ALGN-2014.9.30-Q3
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 September 30, 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 October 24, 2014 was 80,289,814.

 


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, the Invisalign logo, 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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net revenues
$
189,876

 
$
164,506

 
$
563,053

 
$
481,914

Cost of net revenues
44,822

 
39,416

 
135,272

 
120,284

Gross profit
145,054

 
125,090

 
427,781

 
361,630

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
52,368

 
45,224

 
161,642

 
135,352

General and administrative
28,285

 
27,487

 
84,533

 
84,862

Research and development
12,854

 
10,915

 
39,523

 
33,113

Impairment of goodwill

 

 

 
40,693

Impairment of long-lived assets

 

 

 
26,320

Total operating expenses
93,507

 
83,626

 
285,698

 
320,340

Income from operations
51,547

 
41,464

 
142,083

 
41,290

Interest and other income (expenses), net
(1,999
)
 
449

 
(1,491
)
 
(874
)
Net income before provision for income taxes
49,548

 
41,913

 
140,592

 
40,416

Provision for income taxes
11,301

 
7,376

 
34,301

 
18,542

Net income
$
38,247

 
$
34,537

 
$
106,291

 
$
21,874

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.47

 
$
0.43

 
$
1.31

 
$
0.27

Diluted
$
0.47

 
$
0.42

 
$
1.29

 
$
0.26

Shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
80,629

 
79,967

 
80,924

 
80,592

Diluted
82,014

 
81,848

 
82,443

 
82,549

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
(in thousands)
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
38,247

 
$
34,537

 
$
106,291

 
$
21,874

Net change in cumulative translation adjustment
(257
)
 
171

 
(155
)
 
109

Change in unrealized gains (losses) on available-for-sale securities, net of tax
(191
)
 
203

 
(81
)
 
20

Other comprehensive income (loss)
(448
)
 
374

 
(236
)
 
129

Comprehensive income
$
37,799

 
$
34,911

 
$
106,055

 
$
22,003

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)

 
 
September 30,
2014
 
December 31,
2013
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
180,676

 
$
242,953

Marketable securities, short-term
244,820

 
127,040

Accounts receivable, net of allowances for doubtful accounts and returns of $1,813 and $1,733, respectively
130,047

 
113,250

Inventories
15,983

 
13,968

Prepaid expenses and other current assets
44,146

 
47,465

Total current assets
615,672

 
544,676

Marketable securities, long-term
136,017

 
101,978

Property, plant and equipment, net
86,447

 
75,743

Goodwill and intangible assets, net
82,926

 
85,362

Deferred tax assets
19,714

 
15,766

Other assets
7,513

 
8,622

Total assets
$
948,289

 
$
832,147

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
24,517

 
$
17,718

Accrued liabilities
86,600

 
80,345

Deferred revenues
87,443

 
77,275

Total current liabilities
198,560

 
175,338

Other long-term liabilities
27,273

 
22,839

Total liabilities
225,833

 
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; 80,516 and 80,583 issued and outstanding, respectively)
8

 
8

Additional paid-in capital
775,523

 
729,578

Accumulated other comprehensive income
60

 
294

Accumulated deficit
(53,135
)
 
(95,910
)
Total stockholders’ equity
722,456

 
633,970

Total liabilities and stockholders’ equity
$
948,289

 
$
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)
 
 
Nine Months Ended
 
September 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
106,291

 
$
21,874

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Deferred taxes
20,870

 
14,501

Depreciation and amortization
13,469

 
12,647

Stock-based compensation
29,348

 
21,265

Excess tax benefit from share-based payment arrangements
(18,887
)
 
(21,849
)
Impairment of goodwill

 
40,693

Impairment of long-lived assets

 
26,320

Other non-cash operating activities
7,368

 
1,200

Changes in assets and liabilities:
 
 
 
Accounts receivable
(24,930
)
 
(5,936
)
Inventories
(2,033
)
 
467

Prepaid expenses and other assets
(2,349
)
 
256

Accounts payable
3,788

 
(318
)
Accrued and other long-term liabilities
12,402

 
(671
)
Deferred revenues
9,957

 
8,415

Net cash provided by operating activities
155,294

 
118,864

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Acquisition, net of cash acquired

