Edgar Filing: ALIGN TECHNOLOGY INC

ALGN-2014.6.30-Q2

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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, 2014



¨	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 25, 2014 was 80,793,072.

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ALIGN TECHNOLOGY, INC.

INDEX




PART I	FINANCIAL INFORMATION	3
ITEM 1.	FINANCIAL STATEMENTS (UNAUDITED):	3
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS	3
	CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)	4
	CONDENSED CONSOLIDATED BALANCE SHEETS	5
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS	6
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	21
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	34
ITEM 4.	CONTROLS AND PROCEDURES	34
PART II	OTHER INFORMATION	35
ITEM 1.	LEGAL PROCEEDINGS	35
ITEM 1A.	RISK FACTORS	36
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	50
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	50
ITEM 4.	MINE SAFETY DISCLOSURES	50
ITEM 5.	OTHER INFORMATION	50
ITEM 6.	EXHIBITS	50
SIGNATURES		52

Invisalign, Align, ClinCheck, Invisalign Assist, Invisalign Teen, Vivera, SmartForce, SmartTrack, Power Ridge, iTero, Orthocad, iCast and iRecord, among others, are trademarks and/or service marks of Align Technology, Inc. or one of its subsidiaries or affiliated companies and may be registered in the United States and/or other countries.

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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,
	2014			2013			2014		2013
Net revenues	$	192,531		$	163,828		$	373,177	$	317,408
Cost of net revenues	47,055			40,137			90,450		80,868
Gross profit	145,476			123,691			282,727		236,540
Operating expenses:
Sales and marketing	56,386			47,847			109,274		90,128
General and administrative	27,069			27,027			56,248		57,375
Research and development	13,289			10,916			26,669		22,198
Impairment of goodwill	—			—			—		40,693
Impairment of long-lived assets	—			—			—		26,320
Total operating expenses	96,744			85,790			192,191		236,714
Operating profit (loss)	48,732			37,901			90,536		(174		)
Interest and other income (expenses), net	(93		)	(335		)	508		(1,323		)
Net income (loss) before provision for income taxes	48,639			37,566			91,044		(1,497		)
Provision for income taxes	13,039			8,246			23,000		11,166
Net income (loss)	$	35,600		$	29,320		$	68,044	$	(12,663	)

Net income (loss) per share:
Basic	$	0.44		$	0.36		$	0.84	$	(0.16	)
Diluted	$	0.43		$	0.36		$	0.82	$	(0.16	)
Shares used in computing net income (loss) per share:
Basic	81,027			80,576			81,073		80,909
Diluted	82,341			82,149			82,651		80,909

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

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ALIGN TECHNOLOGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)



	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2014			2013			2014		2013
Net income (loss)	$	35,600		$	29,320		$	68,044	$	(12,663	)
Net change in cumulative translation adjustment	(4		)	(8		)	102		(64		)
Change in unrealized gains (losses) on available-for-sale securities, net of tax	70			(186		)	112		(183		)
Other comprehensive income (loss)	66			(194		)	214		(247		)
Comprehensive income (loss)	$	35,666		$	29,126		$	68,258	$	(12,910	)

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

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ALIGN TECHNOLOGY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)



	June 30, 2014			December 31, 2013
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	167,471		$	242,953
Marketable securities, short-term	198,059			127,040
Accounts receivable, net of allowances for doubtful accounts and returns of $1,969 and $1,733, respectively	131,028			113,250
Inventories	13,115			13,968
Prepaid expenses and other current assets	44,839			47,465
Total current assets	554,512			544,676
Marketable securities, long-term	137,148			101,978
Property, plant and equipment, net	81,312			75,743
Goodwill and intangible assets, net	83,795			85,362
Deferred tax assets	20,456			15,766
Other assets	8,210			8,622
Total assets	$	885,433		$	832,147

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	20,939		$	17,718
Accrued liabilities	81,049			80,345
Deferred revenues	85,125			77,275
Total current liabilities	187,113			175,338
Other long-term liabilities	22,524			22,839
Total liabilities	209,637			198,177
Commitments and contingencies (Note 8)
Stockholders’ equity:
Preferred stock, $0.0001 par value (5,000 shares authorized; none issued)	—			—
Common stock, $0.0001 par value (200,000 shares authorized; 80,783 and 80,583 issued and outstanding at 2014 and 2013, respectively)	8			8
Additional paid-in capital	742,886			729,578
Accumulated other comprehensive income	508			294
Accumulated deficit	(67,606		)	(95,910		)
Total stockholders’ equity	675,796			633,970
Total liabilities and stockholders’ equity	$	885,433		$	832,147

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

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ALIGN TECHNOLOGY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



	Six Months Ended
	June 30,
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	68,044		$	(12,663	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Deferred taxes	17,496			6,272
Depreciation and amortization	9,130			8,789
Stock-based compensation	19,438			13,675
Excess tax benefit from share-based payment arrangements	(16,161		)	(15,331		)
Impairment of goodwill	—			40,693
Impairment of long-lived assets	—			26,320
Other non-cash operating activities	5,095			389
Changes in assets and liabilities:
Accounts receivable	(21,407		)	(9,050		)
Inventories	855			(581		)
Prepaid expenses and other assets	(2,806		)	(234		)
Accounts payable	(9		)	50
Accrued and other long-term liabilities	1,343			3,298
Deferred revenues	6,705			2,099
Net cash provided by operating activities	87,723			63,726
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition, net of cash acquired	—			(7,652		)
Purchase of property, plant and equipment	(9,960		)	(9,389		)
Purchase of marketable securities	(232,178		)	(150,806		)
Proceeds from maturities of marketable securities	92,005			18,117
Proceeds from sales of marketable securities	32,683			5,043
Other investing activities	(133		)	915
Net cash used in investing activities	(117,583		)	(143,772		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock	12,622			21,128
Common stock repurchases	(49,000		)	(95,108		)
Equity forward contract related to accelerated share repurchase	(21,000		)	—
Excess tax benefit from share-based payment arrangements	16,161			15,331
Employees’ taxes paid upon the vesting of restricted stock units	(4,650		)	(3,234		)
Other financing activities	—			(13		)
Net cash used in financing activities	(45,867		)	(61,896		)
Effect of foreign exchange rate changes on cash and cash equivalents	245			53
Net decrease in cash and cash equivalents	(75,482		)	(141,889		)
Cash and cash equivalents, beginning of the period	242,953			306,386
Cash and cash equivalents, end of the period	$	167,471		$	164,497

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

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ALIGN TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared by Align Technology, Inc. (“we”, “our”, or “Align”) in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") and contain all adjustments, including normal recurring adjustments, necessary to present fairly our results of operations for the three and six months ended June 30, 2014 and 2013, our comprehensive income (loss) for the three and six months ended June 30, 2014 and 2013, our financial position as of June 30, 2014 and our cash flows for the six months ended June 30, 2014 and 2013. The Condensed Consolidated Balance Sheet as of December 31, 2013 was derived from the December 31, 2013 audited financial statements. Net revenues by geographic area for prior period amounts in Note 13 have been reclassified to conform with the current period presentation. These reclassifications had no impact on our financial position for the three or six months ended June 30, 2014 and 2013.

