset-backed securities, U.S. government treasury bonds and our Israeli funds that are mainly invested in insurance policies. We obtain fair values for Level 2 investments from our asset manager for each of our portfolios. Our custody bank and asset managers independently use professional pricing services to gather pricing data which may include quoted market prices for identical or comparable financial instruments, or inputs other than quoted prices that are observable either directly or indirectly, and we are ultimately responsible for these underlying estimates.

We did not hold any Level 2 liabilities as of March 31, 2014 or December 31, 2013.

Level 3 — Unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.

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We did not hold any Level 3 assets or liabilities as of March 31, 2014 or December 31, 2013.
Non-Recurring Fair Value Measurements

During the three months ended March 31, 2013, we recorded an impairment charge to our long-lived assets and goodwill of $26.3 million and $40.7 million, respectively, related to our Scanner and Services ("Scanner") reporting unit, formerly referred to as Scanner and CAD/CAM Services ("SCCS"), as an event occurred and circumstances changed that led us to perform an impairment analysis prior to our annual test which required us to determine the fair value of the Scanner reporting unit (Refer to Note 5). These fair value measurements were calculated using unobservable inputs, using the income approach which is classified as Level 3 within the fair value hierarchy. Inputs for the income approach includes the amount and timing of future cash flows based on our most recent operational budgets, strategic plans, terminal growth rates assumptions and other estimates.
Recurring Fair Value Measurements

The following table summarizes our financial assets measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013 (in thousands):
 
Description
Balance as of
March 31, 2014
 
Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable  Inputs
(Level 2)
Cash equivalents:
 
 
 
 
 
Money market funds
$
55,518

 
$
55,518

 
$

Commercial paper
32,995

 

 
32,995

Corporate bonds
2,010

 

 
2,010

Short-term investments:
 
 
 
 
 
Commercial paper
67,341

 

 
67,341

Corporate bonds
59,310

 

 
59,310

U.S. government agency bonds
22,805

 

 
22,805

Asset-backed securities
13,941

 

 
13,941

Municipal securities
9,626

 

 
9,626

U.S. dollar dominated foreign corporate bonds
8,108

 

 
8,108

U.S. government treasury bonds
2,546

 

 
2,546

Long-term investments:
 
 
 
 
 
Corporate bonds
45,836

 

 
45,836

U.S. government agency bonds
31,084

 

 
31,084

Asset-backed securities
20,501

 

 
20,501

U.S. government treasury bonds
20,612

 
20,612

 

U.S. dollar dominated foreign corporate bonds
13,768

 

 
13,768

Municipal securities
7,128

 

 
7,128

Other assets:
 
 
 
 
 
Israeli funds
2,274

 

 
2,274

 
$
415,403

 
$
76,130

 
$
339,273



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Description
Balance as of
December 31, 2013
 
Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable  Inputs
(Level 2)
Cash equivalents:
 
 
 
 
 
Money market funds
$
143,540

 
$
143,540

 
$

Commercial paper
15,398

 

 
15,398

Short-term investments:
 
 
 
 
 
Commercial paper
54,328

 

 
54,328

Corporate bonds
29,085

 

 
29,085

U.S. dollar denominated foreign corporate bonds
13,971

 

 
13,971

Municipal securities
7,014

 

 
7,014

U.S. government agency bonds
16,703

 

 
16,704

Asset-backed securities
5,939

 

 
5,938

Long-term investments:
 
 
 
 
 
U.S. government agency bonds
38,118

 

 
38,118

Corporate bonds
23,313

 

 
23,313

U.S. dollar denominated foreign corporate bonds
19,495

 

 
19,495

U.S. government treasury bonds
6,919

 
6,919

 

Municipal securities
8,331

 

 
8,331

Asset-backed securities
5,802

 

 
5,802

Other assets:
 
 
 
 
 
Israeli funds
2,193

 

 
2,193

 
$
390,149

 
$
150,459

 
$
239,690



Note 3. Balance Sheet Components

Inventories

Inventories consist of the following (in thousands):
 
 
March 31,
2014
 
December 31,
2013
Raw materials
$
5,962

 
$
5,172

Work in process
3,592

 
4,241

Finished goods
6,286

 
4,555

Total Inventories
$
15,840

 
$
13,968


Work in process includes costs to produce our clear aligner and intra-oral products. Finished goods primarily represent our intra-oral scanners and ancillary products that support our clear aligner products.

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Accrued liabilities

Accrued liabilities consist of the following (in thousands):
 
 
March 31,
2014
 
December 31,
2013
Accrued payroll and benefits
$
32,400

 
$
43,029

Accrued sales rebates
9,851

 
10,100

Accrued sales tax and value added tax
6,230

 
6,215

Accrued sales and marketing expenses
4,689

 
3,893

Accrued accounts payable
5,622

 
4,053

Accrued warranty
3,048

 
3,104

Accrued professional fees
2,085

 
1,892

Accrued income taxes
408

 
1,205

Other accrued liabilities
7,016

 
6,854

Total Accrued Liabilities
$
71,349

 
$
80,345


Warranty

We regularly review the accrued warranty balances and update these balances based on historical warranty trends. Actual warranty costs incurred have not materially differed from those accrued; however, future actual warranty costs could differ from the estimated amounts.

Clear Aligner

We warrant our Invisalign products against material defects until the Invisalign case is complete. We accrue for warranty costs in cost of net revenues upon shipment of products. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on replacement costs.

Scanners

We warrant our scanners for a period of one year from the date of training and installation. We accrue for these warranty costs which includes materials and labor based on estimated historical repair costs. Extended service packages may be purchased for additional fees.

Warranty accrual as of March 31, 2014 and 2013 consists of the following activity (in thousands):
 
 
Three Months Ended
March 31,
 
2014
 
2013
Balance at beginning of period
$
3,104

 
$
4,050

Charged to cost of net revenues
653

 
1,263

Actual warranty expenditures
(709
)
 
(1,184
)
Balance at end of period
$
3,048

 
$
4,129


Note 4. Business Combinations

On April 30, 2013, we completed the acquisition of ICA Holdings Pty Limited ("ICA") upon the expiration of the distribution agreement between certain subsidiaries of ICA and Align Technology B.V., for a total cash consideration of approximately $8.6 million, of which $7.4 million was attributed to assets acquired, $2.4 million in liabilities assumed and $3.6 million to goodwill. Goodwill as a result of this acquisition represents the excess of the purchase price over the fair value of the underlying net assets acquired and represents the knowledge and experience of the workforce in place. None of this goodwill will be deductible for tax purposes. Under the applicable accounting guidance, goodwill will not be amortized but will be tested for impairment on an annual basis or more frequently if certain indicators are present.  


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We believe that the transition from our distributor arrangement to a direct sales model as a result of the acquisition of ICA will increase our net revenues in the region as we will experience higher average selling price(s) (“ASP”) as compared to our discounted ASP under the prior distribution agreement. 

Pro forma results of operations for this acquisition have not been presented as it is not material to our results of operations, either individually or in aggregate, for the three months ended March 31, 2013.

Note 5. Goodwill and Long-lived Assets

Goodwill
The change in the carrying value of goodwill for the three months ended March 31, 2014 by our reportable segments, which are also our reporting units, is as follows (in thousands):
 
Clear Aligner
Balance as of December 31, 2013
$
61,623

Adjustments 1
128

Balance as of March 31, 2014
$
61,751

1 The adjustments to goodwill during the three months ended March 31, 2014 were due to foreign currency translation.

The goodwill balance is entirely attributable to our Clear Aligner reporting unit. During the fourth quarter of fiscal 2013, we performed the annual goodwill impairment testing and found no impairment events as the fair value of our Clear Aligner reporting unit was significantly in excess of the carrying value.
Impairment of Goodwill in 2013
We evaluate our goodwill for impairment at least annually on November 30th or more frequently if indicators are present, an event occurs or circumstances change that suggest an impairment may exist and that it would more likely than not reduce the fair value of the reporting unit below its carrying amount. During March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, that caused us to lower our expectations for growth and profitability for our Scanner reporting unit. As a result, we determined that goodwill related only to our Scanner reporting unit should be tested for impairment as of March 2013 due to these facts and circumstances which would more likely than not reduce the fair value of our Scanner reporting unit below its carrying amount. There was no triggering event related to our Clear Aligner goodwill.
We performed a step one analysis for our Scanner reporting unit which consists of a comparison of the fair value of the Scanner reporting unit against its carrying amount, including the goodwill allocated to it. In deriving the fair value of the Scanner reporting unit, we utilized the income approach which is classified as Level 3 within the fair value hierarchy. This approach provides an estimated fair value based on discounted expected future cash flows, which are based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the business and the projected cash flows.
As a result of our step one analysis, we concluded that the fair value of the Scanner reporting unit was less than its carrying value; therefore, we proceeded to step two of the goodwill impairment analysis. Step two of the goodwill impairment analysis measures the impairment charge by allocating the reporting unit's fair value to all of the assets and liabilities of the reporting unit in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. This allocation process was performed only for the purposes of measuring the goodwill impairment and not to adjust the carrying values of the recognized tangible assets and liabilities. Any excess of the carrying value of the reporting unit's goodwill over the implied fair value of the reporting unit's goodwill is recorded as an impairment loss. We use a discounted cash flow ("DCF") approach, utilizing the harvest model, to estimate the fair value of a reporting unit which we believe is the most reliable indicator of fair value of this business, and is most consistent with the approach a market place participant would use. Based on our analysis, there was no implied goodwill for the Scanner reporting unit; therefore, we recorded a goodwill impairment charge of $40.7 million in the three months ended March 31, 2013, which represents the remaining goodwill balance in the Scanner reporting unit. None of the goodwill impairment charge was deductible for tax purposes.