 
(7,652
)
Purchase of property, plant and equipment
(16,957
)
 
(15,172
)
Purchase of marketable securities
(350,611
)
 
(213,990
)
Proceeds from maturities of marketable securities
124,101

 
32,229

Proceeds from sales of marketable securities
72,276

 
6,943

Other investing activities
(182
)
 
(2,347
)
Net cash used in investing activities
(171,373
)
 
(199,989
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock
17,373

 
28,291

Common stock repurchases
(77,417
)
 
(95,105
)
Excess tax benefit from share-based payment arrangements
18,887

 
21,849

Employees’ taxes paid upon the vesting of restricted stock units
(5,761
)
 
(3,931
)
Other financing activities

 
(6
)
Net cash used in financing activities
(46,918
)
 
(48,902
)
Effect of foreign exchange rate changes on cash and cash equivalents
720

 
(520
)
Net decrease in cash and cash equivalents
(62,277
)
 
(130,547
)
Cash and cash equivalents, beginning of the period
242,953

 
306,386

Cash and cash equivalents, end of the period
$
180,676

 
$
175,839

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 and nine months ended September 30, 2014 and 2013, our comprehensive income for the three and nine months ended September 30, 2014 and 2013, our financial position as of September 30, 2014 and our cash flows for the nine months ended September 30, 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 13 have been reclassified to conform with the current period presentation. These reclassifications had no impact on our financial position for the three or nine months ended September 30, 2014 and 2013.

The results of operations for the three months ended September 30, 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 May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, “Revenue from Contracts with Customers,” requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The updated standard becomes effective for us in the first quarter of fiscal 2017. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.



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Note 2. Marketable Securities and Fair Value Measurements

As of September 30, 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
September 30, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Commercial paper
$
44,840

 
$

 
$

 
$
44,840

Corporate bonds
117,981

 
45

 
(50
)
 
117,976

U.S. government agency bonds
47,560

 
31

 
(2
)
 
47,589

U.S. dollar dominated foreign corporate bonds
911

 
2

 

 
913

Municipal securities
13,567

 
18

 

 
13,585

U.S. government treasury bonds
18,496

 
24

 

 
18,520

Certificates of deposit
1,397

 

 

 
1,397

Total Marketable Securities, Short-Term
$
244,752

 
$
120

 
$
(52
)
 
$
244,820


Long-term
September 30, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
U.S. government agency bonds
$
28,887

 
$
7

 
$
(6
)
 
$
28,888

Corporate bonds
73,494

 
13

 
(104
)
 
73,403

Municipal securities
10,007

 
4

 
(6
)
 
10,005

U.S. government treasury bonds
11,298

 
1

 
(4
)
 
11,295

Asset-backed securities
12,439

 

 
(13
)
 
12,426

Total Marketable Securities, Long-Term
$
136,125

 
$
25

 
$
(133
)
 
$
136,017


Short-term
December 31, 2013
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Commercial paper
$
54,318

 
$
10

 
$

 
$
54,328

Corporate bonds
29,079

 
10

 
(4
)
 
29,085

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 and nine months ended September 30, 2014 and 2013, realized gains were immaterial. Unrealized gains and losses for our available for sale securities as of September 30, 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 September 30, 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 and nine months ended September 30, 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, U.S. government treasury bonds, certificates of deposit and asset-backed securities that have a maximum maturity of 27 months. 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 as of September 30, 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 September 30, 2014 and December 31, 2013 (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
Due in one year or less
$
244,820

 
$
127,040

Due in greater than one year
136,017

 
101,978

Total available for sale short-term and long-term marketable securities
$
380,837

 
$
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 September 30, 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. government agency bonds, asset-backed securities, municipal securities, U.S. dollar dominated foreign corporate bonds, certificates of deposit 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 September 30, 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.

We did not hold any Level 3 assets or liabilities as of September 30, 2014 or December 31, 2013.

