ALGN-2015.06.30 -Q2
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 June 30, 2015
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 July 24, 2015 was 80,078,373.

 


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, SmartStage, Power Ridge, iTero, iTero Element, 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.



2

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
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net revenues
$
209,488

 
$
192,531

 
$
407,574

 
$
373,177

Cost of net revenues
50,854

 
47,055

 
97,850

 
90,450

Gross profit
158,634

 
145,476

 
309,724

 
282,727

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
100,625

 
83,455

 
188,906

 
165,522

Research and development
15,684

 
13,289

 
29,569

 
26,669

Total operating expenses
116,309

 
96,744

 
218,475

 
192,191

Income from operations
42,325

 
48,732

 
91,249

 
90,536

Interest and other income (expenses), net
174

 
(93
)
 
(1,278
)
 
508

Net income before provision for income taxes
42,499

 
48,639

 
89,971

 
91,044

Provision for income taxes
11,149

 
13,039

 
22,444

 
23,000

Net income
$
31,350

 
$
35,600

 
$
67,527

 
$
68,044

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.39

 
$
0.44

 
$
0.84

 
$
0.84

Diluted
$
0.39

 
$
0.43

 
$
0.83

 
$
0.82

Shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
80,257

 
81,027

 
80,358

 
81,073

Diluted
81,394

 
82,341

 
81,729

 
82,651

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

3

Table of Contents

ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
31,350

 
$
35,600

 
$
67,527

 
$
68,044

Net change in cumulative translation adjustment
52

 
(4
)
 
(209
)
 
102

Change in unrealized gains (losses) on available-for-sale securities, net of tax
(133
)
 
70

 
162

 
112

Other comprehensive income (loss)
(81
)
 
66

 
(47
)
 
214

Comprehensive income
$
31,269

 
$
35,666

 
$
67,480

 
$
68,258

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

4

Table of Contents


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

 
 
June 30,
2015
 
December 31,
2014
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
161,753

 
$
199,871

Marketable securities, short-term
276,789

 
254,787

Accounts receivable, net of allowances for doubtful accounts and returns of $1,548 and $1,563, respectively
146,466

 
129,751

Inventories
16,415

 
15,928

Prepaid expenses and other current assets
26,511

 
19,770

Deferred tax assets
29,972

 
37,053

Total current assets
657,906

 
657,160

Marketable securities, long-term
158,161

 
147,892

Property, plant and equipment, net
108,029

 
90,125

Goodwill and intangible assets, net
80,590

 
82,056

Deferred tax assets
16,014

 
3,099

Other assets
7,881

 
7,665

Total assets
$
1,028,581

 
$
987,997

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
29,513

 
$
23,247

Accrued liabilities
91,992

 
87,880

Deferred revenues
101,420

 
90,684

Total current liabilities
222,925

 
201,811

Income tax payable
33,726

 
30,483

Other long-term liabilities
2,129

 
2,932

Total liabilities
258,780

 
235,226

Commitments and contingencies (Note 6 and 7)

 

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

 

Common stock, $0.0001 par value (200,000 shares authorized; 80,069 and 80,205 issued and outstanding, respectively)
8

 
8

Additional paid-in capital
775,806

 
783,410

Accumulated other comprehensive loss, net
(187
)
 
(140
)
Accumulated deficit
(5,826
)
 
(30,507
)
Total stockholders’ equity
769,801

 
752,771

Total liabilities and stockholders’ equity
$
1,028,581

 
$
987,997

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

5

Table of Contents

ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Six Months Ended
 
June 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
67,527

 
$
68,044

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Deferred taxes
297

 
17,496

Depreciation and amortization
8,638

 
9,130

Stock-based compensation
24,474

 
19,438

Excess tax benefit from share-based payment arrangements
(6,207
)
 
(16,161
)
Other non-cash operating activities
6,162

 
5,095

Changes in assets and liabilities:
 
 
 
Accounts receivable
(22,904
)
 
(21,407
)
Inventories
(510
)
 
855

Prepaid expenses and other assets
(4,786
)
 
(2,806
)
Accounts payable
4,902

 
(9
)
Accrued and other long-term liabilities
8,259

 
1,343

Deferred revenues
12,733

 
6,705

Net cash provided by operating activities
98,585

 
87,723

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of property, plant and equipment
(26,172
)
 
(9,960
)
Purchase of marketable securities
(195,399
)
 
(232,178
)
Proceeds from maturities of marketable securities
148,685

 
92,005

Proceeds from sales of marketable securities
12,518

 
32,683

Other investing activities
46

 
(133
)
Net cash used in investing activities
(60,322
)
 
(117,583
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock
6,036

 
12,622

Common stock repurchases
(50,781
)
 
(49,000
)
Equity forward contract related to accelerated share repurchase
(21,000
)
 
(21,000
)
Excess tax benefit from share-based payment arrangements
6,207

 
16,161

Employees’ taxes paid upon the vesting of restricted stock units
(15,389
)
 
(4,650
)
Net cash used in financing activities
(74,927
)
 
(45,867
)
Effect of foreign exchange rate changes on cash and cash equivalents
(1,454
)
 
245

Net decrease in cash and cash equivalents
(38,118
)
 
(75,482
)
Cash and cash equivalents, beginning of the period
199,871

 
242,953

Cash and cash equivalents, end of the period
$
161,753

 
$
167,471

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


6

Table of Contents

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 six months ended June 30, 2015 and 2014, our comprehensive income for the three and six months ended June 30, 2015 and 2014, our financial position as of June 30, 2015 and our cash flows for the six months ended June 30, 2015 and 2014. The Condensed Consolidated Balance Sheet as of December 31, 2014 was derived from the December 31, 2014 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 and six months ended June 30, 2015 and 2014.

The results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 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, 2014.

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, revenue recognition, 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. In July 2015, the FASB voted to defer the effective date for annual reporting periods beginning after December, 15, 2017 (including interim reporting periods within those periods) and permitted early adoption of the standard, but not before the original effective date of December 15, 2016. We expect the updated standard to become effective for us in the first quarter of fiscal 2018. 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.
In April 2015, the FASB issued ASU No. 2015-05, "Customer's Accounting for Fees Paid in a Cloud Computing Arrangement." providing guidance to entities about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the entity should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the entity should account for the arrangement as a service contract. The new guidance does not change the accounting for an entity's accounting for service contracts. The updated standard becomes effective for interim and annual reporting periods beginning after December 15, 2015. We are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.