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Long-lived Assets

Impairment of Long-lived Assets in 2013

We amortize our intangible assets over their estimated useful lives. We evaluate long-lived assets, which includes property, plant and equipment and intangible assets, for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. The carrying value is not recoverable if it exceeds the undiscounted cash flows resulting from the use of the asset and its eventual disposition. Our estimates of future cash flows attributable to our long-lived assets require significant judgment based on our historical and anticipated results and are subject to many factors. Factors we consider important which could trigger an impairment review include significant negative industry or economic trends, significant loss of customers and changes in the competitive environment of our intra-oral scanning business.

During March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, that caused us to lower our expectations for growth and profitability for our Scanner reporting unit. As a result, we determined that the carrying value of the Scanner long-lived assets was not recoverable as compared to the value of the undiscounted cash flows of our revised projections for the asset group. In order to determine the impairment amount of our long-lived assets, we fair valued each key component of our long-lived assets within the asset group, which involved the use of significant estimates and assumptions including replacement costs, revenue growth rates, operating margins, and plant and equipment cost trends. We use a DCF approach, utilizing the harvest model, to estimate the fair value of a reporting unit which we believe is the most reliable indicator of fair value of this business, and is most consistent with the approach a market place participant would use. The estimation of fair value utilizing a DCF approach includes numerous uncertainties which require our significant judgment when making assumptions of expected growth rates and the selection of discount rates, as well as assumptions regarding general economic and business conditions, and the structure that would yield the highest economic value, among other factors. Key assumptions used in measuring the fair values of the Scanner reporting unit included the discount rate (based on the weighted-average cost of capital) and revenue growth. The fair value of Scanner’s trademark was determined using a risk-adjusted DCF approach under the relief-from-royalty method. The royalty rate used was based on a consideration of market rates. The fair value of Scanner’s finite-lived customer relationships was determined using a DCF approach under the multi-period excess earnings method. We determined our long-lived asset group within the Scanner reporting unit to be primarily finite-lived intangible assets, plant and equipment. Upon completion of this analysis, we recorded a total impairment charge of $26.3 million of which $19.3 million represented the impairment related to our Scanner intangible assets and $7.0 million related to plant and equipment. There was no triggering event related to the Clear Aligner asset group.

Intangible assets arising either as a direct result from the Cadent acquisition or individually acquired are being amortized as follows (in thousands):
 
 
Weighted Average Amortization Period (in years)
 
Gross Carrying Amount as of
March 31, 2014
 
Accumulated
Amortization
 
Accumulated
Impairment Loss
 
Net Carrying
Value as of
March 31, 2014
Trademarks
15
 
$
7,100

 
$
(1,249
)
 
$
(4,179
)
 
$
1,672

Existing technology
13
 
12,600

 
(2,591
)
 
(4,328
)
 
5,681

Customer relationships
11
 
33,500

 
(7,701
)
 
(10,751
)
 
15,048

Other
8
 
285

 
(49
)
 

 
236

Total Intangible Assets
 
 
$
53,485

 
$
(11,590
)
 
$
(19,258
)
 
$
22,637


 
Weighted Average Amortization Period (in years)
 
Gross Carrying
Amount as of
December 31, 2013
 
Accumulated
Amortization
 
Accumulated Impairment Loss
 
Net Carrying
Value as of
December 31, 2013
Trademarks
15
 
$
7,100

 
$
(1,100
)
 
(4,179
)
 
$
1,821

Existing technology
13
 
12,600

 
(2,236
)
 
(4,328
)
 
6,036

Customer relationships
11
 
33,500

 
(7,112
)
 
(10,751
)
 
15,637

Other
8
 
285

 
(40
)
 

 
245

Total Intangible Assets
 
 
$
53,485

 
$
(10,488
)
 
$
(19,258
)
 
$
23,739


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The total estimated annual future amortization expense for these acquired intangible assets as of March 31, 2014 is as follows (in thousands):
 
Fiscal Year Ending December 31,
 
Remainder of 2014
$
1,951

2015
2,600

2016
2,600

2017
2,600

2018
2,600

Thereafter
10,286

Total
$
22,637



Note 6. Credit Facilities

On March 22, 2013, we entered into a credit facility with Wells Fargo Bank. The credit facility provides for a $50.0 million revolving line of credit, with a $10.0 million letter of credit sublimit, and has a maturity date on March 22, 2016. The credit facility also requires us to maintain a minimum unrestricted cash balance of $50.0 million and comply with specific financial conditions and performance requirements. The loans bear interest, at our option, at a fluctuating rate per annum equal to the daily one-month adjusted LIBOR rate plus a spread of 1.75% or an adjusted LIBOR rate (based on one, three, six or twelve-month interest periods) plus a spread of 1.75%. As of March 31, 2014, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.

Note 7. Legal Proceedings
    
Securities Class Action Lawsuit
    
On November 28, 2012, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System filed a lawsuit against Align, Thomas M. Prescott (“Mr. Prescott”), Align's President and Chief Executive Officer, and Kenneth B. Arola (“Mr. Arola”), Align's former Vice President, Finance and Chief Financial Officer, in the United States District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock (the "Securities Action"). On July 11, 2013, an amended complaint was filed, which named the same defendants, on behalf of a purported class of purchasers of our common stock between January 31, 2012 and October 17, 2012. The amended complaint alleged that Align, Mr. Prescott and Mr. Arola violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that Mr. Prescott and Mr. Arola violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the amended complaint alleged that during the purported class period defendants failed to take an appropriate goodwill impairment charge related to the April 29, 2011 acquisition of Cadent Holdings, Inc. in the fourth quarter of 2011, the first quarter of 2012 or the second quarter of 2012, which rendered our financial statements and projections of future earnings materially false and misleading and in violation of U.S. GAAP. The amended complaint sought monetary damages in an unspecified amount, costs and attorney's fees. On December 9, 2013, the court granted defendant's motion to dismiss with leave for plaintiff to file a second amended complaint. Plaintiff filed a second amended complaint on January 8, 2014 on behalf of the same purported class. The second amended complaint states the same claims as the first amended complaint. We filed a motion to dismiss the second amended complaint on February 7, 2014. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this amended complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.
    
Shareholder Derivative Lawsuit
    
On February 1, 2013, plaintiff Gary Udis filed a shareholder derivative lawsuit against several of Align's current and former officers and directors in the Superior Court of California, County of Santa Clara. The complaint alleges that our reported income and earnings were materially overstated because of a failure to timely write down goodwill related to the April 29, 2011 acquisition of Cadent Holdings, Inc., and that defendants made allegedly false statements concerning our forecasts. The complaint asserts various state law causes of action, including claims of breach of fiduciary duty, unjust enrichment, and insider trading, among others. The complaint seeks unspecified damages on behalf of Align, which is named solely as nominal defendant against whom no recovery is sought. The complaint also seeks an order directing Align to reform and improve its

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corporate governance and internal procedures, and seeks restitution in an unspecified amount, costs, and attorney's fees. On July 8, 2013, an Order was entered staying this derivative lawsuit until an initial ruling on our first motion to dismiss the Securities Action. On January 15, 2014, an Order was entered staying this derivative lawsuit until an initial ruling on our second motion to dismiss the Securities Action discussed above. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible losses.

In addition, in the course of Align's operations, Align is involved in a variety of claims, suits, investigations, and proceedings, including actions with respect to intellectual property claims, patent infringement claims, government investigations, labor and employment claims, breach of contract claims, tax, and other matters. Regardless of the outcome, these proceedings can have an adverse impact on us because of defense costs, diversion of management resources, and other factors. Although the results of complex legal proceedings are difficult to predict and Align's view of these matters may change in the future as litigation and events related thereto unfold; Align currently does not believe that these matters, individually or in the aggregate, will materially affect Align's financial position, results of operations or cash flows.