The results of operations for the three months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 or any other future period, and we make no representations related thereto. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A and 8, respectively, in our Annual Report on Form 10-K for the year ended December 31, 2013.

Use of estimates

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

Recent Accounting Pronouncements

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

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Note 2. Marketable Securities and Fair Value Measurements

As of June 30, 2014 and December 31, 2013, the estimated fair value of our short-term and long-term marketable securities, classified as available for sale, are as follows (in thousands):

Short-term



June 30, 2014	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Commercial paper	$	51,103	$	—	$	—		$	51,103
Corporate bonds	88,333		55		(16		)	88,372
U.S. government agency bonds	22,729		7		(1		)	22,735
Asset-backed securities	14,341		10		—			14,351
Municipal securities	11,663		24		—			11,687
U.S. dollar dominated foreign corporate bonds	921		4		—			925
U.S. government treasury bonds	8,876		10		—			8,886
Total Marketable Securities, Short-Term	$	197,966	$	110	$	(17	)	$	198,059

Long-term



June 30, 2014	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Corporate bonds	$	62,996	$	34	$	(36	)	$	62,994
U.S. government agency bonds	31,025		26		—			31,051
Asset-backed securities	20,330		11		(8		)	20,333
U.S. government treasury bonds	16,269		16		—			16,285
Municipal securities	6,470		15		—			6,485
Total Marketable Securities, Long-Term	$	137,090	$	102	$	(44	)	$	137,148

Short-term



December 31, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Commercial paper	$	54,318	$	10	$	—		$	54,328
Corporate bonds	29,079		10		(4		)	29,085
U.S. government agency bonds	16,693		10		—			16,703
U.S. dollar dominated foreign corporate bonds	13,959		12		—			13,971
Municipal securities	7,006		11		(3		)	7,014
Asset-backed securities	5,937		2		—			5,939
Total Marketable Securities, Short-Term	$	126,992	$	55	$	(7	)	$	127,040

Long-term



December 31, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U.S. government agency bonds	$	38,138	$	1	$	(21	)	$	38,118
Corporate bonds	23,308		14		(9		)	23,313
U.S. dollar dominated foreign corporate bonds	19,485		27		(17		)	19,495
Municipal securities	8,326		13		(8		)	8,331
U.S. government treasury bonds	6,916		3		—			6,919
Asset-backed securities	5,800		4		(2		)	5,802
Total Marketable Securities, Long-Term	$	101,973	$	62	$	(57	)	$	101,978

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For the three and six months ended June 30, 2014 and 2013, realized gains were immaterial. Unrealized gains and losses for our available for sale securities as of June 30, 2014 and December 31, 2013 were also immaterial. Cash and cash equivalents are not included in the table above as the gross unrealized gains and losses are not material. We have no material short-term or long-term investments that have been in a continuous unrealized loss position for greater than twelve months as of June 30, 2014 and December 31, 2013. Amounts reclassified to earnings from accumulated other comprehensive income related to unrealized gain or losses were immaterial for the three and six months ended June 30, 2014 and 2013.

Our fixed-income securities investment portfolio consists of corporate bonds, U.S. dollar dominated foreign corporate bonds, commercial paper, municipal securities, U.S. government agency bonds, U.S. government treasury bonds, 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 months as of June 30, 2014 and December 31, 2013.

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, 2014 and December 31, 2013 (in thousands):



	June 30,		December 31,
	2014		2013
Due in one year or less	$	198,059	$	127,040
Due in one year to 27 months	137,148		101,978
Total available for sale short-term and long-term marketable securities	$	335,207	$	229,018

Fair Value Measurements

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

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

Our Level 1 assets consist of money market funds and U.S. government treasury bonds. We did not hold any Level 1 liabilities as of June 30, 2014 or December 31, 2013.

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

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

We did not hold any Level 2 liabilities as of June 30, 2014 or December 31, 2013.

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

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

Non-Recurring Fair Value Measurements

During the six months ended June 30, 2013, we recorded an impairment charge to our long-lived assets and goodwill of $26.3 million and $40.7 million, respectively, related to our Scanner and Services ("Scanner") reporting unit, formerly referred to as Scanner and CAD/CAM Services ("SCCS"), as an event occurred and circumstances changed that led us to perform an impairment analysis prior to our annual test which required us to determine the fair value of the Scanner reporting unit (Refer to Note 5). These fair value measurements were calculated using unobservable inputs, using the income approach which is classified as Level 3 within the fair value hierarchy. Inputs for the income approach includes the amount and timing of future cash flows based on our most recent operational budgets, strategic plans, terminal growth rates assumptions and other estimates.

Recurring Fair Value Measurements

The following table summarizes our financial assets measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013 (in thousands):



Description	Balance as of June 30, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
Cash equivalents:
Money market funds	$	59,929	$	59,929	$	—
Commercial paper	32,244		—		32,244
Short-term investments:
Commercial paper	51,103		—		51,103
Corporate bonds	88,372		—		88,372
U.S. government agency bonds	22,735		—		22,735
Asset-backed securities	14,351		—		14,351
Municipal securities	11,687		—		11,687
U.S. dollar dominated foreign corporate bonds	925		—		925
U.S. government treasury bonds	8,886		8,886		—
Long-term investments:
Corporate bonds	62,994		—		62,994
U.S. government agency bonds	31,051		—		31,051
Asset-backed securities	20,333		—		20,333
U.S. government treasury bonds	16,285		16,285		—
Municipal securities	6,485		—		6,485
Other assets:
Israeli funds	2,434		—		2,434
	$	429,814	$	85,100	$	344,714