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Non-Recurring Fair Value Measurements

During the nine months ended September 30, 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 tables summarize our financial assets measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 (in thousands): 
Description
Balance as of
September 30, 2014
 
Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable  Inputs
(Level 2)
Cash equivalents:
 
 
 
 
 
Money market funds
$
74,985

 
$
74,985

 
$

Commercial paper
27,493

 

 
27,493

Short-term investments:
 
 
 
 
 
Commercial paper
44,840

 

 
44,840

Corporate bonds
117,976

 

 
117,976

U.S. government agency bonds
47,589

 

 
47,589

Municipal securities
13,585

 

 
13,585

U.S. dollar dominated foreign corporate bonds
913

 

 
913

U.S. government treasury bonds
18,520

 
18,520

 

Certificates of deposit
1,397

 

 
1,397

Long-term investments:
 
 
 
 
 
Corporate bonds
73,403

 

 
73,403

U.S. government agency bonds
28,888

 

 
28,888

Asset-backed securities
12,426

 

 
12,426

Municipal securities
10,005

 

 
10,005

U.S. government treasury bonds
11,295

 
11,295

 

Other assets:
 
 
 
 
 
Israeli funds
2,371

 

 
2,371

 
$
485,686

 
$
104,800

 
$
380,886



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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

U.S. government agency bonds
16,703

 

 
16,703

Municipal securities
7,014

 

 
7,014

Asset-backed securities
5,939

 

 
5,939

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

Municipal securities
8,331

 

 
8,331

U.S. government treasury bonds
6,919

 
6,919

 

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): 
 
September 30,
2014
 
December 31,
2013
Raw materials
$
6,240

 
$
5,172

Work in process
3,734

 
4,241

Finished goods
6,009

 
4,555

Total Inventories
$
15,983

 
$
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): 
 
September 30,
2014
 
December 31,
2013
Accrued payroll and benefits
$
39,265

 
$
43,029

Accrued sales rebates
10,256

 
10,100

Accrued sales tax and value added tax
7,144

 
6,215

Accrued sales and marketing expenses
5,397

 
3,893

Accrued accounts payable
5,536

 
4,053

Accrued warranty
3,263

 
3,104

Accrued professional fees
1,605

 
1,892

Accrued income taxes
3,949

 
1,205

Other accrued liabilities
10,185

 
6,854

Total Accrued Liabilities
$
86,600

 
$
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 September 30, 2014 and 2013 consists of the following activity (in thousands): 
 
Nine Months Ended
September 30,
 
2014
 
2013
Balance at beginning of period
$
3,104

 
$
4,050

Charged to cost of net revenues
1,529

 
2,813

Actual warranty expenditures
(1,370
)
 
(3,057
)
Balance at end of period
$
3,263

 
$
3,806


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.  

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 or nine months ended September 30, 2013.


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Note 5. Goodwill and Long-lived Assets

Goodwill
The change in the carrying value of goodwill for the nine months ended September 30, 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
(34
)
Balance as of September 30, 2014
$
61,589

1 The adjustments to goodwill during the nine months ended September 30, 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 in the three months ended March 31, 2013, 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 Holdings, Inc. acquisition ("Cadent") or individually acquired are being amortized as follows (in thousands): 
 
Weighted Average Amortization Period (in years)
 
Gross Carrying Amount as of
September 30, 2014
 
Accumulated
Amortization
 
Accumulated
Impairment Loss
 
Net Carrying
Value as of
September 30, 2014
Trademarks
15
 
$
7,100

 
$
(1,319
)
 
$
(4,179
)
 
$
1,602

Existing technology
13
 
12,600

 
(2,873
)
 
(4,328
)
 
5,399

Customer relationships
11
 
33,500

 
(8,630
)
 
(10,751
)
 
14,119

Other
8
 
285

 
(68
)
 

 
217

Total Intangible Assets
 
 
$
53,485

 
$
(12,890
)
 
$
(19,258
)
 
$
21,337


 
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 September 30, 2014 is as follows (in thousands):
 
Fiscal Year Ending December 31,
 
Remainder of 2014
$
649

2015
2,600

2016
2,600

2017
2,600

2018
2,600

Thereafter
10,288

Total
$
21,337


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 loan bears 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 September 30, 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 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. On August 22, 2014, the court granted our motion to dismiss without leave to amend. On September 22, 2014, Plaintiff filed a notice of appeal to the Ninth Circuit Court of Appeals. 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, if any.
    