Note 8. Commitments and Contingencies

Operating Leases

As of March 31, 2014, minimum future lease payments for non-cancelable operating leases are as follows (in thousands): 
Fiscal Year Ending December 31,
 
Operating leases
Remainder of 2014
 
$
6,960

2015
 
8,437

2016
 
7,717

2017
 
4,413

2018
 
1,539

Thereafter
 
500

Total minimum future lease payments
 
$
29,566


Off-balance Sheet Arrangements

As of March 31, 2014, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Indemnification Provisions

In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and our executive officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim.
It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of March 31, 2014, we did not have any material indemnification claims that were probable or reasonably possible.

Note 9. Stock-based Compensation

Summary of stock-based compensation expense


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As of March 31, 2014, we had a total reserve of 23,283,379 shares for issuance, plus up to an aggregate of 5,000,000 shares that would have been returned to our 2001 Stock Incentive Plan as a result of termination of options on or after March 28, 2005.

Stock-based compensation is based on the estimated fair value of awards, net of estimated forfeitures, and recognized over the requisite service period. Estimated forfeitures are based on historical experience at the time of grant and may be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The stock-based compensation related to all of our stock-based awards and employee stock purchases for the three months ended March 31, 2014 and 2013 is as follows (in thousands):
 
 
Three Months Ended
March 31,
 
2014
 
2013
Cost of net revenues
$
844

 
$
580

Sales and marketing
2,667

 
1,011

General and administrative
4,050

 
3,927

Research and development
1,571

 
892

Total stock-based compensation
$
9,132

 
$
6,410


Options

Activity for the three month period ended March 31, 2014 under the stock option plans is set forth below (in thousands, except years and per share amounts):
 
 
Stock Options
Number of Shares
Underlying
Stock Options
 
Weighted
Average
Exercise
Price per Share
 
Weighted Average
Remaining
Contractual Term
 
Aggregate
Intrinsic
Value
 
 
 
 
 
(in years )
 
 
Outstanding as of December 31, 2013
1,321

 
 
 
 
 
 
Granted

 
 
 
 
 
 
Exercised
(472
)
 
 
 
 
 
 
Cancelled or expired
(1
)
 
 
 
 
 
 
Outstanding as of March 31, 2014
848

 
$
15.47

 
3.56
 
$
30,814

Vested and expected to vest at March 31, 2014
846

 
$
15.46

 
3.56
 
$
30,755

Exercisable at March 31, 2014
783

 
$
14.96

 
3.53
 
$
28,857


There were no stock options granted during the three months ended March 31, 2014 and 2013.

As of March 31, 2014, the total unamortized compensation cost related to stock options, net of estimated forfeitures, is $0.6 million, which we expect to recognize over a weighted average period of 1.0 year.

Restricted Stock Units (“RSU”)

A summary of the RSU activity for the three months ended March 31, 2014 is as follows (in thousands, except years):
 
 
Number of Shares
Underlying RSU
 
Weighted Remaining
Vesting Period
 
Aggregate
Intrinsic Value
 
 
 
(in years)
 
 
Nonvested as of December 31, 2013
2,044

 
 
 
 
Granted
894

 
 
 
 
Vested and released
(470
)
 
 
 
 
Forfeited
(49
)
 
 
 
 
Nonvested as of March 31, 2014
2,419

 
1.89
 
$
125,272



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As of March 31, 2014, the total unamortized compensation cost related to RSU, net of estimated forfeitures, was $81.7 million, which we expect to recognize over a weighted average period of 2.9 years.

We have granted market-performance based restricted stock units (“MSU”) to our executive officers. Each MSU represents the right to one share of Align’s common stock and will be issued through our amended 2005 Incentive Plan. The actual number of MSU which will be eligible to vest will be based on the performance of Align’s stock price relative to the performance of the NASDAQ Composite Index over the vesting period, generally two to three years, up to 150% of the MSU initially granted.

The following table summarizes the MSU activity for the three months ended March 31, 2014 (in thousands, except years): 
 
Number of Shares
Underlying MSU
 
Weighted Average
Remaining
Vesting Period
 
Aggregate
Intrinsic Value
 
 
 
(in years )
 
 
Nonvested as of December 31, 2013
307

 
 
 
 
Granted
243

 
 
 
 
Vested and released
(53
)
 
 
 
 
Forfeited

 
 
 
 
Nonvested as of March 31, 2014
497

 
2.13
 
$
25,766


As of March 31, 2014, the total unamortized compensation costs related to the MSU, net of estimated forfeitures, was $14.1 million, which we expect to recognize over a weighted average period of 2.1 years.

Employee Stock Purchase Plan ("ESPP")

In May 2010, our stockholders approved the 2010 Employee Stock Purchase Plan ("2010 Purchase Plan") which will continue until terminated by either the Board of Directors or its administrator. The maximum number of shares available for purchase under the 2010 Purchase Plan is 2,400,000 shares. As of March 31, 2014, there remains 1,475,372 shares available for purchase under the 2010 Purchase Plan.

The fair value of the option component of the 2010 Purchase Plan shares was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:
 
Three Months Ended March 31,
 
2014
 
2013
Employee Stock Purchase Plan:
 
 
 
Expected term (in years)
1.2

 
1.2

Expected volatility
42.3
%
 
46.7
%
Risk-free interest rate
0.2
%
 
0.2
%
Expected dividends

 

Weighted average fair value at grant date
$
17.97

 
$
11.17


As of March 31, 2014, the total unamortized compensation cost related to employee purchases we expect to recognize was $2.1 million over a weighted average period of 0.7 year.

Note 10. Accounting for Income Taxes

Our provision for income taxes was $10.0 million and $2.9 million for the three months ended March 31, 2014 and 2013, respectively. This represents effective tax rates of 23.5% and (7.5)%, respectively. The increase in provision for income taxes was primarily due to higher pre-tax income, which was partially offset by a jurisdictional shift in forecasted earnings from the U.S. to lower-tax non-U.S. jurisdictions. The effective tax rate for the three months ended March 31, 2013 reflects a non-deductible goodwill impairment charge of $40.7 million.

We exercise significant judgment in regards to estimates of future market growth, forecasted earnings and projected taxable income in determining the provision for income taxes, and for purposes of assessing our ability to utilize any future benefit from deferred tax assets.
    
As of March 31, 2014, we maintained a valuation allowance of $35.4 million against deferred tax assets primarily related to foreign net operating loss carryforwards and capital loss carryforwards. These net operating and capital loss carryforwards would result in an income tax benefit if we were to conclude it is more likely than not that the related deferred tax assets will be realized.
    
During the three months ended March 31, 2014, the change in our gross unrecognized tax benefits was not material. The total amount of gross unrecognized tax benefits was $27.9 million as of March 31, 2014, all of which would impact our effective tax rate if recognized. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. The change in accrued interest and penalties during the three months ended March 31, 2014, was not material. We do not expect any significant changes to the amount of unrecognized tax benefit within the next twelve months.

During the first quarter of 2014, we adopted ASU 2013-11, "Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)." The adoption of this standard had the effect of reducing our accruals for uncertain tax positions by $8.4 million, with an offsetting reduction in our long term deferred tax assets, but had no effect on net income.
We are subject to taxation in the U.S. and various states and foreign jurisdictions. All of our tax years will be open to examination by the U.S. federal and most state tax authorities due to our net operating loss and overall credit carryforward position. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2006.

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In June 2009, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted a twelve year extension of certain income tax incentives, which were previously granted in 2002. The incentive tax rates will expire in various years beginning in 2017. Under these incentives, all of the income in Costa Rica during these twelve year incentive periods is subject to reduced rate of Costa Rica income tax. In order to receive the benefit of these incentives, we must hire specified numbers of employees and maintain certain minimum levels of fixed asset investment in Costa Rica. If we do not fulfill these conditions for any reason, our incentive could lapse, and our income in Costa Rica would be subject to taxation at higher rates. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2014. As a result of these incentives, income taxes were reduced by $7.6 million and $6.0 million for the three months ended March 31, 2014 and 2013, respectively, representing a benefit to diluted net income per share of $0.09 and $0.07 in 2014 and 2013, respectively.

Note 11. Net Income (Loss) Per Share

Basic net income (loss) per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed using the weighted average number of shares of common stock, adjusted for the dilutive effect of potential common stock. Potential common stock, computed using the treasury stock method, includes stock options, RSU, MSU and ESPP.

The following table sets forth the computation of basic and diluted net income (loss) per share attributable to common stock (in thousands, except per share amounts):
 

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Three Months Ended,
March 31
 
2014
 
2013
Numerator:
 
 
 
Net income (loss)
$
32,444

 
$
(41,983
)
Denominator:
 
 
 
Weighted-average common shares outstanding, basic
81,120

 
81,248

Dilutive effect of potential common stock
1,697

 

Total shares, diluted
82,817

 
81,248

Net income (loss) per share, basic
$
0.40

 
$
(0.52
)
Net income (loss) per share, diluted
$
0.39

 
$
(0.52
)

For the three months ended March 31, 2014, the anti-dilutive affect from stock options, RSU, MSU and ESPP was not material.