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Description	Balance as of December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
Cash equivalents:
Money market funds	$	143,540	$	143,540	$	—
Commercial paper	15,398		—		15,398
Short-term investments:
Commercial paper	54,328		—		54,328
Corporate bonds	29,085		—		29,085
U.S. dollar denominated foreign corporate bonds	13,971		—		13,971
U.S. government agency bonds	16,703		—		16,704
Municipal securities	7,014		—		7,014
Asset-backed securities	5,939		—		5,938
Long-term investments:
U.S. government agency bonds	38,118		—		38,118
Corporate bonds	23,313		—		23,313
U.S. dollar denominated foreign corporate bonds	19,495		—		19,495
Municipal securities	8,331		—		8,331
U.S. government treasury bonds	6,919		6,919		—
Asset-backed securities	5,802		—		5,802
Other assets:
Israeli funds	2,193		—		2,193
	$	390,149	$	150,459	$	239,690

Note 3. Balance Sheet Components

Inventories

Inventories consist of the following (in thousands):



	June 30, 2014		December 31, 2013
Raw materials	$	3,493	$	5,172
Work in process	3,430		4,241
Finished goods	6,192		4,555
Total Inventories	$	13,115	$	13,968

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

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Accrued liabilities

Accrued liabilities consist of the following (in thousands):



	June 30, 2014		December 31, 2013
Accrued payroll and benefits	$	43,332	$	43,029
Accrued sales rebates	10,137		10,100
Accrued sales tax and value added tax	6,447		6,215
Accrued sales and marketing expenses	4,488		3,893
Accrued accounts payable	2,504		4,053
Accrued warranty	3,252		3,104
Accrued professional fees	1,872		1,892
Accrued income taxes	2,248		1,205
Other accrued liabilities	6,769		6,854
Total Accrued Liabilities	$	81,049	$	80,345

Warranty

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

Clear Aligner

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

Scanners

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

Warranty accrual as of June 30, 2014 and 2013 consists of the following activity (in thousands):



	Six Months Ended June 30,
	2014			2013
Balance at beginning of period	$	3,104		$	4,050
Charged to cost of net revenues	1,195			2,784
Actual warranty expenditures	(1,047		)	(2,381		)
Balance at end of period	$	3,252		$	4,453

Note 4. Business Combinations

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

Pro forma results of operations for this acquisition have not been presented as it is not material to our results of operations, either individually or in aggregate, for the three or six months ended June 30, 2013.

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Note 5. Goodwill and Long-lived Assets

Goodwill

The change in the carrying value of goodwill for the six months ended June 30, 2014 by our reportable segments, which are also our reporting units, is as follows (in thousands):



	Clear Aligner
Balance as of December 31, 2013	$	61,623
Adjustments ¹	184
Balance as of June 30, 2014	$	61,807

¹The adjustments to goodwill during the six months ended June 30, 2014 were due to foreign currency translation.

The goodwill balance is entirely attributable to our Clear Aligner reporting unit. During the fourth quarter of fiscal 2013, we performed the annual goodwill impairment testing and found no impairment events as the fair value of our Clear Aligner reporting unit was significantly in excess of the carrying value.

Impairment of Goodwill in 2013

We evaluate our goodwill for impairment at least annually on November 30th or more frequently if indicators are present, an event occurs or circumstances change that suggest an impairment may exist and that it would more likely than not reduce the fair value of the reporting unit below its carrying amount. During March 2013, changes in the competitive environment for intra-oral scanners, including announcements from our competitors of new low-priced scanners targeted at orthodontists and general practitioner dentists in North America, that caused us to lower our expectations for growth and profitability for our Scanner reporting unit. As a result, we determined that goodwill related only to our Scanner reporting unit should be tested for impairment as of March 2013 due to these facts and circumstances which would more likely than not reduce the fair value of our Scanner reporting unit below its carrying amount. There was no triggering event related to our Clear Aligner goodwill.

We performed a step one analysis for our Scanner reporting unit which consists of a comparison of the fair value of the Scanner reporting unit against its carrying amount, including the goodwill allocated to it. In deriving the fair value of the Scanner reporting unit, we utilized the income approach which is classified as Level 3 within the fair value hierarchy. This approach provides an estimated fair value based on discounted expected future cash flows, which are based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used is based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the business and the projected cash flows.

As a result of our step one analysis, we concluded that the fair value of the Scanner reporting unit was less than its carrying value; therefore, we proceeded to step two of the goodwill impairment analysis. Step two of the goodwill impairment analysis measures the impairment charge by allocating the reporting unit's fair value to all of the assets and liabilities of the reporting unit in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. This allocation process was performed only for the purposes of measuring the goodwill impairment and not to adjust the carrying values of the recognized tangible assets and liabilities. Any excess of the carrying value of the reporting unit's goodwill over the implied fair value of the reporting unit's goodwill is recorded as an impairment loss. We use a discounted cash flow ("DCF") approach, utilizing the harvest model, to estimate the fair value of a reporting unit which we believe is the most reliable indicator of fair value of this business, and is most consistent with the approach a market place participant would use. Based on our analysis, there was no implied goodwill for the Scanner reporting unit; therefore, we recorded a goodwill impairment charge of $40.7 million in the three months ended March 31, 2013, which represents the remaining goodwill balance in the Scanner reporting unit. None of the goodwill impairment charge was deductible for tax purposes.

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Long-lived Assets

Impairment of Long-lived Assets in 2013

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

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

Intangible assets arising either as a direct result from the Cadent Holdings, Inc. acquisition ("Cadent") or individually acquired are being amortized as follows (in thousands):



	Weighted Average Amortization Period (in years)	Gross Carrying Amount as of June 30, 2014		Accumulated Amortization			Accumulated Impairment Loss			Net Carrying Value as of June 30, 2014
Trademarks	15	$	7,100	$	(1,285	)	$	(4,179	)	$	1,636
Existing technology	13	12,600		(2,732		)	(4,328		)	5,540
Customer relationships	11	33,500		(8,164		)	(10,751		)	14,585
Other	8	285		(58		)	—			227
Total Intangible Assets		$	53,485	$	(12,239	)	$	(19,258	)	$	21,988



	Weighted Average Amortization Period (in years)	Gross Carrying Amount as of December 31, 2013		Accumulated Amortization			Accumulated Impairment Loss			Net Carrying Value as of December 31, 2013
Trademarks	15	$	7,100	$	(1,100	)	$	(4,179	)	$	1,821
Existing technology	13	12,600		(2,236		)	(4,328		)	6,036
Customer relationships	11	33,500		(7,112		)	(10,751		)	15,637
Other	8	285		(40		)	—			245
Total Intangible Assets		$	53,485	$	(10,488	)	$	(19,258	)	$	23,739