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

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Action. On October 14, 2014, an Order was entered staying this derivative lawsuit until a ruling by the Ninth Circuit in the Securities Action discussed above. 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 September 30, 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
 
$
2,282

2015
 
8,480

2016
 
7,690

2017
 
4,346

2018
 
1,490

Thereafter
 
437

Total minimum future lease payments
 
$
24,725


Off-balance Sheet Arrangements

As of September 30, 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 September 30, 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

As of September 30, 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.

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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 and nine months ended September 30, 2014 and 2013 is as follows (in thousands): 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Cost of net revenues
$
867

 
$
664

 
$
2,648

 
$
1,881

Sales and marketing
2,837

 
2,215

 
8,615

 
5,238

General and administrative
4,544

 
3,687

 
13,133

 
11,170

Research and development
1,662

 
1,024

 
4,952

 
2,976

Total stock-based compensation
$
9,910

 
$
7,590

 
$
29,348

 
$
21,265


Options

Activity for the nine months ended September 30, 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

 
$
16.08

 
 
 
 
Granted

 

 
 
 
 
Exercised
(598
)
 
16.88

 
 
 
 
Cancelled or expired
(4
)
 
18.33

 
 
 
 
Outstanding as of September 30, 2014
719

 
$
15.40

 
3.10
 
$
26,098

Vested and expected to vest at September 30, 2014
719

 
$
15.39

 
3.10
 
$
26,085

Exercisable at September 30, 2014
692

 
$
15.12

 
3.09
 
$
25,294


There were no stock options granted during the three and nine months ended September 30, 2014 and 2013.

As of September 30, 2014, the total unamortized compensation cost related to stock options, net of estimated forfeitures, is $0.3 million, which we expect to recognize over a weighted average period of 0.5 years.

Restricted Stock Units (“RSU”)

A summary of the RSU activity for the nine months ended September 30, 2014 is as follows (in thousands, except years):
 
 
Number of Shares
Underlying RSU
 
Weighted Average Grant Date Fair Value
 
Weighted 
Remaining
Contractual 
Period
 
Aggregate
Intrinsic
 Value
 
 
 
 
 
(in years)
 
 
Nonvested as of December 31, 2013
2,044

 
$
36.68

 
 
 
 
Granted
958

 
53.71

 
 
 
 
Vested and released
(639
)
 
28.59

 
 
 
 
Forfeited
(144
)
 
36.84

 
 
 
 
Nonvested as of September 30, 2014
2,219

 
$
41.93

 
1.51
 
$
114,662


As of September 30, 2014, the total unamortized compensation cost related to RSU, net of estimated forfeitures, was $68.4 million, which we expect to recognize over a weighted average period of 2.5 years.

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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 nine months ended September 30, 2014 (in thousands, except years): 
 
Number of Shares
Underlying MSU
 
Weighted Average Grant Date Fair Value
 
Weighted Average
Remaining
Contractual Period
 
Aggregate
Intrinsic 
Value
 
 
 
 
 
(in years )
 
 
Nonvested as of December 31, 2013
307

 
$
31.96

 
 
 
 
Granted
243

 
50.46

 
 
 
 
Vested and released
(52
)
 
22.41

 
 
 
 
Forfeited

 

 
 
 
 
Nonvested as of September 30, 2014
498

 
$
42.00

 
1.63
 
$
25,711


As of September 30, 2014, the total unamortized compensation costs related to the MSU, net of estimated forfeitures, was $11.1 million, which we expect to recognize over a weighted average period of 1.6 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 September 30, 2014, there remains 1,363,827 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
September 30,
 
Nine Months Ended
September 30,
 
 
2014
 
2013
 
2014
 
2013
ESPP:
 
 
 
 
 
 
 
 
Expected term (in years)
 
1.3

 
1.2

 
1.2

 
1.2

Expected volatility
 
35.8
%
 
37.3
%
 
38.8
%
 
44.9
%
Risk-free interest rate
 
0.24
%
 
0.20
%
 
0.20
%
 
0.20
%
Expected dividends
 

 

 

 

Weighted average fair value at grant date
 
$
16.44

 
$
13.84

 
$
17.15

 
$
11.70


As of September 30, 2014, the total unamortized compensation cost related to employee purchases was $1.3 million, which we expect to recognize over a weighted average period of 0.6 year.