For the three months ended March 31, 2013, stock options, RSU, MSU and ESPP totaling 1.8 million of potentially dilutive shares have been excluded from the total diluted shares because there was a net loss during the period.

Note 12. Segments and Geographical Information

Segment Information

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer. We report segment information based on the management approach. The management approach designates the internal reporting used by CODM for decision making and performance assessment as the basis for determining our reportable segments. The performance measures of our reportable segments include net revenues and gross profit.

We have grouped our operations into two reportable segments which are also our reporting units: Clear Aligner segment and Scanner 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 Scanner 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.
These reportable operating segments are based on how our CODM views and evaluates our operations as well as allocation of resources (in thousands):


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For the Three Months Ended March 31,
Net Revenues
2014
 
2013
Clear Aligner
 
 
 
      Invisalign Full Products
$
138,133

 
$
112,780

      Invisalign Express/Lite Products
19,625

 
16,083

      Invisalign non-case revenues
10,481

 
12,709

Scanner
 
 
 
      Scanners and Services
12,407

 
12,008

Total net revenues
$
180,646

 
$
153,580

 
 
 
 
Gross profit
 
 
 
    Clear Aligner
$
133,083

 
$
109,327

    Scanners and Services
4,168

 
3,522

Total gross profit
$
137,251

 
$
112,849


Geographical Information

Net revenues and tangible long-lived assets are presented below by geographic area (in thousands):
 
 
For the Three Months Ended March 31,
 
2014
 
2013
Net revenues: (1)
 
 
 
U.S.
$
128,640

 
$
119,840

the Netherlands
38,843

 
26,947

Other international
13,163

 
6,793

Total net revenues
$
180,646

 
$
153,580

(1) Net revenues are attributed to countries based on location of where revenue is recognized.

 
March 31,
 
December 31,
 
2014
 
2013
Long-lived assets:(2)
 
 
 
United States
$
65,141

 
$
61,439

Mexico
6,272

 
6,291

the Netherlands
1,492

 
1,630

Other International
6,188

 
6,383

Total long-lived assets
$
79,093

 
$
75,743

 
(2) Long-lived assets are attributed to countries based on entity that owns the asset.


Note 13. Subsequent Events

On April 23, 2014, we announced that our Board of Directors had authorized a stock repurchase program pursuant to which we may purchase up to $300.0 million of our common stock over the next three years, with $100.0 million of that amount authorized to be purchased over the next twelve months. Any purchases under this stock repurchase program may be made, from time-to-time, pursuant to open market purchases (including pursuant to Rule 10b5-1 plans), privately-negotiated transactions, accelerated stock repurchases, block trades or derivative contracts or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934.
As part of our $300.0 million stock repurchase program, we entered into an accelerated share repurchase agreement ("ASR") with Goldman, Sachs & Co. on April 28, 2014 to repurchase $70.0 million of our common stock. Under the terms of

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the ASR, we agreed to repurchase in total $70.0 million of our common stock, with an initial delivery of approximately 1.0 million shares based on current market prices. The final number of shares to be repurchased will be based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount. The ASR is expected to be completed by July 29, 2014.


22


ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

In addition to historical information, this quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, our expectations regarding the anticipated impact that our new products and product enhancements will have on doctor utilization and our market share, our expectations regarding product mix and product adoption, our expectations regarding the existence and impact of seasonality, our expectations regarding the financial and strategic benefits of the scanner and services business, our expectations to increase our investment in manufacturing capacity, our expectations regarding the continued expansion of our international markets, the anticipated number of new doctors trained and their impact on volumes, the impact of the termination of our Asia Pacific distributor relationship and reverting to a direct sales model in that region by acquiring the distributor business, our expectations regarding our stock repurchase program, the level of our operating expenses and gross margins, and other factors beyond our control, as well as other statements regarding our future operations, financial condition and prospects and business strategies. These statements may contain words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” or other words indicating future results. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and in particular, the risks discussed below in Part II, Item 1A “Risk Factors”. We undertake no obligation to revise or update these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

The following discussion and analysis of our financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.
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 Services ("Scanner"), known as the iTero intra-oral scanners and OrthoCAD services (which we previously referred to as Scanner and CAD/CAM Services ("SCCS")).
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 in North America, Europe and other international markets where we have obtained regulatory approval. Most recently, in February 2014, 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 computer-aided design and computer-aided manufacturing ("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

23


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 device 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 our 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 updated 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 North America, in February 2014, we also 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 intend to launch ClinCheck Pro in our other country markets in the first quarter of 2015. 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 9 quarters are as follows:
*    Invisalign Utilization rates = # of cases shipped divided by # of doctors cases were shipped to

Total utilization in the first quarter of 2014 was 4.3 cases per doctor and was flat compared to the first quarter of 2013. Utilization among our North American orthodontist customers increased slightly to 8.1 case per doctor in the first quarter of 2014 from 8.0 in the first quarter of 2013, while our International doctor utilization increased to 4.3 in the first quarter of 2014 from 4.0 in the first quarter of 2013. This increase in North America orthodontist

24


utilization reflects improvements in product and technology over the past year, including Invisalign G5, 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. Increased International utilization reflects strong growth in both the Europe Middle East and Africa ("EMEA") and Asia Pacific regions driven by go to market and sales coverage investments, improving clinical education and support as well as the introduction of new products such as Invisalign G5. Year over year utilization for our North American GP customers was relatively unchanged. 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 transitioned a small number of these 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.
Medical Device Excise Tax. During March 2014, Align had extensive discussions with the IRS and they informed us that our aligners are not subject to the medical device excise tax ("MDET") which we had been paying and expensing in general and administrative expenses in the consolidated statements of operations since January 1, 2013. As a result of these discussions, beginning in March 2014, we ceased expensing and paying the MDET for aligners, which reduced our first quarter general and administrative expense by approximately $0.5 million. In future quarters, we expect our general and administrative expense in relation to MDET to decrease by approximately $1.8 million per quarter based on current revenues. Additionally, we are in process of claiming a $8.0 million refund of MDET paid in 2013 and 2014; however, because this claim is subject to review and approval by the IRS, we have not recorded a receivable as the outcome of our audit is uncertain. Any future changes in the applicability of the MDET as it applies to us or refunds of amounts previously paid will be recorded as an additional expense or a credit to the consolidated statement of operations in the period in which is becomes probable and reasonably estimable.
Stock Repurchase Authorization. On April 23, 2014, we announced that our Board of Directors had authorized a stock repurchase program pursuant to which we may purchase up to $300.0 million of our common stock over the next three years, with $100.0 million of that amount authorized to be purchased over the next twelve months. Any purchases under this stock repurchase program may be made, from time-to-time, pursuant to open market purchases (including pursuant to Rule 10b5-1 plans), privately-negotiated transactions, accelerated stock repurchases, block trades or derivative contracts or otherwise in accordance with applicable federal securities

25


laws, including Rule 10b-18 of the Securities Exchange Act of 1934. The program does not obligate Align to acquire any particular amount of common stock and depending on market conditions or other factors these purchases may be commenced or suspended at any time, or from time-to-time without prior notice. The authorization or continuance of any repurchases under stock repurchase programs is contingent on a variety of factors, including our financial condition, results of operations, business requirements, and our Board of Directors' continuing determination that such stock repurchases are in the best interests of our stockholders and in compliance with all laws and applicable agreements. Additionally, there can be no assurance that our stock repurchase program will have a beneficial impact on our stock price.
Accelerated Stock Repurchase Agreement. As part of our $300.0 million stock repurchase program, we entered into an accelerated share repurchase agreement ("ASR") with Goldman, Sachs & Co. on April 28, 2014 to repurchase $70.0 million of our common stock. Under the terms of the ASR, we agreed to repurchase in total $70.0 million of our common stock, with an initial delivery of approximately 1.0 million shares based on current market prices. The final number of shares to be repurchased will be based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount. We expect to finance the ASR with current cash on hand and for it to be completed by July 29, 2014.

Balance Sheet Reclassification. Subsequent to the furnishing of our Results of Operations and Financial Conditions on Form 8-K with the SEC on April 23, 2014, we recorded an adjustment to reclassify $2.0 million from long-term marketable securities to short-term marketable securities in our condensed consolidated balance sheet presented in this Form 10-Q. This reclassification was not considered to be material and did not have an impact to our condensed consolidated statement of cash flow or operations for the three months ended March 31, 2014.

Results of Operations

Net revenues by Reportable Segment

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

Our Clear Aligner segment consists of our Invisalign system which includes Invisalign Full, Teen and Assist ("Full Products"), Express/Lite ("Express Products"),Vivera retainers, along with our training and ancillary products for treating malocclusion.

