愛齊科技 (ALGN) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Align Technology fourth quarter and year-end financial results conference call.

During the presentation all participants will be in a listen-only mode.

Afterwards, we will conduct a question-and-answer session.

At that time, if you have a question, please press the 1 followed by the 4 on your telephone.

As a reminder, this conference is being recorded Thursday, February 13, 2003.

I would now like to turn the conference over to Tom Prescott, President and Chief Executive Officer.

Please go ahead, sir.

Thank you, Operator, and thank you all for joining us this afternoon to discuss the results of the fourth quarter and the positive trends that we saw in that period as well as providing an update on our progress in completing the significant restructuring announced in July, which was geared around achieving profitability by the end of 2003.

We will also discuss the growing adoption of Invisalign by our primary customers, orthodontists, as well as discussing our strategy to expand the market to GP dentists.

Access to the huge GP dentist patient base will not only benefit the GP channel through treatment of simple cases but should also drive increased referrals for our orthodontist customer base.

On the call with me today is Eldon Bullington, our Chief Financial Officer, and Roger George, our General Counsel.

We will lead off with some remarks on forward-looking statements that we may make in the call.

Then we'll provide some details on the fourth quarter results and general guidance on fiscal 2003 followed by a question-and-answer period.

Now I'll turn the call over to Eldon for those remarks on forward-looking statements.

Thank you, Tom, and good afternoon, everyone.

Concerning any remarks that we may make about future expectations, plans, or prospects for the company during this conference call, or that were made in our earnings press release, those remarks may constitute forward-looking statements for purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties.

A number of important factors could cause actual results to differ materially from those in the forward-looking statements.

These factors, as well as other factors that could cause actual results to differ materially are discussed in more detail in Align Technology's registration statement on Form S-1, our annual 10-K, and quarterly 10-Qs and other filings that we make from time to time with the Securities and Exchange Commission.

Thanks, Eldon.

I would like to welcome all of our shareholders and friends who have joined on the call today.

Many of you participated in our second and third quarter calls, where we described a wide-ranging set of initiatives designed to ensure that Align had the right cost structure and operating platform to achieve profitability before the end of 2003.

Those initiatives have been successfully completed.

I'd like to start off this afternoon by giving you a brief update on that progress.

The streamlining of our manufacturing network is complete.

The company has now fully completed manufacturing transfer out of lower Pakistan and Sharja in the United Arab Emirates.

Some minor activities continue into 2003 as we close down the legal entities and dispose of land holdings in Pakistan.

All asset write-downs were recorded in 2002 in accordance with GAAP.

Our employees in Pakistan and the United Arab Emirates demonstrated the kind of professionalism and customer-focused attitudes that has enabled this transition to occur with no adverse impact on our customers.

Our manufacturing team conducted this transition in an exemplary manner on schedule and under budget.

The second major initiative was targeted at rationalizing our international sales structure to create a balance between near-term growth prospects and investment.

To that end, we completed a resizing of our organizations and infrastructure in Europe and Latin America.

We are absolutely committed to these regions for the long term, however, our spending had gotten significantly out of our revenue ramp.

Over the next year or so we will focus on building a solid core franchise in the most attractive countries rather than to push for major regional expansion and large growth and new doctors trained.

Our international customers have seen us renew our efforts to help them successfully adopt Invisalign and are heartened that we are focused on building a successful, profitable, and sustainable enterprise.

I believe it's important to repeat the strategic rationale behind taking these significant actions.

Align has pioneered a new technology, launched a great new product, and established a foothold in an enormous untapped market.

It is essential to ensure the right foundation is in place so we can truly reach to achieve a leadership position in this industry.

A good foundation begins with a sustainable, profitable operating platform, and customer satisfaction.

We are within sight of those goals.

As we achieve our near and intermediate term objectives, including profitability, we will tap into the enormous growth potential ahead and significantly accelerate the top line.