Note 10. Common Stock Repurchase

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 first 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. We paid $70.0 million on April 29, 2014 and received an initial delivery of approximately 1.0 million shares. The ASR was completed on July 29, 2014 with a final delivery of approximately 0.4 million shares. We received a total of approximately 1.4 million shares under the ASR for an

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average purchase price per share of $51.46, which all shares were retired. The final number of shares repurchased was based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount.
During the three months ended September 30, 2014, we repurchased on the open market approximately 0.1 million shares of our common stock at an average price of $54.22 per share, including commissions, for an aggregate purchase price of approximately $7.4 million. All repurchased shares were retired. As of September 30, 2014, we have $222.6 million remaining under the April 2014 stock repurchase program, $22.6 million of which we expect to purchase over the next six months.
Note 11. Accounting for Income Taxes

Our provision for income taxes was $11.3 million and $7.4 million for the three months ended September 30, 2014 and 2013, respectively. This represents effective tax rates of 22.8% and 17.6%, respectively. The increase in our 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.

Our provision for income taxes was $34.3 million and $18.5 million for the nine months ended September 30, 2014 and 2013, respectively. This represents effective tax rates of 24.4% and 45.9%, respectively. Our provision for income taxes reflects a negative impact from a $1.8 million adjustment related to prior years, 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 nine months ended September 30, 2013 reflects a non-deductible goodwill impairment charge of $40.7 million recorded during the three months ended March 31, 2013.

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 September 30, 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 September 30, 2014, the change in our gross unrecognized tax benefits was not material. The total amount of gross unrecognized tax benefits was $31.1 million as of September 30, 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 September 30, 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.

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, which could have a negative impact on our operating results. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2014. As a result of these incentives, our income taxes were reduced by $22.8 million and $18.0 million for the nine months ended September 30, 2014 and 2013, respectively, representing a benefit to diluted net income per share of $0.28 and $0.22 in 2014 and 2013, respectively. For the three months ended September 30, 2014 and 2013, income taxes were reduced by $7.7 million and $6.1 million, respectively, representing a benefit to diluted net income per share of $0.09 and $0.08, respectively.



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Note 12. Net Income Per Share

Basic net income 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 any 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 per share attributable to common stock (in thousands, except per share amounts): 
 
Three Months Ended,
September 30,
 
Nine Months Ended,
September 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net income
$
38,247

 
$
34,537

 
$
106,291

 
$
21,874

Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding, basic
80,629

 
79,967

 
80,924

 
80,592

Dilutive effect of potential common stock
1,385

 
1,881

 
1,519

 
1,957

Total shares, diluted
82,014

 
81,848

 
82,443

 
82,549

Net income per share, basic
$
0.47

 
$
0.43

 
$
1.31

 
$
0.27

Net income per share, diluted
$
0.47

 
$
0.42

 
$
1.29

 
$
0.26


For the three and nine months ended September 30, 2014 and September 30, 2013, the anti-dilutive effect from stock options, RSU, MSU and ESPP was not material.

Note 13. 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.

20

Table of Contents

These reportable operating segments are based on how our CODM views and evaluates our operations as well as allocation of resources. The following information relates to these segments (in thousands):

 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
Net Revenues
2014
 
2013
 
2014
 
2013
Clear Aligner
 
 
 
 
 
 
 
      Invisalign Full Products
$
147,583

 
$
125,169

 
$
432,874

 
$
361,328

      Invisalign Express/Lite Products
19,205

 
17,702

 
59,308

 
52,943

      Invisalign non-case revenues
11,350

 
10,679

 
33,930

 
34,154

Scanner
 
 
 
 
 
 
 
      Scanners and Services
11,738

 
10,956

 
36,941

 
33,489

Total net revenues
$
189,876

 
$
164,506

 
$
563,053

 
$
481,914

 
 
 
 
 
 
 
 
Gross profit
 
 
 
 
 
 
 
    Clear Aligner
$
141,117

 
$
122,663

 
$
415,903

 
$
352,114

    Scanners and Services
3,937

 
2,427

 
11,878

 
9,516

Total gross profit
$
145,054

 
$
125,090

 
$
427,781

 
$
361,630


Geographical Information

Net revenues are presented below by geographic area (in thousands):
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Net revenues: (1)
 