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The total estimated annual future amortization expense for these acquired intangible assets as of June 30, 2014 is as follows (in thousands):



Fiscal Year Ending December 31,
Remainder of 2014	$	1,300
2015	2,600
2016	2,600
2017	2,600
2018	2,600
Thereafter	10,288
Total	$	21,988

Note 6. Credit Facilities

On March 22, 2013, we entered into a credit facility with Wells Fargo Bank. The credit facility provides for a $50.0 million revolving line of credit, with a $10.0 million letter of credit sublimit, and has a maturity date on March 22, 2016. The credit facility also requires us to maintain a minimum unrestricted cash balance of $50.0 million and comply with specific financial conditions and performance requirements. The loan bears interest, at our option, at a fluctuating rate per annum equal to the daily one-month adjusted LIBOR rate plus a spread of 1.75% or an adjusted LIBOR rate (based on one, three, six or twelve-month interest periods) plus a spread of 1.75%. As of June 30, 2014, we had no outstanding borrowings under this credit facility and were in compliance with the conditions and performance requirements.

Note 7. Legal Proceedings

Securities Class Action Lawsuit

On November 28, 2012, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System filed a lawsuit against Align, Thomas M. Prescott (“Mr. Prescott”), Align's President and Chief Executive Officer, and Kenneth B. Arola (“Mr. Arola”), Align's former Vice President, Finance and Chief Financial Officer, in the United States District Court for the Northern District of California on behalf of a purported class of purchasers of our common stock (the "Securities Action"). On July 11, 2013, an amended complaint was filed, which named the same defendants, on behalf of a purported class of purchasers of our common stock between January 31, 2012 and October 17, 2012. The amended complaint alleged that Align, Mr. Prescott and Mr. Arola violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that Mr. Prescott and Mr. Arola violated Section 20(a) of the Securities Exchange Act of 1934. Specifically, the amended complaint alleged that during the purported class period defendants failed to take an appropriate goodwill impairment charge related to the April 29, 2011 acquisition of Cadent Holdings, Inc. in the fourth quarter of 2011, the first quarter of 2012 or the second quarter of 2012, which rendered our financial statements and projections of future earnings materially false and misleading and in violation of U.S. GAAP. The amended complaint sought monetary damages in an unspecified amount, costs and attorney's fees. On December 9, 2013, the court granted defendant's motion to dismiss with leave for plaintiff to file a second amended complaint. Plaintiff filed a second amended complaint on January 8, 2014 on behalf of the same purported class. The second amended complaint states the same claims as the first amended complaint. We filed a motion to dismiss the second amended complaint on February 7, 2014. On June 12, 2014, the Court held a hearing on our motion and took the matter under submission. 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 attorney's fees. On July 8, 2013, an Order was entered staying this derivative lawsuit until an initial ruling on our first motion to dismiss the Securities Action. On January 15, 2014, an Order was entered staying this derivative lawsuit until an initial ruling on our

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second motion to dismiss the Securities Action discussed above. Align intends to vigorously defend itself against these allegations. Align is currently unable to predict the outcome of this complaint and therefore cannot determine the likelihood of loss nor estimate a range of possible losses.

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

Note 8. Commitments and Contingencies

Operating Leases

As of June 30, 2014, minimum future lease payments for non-cancelable operating leases are as follows (in thousands):



Fiscal Year Ending December 31,	Operating leases
Remainder of 2014	$	4,598
2015	8,494
2016	7,770
2017	4,471
2018	1,525
Thereafter	494
Total minimum future lease payments	$	27,352

Off-balance Sheet Arrangements

As of June 30, 2014, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Indemnification Provisions

In the normal course of business to facilitate transactions in our services and products, we indemnify certain parties: customers, vendors, lessors and other parties with respect to certain matters, including, but not limited to, services to be provided by us and intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and our executive officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim.

It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of June 30, 2014, we did not have any material indemnification claims that were probable or reasonably possible.

Note 9. Stock-based Compensation

Summary of stock-based compensation expense

As of June 30, 2014, we had a total reserve of 23,283,379 shares for issuance, plus up to an aggregate of 5,000,000 shares that would have been returned to our 2001 Stock Incentive Plan as a result of termination of options on or after March 28, 2005.

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Stock-based compensation is based on the estimated fair value of awards, net of estimated forfeitures, and recognized over the requisite service period. Estimated forfeitures are based on historical experience at the time of grant and may be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The stock-based compensation related to all of our stock-based awards and employee stock purchases for the three and six months ended June 30, 2014 and 2013 is as follows (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Cost of net revenues	$	937	$	637	$	1,781	$	1,217
Sales and marketing	3,111		2,012		5,778		3,023
General and administrative	4,539		3,556		8,589		7,483
Research and development	1,719		1,060		3,290		1,952
Total stock-based compensation	$	10,306	$	7,265	$	19,438	$	13,675

Options

Activity for the six months ended June 30, 2014 under the stock option plans is set forth below (in thousands, except years and per share amounts):



	Stock Options Number of Shares Underlying Stock Options		Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
					(in years )
Outstanding as of December 31, 2013	1,321		$	16.08
Granted	—		—
Exercised	(514	)	17.08
Cancelled or expired	(2	)	24.47
Outstanding as of June 30, 2014	805		$	15.41	3.34	$	32,704
Vested and expected to vest at June 30, 2014	804		$	15.41	3.34	$	32,662
Exercisable at June 30, 2014	760		$	15.04	3.31	$	31,167

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

As of June 30, 2014, the total unamortized compensation cost related to stock options, net of estimated forfeitures, is $0.5 million, which we expect to recognize over a weighted average period of 0.8 years.

Restricted Stock Units (“RSU”)

A summary of the RSU activity for the six months ended June 30, 2014 is as follows (in thousands, except years):



	Number of Shares Underlying RSU		Weighted Remaining Contractual Period	Aggregate Intrinsic Value
			(in years)
Nonvested as of December 31, 2013	2,044
Granted	943
Vested and released	(580	)
Forfeited	(111	)
Nonvested as of June 30, 2014	2,296		1.71	$	128,685

As of June 30, 2014, the total unamortized compensation cost related to RSU, net of estimated forfeitures, was $78.1 million, which we expect to recognize over a weighted average period of 2.7 years.