Our Scanner 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 and product and our Scanner segment by region for the three months ended March 31, 2014 and 2013 as follows (in millions):

 
Three Months Ended March 31,
Clear Aligner:
2014
 
2013
 
Net
Change
 
%
Change
Region
 
 
 
 
 
 
 
North America
107.9

 
97.1

 
10.8

 
11.1
 %
International
49.8

 
31.8

 
18.0

 
56.6
 %
Invisalign non-case net revenues
10.5

 
12.7

 
(2.2
)
 
(17.3
)%
Total Clear Aligner net revenues
$
168.2

 
$
141.6

 
$
26.6

 
18.8
 %
Product
 
 
 
 
 
 
 
Invisalign Full Products
$
138.1

 
$
112.8

 
$
25.3

 
22.4
 %
Invisalign Express Products
19.6

 
16.1

 
3.5

 
21.7
 %
Invisalign non-case net revenues
10.5

 
12.7

 
(2.2
)
 
(17.3
)%
Total Clear Aligner net revenues
$
168.2

 
$
141.6

 
$
26.6

 
18.8
 %
Scanner:
 
 
 
 
 
 
 
Region
 
 
 
 
 
 
 
North America
$
12.3

 
$
11.5

 
$
0.8

 
7.0
 %
International
0.1

 
0.5

 
(0.4
)
 
(80.0
)%
Total Scanner net revenues
$
12.4

 
$
12.0

 
$
0.4

 
3.3
 %
 
 
 
 
 
 
 
 
Total net revenues
$
180.6

 
$
153.6

 
$
27.0

 
17.6
 %


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Clear Aligner Case Volume by Channel and Product

Case volume data which represents Invisalign case shipments by region and product, for the three months ended March 31, 2014 and 2013 is as follows (in thousands):
 
 
Three Months Ended March 31,
Region
2014
 
2013
 
Net
Change
 
%
Change
North American Invisalign
81.4

 
74.7

 
6.7

 
9.0
%
International Invisalign
30.8

 
23.5

 
7.3

 
31.1
%
Total Invisalign case volume
112.2

 
98.2

 
14.0

 
14.3
%
Product
 
 
 
 
 
 
 
Invisalign Full Product Group
92.3

 
79.3

 
13.0

 
16.4
%
Invisalign Express Product Group
19.8

 
18.9

 
0.9

 
4.8
%
Total Invisalign case volume
112.1

 
98.2

 
13.9

 
14.2
%


Total net revenues increased by $27.0 million for the three months ended March 31, 2014, as compared to the same period in 2013 primarily as a result of Invisalign case volume growth across all regions and most products.

Clear Aligner

In the three months ended March 31, 2014, Clear Aligner North America net revenues increased by $10.8 million or 11.1% compared to the same period in 2013 primarily due to Invisalign case volume growth of approximately $8.7 million across all channels and most products and, to a lesser extent, higher average selling prices ("ASP") which contributed approximately $2.1 million to the increase in net revenues. The increase in ASP was primarily a result of lower promotional discounts in the current period compared to the same period in the prior year.

In the three months ended March 31, 2014, Clear Aligner international net revenues increased by $18.0 million or 56.6% compared to the same period in 2013 primarily driven by Invisalign case volume growth of $9.9 million across all products and higher ASP which contributed approximately $8.1 million to the increase in net revenues. The increase in ASP was primarily due to the impact from acquiring our distributor in the Asia Pacific region on April 30, 2013, as we now recognize direct sales of Invisalign products sold in that region at our full ASP rather than the discounted ASP under the distributor agreement, as well as price increases which were effective July 2013 along with a favorable impact from foreign exchange rates.

Invisalign non-case net revenues, consisting of training fees and ancillary product revenues, decreased $2.2 million or 17.3% for the three months ended March 31, 2014 compared to the same periods in 2013 primarily due to the consolidation of our Vivera product shipments in North America. In the first quarter of 2013, we began consolidating Vivera shipments into one shipment per year rather than four shipments per year. As a result, net revenues for the three months ended March 31, 2013 reflected a benefit of approximately $4.4 million as we recognized nine additional months of the subscription revenue in the first quarter instead of recognizing it ratably every quarter for one year. This decrease was offset in part by increased Vivera volume both in North America and international regions.

Scanner and Services

Scanner and Services net revenues increased $0.4 million or 3.3% for the three months ended March 31, 2014 compared to the same period in 2013 primarily due to an increase in the volume of services resulting from a larger installed base of scanner partially offset by a decrease in scanner revenue primarily due to lower scanner ASP as a result of promotional discounts as well as permanent price reductions. Additionally, net revenues for the three months ended March 31, 2013 included a release of $1.4 million of revenue previously reserved for the new iTero upgrade program which was completed in the first quarter of 2013.


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Cost of net revenues and gross profit (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Clear Aligner
 
 
 
 
 
Cost of net revenues
$
35.2

 
$
32.2

 
$
3.0

% of net segment revenues
20.9
%
 
22.8
%
 
 
Gross profit
$
133.1

 
$
109.3

 
$
23.8

Gross margin %
79.1
%
 
77.2
%
 
 
Scanner
 
 
 
 
 
Cost of net revenues
$
8.2

 
$
8.5

 
$
(0.3
)
% of net segment revenues
66.4
%
 
70.7
%
 
 
Gross profit
$
4.2

 
$
3.5

 
$
0.7

Gross margin %
33.6
%
 
29.3
%
 
 
Total cost of net revenues
$
43.4

 
$
40.7

 
$
2.7

% of net revenues
24.0
%
 
26.5
%
 
 
Gross profit
$
137.3

 
$
112.9

 
$
24.4

Gross margin %
76.0
%
 
73.5
%
 
 

Cost of net revenues for our Clear Aligner and Scanner segments 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.

Clear Aligner

Gross margin increased for the three months ended March 31, 2014 compared to the same period in 2013 due to higher ASP along with lower inventory reserves in comparison to the prior year period when we transitioned to our new SmartTrack material in February 2013. In addition, we experienced lower warranty costs as a result of reduced claims corresponding with the change in our mid-course correction policy in June 2013.

Scanner

Gross margin increased for the three months ended March 31, 2014 compared to the same period in 2013 due to increased absorption of manufacturing spend from higher production volumes, reduced freight costs and lower inventory reserves. These improvements were partially offset by the benefit in the prior year period which included a release of $1.4 million of revenue previously reserved for the new iTero upgrade program along with lower ASPs in the current year due to price reductions.

Sales and marketing (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Sales and marketing
$
52.9

 
$
42.3

 
$
10.6

% of net revenues
29.3
%
 
27.5
%
 
 

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

Our sales and marketing expense for the three months ended March 31, 2014 increased compared to the same period in 2013 primarily due to higher compensation related costs of $7.6 million from increased headcount, including additional employees as a result of the acquisition of our APAC distributor in April 2013, higher salaries as a result of our annual focal review and higher stock-based compensation. In addition, advertising and media costs increased by approximately $2.1 million related to network and television media campaigns.



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General and administrative (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
General and administrative
$
29.2

 
$
30.3

 
$
(1.1
)
% of net revenues
16.2
%
 
19.8
%
 
 

General and administrative expense primarily includes administrative personnel compensation costs including stock-based compensation, outside consulting services, legal expenses, depreciation and amortization expense, the medical device excise tax ("MDET") and allocations of corporate overhead expenses including facilities, IT and human resources.

General and administrative expense decreased for the three months ended March 31, 2014 compared to the same period in 2013 primarily due to lower outside litigation costs and decreased compensation costs as a result of severance costs in 2013 offset in part by increased salaries from our annual focal review. In addition, these costs were partially offset by higher customer credit card processing fees from increased volume on revenues.

As previously noted,in March 2014, the IRS informed us that our aligners are not subject to the medical device excise tax ("MDET"), which we had been paying and expensing in general and administrative expenses in the consolidated statements of operations since January 1, 2013. In future quarters of 2014, we expect our general and administrative expense in relation to the MDET to decrease by approximately $1.8 million per quarter based on current revenues. Additionally, we are in process of claiming a $8.0 million refund of MDET paid in 2013 and 2014; however, because this claim is subject to review and approval by the IRS, we have not recorded a receivable as the outcome of our audit is uncertain. Any future changes in the applicability of the MDET as it applies to us or refunds of amounts previously paid will be recorded as an additional expense or a credit to the consolidated statement of operations in the period in which is becomes probable and reasonably estimable.

Research and development (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Research and development
$
13.4

 
$
11.3

 
$
2.1

% of net revenues
7.4
%
 
7.3
%
 
 
Research and development expense includes the personnel-related costs and outside consulting expenses associated with the research and development of new products and enhancements to existing products, corporate allocations, facility and facility related costs and stock-based compensation expense.