 
 
 
 
 
 
U.S.
$
134,244

 
$
123,904

 
$
396,837

 
$
365,596

the Netherlands
35,878

 
26,494

 
118,401

 
86,049

Other international
19,754

 
14,108

 
47,815

 
30,269

Total net revenues
$
189,876

 
$
164,506

 
$
563,053

 
$
481,914

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

Tangible long-lived assets are presented below by geographic area (in thousands):

 
September 30,
 
December 31,
 
2014
 
2013
Long-lived assets:(2)
 
 
 
United States
$
72,616

 
$
61,439

Mexico
6,266

 
6,291

the Netherlands
1,067

 
1,630

Other International
6,498

 
6,383

Total long-lived assets
$
86,447

 
$
75,743

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



21


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, the effectiveness of our new training course and its impact on volumes, 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 Europe Middle East and Africa ("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 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

22


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 80 countries and has been used to treat more than 2.8 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 2,300 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 more 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 help doctors achieve even better clinical outcomes when treating patients with deep bites - a prevalent orthodontic problem. 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

23



Total utilization in the third quarter of 2014 was 4.4 cases per doctor, up slightly from 4.3 cases in the third quarter of 2013 driven primarily by North America orthodontist and International customers. Utilization among our North American orthodontist customers increased to 8.8 cases per doctor in the third quarter of 2014 from 8.4 cases in the third quarter of 2013, while our International doctor utilization increased to 4.3 cases in the third quarter of 2014 from 4.1 cases in the third quarter of 2013. This increase in North America orthodontist utilization reflects improvements in product and technology, 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, including their teenage patients. Increased International utilization reflects growth in both the EMEA and Asia Pacific regions driven by go-to-market and sales coverage investments, improving clinical education and support as well as ongoing technology innovation. Year over year utilization for our North American GP customers decreased to 2.8 cases per doctor in the third quarter of 2014 from 2.9 cases in the third quarter of 2013. 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 due to a variety of factors, including as a result of seasonal trends in our business.

Seasonal Trends. In North America, summer is typically the busiest season for orthodontists with practices that have a high percentage of adolescent and teenage patients as many parents want to get their teenagers started in treatment before the start of the school year; however, many GPs are on vacation during this time and, therefore, tend to start fewer cases.  Internationally, sales of Invisalign treatment are often weaker in the summer months due to our customers and their patients being on holiday. The fourth quarter is often a slower period for North American Orthodontists as fewer teenagers start orthodontic treatment once the school year has started. As such, we expect North American Orthodontists to be down sequentially in the fourth quarter. Offsetting this trend, our fourth quarter has historically been a stronger quarter for our international doctors and North American GPs as they rebound from a seasonally slower summer quarter. We expect volume for both international and North American GPs to be up sequentially in the fourth quarter. Consequently, we expect that our Invisalign volume in the fourth quarter of 2014 will be up slightly compared to the third quarter.

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 have implemented 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 27.8%, driven primarily by growth in Europe as well as by strong performance in the Asia Pacific region. In 2014, we are continuing 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 began the transition of a small number of countries into direct sales regions. We continued the transition of additional smaller countries during the current quarter which will continue through February 2015. 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. In the third quarter of 2014, our net revenues were negatively impacted by $0.8 million and we incurred other foreign currency translation net losses of $2.1 million in Interest and Other Income (Expense) net, due to current fluctuations of the Euro to the U.S. Dollar.

24


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; however, our scanners are still subject to the MDET. 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 June 2014, we received a $1.2 million refund for MDET paid in 2014 related to our aligners which reduced general and administrative expenses for the three months ended June 30, 2014. In the current quarter, MDET expense was lower by approximately $1.6 million compared to the same quarter in the prior year. Additionally, we are in process of claiming a $6.8 million refund of MDET paid in 2013 related to our aligners; however, because this claim is subject to review and approval by the IRS, we have not recorded a receivable as the outcome of the 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 it 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 first 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. 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. As of September 30, 2014, there is approximately $222.6 million remaining under the April 2014 stock repurchase program.
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. We paid $70.0 million on April 29, 2014 and received an initial delivery of approximately 1.0 million shares based on the then current market price, which were retired. The ASR was completed on July 29, 2014 with a final delivery of approximately 0.4 million shares. Under the ASR, we received a total of approximately 1.4 million shares of our common stock for an average purchase price per share of $51.46. The final number of shares repurchased was based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount.