7

Table of Contents


Note 2. Marketable Securities and Fair Value Measurements

As of June 30, 2015 and December 31, 2014, 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
June 30, 2015
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Commercial paper
$
23,113

 
$

 
$

 
$
23,113

Corporate bonds
154,667

 
21

 
(105
)
 
154,583

Municipal securities
10,237

 
2

 
(1
)
 
10,238

U.S. government agency bonds
62,233

 
17

 
(1
)
 
62,249

U.S. government treasury bonds
23,592

 
14

 

 
23,606

Agency discount notes
2,999

 
1

 

 
3,000

Total Marketable Securities, Short-Term
$
276,841

 
$
55

 
$
(107
)
 
$
276,789


Long-term
June 30, 2015
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value

U.S. government agency bonds
$
39,489

 
$
46

 
$
(12
)
 
$
39,523

Corporate bonds
65,988

 
5

 
(82
)
 
65,911

U.S. dollar dominated foreign corporate bonds
517

 

 

 
517

U.S. government treasury bonds
35,746

 
66

 
(1
)
 
35,811

Municipal securities
7,161

 
4

 
(6
)
 
7,159

Asset-backed securities
9,240

 
2

 
(2
)
 
9,240

Total Marketable Securities, Long-Term
$
158,141

 
$
123

 
$
(103
)
 
$
158,161


Short-term
December 31, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Commercial paper
$
33,998

 
$

 
$

 
$
33,998

Corporate bonds
152,055

 
27

 
(116
)
 
151,966

U.S. dollar dominated foreign corporate bonds
901

 

 

 
901

Municipal securities
9,147

 
13

 

 
9,160

U.S. government agency bonds
41,574

 
14

 
(1
)
 
41,587

U.S. government treasury bonds
15,770

 
7

 

 
15,777

Certificates of Deposits
1,398

 

 

 
1,398

Total Marketable Securities, Short-Term
$
254,843

 
$
61

 
$
(117
)
 
$
254,787


8

Table of Contents

Long-term 
December 31, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
U.S. government agency bonds
$
48,233

 
$
12

 
$
(28
)
 
$
48,217

Corporate bonds
57,195

 
6

 
(112
)
 
57,089

U.S. dollar dominated foreign corporate bonds
523

 

 
(2
)
 
521

U.S. government treasury bonds
20,814

 
5

 
(6
)
 
20,813

Municipal securities
9,552

 
5

 
(6
)
 
9,551

Asset-backed securities
11,713

 

 
(12
)
 
11,701

Total Marketable Securities, Long-Term
$
148,030

 
$
28

 
$
(166
)
 
$
147,892

 For the three and six months ended June 30, 2015 and 2014, realized gains were immaterial. Unrealized gains and losses for our available for sale securities as of June 30, 2015 and December 31, 2014 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 June 30, 2015 and December 31, 2014. Amounts reclassified to earnings from accumulated other comprehensive income related to unrealized gain or losses were immaterial for the three and six months ended June 30, 2015 and 2014.

Our fixed-income securities investment portfolio consists of corporate bonds, certificates of deposits, U.S. dollar dominated foreign corporate bonds, commercial paper, municipal securities, U.S. government agency bonds, U.S. government treasury bonds, agency discount notes 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 10 and 11 months as of June 30, 2015 and December 31, 2014, 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 June 30, 2015 and December 31, 2014 (in thousands):
 
June 30, 2015
 
December 31, 2014
Due in one year or less
$
276,789

 
$
254,787

Due in greater than one year
158,161

 
147,892

Total available for sale short-term and long-term marketable securities
$
434,950

 
$
402,679


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 June 30, 2015 or December 31, 2014.

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, certificates of deposits, U.S. government agency bonds, asset-backed securities, municipal securities, U.S. dollar dominated foreign corporate bonds, agency discount notes and our Israeli

9

Table of Contents

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 June 30, 2015 or December 31, 2014.

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 June 30, 2015 or December 31, 2014.
Recurring Fair Value Measurements

The following tables summarize our financial assets measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014 (in thousands): 
Description
Balance as of
June 30, 2015
 
Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable  Inputs
(Level 2)
Cash equivalents:
 
 
 
 
 
Money market funds
$
69,376

 
$
69,376

 
$

Commercial paper
32,644

 

 
32,644

Short-term investments:
 
 
 
 
 
Commercial paper
23,113

 

 
23,113

Corporate bonds
154,583

 

 
154,583

Municipal securities
10,238

 

 
10,238

U.S. government agency bonds
62,249

 

 
62,249

U.S. government treasury bonds
23,606

 
23,606

 

Agency discount notes
3,000

 

 
3,000

Long-term investments:
 
 
 
 
 
U.S. government agency bonds
39,523

 

 
39,523

Corporate bonds
65,911

 

 
65,911

U.S. dollar dominated foreign corporate bonds
517

 

 
517

U.S. government treasury bonds
35,811

 
35,811

 

Municipal securities
7,159

 

 
7,159

Asset-backed securities
9,240

 

 
9,240

Other assets:
 
 
 
 
 
Israeli funds
2,396

 

 
2,396

 
$
539,366

 
$
128,793

 
$
410,573



10

Table of Contents

 
Description
Balance as of
December 31, 2014
 
Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable  Inputs
(Level 2)
Cash equivalents:
 
 
 
 
 
Money market funds
$
80,786

 
$
80,786

 
$

Commercial paper
21,997

 

 
21,997

Corporate bonds
1,745

 

 
1,745

Short-term investments:
 
 
 
 
 
Commercial paper
33,998

 

 
33,998

Corporate bonds
151,966

 

 
151,966

U.S. dollar denominated foreign corporate bonds
901

 

 
901

Municipal securities
9,160

 

 
9,160

U.S. government agency bonds
41,587

 

 
41,587

U.S. government treasury bonds
15,777

 
15,777

 

Certificates of Deposits
1,398

 

 
1,398

Long-term investments:
 
 
 
 
 
U.S. government agency bonds
48,217

 

 
48,217

Corporate bonds
57,089

 

 
57,089

U.S. dollar denominated foreign corporate bonds
521

 

 
521

U.S. government treasury bonds
20,813

 
20,813

 

Municipal securities
9,551

 

 
9,551

Asset-backed securities
11,701

 

 
11,701

Other assets:
 
 
 
 
 
Israeli funds
2,307

 

 
2,307

 
$
509,514

 
$
117,376

 
$
392,138


Note 3. Balance Sheet Components

Inventories

Inventories consist of the following (in thousands): 
 
June 30,
2015
 
December 31,
2014
Raw materials
$
7,352

 
$
8,143

Work in process
5,243

 
2,970

Finished goods
3,820

 
4,815

Total Inventories
$
16,415

 
$
15,928


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.