Research and development expense during the three months ended March 31, 2014, compared to the same period in 2013 increased slightly primarily due to of higher compensation costs from additional headcount, increased salaries from our annual focal review and higher stock-based compensation.

Impairment of goodwill (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Impairment of goodwill
$

 
$
40.7

 
$
(40.7
)
% of net revenues
%
 
26.5
%
 
 
    
There was no goodwill impairment charge recorded in the first quarter of 2014.

In the first quarter of 2013, we determined that the goodwill for our Scanner reporting unit should be tested for impairment between annual tests since an event occurred or circumstances changed that would more likely than not reduce the fair value of our Scanner reporting unit below its carrying amount. As a result of our analysis, we recorded a goodwill impairment charge of $40.7 million in the first quarter of 2013, none of which was deductible for tax purposes. Refer to Note 5 for details of the impairment analysis.


29

Table of Contents

Impairment of long-lived assets (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Impairment of long-lived assets
$

 
$
26.3

 
$
(26.3
)
% of net revenues
%
 
17.1
%
 
 

We recorded $26.3 million related to the impairment of long-lived assets during the first quarter of 2013 as a result of changes in the competitive environment of our intra-oral scanners, which included announcements of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, which caused us to lower our expectations for growth and profitability for our Scanner reporting unit. Therefore, we determined that the carrying value of the long-lived assets was not recoverable and recorded an impairment charge of $26.3 million. Refer to Note 5 for details of the impairment analysis.

Interest and other income (expense), net (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Interest and other income (expense), net
$
0.6

 
$
(1.0
)
 
$
1.6


Interest and other income (expense), net, includes interest income earned on cash, cash equivalents and investment balances, foreign currency translation gains and losses and other miscellaneous charges.

Interest and other income (expense), net for the three months ended March 31, 2014 increased compared to the same period in 2013 due to foreign exchange gains in the current year period primarily as a result of the weakening of the U.S. dollar to the Euro as compared to losses in the prior year period.

Income tax (in millions):
 
 
Three Months Ended March 31,
 
2014
 
2013
 
Change
Provision for income taxes
$
10.0

 
$
2.9

 
$
7.1

Effective tax rates
23.5
%
 
(7.5
)%
 
 
    
Our provision for income taxes was $10.0 million and $2.9 million for the three months ended March 31, 2014 and 2013, respectively. This represents effective tax rates of 23.5% and (7.5)%, respectively. The increase in provision for income taxes was primarily due to higher pre-tax income, which was partially offset by a jurisdictional shift in forecasted earnings from the U.S. to lower-tax non-U.S. jurisdictions. The effective tax rate for the three months ended March 31, 2013 reflects a non-deductible goodwill impairment charge of $40.7 million.

We exercise significant judgment in regards to estimates of future market growth, forecasted earnings and projected taxable income in determining the provision for income taxes, and for purposes of assessing our ability to utilize any future benefit from deferred tax assets.

As of March 31, 2014, we maintained a valuation allowance of $35.4 million against deferred tax assets primarily related to foreign net operating loss carryforwards and capital loss carryforwards. These net operating and capital loss carryforwards would result in an income tax benefit if we were to conclude it is more likely than not that the related deferred tax assets will be realized.
    
During the three months ended March 31, 2014, the change in our gross unrecognized tax benefits was not material. The total amount of gross unrecognized tax benefits was $27.9 million as of March 31, 2014, all of which would impact our effective tax rate if recognized. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. The change in accrued interest and penalties during the three months ended March 31, 2014, was not material. We do not expect any significant changes to the amount of unrecognized tax benefit within the next twelve months.


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During the first quarter of 2014, we adopted ASU 2013-11, "Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)." The adoption of this standard had the effect of reducing our accruals for uncertain tax positions by $8.4 million, with an offsetting reduction in our long term deferred tax assets, but had no effect on net income.

We are subject to taxation in the U.S. and various states and foreign jurisdictions. All of our tax years will be open to examination by the U.S. federal and most state tax authorities due to our net operating loss and overall credit carryforward position. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2006.

Liquidity and Capital Resources

We fund our operations from product sales and the proceeds from the sale of our common stock. As of March 31, 2014 and December 31, 2013, we had the following cash, cash equivalents, and short-term and long-term marketable securities(in thousands):
 
 
March 31,
2014
 
December 31, 2013
Cash and cash equivalents
$
182,766

 
$
242,953

Marketable securities, short-term
183,677

 
127,040

Marketable securities, long-term
138,929

 
101,978

Total cash, cash equivalents and short-term and long-term marketable securities
$
505,372

 
$
471,971


Cash flows (in thousands):
 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
Net cash flow (used in) provided by:
 
 
 
 
Operating activities
 
$
17,993

 
$
10,418

Investing activities
 
(99,347
)
 
(3,445
)
Financing activities
 
21,061

 
15,423

Effects of exchange rate changes on cash and cash equivalents
 
106

 
(37
)
Net (decrease) increase in cash and cash equivalents
 
$
(60,187
)
 
$
22,359


As of March 31, 2014, we had $505.4 million of cash, cash equivalents and short-term and long-term marketable securities. Cash equivalents and marketable securities are comprised of money market funds and debt instruments which include commercial paper, corporate bonds, U.S. government agency bonds, U.S. dollar dominated foreign corporate bonds, U.S. government treasury bonds, municipal securities and asset-backed securities.

As of March 31, 2014, approximately $238.7 million of cash, cash equivalents and short-term and long-term marketable securities was held by our foreign subsidiaries. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S. The costs to repatriate our foreign earnings to the U.S. would likely be material; however, our intent is to permanently reinvest our earnings from foreign operations, and our current plans do not require us to repatriate them to fund our U.S. operations as we generate sufficient domestic operating cash flow and have access to external funding under our current revolving line of credit.

On April 28, 2014, we announced that we entered into an accelerated share repurchase agreement (ASR) with Goldman, Sachs & Co. to repurchase $70.0 million of our common stock. The ASR is part of our $300.0 million stock repurchase program announced on April 23, 2014. Under the terms of the ASR, we agreed to repurchase in total $70.0 million of our common stock from Goldman, Sachs & Co., with an initial delivery of approximately 1.0 million shares based on current market prices. The final number of shares to be repurchased will be based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount. We expect to finance the ASR with current cash on hand and for it to be completed by July 29, 2014.

On March 22, 2013, we entered into a credit facility with Wells Fargo Bank. The credit facility provides for a $50.0 million revolving line of credit, with a $10.0 million letter of credit sublimit, and has a maturity date on March 22, 2016. The credit facility also requires us to maintain a minimum unrestricted cash balance of $50.0 million and comply with specific

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financial conditions and performance requirements. The loans bear interest, at our option, at a fluctuating rate per annum equal to the daily one-month adjusted LIBOR rate plus a spread of 1.75% or an adjusted LIBOR rate (based on one, three, six or twelve-month interest periods) plus a spread of 1.75%. As of March 31, 2014, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.

We believe that our current cash and cash equivalents and marketable debt securities combined with our positive cash flows from operations will be sufficient to fund our operations for at least the next 12 months. If we are unable to generate adequate operating cash flows, we may need to seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations.  Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.
 
Operating Activities

For the three months ended March 31, 2014, cash flows from operations of $18.0 million resulted primarily from our net income of approximately $32.4 million as well as the following:

Significant non-cash activities:

Excess tax benefits from our share-based compensation arrangements of $13.6 million,
deferred taxes of $12.8 million,
stock-based compensation of $9.1 million related to equity incentive compensation awards granted to our employees, and
depreciation and amortization of property, plant and equipment and intangibles of $4.8 million.

Significant changes in working capital:

A decrease of $15.3 million in accrued and other long-term liabilities due to the payment of our 2013 annual bonuses, and
an increase of $13.9 million in accounts receivable which is a result of the increase in net revenues.

Investing Activities

Net cash used in investing activities was $99.3 million for the three months ended March 31, 2014 primarily consisted of purchases of marketable securities of $157.9 million, property, plant and equipment purchases of $5.0 million. These outflows were partially offset by $63.7 million of maturities and sales of our marketable securities.

For the remainder of 2014, we expect to spend an additional $35.0 million to $45.0 million on capital expenditures for estimated total capital expenditures of $40.0 million to $50.0 million for 2014 primarily for additional manufacturing capacity and infrastructure. Although we believe our current investment portfolio has little risk of impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain unimpaired.

Financing Activities

Net cash provided by financing activities was $21.1 million for the three months ended March 31, 2014 primarily resulting from $11.9 million proceeds from issuance of common stock, $13.6 million from excess tax benefit from our share-based compensation arrangements. These inflows were offset by $4.5 million related to payroll taxes paid for vesting of restricted stock units through share withholdings.