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

The following table summarizes the MSU activity for the six months ended June 30, 2014 (in thousands, except years):



	Number of Shares Underlying MSU		Weighted Average Remaining Contractual Period	Aggregate Intrinsic Value
			(in years )
Nonvested as of December 31, 2013	307
Granted	243
Vested and released	(52	)
Forfeited	—
Nonvested as of June 30, 2014	498		1.88	$	27,880

As of June 30, 2014, the total unamortized compensation costs related to the MSU, net of estimated forfeitures, was $13.2 million, which we expect to recognize over a weighted average period of 1.9 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, 2014, there remains 1,475,372 shares available for purchase under the 2010 Purchase Plan.

The fair value of the option component of the 2010 Purchase Plan shares was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:



	Six Months Ended June 30,
	2014			2013
ESPP:
Expected term (in years)	1.2			1.2
Expected volatility	42.3		%	46.7		%
Risk-free interest rate	0.17		%	0.18		%
Expected dividends	—			—
Weighted average fair value at grant date	$	17.97		$	11.17

There were no new ESPP cycles that started during the three months ended June 30, 2014 or June 30, 2013.

As of June 30, 2014, the total unamortized compensation cost related to employee purchases was $1.3 million, which we expect to recognize over a weighted average period of 0.4 year.

Note 10. Common Stock Repurchase

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

As part of our $300.0 million stock repurchase program, we entered into an accelerated share repurchase agreement ("ASR") with Goldman, Sachs & Co. on April 28, 2014 to repurchase $70.0 million of our common stock. We paid $70.0 million on April 29, 2014 and received an initial delivery of approximately 1.0 million shares based on the then current market price of $49.17, which were retired. The remaining $21.0 million was recorded as an equity forward contract and was included

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in Additional paid-in capital in stockholder's equity in the Condensed balance sheet as of June 30, 2014. The final number of shares to be repurchased is based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount.

The ASR was completed on July 29, 2014 with a final delivery of approximately 0.4 million shares. We will have received a total of approximately 1.4 million million shares under the ASR for an average purchase share price of $51.46.

Note 11. Accounting for Income Taxes

Our provision for income taxes was $13.0 million and $8.2 million for the three months ended June 30, 2014 and 2013, respectively. This represents effective tax rates of 26.8% and 22.0%, respectively. The increase in our provision for income taxes was primarily due to higher pre-tax income and a negative impact from a $2.1 million adjustment related to prior periods. These were offset partially by a jurisdictional shift in forecasted earnings from the U.S. to lower-tax non-U.S. jurisdictions.

Our provision for income taxes was $23.0 million and $11.2 million for the six months ended June 30, 2014 and 2013, respectively. This represents effective tax rates of 25.3% and (745.9)%, respectively. The increase in our provision for income taxes was primarily due to higher pre-tax income and a negative impact from a $1.8 million adjustment related to prior years. These were offset partially by a jurisdictional shift in forecasted earnings from the U.S. to lower-tax non-U.S. jurisdictions. The effective tax rate for the six months ended June 30, 2013 reflects a non-deductible goodwill impairment charge of $40.7 million recorded during the three months ended March 31, 2013.

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

As of June 30, 2014, we maintained a valuation allowance of $35.4 million against deferred tax assets primarily related to foreign net operating loss carryforwards and capital loss carryforwards. These net operating and capital loss carryforwards would result in an income tax benefit if we were to conclude it is more likely than not that the related deferred tax assets will be realized.

During the three months ended June 30, 2014, the change in our gross unrecognized tax benefits was not material. The total amount of gross unrecognized tax benefits was $29.5 million as of June 30, 2014, all of which would impact our effective tax rate if recognized. We have elected to recognize interest and penalties related to unrecognized tax benefits as a component of income taxes. The change in accrued interest and penalties during the three months ended June 30, 2014 was not material. We do not expect any significant changes to the amount of unrecognized tax benefit within the next twelve months.

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

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

In June 2009, the Costa Rica Ministry of Foreign Trade, an agency of the Government of Costa Rica, granted a twelve year extension of certain income tax incentives, which were previously granted in 2002. The incentive tax rates will expire in various years beginning in 2017. Under these incentives, all of the income in Costa Rica during these twelve year incentive periods is subject to reduced rate of Costa Rica income tax. In order to receive the benefit of these incentives, we must hire specified numbers of employees and maintain certain minimum levels of fixed asset investment in Costa Rica. If we do not fulfill these conditions for any reason, our incentive could lapse, and our income in Costa Rica would be subject to taxation at higher rates, which could have a negative impact on our operating results. The Costa Rica corporate income tax rate that would apply, absent the incentives, is 30% for 2014. As a result of these incentives, our income taxes were reduced by $15.1 million and $12.0 million for the six months ended June 30, 2014 and 2013, respectively, representing a benefit to diluted net income per share of $0.18 and $0.15 in 2014 and 2013, respectively. For the three months ended June 30, 2014 and 2013, the income taxes was reduced by$7.5 million and $5.9 million, respectively, representing a benefit to diluted net income per share of $0.09 and $0.07, respectively.

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Note 12. Net Income (Loss) Per Share

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

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



	Three Months Ended, June 30,				Six Months Ended, June 30,
	2014		2013		2014		2013
Numerator:
Net income (loss)	$	35,600	$	29,320	$	68,044	$	(12,663	)
Denominator:
Weighted-average common shares outstanding, basic	81,027		80,576		81,073		80,909
Dilutive effect of potential common stock	1,314		1,573		1,578		—
Total shares, diluted	82,341		82,149		82,651		80,909
Net income (loss) per share, basic	$	0.44	$	0.36	$	0.84	$	(0.16	)
Net income (loss) per share, diluted	$	0.43	$	0.36	$	0.82	$	(0.16	)

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

For the three months ended June 30, 2013, the anti-dilutive affect from stock options, RSU, MSU and ESPP was not material. For the six months ended June 30, 2013, stock options, RSU, MSU and ESPP totaling 1.8 million of potentially dilutive shares have been excluded from the total diluted shares because there was a net loss during the period.

Note 13. Segments and Geographical Information

Segment Information

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

We have grouped our operations into two reportable segments which are also our reporting units: Clear Aligner segment and Scanner segment.