11

Table of Contents

Accrued liabilities

Accrued liabilities consist of the following (in thousands): 
 
June 30,
2015
 
December 31,
2014
Accrued payroll and benefits
$
48,448

 
$
44,610

Accrued sales rebates
12,647

 
11,110

Accrued sales and marketing expenses
6,231

 
5,979

Accrued sales tax and value added tax
5,387

 
5,456

Accrued accounts payable
3,678

 
5,736

Accrued warranty
2,986

 
3,148

Accrued professional fees
2,487

 
2,494

Accrued income taxes
1,939

 
2,027

Other accrued liabilities
8,189

 
7,320

Total Accrued Liabilities
$
91,992

 
$
87,880


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 June 30, 2015 and 2014 consists of the following activity (in thousands): 
 
Six Months Ended
June 30,
 
2015
 
2014
Balance at beginning of period
$
3,148

 
$
3,104

Charged to cost of net revenues
976

 
1,195

Actual warranty expenditures
(1,138
)
 
(1,047
)
Balance at end of period
$
2,986

 
$
3,252


Note 4. Goodwill and Long-lived Assets

Goodwill

On April 29, 2011, we acquired Cadent Holdings, Inc. (“Cadent”). In connection with the acquisition, we allocated approximately $58.0 million of goodwill to our Clear Aligner reporting unit based on the expected relative synergies generated by the acquisition. On April 30, 2013, we acquired ICA Holdings Pty Limited in a purchase business combination of which $3.6 million was recorded to goodwill, which was attributed to our Clear Aligner reporting unit.

The change in the carrying value of goodwill for the six months ended June 30, 2015, all attributable to our Clear Aligner reporting unit, is as follows (in thousands):

12

Table of Contents

 
Clear Aligner
Balance as of December 31, 2014
$
61,369

Adjustments 1
(166
)
Balance as of June 30, 2015
$
61,203

1 The adjustments to goodwill during the six months ended June 30, 2015 were due to foreign currency translation.

During the fourth quarter of fiscal 2014, 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.

Acquired 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
June 30, 2015
 
Accumulated
Amortization
 
Accumulated
Impairment Loss
 
Net Carrying
Value as of
June 30, 2015
Trademarks
15
 
$
7,100

 
$
(1,423
)
 
$
(4,179
)
 
$
1,498

Existing technology
13
 
12,600

 
(3,296
)
 
(4,328
)
 
4,976

Customer relationships
11
 
33,500

 
(10,027
)
 
(10,751
)
 
12,722

Other
8
 
285

 
(94
)
 

 
191

Total Intangible Assets
 
 
$
53,485

 
$
(14,840
)
 
$
(19,258
)
 
$
19,387


 
Weighted Average Amortization Period (in years)
 
Gross Carrying
Amount as of
December 31, 2014
 
Accumulated
Amortization
 
Accumulated Impairment Loss
 
Net Carrying
Value as of
December 31, 2014
Trademarks
15
 
$
7,100

 
$
(1,354
)
 
$
(4,179
)
 
$
1,567

Existing technology
13
 
12,600

 
(3,015
)
 
(4,328
)
 
5,257

Customer relationships
11
 
33,500

 
(9,095
)
 
(10,751
)
 
13,654

Other
8
 
285

 
(76
)
 

 
209

Total Intangible Assets
 
 
$
53,485

 
$
(13,540
)
 
$
(19,258
)
 
$
20,687


The total estimated annual future amortization expense for these acquired intangible assets as of June 30, 2015 is as follows (in thousands):
 
Fiscal Year Ending December 31,
 
Remainder of 2015
$
1,300

2016
2,600

2017
2,600

2018
2,600

2019
2,592

Thereafter
7,695

Total
$
19,387


Note 5. Credit Facilities

On March 22, 2013, we entered into a credit facility, which 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 June 30, 2015, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.


13

Table of Contents

Note 6. 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 former 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 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.



14

Table of Contents

Note 7. Commitments and Contingencies

Operating Leases

As of June 30, 2015, minimum future lease payments for non-cancelable operating leases are as follows (in thousands):  
Fiscal Year Ending December 31,
 
Operating leases
Remainder of 2015
 
$
5,090

2016
 
9,831

2017
 
5,885

2018
 
2,345

2019
 
529

Thereafter
 
438

Total minimum future lease payments
 
$
24,118


Off-balance Sheet Arrangements

As of June 30, 2015, 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 June 30, 2015, we did not have any material indemnification claims that were probable or reasonably possible.

Note 8. Stock-based Compensation

Summary of stock-based compensation expense

As of June 30, 2015, we had a total reserve of 23,283,379 shares for issuance.

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 six months ended June 30, 2015 and 2014 is as follows (in thousands): 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
Cost of net revenues
$
967

 
$
937

 
$
1,945

 
$
1,781

Selling, general and administrative
9,771

 
7,650

 
18,542

 
14,367

Research and development
2,088

 
1,719

 
3,987

 
3,290

Total stock-based compensation
$
12,826

 
$
10,306

 
$
24,474

 
$
19,438



15

Table of Contents

Options

Activity for the six months ended June 30, 2015 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, 2014
668

 
$
15.57

 
 
 
 
Granted

 

 
 
 
 
Exercised
(112
)
 
16.05

 
 
 
 
Cancelled or expired

 

 
 
 
 
Outstanding as of June 30, 2015
556

 
$
15.47

 
2.51
 
$
26,247

Vested and expected to vest at June 30, 2015
556

 
$
15.47

 
2.51
 
$
26,247

Exercisable at June 30, 2015
556

 
$
15.47

 
2.51
 
$
26,247


There were no stock options granted during the six months ended June 30, 2015 and 2014. All compensation costs relating to stock options have been recognized as of June 30, 2015.