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Contractual Obligations

Our contractual obligations have not significantly changed since December 31, 2013 as disclosed in our Annual Report on Form 10-K. We believe that our current cash, cash equivalents and short-term marketable securities combined with our existing borrowing capacity will be sufficient to fund our operations for at least the next 12 months. If we are unable to generate adequate operating cash flows and need more funds beyond those available under our credit facility, we may need to seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations. Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.

Off-Balance Sheet Arrangements

As of March 31, 2014, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Indemnification Provisions
In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim.
It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of March 31, 2014, we did not have any material indemnification claims that were probable or reasonably possible.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of condensed consolidated financial statements requires our management to make estimates and judgments that affect the reported amounts of assets and liabilities, net revenues and expenses and disclosures at the date of the financial statements. We evaluate our estimates on an on-going basis, including those related to revenue recognition, accounts receivable, intangible assets, legal contingencies, impairment of goodwill and income taxes. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates.

We believe the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements. These critical accounting policies and related disclosures appear in our Annual Report on Form 10-K for the year ended December 31, 2013:

Revenue recognition;
Stock-based compensation expense;
Goodwill and finite-lived acquire assets,
Impairment of goodwill, finite-lived acquire assets and long-lived assets, and
Accounting for Income Taxes.

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Recent Accounting Pronouncements

See Note 1 “Summary of Significant Accounting Policies” of the Notes to Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risk affecting us, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended December 31, 2013, which is incorporated herein by reference. Our exposure to market risk has not changed materially since December 31, 2013.
 
ITEM 4.CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures.

Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of March 31, 2014, to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION
 

ITEM 1.     LEGAL PROCEEDINGS

Securities Class Action Lawsuit
    
On November 28, 2012, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System filed a lawsuit against Align, Thomas M. Prescott (“Mr. Prescott”), Align’s President and Chief Executive Officer, and Kenneth B. Arola (“Mr. Arola”), Align’s former Vice President, Finance and Chief Financial Officer, in the United States District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock (the “Securities Action”). On July 11, 2013, an amended complaint was filed, which named the same defendants, on behalf of a purported class of purchasers of our common stock between January 31, 2012 and October 17, 2012. The amended complaint alleged that Align, Mr. Prescott and Mr. Arola violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that Mr. Prescott and Mr. Arola violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the amended complaint alleged that during the purported class period defendants failed to take an appropriate goodwill impairment charge related to the April 29, 2011 acquisition of Cadent Holdings, Inc. in the fourth quarter of 2011, the first quarter of 2012 or the second quarter of 2012, which rendered our financial statements and projections of future earnings materially false and misleading and in violation of U.S. GAAP. The amended complaint sought monetary damages in an unspecified amount, costs and attorneys’ fees. On December 9, 2013, the court granted defendants’ motion to dismiss with leave for plaintiff to file a second amended complaint. Plaintiff filed a second amended complaint on January 8, 2014 on behalf of the same purported class. The second amended complaint states the same claims as the amended complaint. We filed a motion to dismiss the second amended complaint on February 7, 2014. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this amended complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.
    
Shareholder Derivative Lawsuit
    
On February 1, 2013, plaintiff Gary Udis filed a shareholder derivative lawsuit against several of Align’s current and former officers and directors in the Superior Court of California, County of Santa Clara. The complaint alleges that our reported income and earnings were materially overstated because of a failure to timely write down goodwill related to the April 29, 2011 acquisition of Cadent Holdings, Inc., and that defendants made allegedly false statements concerning our forecasts. The complaint asserts various state law causes of action, including claims of breach of fiduciary duty, unjust enrichment, and insider trading, among others. The complaint seeks unspecified damages on behalf of Align, which is named solely as nominal defendant against whom no recovery is sought. The complaint also seeks an order directing Align to reform and improve its corporate governance and internal procedures, and seeks restitution in an unspecified amount, costs, and attorneys’ fees. On July 8, 2013, an Order was entered staying this derivative lawsuit until an initial ruling on our first motion to dismiss the Securities Action. On January 15, 2014, an Order was entered staying this derivative lawsuit until an initial ruling on our second motion to dismiss the Securities Action. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible losses.

In addition, in the course of Align's operations, Align is involved in a variety of claims, suits, investigations, and proceedings, including actions with respect to intellectual property claims, patent infringement claims, government investigations, labor and employment claims, breach of contract claims, tax, and other matters. Regardless of the outcome, these proceedings can have an adverse impact on us because of defense costs, diversion of management resources, and other factors. Although the results of complex legal proceedings are difficult to predict and Align's view of these matters may change in the future as litigation and events related thereto unfold; Align currently does not believe that these matters, individually or in the aggregate, will materially affect Align's financial position, results of operations or cash flows.

ITEM 1A.RISK FACTORS

We depend on the sale of the Invisalign system for the vast majority of our net revenues, and any decline in sales of Invisalign treatment for any reason, a continued weakness in general economic conditions, or a decline in average selling prices would adversely affect net revenues, gross margin and net income.

We expect that net revenues from the sale of the Invisalign System, primarily Invisalign Full and Invisalign Teen, will continue to account for the vast majority of our total net revenues for the foreseeable future.  Continued and widespread market acceptance of Invisalign by orthodontists, GPs and consumers is critical to our future success.  If orthodontists and GPs experience a reduction in consumer demand for orthodontic services, if consumers prove unwilling to adopt Invisalign as

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rapidly as we anticipate or in the volume that we anticipate, if orthodontists or GPs choose to use a competitive product rather than Invisalign or if the average selling price of our product declines, our operating results would be harmed.

Demand for our products may not increase as rapidly as we anticipate due to a variety of factors including a continued weakness in general economic conditions.

Consumer spending habits are affected by, among other things, prevailing economic conditions, levels of employment, salaries and wage rates, gas prices, consumer confidence and consumer perception of economic conditions.  A general slowdown in the U.S. economy and certain international economies or an uncertain economic outlook would adversely affect consumer spending habits which may, among other things, result in a decrease in the number of overall orthodontic case starts, reduced patient traffic in dentists’ offices, reduction in consumer spending on higher value procedures or a reduction in the demand for dental services generally, each of which would have a material adverse effect on our sales and operating results.  Continued weakness in the global economy results in a challenging environment for selling dental technologies and dentists may postpone investments in capital equipment, such as intra-oral scanners.  In addition, Invisalign treatment, which currently accounts for the vast majority of our net revenues, represents a significant change from traditional orthodontic treatment, and customers and consumers may be reluctant to accept it or may not find it preferable to traditional treatment. We have generally received positive feedback from orthodontists, GPs and consumers regarding Invisalign treatment as both an alternative to braces and as a clinical method for treatment of malocclusion, but a number of dental professionals believe that Invisalign treatment is appropriate for only a limited percentage of their patients.  Increased market acceptance of all of our products will depend in part upon the recommendations of dental professionals, as well as other factors including effectiveness, safety, ease of use, reliability, aesthetics, and price compared to competing products.

The frequency of use of the Invisalign system by orthodontists or GPs may not increase at the rate that we anticipate or at all.

One of our key objectives is to continue to increase utilization, or the adoption and frequency of use, of the Invisalign System by new and existing customers. If utilization of the Invisalign System by our existing and newly trained orthodontists or GPs does not occur or does not occur as quickly as we anticipate, our operating results could be harmed.

We may experience declines in average selling prices of our products which may decrease our net revenues.

In response to challenges in our business, including increased competition, we have in the past reduced the list price of our products. We also provide volume based discount programs to our doctors. In addition, we sell a number of products at different list prices. If we introduce any price reductions or consumer rebate programs; if we expand our discount programs in the future or participation in these programs increases; if our product mix shifts to lower priced products or products that have a higher percentage of deferred revenue; or if sales by our distributors grows at a faster pace than our direct sales, our average selling prices would be adversely affected and our net revenues, gross profit, gross margin and net income may be reduced.  Furthermore, although the U.S. dollar is our reporting currency, a portion of our net revenues and net income are generated in foreign currencies.  Net revenues and net 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 are affected by changes in exchange rates. As a result, negative movements in currency exchange rates against the U.S. dollar will adversely affect our average selling price and consequently the amount of net revenues and net income in our consolidated financial statements.

As we continue to grow, we are subject to growth related risks, including risks related to excess or constrained capacity at our existing facilities.

We are subject to growth related risks, including capacity constraints and pressure on our internal systems and personnel.  In order to manage current operations and future growth effectively, we will need to continue to implement and improve our operational, financial and management information systems and to hire, train, motivate, manage and retain employees. We may be unable to manage such growth effectively. Any such failure could have a material adverse impact on our business, operations and prospects. 

 Because we cannot always immediately adapt our production capacity and related cost structures to changing market conditions, our manufacturing capacity may at times exceed or fall short of our production requirements. In addition, if product demand decreases or we fail to forecast demand accurately, we could be required to write off inventory or record excess capacity charges, which would lower our gross margin. Any or all of these problems could result in the loss of customers, provide an opportunity for competing products to gain market acceptance and otherwise harm our business and financial results.