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.

25

Table of Contents


Net revenues for our Clear Aligner segment by region and product and our Scanner segment by region for the three and nine months ended September 30, 2014 and 2013 is as follows (in millions).

 
For the Three Months Ended,
September 30,
 
For the Nine Months Ended,
September 30,
Clear Aligner:
2014
 
2013
 
Net
Change
 
%
Change
 
2014
 
2013
 
Net
Change
 
%
Change
Region
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
North America
$
113.3

 
$
103.9

 
$
9.4

 
9.0
%
 
$
332.9

 
$
303.2

 
$
29.7

 
9.8
 %
International
53.4

 
38.9

 
14.5

 
37.3
%
 
159.3

 
111.0

 
48.3

 
43.5
 %
Invisalign non-case net revenues
11.4

 
10.7

 
0.7

 
6.5
%
 
33.9

 
34.2

 
(0.3
)
 
(0.9
)%
Total Clear Aligner net revenues
$
178.1

 
$
153.5

 
$
24.6

 
16.0
%
 
$
526.1

 
$
448.4

 
$
77.7

 
17.3
 %
Product
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Invisalign Full Products
$
147.6

 
$
125.1

 
$
22.5

 
18.0
%
 
$
432.9

 
$
361.2

 
$
71.7

 
19.9
 %
Invisalign Express Products
19.2

 
17.7

 
1.5

 
8.5
%
 
59.3

 
53.0

 
6.3

 
11.9
 %
Invisalign non-case net revenues
11.3

 
10.7

 
0.6

 
5.6
%
 
33.9

 
34.2

 
(0.3
)
 
(0.9
)%
Total Clear Aligner net revenues
$
178.1

 
$
153.5

 
$
24.6

 
16.0
%
 
$
526.1

 
$
448.4

 
$
77.7

 
17.3
 %
Scanner:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Region
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
North America
$
11.6

 
$
10.9

 
$
0.7

 
6.4
%
 
$
36.6

 
$
33.2

 
$
3.4

 
10.2
 %
International
0.1

 
0.1

 

 
%
 
0.3

 
0.3

 

 
 %
Total Scanner net revenues
$
11.7

 
$
11.0

 
$
0.7

 
6.4
%
 
$
36.9

 
$
33.5

 
$
3.4

 
10.1
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total net revenues
$
189.9

 
$
164.5

 
$
25.4

 
15.4
%
 
$
563.1

 
$
481.9

 
$
81.2

 
16.8
 %

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Clear Aligner Case Volume by Region and Product

Case volume data which represents Invisalign case shipments by region and product, for the three and nine months ended September 30, 2014 and 2013 is as follows (in thousands).
 
For the Three Months Ended,
September 30,
 
For the Nine Months Ended,
September 30,
Region
2014
 
2013
 
Net
Change
 
%
Change
 
2014
 
2013
 
Net
Change
 
%
Change
North American Invisalign
85.4

 
80.1

 
5.3

 
6.6
%
 
251.7

 
233.6

 
18.1

 
7.7
%
International Invisalign
34.2

 
26.8

 
7.4

 
27.6
%
 
99.4

 
77.6

 
21.8

 
28.1
%
Total Invisalign case volume
119.6

 
106.9

 
12.7

 
11.9
%
 
351.1

 
311.2

 
39.9

 
12.8
%
Product
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Invisalign Full Product Group
99.4

 
87.7

 
11.7

 
13.3
%
 
290.3

 
251.8

 
38.5

 
15.3
%
Invisalign Express Product Group
20.2

 
19.2

 
1.0

 
5.2
%
 
60.8

 
59.4

 
1.4

 
2.4
%
Total Invisalign case volume
119.6

 
106.9

 
12.7

 
11.9
%
 
351.1

 
311.2

 
39.9

 
12.8
%

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.