Restricted Stock Units (“RSU”)

A summary of the RSU activity for the six months ended June 30, 2015 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, 2014
2,124

 
$
42.08

 
 
 
 
Granted
806

 
57.62

 
 
 
 
Vested and released
(585
)
 
36.15

 
 
 
 
Forfeited
(44
)
 
45.32

 
 
 
 
Nonvested as of June 30, 2015
2,301

 
$
48.98

 
1.54
 
$
144,297


As of June 30, 2015, the total unamortized compensation cost related to RSU, net of estimated forfeitures, was $84.8 million, which we expect to recognize over a weighted average period of 2.5 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 six months ended June 30, 2015 (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, 2014
498

 
$
42.00

 
 
 
 
Granted
289

 
61.73

 
 
 
 
Vested and released
(156
)
 
29.45

 
 
 
 
Nonvested as of June 30, 2015
631

 
$
45.31

 
1.80
 
$
39,526



16

Table of Contents

As of June 30, 2015, the total unamortized compensation costs related to the MSU, net of estimated forfeitures, was $19.0 million, which we expect to recognize over a weighted average period of 1.8 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 June 30, 2015, there remains 1,226,899 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:
 
 
Six Months Ended
June 30,
 
 
2015
 
2014
Expected term (in years)
 
1.2

 
1.2

Expected volatility
 
31.9
%
 
42.3
%
Risk-free interest rate
 
0.26
%
 
0.17
%
Expected dividends
 

 

Weighted average fair value at grant date
 
$
15.98

 
$
17.97


There were no new ESPP cycles that started during the three months ended June 30, 2015 or June 30, 2014.

As of June 30, 2015, the total unamortized compensation cost related to employee purchases was $2.6 million, which we expect to recognize over a weighted average period of 0.7 year.

Note 9. 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 authorized over the first 12 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, on April 28, 2014, we entered into an accelerated share repurchase agreement ("2014 ASR") to repurchase $70.0 million of our common stock which was completed in July 2014. We received a total of approximately 1.4 million shares under the 2014 ASR for an 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 2014, we repurchased on the open market approximately 0.6 million shares of our common stock at an average price of $50.93 per share, including commissions, for an aggregate purchase price of approximately $28.2 million. In the first quarter of 2015, we repurchased on the open market approximately 0.03 million shares of our common stock at an average price of $57.49 per share, including commission for an aggregate purchase price of approximately $1.8 million. All repurchased shares were retired.

In January 2015, our Board of Directors authorized the repurchase of the next $100.0 million under the repurchase program which we anticipate completing within twelve months. On April 28, 2015, we entered into an accelerated share purchase agreement ("2015 ASR") to repurchase $70.0 million of our common stock. Under the terms of the 2015 ASR, we paid $70.0 million on April 29, 2015 and received an initial delivery of approximately 0.8 million shares based on the current market price of $59.45, which we retired. The remaining $21.0 million was recorded as an equity forward contract and was included in Additional paid-in capital in stockholders' equity in the Condensed balance sheet as of June 30, 2015. As of June 30, 2015, we have $130.0 million remaining under the April 2014 stock repurchase program. The 2015 ASR was completed on July 23, 2015 with a final delivery of approximately 0.3 million shares. Under the 2015 ASR, we received a total of approximately 1.2 million shares for an average share price of $60.52. 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.


17

Table of Contents

Note 10. Accounting for Income Taxes

Our provision for income taxes was $11.1 million and $13.0 million for the three months ended June 30, 2015 and 2014, respectively. This represents effective tax rates of 26.2% and 26.8%, respectively. Our effective tax rates differ from the statutory federal income tax rate of 35% due to certain foreign earnings, primarily from Costa Rica, which are subject to a lower tax rate, state income tax expense, the tax impact of certain stock-based compensation charges and unrecognized tax benefits. The provision for income taxes was higher in the prior year due to a negative impact from a $2.1 million adjustment which related to prior periods.

Our provision for income taxes was $22.4 million and $23.0 million for the six months ended June 30, 2015 and 2014, respectively. This represents effective tax rates of 24.9% and 25.3%, respectively. The provision for income taxes was higher in the prior year due to a negative impact from a $1.8 million adjustment which related to prior periods.

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 June 30, 2015, we maintained a valuation allowance of $32.8 million against deferred tax assets primarily related to Israel and California operating loss carryforwards and Australia 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.
    
Our total gross unrecognized tax benefits was $36.3 million and $33.1 million as of June 30, 2015 and December 31, 2014, respectively, 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 and six months ended June 30, 2015 was not material. We do not expect any significant changes to the amount of unrecognized tax benefit within the next twelve months.

We file U.S. federal, U.S. state, and non-U.S. income tax returns. Our major tax jurisdictions are U.S. federal and the State of California. For U.S. federal and state tax returns, we are no longer subject to tax examinations for years before 2000. With few exceptions, we are no longer subject to examination by foreign tax authorities for years before 2007. We are currently under audit by the California Franchise Tax Board for fiscal year 2011, 2012 and 2013.

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 2015. Income taxes were reduced by $8.2 million and $7.5 million for the three months ended June 30, 2015 and 2014, respectively, representing a benefit to diluted net income per share of $0.10 and $0.09 in 2015 and 2014, respectively. As a result of these incentives, our income taxes were reduced by $16.4 million and $15.1 million for the six months ended June 30, 2015 and 2014, respectively, representing a benefit to diluted net income per share of $0.20 and $0.18 in 2015 and 2014, respectively.

Note 11. 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.