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


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

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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	2014		2013		2014		2013
Clear Aligner
Invisalign Full Products	$	147,158	$	123,379	$	285,291	$	236,159
Invisalign Express/Lite Products	20,478		19,158		40,103		35,241
Invisalign non-case revenues	12,099		10,766		22,580		23,475
Scanner
Scanners and Services	12,796		10,525		25,203		22,533
Total net revenues	$	192,531	$	163,828	$	373,177	$	317,408

Gross profit
Clear Aligner	$	141,703	$	120,124	$	274,786	$	229,451
Scanners and Services	3,773		3,567		7,941		7,089
Total gross profit	$	145,476	$	123,691	$	282,727	$	236,540

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,
	2014		2013		2014		2013
Net revenues: ⁽¹⁾
U.S.	$	133,954	$	121,651	$	262,593	$	241,692
the Netherlands	43,680		32,363		82,523		63,458
Other international	14,897		9,814		28,061		12,258
Total net revenues	$	192,531	$	163,828	$	373,177	$	317,408

⁽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,		December 31,
	2014		2013
Long-lived assets:⁽²⁾
United States	$	67,386	$	61,439
Mexico	6,184		6,291
the Netherlands	1,297		1,630
Other International	6,445		6,383
Total long-lived assets	$	81,312	$	75,743

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

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

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

The following discussion and analysis of our financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.

Overview

Align Technology, Inc. is a global medical device company that advanced the invisible orthodontics market with the introduction of the Invisalign System in 1999. Today, we are focused on designing, manufacturing and marketing innovative technology-rich products to help dental professionals achieve the clinical results they expect and deliver effective, convenient cutting-edge dental treatment options to their patients. Align Technology was founded in March 1997 and is headquartered in San Jose, California with offices worldwide. Our international headquarters are located in Amsterdam, the Netherlands. We have two operating segments: (1) Clear Aligner, known as the Invisalign System; and (2) Scanner and Services ("Scanner"), known as the iTero intra-oral scanners and OrthoCAD services (which we previously referred to as Scanner and CAD/CAM Services ("SCCS")).

We received FDA clearance in 1998 and began our first commercial sales of Invisalign to U.S. orthodontists in 1999 followed by U.S. General Practitioner Dentists ("GPs") in 2002. Over the next decade, we introduced Invisalign to the European market and Japan, added distribution partners in Asia-Pacific, Latin America, and Europe Middle East and Africa ("EMEA"), and introduced a full range of treatment options including Invisalign Express 10, Invisalign Teen, Invisalign Assist, and Vivera Retainers. By 2011, we launched significant new aligner and software features across all Invisalign products that make it easier for doctors to use Invisalign on more complex cases, and introduced Invisalign to the People’s Republic of China. In 2013, we launched SmartTrack, the next generation of Invisalign clear aligner material, which became the new standard aligner material for Invisalign products in North America, Europe and other international markets where we have obtained regulatory approval. Most recently, in February 2014, we launched Invisalign G5 innovations, specifically designed for treatment of deep bite malocclusion as well as ClinCheck Pro, the next generation Invisalign treatment software tool, designed to help Invisalign providers achieve their treatment goals.

We also sell iTero intra-oral scanners and provide computer-aided design and computer-aided manufacturing ("CAD/CAM") services. Intra-oral scanners provide a dental “chair-side” platform for accessing valuable digital diagnosis and treatment tools, with potential for enhancing accuracy of records, treatment efficiency, and the overall patient experience. We believe there are numerous benefits for customers and the opportunity to accelerate the adoption of Invisalign through interoperability with our intra-oral scanners. The use of digital technologies such as CAD/CAM for restorative dentistry or in-office restorations has been growing rapidly and intra-oral scanning is a critical part of enabling these new digital technologies and procedures in dental practices. In late 2012, we commercially launched the Invisalign Outcome Simulator, the first Invisalign chair-side application powered by the iTero scanner. The interactive application provides dentists and orthodontists an enhanced platform for patient education and is designed to increase treatment acceptance by helping patients visualize the benefits possible with Invisalign treatment. In January 2014, we announced that the 3M™ True Definition scanner was

qualified for use with Invisalign case submissions. This qualification enables Invisalign providers with a True Definition scanner to submit a digital impression in place of a traditional PVS impression as part of the Invisalign case submission process. The 3M True Definition scanner is currently the only third-party scanner that has been qualified for use with Invisalign treatment. We continue to believe in an open systems approach to digital impressions, and are committed to working with other intra-oral scanning companies interested in developing interoperability for use with Invisalign treatment.

The Invisalign System is offered in more than 60 countries and has been used to treat more than 2.7 million patients. Our iTero intra-oral scanner, which is primarily sold in North America, provides dental professionals with an open choice to send digital impressions to any laboratory-based CAD/CAM system or to any of the more than 1,200 dental labs worldwide.

Our goal is to establish Invisalign clear aligners as the standard method for treating malocclusion and to establish the iTero intra-oral scanner as the preferred scanning device for 3D digital scans, ultimately driving increased product adoption by dental professionals. We intend to achieve this by continued focus and execution of our strategic growth drivers set forth in the Business Strategy section in our Annual Report on Form 10-K.

The successful execution of our business strategy and our results in 2014 and beyond may be affected by a number of other factors, which are updated below:

•

New Products, Feature Enhancements and Technology Innovation. Product innovation drives greater treatment predictability and clinical applicability, and ease of use for our customers, which supports adoption of Invisalign in their practices. Increasing applicability and treating more complex cases requires that we move away from individual features to more comprehensive solutions so that Invisalign providers can more predictably treat the whole case, such as with Invisalign G5 for deep bite treatment. Launched in February 2014, Invisalign G5 was engineered to help doctors achieve even better clinical outcomes when treating patients with deep bites - a prevalent orthodontic problem. In North America, in February 2014, we also launched ClinCheck Pro, the next generation Invisalign treatment software tool, designed to provide more precise control over final tooth position and to help Invisalign providers achieve their treatment goals. We intend to launch ClinCheck Pro in our other country markets in the first quarter of 2015. We believe that over the long-term, clinical solutions and treatment tools will increase adoption of Invisalign; however, it is difficult to predict the rate of adoption which may vary by region and channel.