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We may never achieve the anticipated benefits from our acquisitions which may have an adverse effect on our business.

We acquired Cadent Holdings, Inc. in April 2011 for their people, their technology and their existing revenue streams such as, OrthoCAD iRecord and OrthoCAD iCast in addition to their intra-oral scanning technology. This acquisition is expected to strengthen our ability to drive adoption of Invisalign treatment by integrating more fully with mainstream tools and procedures in doctors’ practices. In addition, we believe that the combination of the two companies will help accelerate the use of intra-oral scanning in the dental industry by leveraging Align’s global sales reach, extensive professional and consumer marketing capabilities and large customer base.  We completed the acquisition of our Asia Pacific distributor on April 30, 2013.

We may experience difficulties in achieving the anticipated financial or strategic benefits of these acquisitions. Potential risks include:

slower adoption or lack of acceptance for intra-oral scanning products in general or our chairside features;
our inability to increase utilization by integrating Invisalign treatment more fully with intra-oral scanners;
difficulty in integrating the technology, operations, internal accounting controls or work force of the acquired business with our existing business;
diversion of management resources and focus from ongoing business matters;
retention of key employees following the acquisition;
continued changes in the competitive environment, including recent announcements from competitors of new lower-priced scanners which we expect will lengthen the customer evaluation process and may result in price reductions and/or loss of sales;
difficulty dealing with tax, employment, logistics, and other related issues unique to international operations in Israel and the Asia Pacific region;
possible impairment of relationships with employees and customers as a result of the integration;
possible inconsistencies in standards, controls, procedures and policies among the acquired businesses and Align, which may make it more difficult to implement and harmonize worldwide financial reporting, accounting, billing, information technology and other systems;
a large portion of Cadent’s operations are located in Israel, accordingly, any increase in hostilities in the Middle East involving Israel may cause interruption or suspension of business operations without warning; and
negative impact on our results of operations and financial condition from acquisition-related charges, further impairment of goodwill, impairment of intangible assets and/or asset impairment charges.

If we cannot successfully integrate the acquired business with our existing business, our results of operations and financial condition could be adversely affected.

If we fail to sustain or increase profitability or revenue growth in future periods, the market price for our common stock may decline.

If we are to sustain or increase profitability in future periods, we will need to continue to increase our net revenues, while controlling our expenses. Because our business is evolving, it is difficult to predict our future operating results or levels of growth, and we have in the past not been and may in the future not be able to sustain our historical growth rates. If we do not increase profitability or revenue growth or otherwise meet the expectations of securities analysts or investors, the market price of our common stock will likely decline.


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Our financial results have fluctuated in the past and may fluctuate in the future which may cause volatility in our stock price.

Our operating results have fluctuated in the past and we expect our future quarterly and annual operating results to fluctuate as we focus on increasing doctor and consumer demand for our products. These fluctuations could cause our stock price to decline or significantly fluctuate. Some of the factors that could cause our operating results to fluctuate include:

limited visibility into and difficulty predicting the level of activity in our customers’ practices from quarter to quarter;
weakness in consumer spending as a result of the slowdown in the U.S. economy and global economies;
changes in relationships with our distributors;
changes in the timing of receipt of Invisalign case product orders during a given quarter which, given our cycle time and the delay between case receipts and case shipments, could have an impact on which quarter revenue can be recognized;
fluctuations in currency exchange rates against the U.S. dollar;
changes in product mix;
our inability to predict from period to period the number of trainers or the availability of doctors required to complete intra-oral scanner installations, which may impact the timing of when revenue is recognized;
if participation in our customer rebate program increases our average selling price will be adversely affected;
seasonal fluctuations in the number of doctors in their offices and their availability to take appointments;
success of or changes to our marketing programs from quarter to quarter;
our reliance on our contract manufacturers for the production of sub-assemblies for our intra-oral scanners;
timing of industry tradeshows;
changes in the timing of when revenue is recognized, including as a result of the introduction of new products or promotions or as a result of changes to critical accounting estimates or new accounting pronouncements;
changes to our effective tax rate;
unanticipated delays in production caused by insufficient capacity or availability of raw materials;
any disruptions in the manufacturing process, including unexpected turnover in the labor force or the introduction of new production processes, power outages or natural or other disasters beyond our control;
the development and marketing of directly competitive products by existing and new competitors;
major changes in available technology or the preferences of customers may cause our current product offerings to become less competitive or obsolete;
aggressive price competition from competitors;
costs and expenditures in connection with litigation;
the timing of new product introductions by us and our competitors, as well as customer order deferrals in anticipation of enhancements or new products;
disruptions to our business due to political, economic or other social instability, including the impact of an epidemic any of which results in changes in consumer spending habits, consumers unable or unwilling to visit the orthodontist or general practitioners office, as well as any impact on workforce absenteeism;
inaccurate forecasting of net revenues, production and other operating costs; and
investments in research and development to develop new products and enhancements.


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To respond to these and other factors, we may need to make business decisions that could adversely affect our operating results such as modifications to our pricing policy, business structure or operations. Most of our expenses, such as employee compensation and lease payment obligations, are relatively fixed in the short term. Moreover, our expense levels are based, in part, on our expectations regarding future revenue levels. As a result, if our net revenues for a particular period fall below our expectations, whether caused by changes in consumer spending, consumer preferences, weakness in the U.S. or global economies, changes in customer behavior related to advertising and prescribing our product, or other factors, we may be unable to adjust spending quickly enough to offset any shortfall in net revenues. Due to these and other factors, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. You should not rely on our results for any one quarter as an indication of our future performance.

Our future success may depend on our ability to develop, successfully introduce and achieve market acceptance of new products.

Our future success may depend on our ability to develop, manufacture, market, and obtain regulatory approval or clearance of new products. There can be no assurance that we will be able to successfully develop, sell and achieve market acceptance of these and other new products and applications and enhanced versions of our existing product or software. The extent of, and rate at which, market acceptance and penetration are achieved by future products is a function of many variables, which include, among other things, our ability to:

correctly identify customer needs and preferences and predict future needs and preferences;
include functionality and features that address customer requirements;
ensure compatibility of our computer operating systems and hardware configurations with those of our customers;
allocate our research and development funding to products with higher growth prospects;
anticipate and respond to our competitors’ development of new products and technological innovations;
differentiate our offerings from our competitors’ offerings;
innovate and develop new technologies and applications;
the availability of third-party reimbursement of procedures using our products;
obtain adequate intellectual property rights; and
encourage customers to adopt new technologies.

If we fail to accurately predict customer needs and preferences or fail to produce viable technologies, we may invest heavily in research and development of products that do not lead to significant revenue. Even if we successfully innovate and develop new products and produce enhancements, we may incur substantial costs in doing so, and our profitability may suffer.  In addition, even if our new products are successfully introduced, it is unlikely that they will rapidly gain market share and acceptance primarily due to the relatively long period of time it takes to successfully treat a patient with Invisalign. Since it takes approximately 12 to 24 months to treat a patient, our customers may be unwilling to rapidly adopt our new products until they successfully complete at least one case or until more historical clinical results are available.

Our ability to market and sell new products may also be subject to government regulation, including approval or clearance by the FDA, and foreign government agencies. Any failure in our ability to successfully develop and introduce or achieve market acceptance of our new products or enhanced versions of existing products could have a material adverse effect on our operating results and could cause our net revenues to decline.

A disruption in the operations of our primary freight carrier or higher shipping costs could cause a decline in our net revenues or a reduction in our earnings.

We are dependent on commercial freight carriers, primarily UPS, to deliver our products to our customers. If the operations of these carriers are disrupted for any reason, we may be unable to deliver our products to our customers on a timely basis. If we cannot deliver our products in an efficient and timely manner, our customers may reduce their orders from us and our net revenues and operating profits could materially decline. In a rising fuel cost environment, our freight costs will increase. If freight costs materially increase and we are unable to pass that increase along to our customers for any reason or otherwise offset such increases in our cost of net revenues, our gross margin and financial results could be adversely affected.

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We are dependent on our international operations, which exposes us to foreign operational, political and other risks that may harm our business.

Our key production steps are performed in operations located outside of the U.S.  At our facility in San Jose, Costa Rica, technicians use a sophisticated, internally developed computer-modeling program to prepare digital treatment plans, which are then transmitted electronically to Juarez, Mexico. These digital files form the basis of the ClinCheck treatment plan and are used to manufacture aligner molds. Our order acquisition, aligner fabrication and shipping operations are conducted in Juarez, Mexico. In addition to the research and development efforts conducted in our San Jose, California facility, we also carry out research and development at locations in Moscow, Russia. In addition, our custo