18

Table of Contents

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,
June 30,
 
Six Months Ended,
June 30,
 
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
Net income
$
31,350

 
$
35,600

 
$
67,527

 
$
68,044

Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding, basic
80,257

 
81,027

 
80,358

 
81,073

Dilutive effect of potential common stock
1,137

 
1,314

 
1,371

 
1,578

Total shares, diluted
81,394

 
82,341

 
81,729

 
82,651

 
 
 
 
 
 
 
 
Net income per share, basic
$
0.39

 
$
0.44

 
$
0.84

 
$
0.84

Net income per share, diluted
$
0.39

 
$
0.43

 
$
0.83

 
$
0.82


For the three and six months ended June 30, 2015 and 2014, the anti-dilutive effect from stock options, RSU, MSU and ESPP was not material.

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 and Services 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 and Services ("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. The following information relates to these segments (in thousands):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Net Revenues
2015
 
2014
 
2015
 
2014
Clear Aligner
$
200,817

 
$
179,735

 
$
387,846

 
$
347,974

Scanner
8,671

 
12,796

 
19,728

 
25,203

Total net revenues
$
209,488

 
$
192,531

 
$
407,574

 
$
373,177

 
 
 
 
 
 
 
 
Gross profit
 
 
 
 
 
 
 
Clear Aligner
$
157,337

 
$
141,703

 
$
305,297

 
$
274,786

Scanner
1,297

 
3,773

 
4,427

 
7,941

Total gross profit
$
158,634

 
$
145,476

 
$
309,724

 
$
282,727



19

Table of Contents

Geographical Information

Net revenues are presented below by geographic area (in thousands):
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Net revenues: (1)
 
 
 
 
 
 
 
U.S.
$
145,368

 
$
133,954

 
$
285,072

 
$
262,593

the Netherlands
42,223

 
41,899

 
80,868

 
79,290

Other international
21,897

 
16,678

 
41,634

 
31,294

Total net revenues
$
209,488

 
$
192,531

 
$
407,574

 
$
373,177

(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):

 
June 30, 2015
 
December 31, 2014
 
 
 
 
Long-lived assets:(2)
 
 
 
United States
$
86,989

 
$
76,511

Mexico
13,048

 
6,229

Other International
7,992

 
7,385

Total long-lived assets
$
108,029

 
$
90,125

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


20

Table of Contents


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 expectation that the policy simplification “Additional Aligners At No Charge" will help increase Invisalign utilization and volume as well as the expected impact this policy change will have on Invisalign Clear Aligner net revenues in the third and fourth quarter of 2015 and beyond, 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 ("Scanner") 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 expected date our iTero Element Intraoral Scanner will be available, 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 intraoral scanners and OrthoCAD services.
We received FDA clearance in 1998 and began our first commercial sales of Invisalign to U.S. orthodontists in 1999 followed by U.S. General Practitioner Dentists ("GPs") in 2002. Over the next decade, we introduced Invisalign to the European market and Japan, added distribution partners in Asia Pacific, Latin America, and 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. Over the last several years’ we have continued to build upon our technology and expertise to deliver enhanced clinical innovations aimed at helping our customers treat some of the most challenging cases. These innovations, both launched in early 2014, include Invisalign G5, 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. Most recently, we began the initial commercialization of Invisalign G6 clinical innovations for first premolar extraction during the first quarter of 2015.
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

21


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 March 2015, we announced our next generation iTero Element Intraoral Scanner which features a more compact footprint, enhanced wand and multi-touch display and is engineered to enable faster scan speeds for more efficient, real-time clinical evaluation.
We believe in an open systems approach to our technologies and are committed to working with other intra-oral scanning companies interested in developing interoperability for use 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. In March 2015, we announced that the Sirona CEREC Omnicam with the new CEREC Ortho software 1.1 was qualified for use with Invisalign case submissions. The new CEREC Ortho software is expected to be rolled out in the summer of 2015. The 3M True Definition scanner and Sirona CEREC Omnicam scanner are the only third-party scanners that have been qualified for use with Invisalign treatment.
The Invisalign System is offered in more than 80 countries and has been used to treat more than 3.25 million patients. Our iTero intraoral 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 3,160 dental labs worldwide.
Our goal is to establish Invisalign clear aligners as the standard method for treating malocclusion and to establish the iTero intraoral 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 2015 and beyond may be affected by a number of other factors including:
Retirement of our CEO. Thomas M. Prescott, our former President and Chief Executive Officer ("CEO"), retired effective June 1, 2015. Effective the same date, Joseph M. Hogan joined us as President and CEO, and also as a Director on our Board. Mr. Prescott will continue to serve on our Board. While we expect to engage in an orderly transition with Mr. Hogan as our new CEO, our ability to execute our business strategies and retain key personnel may be adversely affected by the uncertainty associated with this transition.
Additional Aligners at No Charge. In July 2015, we launched a new product policy called "Additional Aligners at No Charge" that addresses one of our customers' top complaints. Previously, we charged customers for additional aligners ordered beyond those covered by the initial treatment plan. With this new policy, we will no longer distinguish between mid-course corrections and case refinements and allow doctors to order additional aligners to address either treatment need at no charge. These changes will be effective for all new Invisalign Full, Teen, and Assist treatments shipped worldwide after July 18, 2015 as well as any open Invisalign Full, Teen and Assist cases as of this date. We expect this product policy change will result in a significant improvement in customer satisfaction and loyalty, which we believe will help increase Invisalign utilization and volume over time.
Based on this new product policy, beginning in the third quarter of 2015, we will now defer more revenue as a result of providing free additional aligners for eligible treatments. Additionally, since we are “grandfathering” over 1 million open cases, we will recognize lower revenue when additional aligners are shipped for at least the next two years until these cases complete. Therefore, we expect this new product policy will decrease Clear Aligner net revenues by approximately $6.0 million to $7.0 million in the third quarter of 2015 and $7.0 million to $8.0 million in the fourth quarter of 2015. These revenues will be recognized in the future as the additional aligners are shipped.
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 and Internationally in the first quarter of 2015, we launched ClinCheck Pro, the next generation Invisalign treatment software tool, designed to provide more precise control over final tooth