Total net revenues increased by $25.4 million and $81.2 million for the three and nine months ended September 30, 2014, respectively, as compared to the same period in 2013 primarily as a result of Invisalign case volume growth across all regions and most products.


26

Table of Contents

Clear Aligner

In the three months ended September 30, 2014, Clear Aligner North America net revenues increased by $9.4 million or 9.0% compared to the same period in 2013 primarily due to Invisalign case volume growth of approximately $6.8 million across all channels and most products and, to a lesser extent, higher average selling prices ("ASP") which contributed approximately $2.6 million to the increase in net revenues. The increase in ASP was primarily a result of increased mid-course correction revenue in the current period compared to the same period in the prior year.

In the nine months ended September 30, 2014, Clear Aligner North America net revenues increased by $29.7 million or 9.8% compared to the same period in 2013 mainly due to Invisalign case volume growth of $23.3 million and, to a lesser extent, higher ASP which contributed approximately $6.4 million to the increase in net revenues. The increase in ASP was a result of a product mix shift towards higher priced Invisalign full products as well as increased mid-course correction revenue in the current period compared to the same period in the prior year.

In the three months ended September 30, 2014, Clear Aligner international net revenues increased by $14.5 million or 37.3% compared to the same period in 2013 primarily driven by Invisalign case volume growth of $10.8 million across all products and higher ASP which contributed approximately $3.6 million to the increase in net revenues. The increase in ASP was a result of a product mix shift towards higher priced Invisalign full products in the current period compared to the same period in the prior year as well as a favorable impact from foreign exchange rates.

In the nine months ended September 30, 2014, Clear Aligner international net revenues increased by $48.3 million or 43.5% compared to the same period in 2013 mainly due to Invisalign case volume growth of $31.5 million and, to a lesser extent, higher ASP which contributed approximately $16.7 million to 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 favorable impact from foreign exchange rates.

Invisalign non-case net revenues, consisting of training fees and ancillary product revenues, increased by $0.7 million or 6.5% for the three months ended September 30, 2014 compared to the same period in 2013 primarily due to increased Vivera volume both in North America and international.

Invisalign non-case net revenue decreased by $0.3 million or 0.9% for the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to the consolidation of our Vivera product shipments in North America from four shipments per year to one shipment in 2013, offset in part by increased Vivera volume both in North America and International for the nine months ended September 30, 2014.

Scanner and Services

Scanner and Services net revenues increased $0.7 million or 6.4% for the three months ended September 30, 2014 compared to the same period in 2013. The increase was primarily due to an increase in the volume of services resulting from a larger installed base of scanners. This increase was offset in part by a decrease in scanner revenue which was primarily due to a decrease in the number of scanners recognized.

Scanner and Services net revenues increased $3.4 million or 10.1% for the nine months ended September 30, 2014 compared to the same period in 2013. The increase was primarily due to an increase in both scanner revenue as well as service revenue. The increase in scanner revenue was primarily due to an increase in the number of scanners recognized offset in part by lower scanner ASP as a result of promotional discounts as well as permanent price reductions. Additionally, scanner revenues for the nine months ended September 30, 2013 included a release of $1.4 million of revenue previously reserved for the iTero upgrade program which was completed in the first quarter of 2013. The increase in services revenue was primarily due to an increase in the volume of services resulting from a larger installed base of scanners.


27

Table of Contents

Cost of net revenues and gross profit (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
Change
 
2014
 
2013
 
Change
Clear Aligner
 
 
 
 
 
 
 
 
 
 
 
Cost of net revenues
$
37.0

 
$
30.9

 
$
6.1

 
$
110.2

 
$
96.3

 
$
13.9

% of net segment revenues
20.8
%
 
20.1
%
 
 
 
20.9
%
 
21.5
%
 
 
Gross profit
$
141.1

 
$
122.7

 
$
18.4

 
$
415.9

 
$
352.1

 
$
63.8

Gross margin %
79.2
%
 
79.9
%
 
 
 
79.1
%
 
78.5
%
 
 
Scanner
 
 
 
 
 
 
 
 
 
 
 
Cost of net revenues
$
7.8

 
$
8.5

 
$
(0.7
)
 
$
25.1