•	Invisalign Utilization rates. Our goal is to establish Invisalign as the treatment of choice for treating malocclusion ultimately driving increased product adoption and frequency of use by dental professionals, also known as "utilization rates". Our quarterly utilization rates for the previous 9 quarters are as follows:

^*Invisalign Utilization rates = # of cases shipped divided by # of doctors cases were shipped to

Total utilization in the second quarter of 2014 was 4.4 cases per doctor and was up compared to the second quarter of 2013 driven primarily by North America orthodontist and International customers. Utilization among our North American orthodontist customers increased slightly to 8.4 cases per doctor in the second quarter of 2014 from 8.0 cases in the second quarter of 2013, while our International doctor utilization increased to 4.5 cases

in the second quarter of 2014 from 4.3 cases in the second quarter of 2013. This increase in North America orthodontist utilization reflects improvements in product and technology, which continues to strengthen our doctors’ clinical confidence in the use of Invisalign such that they now utilize Invisalign more often and on more complex cases, including their teenage patients. Increased International utilization reflects strong growth in both the EMEA and Asia Pacific regions driven by go-to-market and sales coverage investments, improving clinical education and support as well as ongoing technology innovation. Year over year utilization for our North American GP customers decreased to 2.9 cases per doctor in the second quarter of 2014 from 3.0 cases in the second quarter of 2013. Although we expect that over the long-term our utilization rates will gradually improve, we expect that period over period comparisons of our utilization rates will fluctuate.

•

Seasonal Trends. In North America, summer is typically the busiest season for orthodontists with practices that have a high percentage of adolescent and teenage patients as many parents want to get their teenagers started in treatment before the start of the school year; however, many GPs are on vacation during this time and, therefore, tend to start fewer cases. Internationally, sales of Invisalign treatment are often weaker in the summer months due to our customers and their patients being on holiday. Consequently, we expect that our Invisalign volume will be relatively flat in the third quarter of 2014 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 2013, Invisalign growth was driven primarily by increased utilization by our orthodontist customers as well as by the continued expansion of our customer base as we trained a total of 8,065 new Invisalign doctors. GPs are one of the keys to driving growth in the adult segment, and, in 2014, we launched a new CE I training course, now called Invisalign Fundamentals, designed to improve practice integration and increase utilization for newly trained doctors. We have implemented this new Invisalign Fundamentals program across North America and will look for opportunities to adjust our international training programs as we work to help our GP practices worldwide more successfully adopt Invisalign into their practices. During the six months ended June 30, 2014, we trained 4,185 new Invisalign doctors. We believe that this new training approach will increase the number of doctors submitting cases 90-days post-training, as well as the number of cases submitted per doctor.

•

International Clear Aligner. We will continue to focus our efforts towards increasing adoption of our products by dental professionals in our direct international markets. On a year over year basis, international volume increased 26%, driven primarily by growth in Europe as well as by strong performance in the Asia Pacific region. In 2014, we are continuing to expand in our existing markets through targeted investments in sales coverage and professional marketing and education programs, along with consumer marketing in selected country markets. In addition, given the significant long term potential this extensive geography represents and the support we can now provide by utilizing our direct coverage model in Europe, beginning in February 2014, we transitioned a small number of these countries into direct sales regions. We expect to leverage our existing infrastructure and resources to bring sales coverage and customer support to these countries, most of which are adjacent to our directly covered European countries. Due to the small volume of business from our EMEA distributor, we do not anticipate that this transition will have a material effect on our financial results in the next several years.

•

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

•

Medical Device Excise Tax. During March 2014, Align had extensive discussions with the IRS and they informed us that our aligners are not subject to the medical device excise tax ("MDET") which we had been paying and expensing in general and administrative expenses in the consolidated statements of operations since January 1, 2013; however, our scanners are still subject to the MDET. As a result of these discussions, beginning in March 2014, we ceased expensing and paying the MDET for aligners, which reduced our first quarter general and administrative expense by approximately $0.5 million. In future quarters, we expect our general and administrative expense in relation to MDET to decrease by approximately $1.8 million per quarter based on current revenues. In June 2014, we received a $1.2 million refund for MDET paid in 2014 related to our aligners which reduced general and administrative expenses for the three months ended June 30, 2014. Additionally, we are in process of claiming a $6.8 million refund of MDET paid in 2013 related to our aligners; however, because

this claim is subject to review and approval by the IRS, we have not recorded a receivable as the outcome of the audit is uncertain. Any future changes in the applicability of the MDET as it applies to us or refunds of amounts previously paid will be recorded as an additional expense or a credit to the consolidated statement of operations in the period in which is becomes probable and reasonably estimable.

•

Stock Repurchase Authorization. On April 23, 2014, we announced that our Board of Directors had authorized a stock repurchase program pursuant to which we may purchase up to $300.0 million of our common stock over the next three years, with $100.0 million of that amount authorized to be purchased over the 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.

•

Accelerated Stock Repurchase Agreement. As part of our $300.0 million stock repurchase program, we entered into an accelerated share repurchase agreement ("ASR") with Goldman, Sachs & Co. on April 28, 2014 to repurchase $70.0 million of our common stock. We paid $70.0 million on April 29, 2014 and received an initial delivery of approximately 1.0 million shares based on the then current market price, which were retired. The final number of shares to be repurchased is be based on our volume-weighted average stock price during the term of the transaction, less an agreed upon discount. The ASR was completed on July 29, 2014. In accordance with the terms of the ASR, we will have received a total of approximately 1.4 million shares of our common stock for an average purchase share price of $51.46. As of June 30, 2014, there remains approximately $230 million available under our existing stock repurchase authorization.

Results of Operations

Net revenues by Reportable Segment

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


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


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

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, 2014 and 2013 is as follows (in millions):



	Three Months Ended June 30,								Six Months Ended June 30,
Clear Aligner:	2014		2013		Net Change		% Change		2014		2013		Net Change			% Change
Region
North America	$	111.6	$	102.2	$	9.4	9.2	%	$	219.6	$	199.3	$	20.3		10.2	%
International	56.0		40.3		15.7		39.0	%	105.8		72.1		33.7			46.7	%
Invisalign non-case net revenues	12.1		10.8		1.3		12.0	%	22.6		23.5		(0.9		)	(3.8	)%
Total Clear Aligner net revenues	$	179.7	$	153.3	$	26.4	17.2	%	$	348.0	$	294.9	$	53.1		18.0	%
Product
Invisalign Full Products	$	147.1	$	123.3	$	23.8	19.3	%	$	285.3	$	236.1	$	49.2		20.8	%
Invisalign Express Products	20.5		19.2		1.3		6.8	%	40.1		35.3		4.8			13.6	%
Invisalign non-case net revenues	12.1		10.8		1.3		12.0	%	22.6		23.5		(0.9		)	(3.8	)%
Total Clear Aligner net revenues	$	179.7	$	153.3	$	26.4	17.2	%	$	348.0	$	294.9	$	53.1		18.0	%
Scanner:
Region
North America	$	12.7	$	10.4	$	2.3	22.1	%	$	25.0	$	22.3	$	2.7		12.1	%
International	0.1		0.1		—		—	%	0.2		0.2		—			—	%
Total Scanner net revenues	$	12.8	$	10.5	$	2.3	21.9	%	$	25.2	$	22.5	$	2.7		12.0	%