22


position and to help Invisalign providers achieve their treatment goals. Invisalign G6 clinical innovations for premolar extraction became available to Invisalign-trained providers beginning in the first quarter of 2015 with limited commercialization. Full commercialization of Invisalign G6 in Europe, Middle East and Africa ("EMEA"), Asia Pacific, and Latin America geographies will occur throughout 2015 and in North America in early 2016. Invisalign G6 is engineered to improve clinical outcomes for orthodontic treatment of severe crowding and bimaxillary protrusion. Most recently, in March 2015, we announced the next generation iTero Element Intraoral Scanner with improved imaging technology that is designed to enable significantly faster scan speed, accuracy, intuitive operation, and visualization capabilities. Availability for the iTero Element Intraoral Scanner is expected in the second half of 2015. We believe that over the long-term, clinical solutions and treatment tools will increase adoption of Invisalign and increase sales of our intraoral scanners; 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 second quarter of 2015 was 4.6 cases per doctor compared to 4.4 in the second quarter of 2014. Utilization among our North American orthodontist customers reached an all time high of 9.5 cases per doctor in the second quarter of 2015 compared to 8.4 in the second quarter of 2014. International doctor utilization increased slightly to 4.6 in the second quarter of 2015 from 4.5 in the second quarter of 2014. North American GP doctor utilization increased slightly to 3.0 in the second quarter of 2015 from 2.9 in the second quarter of 2014. The 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. We expect that over the long-term our utilization rates will gradually improve as a result of advancements in product and technology, which continue to strengthen our doctors’ clinical confidence in the use of Invisalign, along with the implementation of our Go-To-Market strategy (as discussed below); however, we expect that our utilization rates may fluctuate from period to period due to a variety of factors, including seasonal trends in our business along with adoption rates of new products and features.


23


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 customers and their patients being on holiday. Consequently, we expect that our Invisalign volume will be relatively flat to slightly down in the third quarter of 2015 compared to the second quarter.

Number of new Invisalign doctors trained.  We continue to expand our Invisalign customer base through the training of new doctors. In 2014, Invisalign growth was driven primarily by increased utilization by our North American orthodontist doctors and International doctors as well as by the continued expansion of our customer base as we trained a total of 9,440 new Invisalign doctors, of which 56% were trained internationally. GPs are one of the keys to driving growth in the adult segment, and, in 2014, we launched Invisalign Fundamentals, a new training course, designed to improve practice integration and increase utilization for newly trained doctors. The Invisalign Fundamentals program has been implemented across North America, and we 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, together with our go-to market strategy which includes dedicated focus, pre-and post training, has the potential to increase the number of doctors submitting cases 90-days post-training, as well as the number of cases submitted per doctor. During the second quarter of 2015, we trained 2,460 new Invisalign doctors.

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 30.5% driven primarily by growth in Europe as well as by strong performance in the Asia Pacific region. In 2015, 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. We expect international revenues to continue to grow at a faster rate than North America for the foreseeable future due to our continued investment in international market expansion, the size of the market opportunity, and our relatively low market penetration in this region.
Go-To-Market Evolution. In order to provide more comprehensive sales and service coverage, in 2015, we implemented an updated go-to-market strategy with an expanded team and new structure in North America. In order to ensure our North America sales and marketing team can increase time in-office and help each practice become more successful, we have added approximately 50 sales team members in 2015, the majority of which were in place as of the end of the first quarter. We believe that these investments in a refined go-to-market strategy and the strategic deployment of more people will improve adoption and utilization of Invisalign by our customers.
Increase in Invisalign Selling Price. We have historically invested in research and development and continuous product innovation. In order to continue and even accelerate this product innovation cycle, we recently announced a price increase of approximately 3% on Invisalign Full and Invisalign Teen products. In North America, the increase of $50 per treatment was effective April 1, 2015, and internationally, the price increase of €50 (per treatment was effective July 1, 2015. The prices for Invisalign Assist, Invisalign Express 10 and Invisalign Express 5/Lite products remained unchanged.
Operating Expenses. We expect operating expenses to increase in 2015 compared to 2014 due in part to:
the increase in North American sales force coverage discussed above, as well as additions to our sales force in EMEA and Asia Pacific regions,
infrastructure investments, including a project to implement a new enterprise resource planning system which we started in late 2014 with expected "go-live" for various modules and subsidiaries throughout 2016; and
investments in new products and markets.
We believe that these investments will position us to increase our revenue and continue to grow our market share.
Investments to Increase Manufacturing Capacity. In February 2015, in order to expand our manufacturing capacity to support additional growth, we purchased another facility in Juarez, Mexico. We expect to begin manufacturing aligners in this second facility in the third quarter of 2015. We will also continue to manufacture Aligners at our existing facility in Juarez. Our ability to plan, construct and equip manufacturing facilities is subject to significant risk and uncertainty, including delays and cost overruns. If demand for our product in 2015 exceeds our current expectations, or if the timing of receipt of case product orders during a given quarter is different from our expectations,

24


we may not be able to fulfill orders in a timely manner, which may negatively impact our financial results and overall business. Conversely, if demand decreases or if we fail to forecast demand accurately, we could be required to record excess capacity charges, which would lower our gross margin.
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 second quarter of 2015, we continued to experience a negative impact from the weakening of the Euro and other foreign currencies relative to the U.S. Dollar, which slowed from its decline in prior quarters. In the second quarter of 2015, our net revenues were negatively impacted by $1.2 million in comparison to the first quarter of 2015. If the U.S. Dollar continues to strengthen compared to other foreign currencies, including the Euro, our reported amount of net revenues and income will be negatively impacted compared to the same period last year.
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 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.
In January 2015, we completed the first $100.0 million under the program, and our Board of Directors authorized the repurchase of the next $100.0 million under the repurchase program, which we anticipate completing within twelve months. On April 28, 2015, we entered into an accelerated share repurchase agreement ("2015 ASR") to repurchase $70.0 million of our common stock. Under the terms of the 2015 ASR, we paid $70.0 million on April 29, 2015 and received an initial delivery of approximately 0.8 million shares based on the then current market price, which were retired. As of June 30, 2015, there remains approximately $130.0 million available under our existing stock repurchase authorization. The 2015 ASR was completed on July 23, 2015. Under the 2015 ASR, we received a total of approximately 1.2 million shares of our common stock for an average share price of $60.52. 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 and Services 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 and Services ("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 six months ended June 30, 2015 and 2014 is as follows (in millions).