We expect to dramatically expand this new modality of treatment, and our vision is that one day Invisalign will be a highly valuable, unique, global brand.

Now I would like to shift the discussion to our fourth quarter results.

I'll provide a brief summary and focus on some key drivers for those results, and then ask Eldon to step through the numbers in a bit more detail.

Our overall revenues in the quarter grew to 22.4m, an increase of 82% over the same quarter a year ago and up 21% over last quarter.

Our revenues for the full year 2002 came in at $75.4m representing a 63% increase over 2001.

This revenue growth was in line with our high expectations, demonstrating solid growth in our U.S. orthodontic and GP markets as well as in Europe.

We continue to make substantial progress in the GP dentist market, both in terms of training new doctors as well as generating case volume growth.

This market segment is important to us, both for the revenue opportunity it represents, as well as a strategic linkage between GP practices and their ability to help us cost-effectively access the tens of millions of potential consumers -- their patients -- that are underserved in today's traditional orthodontic care model.

While many GPs may elect not to learn about or how to treat complex cases with Invisalign, the increased knowledge and awareness of malocclusion by GPs and their staffs will enhance consumer awareness of the treatment alternatives and expand referrals of complex cases to orthodontists.

We believe Invisalign, with our fundamentally superior value proposition for most consumers, will benefit very substantially from that growth.

Starting with last quarter's results call, we began to provide more detail about our pipeline of new cases received.

We will continue that detail and share additional information so our shareholders can better understand our progress at building our base of submitting doctors or what we call "adoption," as well as our share of practice, or what we call "utilization."

We continue to see solid expansion in the adoption of Invisalign.

During the fourth quarter we had approximately 5,000 doctors submitting cases compared to 4,200 in the third quarter and 2,400 one year ago.

The number of new GP doctors submitting cases has grown from less than 100 a year ago to 1,200 in Q3 and 1,600 in this most recent quarter, Q4.

As a result, average cases received per business day in Q4 was approximately 240 compared to 200 in Q3 and 110 a year ago.

As we have discussed before, our target cycle time from receipt of a new case to shipment of Aligners is approximately three weeks, depending on volume.

As a result, our pipeline of cases received is almost a month ahead of our revenue recognition, so we generally have good visibility to the quarter ahead by the time we announce prior quarter results.

Briefly turning now to gross margins, spending, and net losses -- as Eldon will describe in just a moment, we are either on track or ahead of our expectations in each of these areas.

I am going to reference pro forma operating numbers here that are net of stock-based compensation or restructuring charges and let Eldon tie these into our reported cap numbers.

We achieved our goal of exceeding 50% gross margins with actual results of 51%.

The drivers behind this performance included continued leverage through implementation of several key programs: CT scanning of impressions, a series of software improvements delivered by our technology team, and rollout of automated forming in our Juarez, Mexico, Aligner facility.

In addition, we also saw favorable absorption from increased volume.

These programs are expected to continue, generating additional leverage going forward.

Our expectation for 2003 is to achieve 60% gross margins by year-end.

We continue to focus on reducing spending and op-ex, bringing our Q4 op-ex down to $17.8m, despite increased investment in North American sales and marketing.

This overall decrease was driven by reductions in international and Santa Clara-based infrastructure and headcount.

As a result, our quarterly pro forma net loss declined by approximately $3.5m to $6.7m in Q4.

Our quarterly pro forma net loss has been nearly cut in half since the second quarter of 2002 from 13m down to 6.7m.

This combination of top-line growth, gross margin expansion, and careful management of spending will continue to reduce these net losses.

This will be especially visible in the first half of 2003 as restructuring costs are behind us and the full impact of our strategic initiatives will be seen.

As discussed on our third quarter earnings call, we were focused on improving the company's cash position.

During the quarter we completed an $18m equity financing and a bank credit facility including a $5m equipment loan.

Our cash balance at the end of the quarter of $41.5m, including the $23m cash infusion, reflects a substantially reduced cash burn approximately 4.5m in the quarter compared to previous quarters.