Total net revenues	$	192.5	$	163.8	$	28.7	17.5	%	$	373.2	$	317.4	$	55.8		17.6	%

Clear Aligner Case Volume by Channel and Product

Case volume data which represents Invisalign case shipments by region and product, for the three and six months ended June 30, 2014 and 2013 is as follows (in thousands):



	Three Months Ended June 30,						Six Months Ended June 30,
Region	2014	2013	Net Change		% Change		2014	2013	Net Change	% Change
North American Invisalign	84.8	78.8	6.0		7.6	%	166.3	153.5	12.8	8.3	%
International Invisalign	34.5	27.3	7.2		26.4	%	65.2	50.8	14.4	28.3	%
Total Invisalign case volume	119.3	106.1	13.2		12.4	%	231.5	204.3	27.2	13.3	%
Product
Invisalign Full Product Group	98.6	84.8	13.8		16.3	%	190.9	164.1	26.8	16.3	%
Invisalign Express Product Group	20.7	21.3	(0.6	)	(2.8	)%	40.6	40.2	0.4	1.0	%
Total Invisalign case volume	119.3	106.1	13.2		12.4	%	231.5	204.3	27.2	13.3	%

Total net revenues increased by $28.7 million and $55.8 million for the three and six months ended June 30, 2014, respectively, as compared to the same period in 2013 primarily as a result of Invisalign case volume growth across all regions and most products.

Clear Aligner

In the three months ended June 30, 2014, Clear Aligner North America net revenues increased by $9.4 million or 9.2% compared to the same period in 2013 primarily due to Invisalign case volume growth of approximately $7.8 million across all channels and most products and, to a lesser extent, higher average selling prices ("ASP") which contributed approximately $1.7 million to the increase in net revenues. The increase in ASP was primarily a result of product mix shift towards higher priced Invisalign full products in the current period compared to the same period in the prior year.

Table of Contents

In the six months ended June 30, 2014, Clear Aligner North America net revenues increased by $20.3 million million or 10.2% compared to the same period in 2013 mainly due to Invisalign case volume growth of $16.4 million and, to a lesser extent, higher ASP which contributed approximately $3.9 million to the increase in net revenues. The increase in ASP was primarily a result of product mix shift towards higher priced Invisalign full products in the current period compared to the same period in the prior year.

In the three months ended June 30, 2014, Clear Aligner international net revenues increased by $15.7 million or 39.0% compared to the same period in 2013 primarily driven by Invisalign case volume growth of $10.6 million across all products and higher ASP which contributed approximately $5.1 million to the increase in net revenues. In the six months ended June 30, 2014, Clear Aligner international net revenues increased by $33.7 million or 46.7% compared to the same period in 2013 mainly due to Invisalign case volume growth of $20.6 million and, to a lesser extent, higher ASP which contributed approximately $13.1 million to increase in net revenues. The increase in ASP for both periods was primarily due to the impact from acquiring our distributor in the Asia Pacific region on April 30, 2013 as we now recognize direct sales of Invisalign products sold in that region at our full ASP rather than the discounted ASP under the distributor agreement, as well as price increases effective July 2013 and a favorable impact from foreign exchange rates.

Invisalign non-case net revenues, consisting of training fees and ancillary product revenues, increased by $1.3 million or 12.0% for the three months ended June 30, 2014 compared to the same period in 2013 primarily due to increased Vivera volume both in North America and International.

Invisalign non-case net revenue decreased by $0.9 million or 3.8% for the six months ended June 30, 2014 compared to the same period in 2013 primarily due to the consolidation of our Vivera product shipments in North America from four shipments per year to one shipment in 2013, offset in part by increased Vivera volume both in North America and International.

Scanner and Services

Scanner and Services net revenues increased $2.3 million or 21.9% for the three months ended June 30, 2014 compared to the same period in 2013 and $2.7 million or 12.0% for the six months ended June 30, 2014 compared to the same period in 2013. The increase in both periods was primarily due to an increase in both scanner revenue as well as service revenue. The increase in scanner revenue was primarily due to an increase in the number of scanners recognized offset in part by lower scanner ASP as a result of promotional discounts as well as permanent price reductions. The increase in services revenue was primarily due to an increase in the volume of services resulting from a larger installed base of scanners. Additionally, net revenues for the three months ended March 31, 2013 included a release of $1.4 million of revenue previously reserved for the new iTero upgrade program which was completed in the first quarter of 2013.

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



	Three Months Ended June 30,								Six Months Ended June 30,
	2014			2013			Change		2014			2013			Change
Clear Aligner
Cost of net revenues	$	38.0		$	33.2		$	4.8	$	73.2		$	65.4		$	7.8
% of net segment revenues	21.2		%	21.6		%			21.0		%	22.2		%
Gross profit	$	141.7		$	120.1		$	21.6	$	274.8		$	229.5		$	45.3
Gross margin %	78.8		%	78.4		%			79.0		%	77.8		%
Scanner
Cost of net revenues	$	9.0		$	6.9		$	2.1	$	17.3		$	15.4		$	1.9
% of net segment revenues	70.5		%	66.1		%			68.5		%	68.5		%
Gross profit	$	3.8		$	3.6		$	0.2	$	7.9		$	7.1		$	0.8
Gross margin %	29.5		%	33.9		%			31.5		%	31.5		%
Total cost of net revenues	$	47.1		$	40.1		$	7.0	$	90.5		$	80.9		$	9.6
% of net revenues	24.4		%	24.5		%			24.2		%	25.5		%
Gross profit	$	145.5		$	123.7		$	21.8	$	282.7		$	236.6		$	46.1
Gross margin %	75.6		%	75.5		%			75.8		%	74.5		%

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

Clear Aligner

Gross margin increased for the three months ended June 30, 2014 compared to the same period in 2013 due to higher ASP. This was partially offset by higher freight costs resulting from an increase in the volume of international shipments.

Gross margin increased for the six months ended June 30, 2014 compared to the same period in 2013 due to higher ASP.