 
For the Three Months Ended,
June 30,
 
For the Six Months Ended,
June 30,
Net Revenues
2015
 
2014
 
Net
Change
 
%
Change
 
2015
 
2014
 
Net
Change
 
%
Change
Clear Aligner Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
North America
$
126.1

 
$
111.6

 
$
14.5

 
13.0
 %
 
$
245.0

 
$
219.6

 
$
25.4

 
11.6
 %
International
61.9

 
56.0

 
5.9

 
10.5
 %
 
117.8

 
105.8

 
12.0

 
11.3
 %
Invisalign non-case
12.8

 
12.1

 
0.7

 
5.8
 %
 
25.0

 
22.6

 
2.4

 
10.6
 %
Total Clear Aligner net revenues
$
200.8

 
$
179.7

 
$
21.1

 
11.7
 %
 
$
387.8

 
$
348.0

 
$
39.8

 
11.4
 %
Scanner net revenues
8.7

 
12.8

 
(4.1
)
 
(32.0
)%
 
19.7

 
25.2

 
(5.5
)
 
(21.8
)%
Total net revenues
$
209.5

 
$
192.5

 
$
16.9

 
8.8
 %
 
$
407.6

 
$
373.2

 
$
34.4

 
9.2
 %

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

Clear Aligner Case Volume by Region

Case volume data which represents Invisalign case shipments by region, for the three and six months ended June 30, 2015 and 2014 is as follows (in thousands).
 
For the Three Months Ended,
June 30,
 
For the Six Months Ended,
June 30,
Region
2015
 
2014
 
Net
Change
 
%
Change
 
2015
 
2014
 
Net
Change
 
%
Change
North American Invisalign
99.6

 
84.8

 
14.8

 
17.5
%
 
190.7

 
166.3

 
24.4

 
14.7
%
International Invisalign
44.9

 
34.5

 
10.4

 
30.1
%
 
84.6

 
65.2

 
19.4

 
29.8
%
Total Invisalign case volume
144.5

 
119.3

 
25.2

 
21.1
%
 
275.3

 
231.5

 
43.8

 
18.9
%

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

Total net revenues increased by $16.9 million and $34.4 million for the three and six months ended June 30, 2015, respectively, as compared to the same period in 2014, primarily as a result of Invisalign case volume growth across all regions and most products.

Clear Aligner - North America

In the three months ended June 30, 2015, Clear Aligner North America net revenues increased by $14.5 million or 13.0% compared to the same period in 2014 primarily due to Invisalign case volume growth of approximately $19.4 million across all channels and products. In addition net revenues increased due to a price increase on Full products effective April 1, 2015. These increases were offset in part by lower average selling prices ("ASP") which decreased net revenues by approximately $4.8 million. The decrease in ASP was primarily a result of higher promotional discounts in the current period compared to the same period in the prior year.

In the six months ended June 30, 2015, Clear Aligner North America net revenues increased by $25.4 million or 11.6% compared to the same period in 2014 primarily due to Invisalign case volume growth of approximately $32.3 million across all channels and products. In addition net revenues increased due to a price increase on Full products effective April 1, 2015. These increases were offset in part by lower ASP, which contributed approximately $6.9 million to the decrease in net revenues. The decrease in ASP was primarily a result of higher promotional discounts as well as higher deferrals primarily in mid-course correction revenues as primary shipments increased in 2015 compared to 2014.

Clear Aligner - International

In the three months ended June 30, 2015, Clear Aligner international net revenues increased by $5.9 million or 10.5% compared to the same period in 2014 primarily driven by Invisalign case volume growth of $17.0 million across all products. This was offset in part by lower ASP which decreased net revenues by approximately $11.1 million. The decrease in ASP was primarily a result

26

Table of Contents

of the unfavorable impact from foreign exchange rates due to the weakening of the Euro compared to the U.S. dollar in the current period compared to the same period in the prior year.

In the six months ended June 30, 2015, Clear Aligner International net revenues increased by $12.0 million or 11.3% compared to the same period in 2014 primarily driven by Invisalign case volume growth of $31.5 million across all products. This was offset by lower ASP which decreased net revenues by approximately $19.5 million. The decrease in ASP was primarily a result of the unfavorable impact from foreign exchange rates due to the weakening of the Euro compared to the U.S. dollar in the current period compared to the same period in the prior year.

Clear Aligner - Invisalign Non-Case

In the three months ended June 30, 2015, Invisalign non-case net revenues, consisting of training fees and ancillary product revenues, increased by $0.7 million or 5.8% compared to the same period in 2014 primarily due to increased Vivera volume both in North America and International.

Invisalign non-case net revenues increased by $2.4 million or 10.6% for the six months ended June 30, 2015 compared to the same period in 2014 primarily due to increased Vivera volume both in North America and International.

Scanner and Services

Scanner and Services net revenues decreased $4.1 million or 32.0% and $5.5 million or 21.8% for the three and six months ended June 30, 2015, respectively, compared to the same periods in 2014. Since we announced the upcoming availability of our next generation scanner in the third quarter of 2015, our net revenues declined due to fewer scanners recognized and a permanent price reduction on our existing scanner. The decreases were partially offset by an increase in service revenues as a result of a larger install base.
 
Cost of net revenues and gross profit (in millions):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Clear Aligner
 
 
 
 
 
 
 
 
 
 
 
Cost of net revenues
$
43.5

 
$
38.0

 
$
5.5

 
$
82.5

 
$
73.2

 
$
9.3

% of net segment revenues
21.7
%
 
21.2
%
 
 
 
21.3
%
 
21.0
%
 
 
Gross profit
$
157.3

 
$
141.7

 
$
15.6

 
$
305.3

 
$
274.8

 
$
30.5

Gross margin %
78.3
%
 
78.8
%
 
 
 
78.7
%
 
79.0
%
 
 
Scanner and Services
 
 
 
 
 
 
 
 
 
 
 
Cost of net revenues
$
7.4

 
$
9.0

 
$
(1.6
)
 
$
15.3

 
$
17.3

 
$
(2.0
)
% of net segment revenues
85.0
%
 
70.5
%
 
 
 
77.6
%
 
68.5
%
 
 
Gross profit
$
1.3

 
$
3.8

 
$
(2.5
)
 
$
4.4

 
$
7.9

 
$
(3.5
)
Gross margin %
15.0
%
 
29.5
%
 
 
 
22.4
%
 
31.5
%
 
 
Total cost of net revenues
$
50.9

 
$
47.1

 
$
3.8

 
$
97.9

 
$
90.5

 
$
7.4

% of net revenues
24.3
%
 
24.4
%
 
 
 
24.0
%
 
24.2
%
 
 
Gross profit
$
158.6

 
$
145.5

 
$
13.1

 
$
309.7

 
$
282.7

 
$
27.0

Gross margin %
75.7
%
 
75.6
%
 
 
 
76.0
%
 
75.8
%
 
 

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

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 declined slightly for the three and six months ended June 30, 2015 compared to the same periods in 2014 due to lower ASP which was partially offset by lower manufacturing costs.