I'll come back at the end and make a few closing comments.

However, now I'd like to turn it over to Eldon.

Thanks, Tom.

I'll dive right in and lay out both pro forma and GAAP results for you while trying to minimize any overlap with what Tom just pulled you through.

Net revenues of $22.4m for the fourth quarter of 2002 increased 82% compared to 12.3m for the same quarter one year ago, while increasing sequentially by 21% compared to 18.6m for the third quarter of this year.

Fourth quarter revenues by segment were $14.9m for U.S. ortho; 2.9m for U.S. GP; and 2.1m for international; worldwide training and other revenues were approximately $1.6m.

Total case shipment volume for the fourth quarter was approximately 13,600 cases.

Full year net revenues were 75.4m for 2002, an increase of 63% compared to $46.4m one year ago.

Full-year case volume shipped for 2002 was approximately 45,000 cases.

Before I discuss gross margins and operating expenses, I want to point out that we are beginning to handle the classification of certain costs and expenses in the income statement in a slightly different manner than in the past.

These reclassifications do not constitute accounting changes and do not change bottom-line net income for a loss historically or perspectively.

The nature of the changes center around the classification of certain order administration expenses, bank processing fees, and information technology costs between operating expense categories and cost of sales.

The company historically has concentrated these costs primarily in general and administrative expenses and other expense on the income statement.

A better presentation of results for the financial statement reader is to allocate these expenses to the function utilizing the services and incurring the expenses.

The effect of these reclassifications increases cost of sales impacting gross margins in the range of 2 to 3 margin points, offset by an equivalent reduction in operating and other expenses.

I will point out the effect on our gross margins and operating expenses as I discuss each category.

Again, these reclassifications do not constitute accounting changes or affect bottom-line performance.

We are focused on presenting financial information that best reflects the business as it is today.

Gross margins for the fourth quarter under GAAP were $10.6m, or 47.2% of revenue.

Cost of revenues for the fourth quarter included approximately $700,000 of stock-based compensation.

As I just previously mentioned, the company began reclassifying certain information technology and manufacturing support costs previously recorded in operating expenses to cost of sales during the fourth quarter.

The impact during the fourth quarter was an increase to cost of sales of approximately $500,000, or 2.2 gross margin points.

For the full year, 2002 GAAP gross margins were $29.4m or 39% of revenue compared to a negative gross margin of $500,000 in 2001.

No historical reclassifications between cost of sales and operating expense have been recorded.

The reclassification of operating expenses to cost of sales is expected to reduce gross margins by approximately 2 to 3 margin points in 2003 compared to prior estimates.

The reclassifications to cost of sales will be directly offset in operating and other expenses with no impact to the bottom line.

Gross margins, excluding stock-based compensation and restructuring charges, were 50.6% for the fourth quarter compared to 25.6 for the same quarter one year ago and 48.7% for the third quarter of this year.

Gross margin performance met our expectations and, as reclassified, are consistent with previous guidance provided during our third quarter call.

Our continued improvements in margins reflect the benefits of cost reduction and cycle time improvements in our manufacturing process and improved fixed cost absorption related to increasing volumes.

Total operating expenses reported under GAAP were $24.3m for the fourth quarter compared to 23.1m for the same quarter one year ago, and 24.6m for the third quarter of this year.

Included in operating expenses for the current quarter were approximately $3.1m of stock-based compensation and approximately $3.4m of restructuring charges related to the shutdown of operations in the Middle East and the resizing of our international infrastructure and domestic support organizations.

Restructuring activities are substantially complete and recorded as of the fourth quarter.

The net impact of reclassifying operating expenses to cost of sales during the fourth quarter was approximately $500,000.

Total operating expenses reported under GAAP for full year 2002 were $97.6m compared to $98.7m in 2001.

Full year 2002 includes $16.9m of stock-based compensation charges compared to 18.2m in 2001.