27

Table of Contents

Scanner

Gross margin decreased for the three months ended June 30, 2015 compared to the same period in 2014 due to lower ASP from permanent price reductions, lower absorption of manufacturing spend on lower production volume and higher inventory reserves.

The gross margin percentage decreased for the six months ended June 30, 2015 compared to the same period in 2014 due to lower ASP from permanent price reductions.

Selling, General and administrative (in millions):
 
Effective for the first quarter of 2015, we combined Sales and Marketing and General and Administrative together to report as Selling, General and Administrative.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Selling, general and administrative
$
100.6

 
$
83.5

 
$
17.1

 
$
188.9

 
$
165.5

 
$
23.4

% of net revenues
48.0
%
 
43.3
%
 
 
 
46.3
%
 
44.4
%
 
 

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

Selling, general and administrative expense includes personnel-related costs including payroll, commissions and stock-based compensation for our sales force, marketing and administration in addition to media and advertising expenses, clinical education, trade shows and industry events, product marketing, outside consulting services, legal expenses, depreciation and amortization expense, the medical device excise tax ("MDET") and allocations of corporate overhead expenses including facilities and IT.

Selling, general and administrative expense for the three months ended June 30, 2015 increased compared to the same period in 2014 primarily due to higher compensation related costs of $9.7 million as a result of increased headcount, which led to higher salaries, stock based compensation and commissions. In addition, we incurred increased consulting expense of $3.1 million primarily as a result of our enterprise resource planning “ERP” project, higher clinical education and public relations costs of $2.1 million due to launch events and consumer campaigns, and additional recruiting costs of $1.2 million. These increased expenses were partially offset by lower advertising costs by $1.3 million. In addition, as noted in prior periods, in March 2014, the IRS informed us that our aligners are not subject to the MDET, which we had been paying and expensing in Selling, General and Administrative expenses 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. In June 2014, we received a $1.2 million refund for MDET paid in 2014 related to our aligners which reduced selling, general and administrative expenses for the three months ended June 30, 2014.

Selling, general and administrative expense for the six months ended June 30, 2015 increased compared to the same period in 2014 primarily due to higher compensation related costs of $17.5 million as a result of increased headcount, which led to higher salaries, stock based compensation and commissions. In addition, consulting costs increased by $5.7 million primarily due to our ERP project, public relations increased by $2.0 million due to launch events along with outside legal expense and recruiting costs. These increased expenses were partially offset by lower advertising costs and trade show costs of $3.6 million. In the first quarter of 2015, the IRS approved our refund claim of $6.8 million MDET paid in 2013 related to our aligners, reducing our expense for the six months ended June 30, 2015 in comparison to the $1.2 million MDET refund received in the six months ended June 30, 2014.

Research and development (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Research and development
$
15.7

 
$
13.3

 
$
2.4

 
$
29.6

 
$
26.7

 
$
2.9

% of net revenues
7.5
%
 
6.9
%
 
 
 
7.3
%
 
7.1
%
 
 

Changes and percentages are based on actual values. Certain tables may not sum or recalculate due to rounding.
Research and development expense includes the personnel-related costs including stock-based compensation and outside consulting expenses associated with the research and development of new products and enhancements to existing products and allocations of corporate overhead expenses including facilities and IT.


28

Table of Contents

Research and development expense for the three months ended June 30, 2015 increased compared to the same period in 2014 due to our continued investment in new products and consulting services.

Research and development expense for the six months ended June 30, 2015 increased compared to the same period in 2014 due to our continued investment in new products and consulting services offset by lower compensation costs due to lower incentive bonuses during the current period.


Interest and other income (expense), net (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Interest and other income (expense), net
$
0.2

 
$
(0.1
)
 
$
0.3

 
(1.3
)
 
0.5

 
$
(1.8
)

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

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

Interest and other income (expense), net for the three months ended June 30, 2015 increased slightly compared to the same period in 2014 due to increased interest income on higher balances of cash, cash equivalents and investments.

Interest and other income (expense), net for the six months ended June 30, 2015 decreased compared to the same period in 2014 primarily due to higher foreign exchange losses in the current year period mainly as a result of the strengthening of the U.S. dollar to the Euro offset in part by increased interest income on higher balances of cash, cash equivalents and investments.

Income tax (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Provision for income taxes
$
11.1

 
$
13.0

 
$
(1.9
)
 
$
22.4

 
$
23.0

 
$
(0.6
)
Effective tax rates
26.2
%
 
26.8
%
 
 
 
24.9
%
 
25.3
%
 
 
    
Our provision for income taxes was $11.1 million and $13.0 million for the three months ended June 30, 2015 and 2014, respectively. This represents effective tax rates of 26.2% and 26.8%, respectively. Our effective tax rates differ from the statutory federal income tax rate of 35% due to certain foreign earnings, primarily from Costa Rica, which are subject to a lower tax rate, state income tax expense, the tax impact of certain stock-based compensation charges and unrecognized tax benefits. The provision for income taxes was higher in the prior year due to a negative impact from a $2.1 million adjustment related to prior periods.

Our provision for income taxes was $22.4 million and $23.0 million for the six months ended June 30, 2015 and 2014, respectively. This represents effective tax rates of 24.9% and 25.3%, respectively. The provision for income taxes was higher in the prior year due to a negative impact from a $1.8 million adjustment related to prior periods.

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.