Restructuring charges for 2002 were approximately $5.2m.

The total operating expenses net of stock-based compensation and restructuring charges for the fourth quarter were $17.8m compared to 18.7m in the same quarter one year ago, 19.2m in the third quarter of this year, and 20.2m in the second quarter of this year.

The reduction in operating expenses between third and fourth quarter of this year was primarily attributable to G&A [ph] expenses in the Middle East as those operations were winding down.

Net loss for the fourth quarter is reported under GAAP with $13.9 or 27 cents per basic and diluted share.

Excluding stock-based compensation and restructuring charges, net loss for the quarter was $6.7m or 13 cents per basic and diluted share.

EPS calculations were based on 51.8m weighted average shares outstanding.

Cash at the end of the quarter was $41.5m in cash and short-term investments compared to $22.8m at the end of the third quarter.

Cash at the end of the fourth quarter included an $18m equity infusion closed in November, and a $5m term loan recorded in December.

The term loan was part of a credit facility provided by America Bank, which also includes a $10m accounts receivable-based revolving credit line.

The company has not borrowed against the revolving credit line at this time.

Excluding the $23m infusion of cash during the quarter, cash burn was approximately $4.5m, substantially reduced compared to the past several quarters, contributing to the improved cash utilization during the quarter for the benefit of spending improvements and improved accounts receivable performance.

Day sales outstanding were reduced from 78 days in Q3 to 68 days in Q4.

As we discussed during our third quarter earnings call, the company was keenly focused on securing our cash position, and we believe we have done just that.

We anticipate that we now have access to the cash resources necessary to finish building a profitable business.

As Tom discussed earlier in the call, the initiatives undertaken by the company to streamline manufacturing and resize our international sales and domestic support organization are on track.

Financial results for the fourth quarter support this view and are within the guidance the company provided during the third quarter results call.

Looking ahead, we will spend a few minutes updating our view of 2003.

These projections are discussed on a pro forma basis excluding non-cash stock-based compensation.

Consistent with our previous guidance, 2003 revenues are projected to be in the $100m to $105m range.

Q1 revenues are expected to be fairly consistent with Q4 2002 in the $21m to [inaudible] range with Q2 through Q4 revenues then growing at a fairly linear rate.

The ortho channel, GP channel, and international are expected to comprise 63%, 25%, and 8% of 2003 revenues, respectively, with the remainder approximately 5% being training and other revenues.

Case volume is projected to be in the range of 61,000 to 64,000 cases for 2003.

Gross margins are expected to grow steadily throughout the year, driven by cost improvements and higher volumes.

Gross margins are projected to be in the 51 to 53% range for Q1, improving to between 59% and 61% by year-end.

At projected revenue levels, gross margins are projected to average in the range of 55 to 57% for the full year.

These margin projections contemplate the expense reclassifications discussed with Q4 results.

As previously mentioned, the reclassification from operating expenses reduces margins by approximately 2 to 3 percentage points when compared to our prior guidance.

Quarterly operating expenses are projected to be in the range of $17m to $18m per quarter, net of the reclassifications to cost of sales. 2003 operating expenses contemplate and then permit in spending to defend the Sybron Ormco patent infringement suit filed against the company in January.

On a pro forma basis, net losses projected to be in the range of $5m to $7m for Q1 and $10m to $13m for the full year.

We project the business will reach a modest level of profitability in the fourth quarter of 2003.

The 2003 projections discussed do not include non-cash stock-based compensation of approximately $4m in Q1 and $16m for the full year. 2003 cash utilization is projected to be in the range of $16m to $18m with cash burn approaching neutral by the end of the year.

Cash balances at year-end are estimated to be in the range of $24m to $26m with no additional borrowings or draw-down of lines of credit.

Cash utilization for Q1 is estimated to be in the range of $6m to $8m as the business has the concentration of annual expenditures early in the year.

For 2003, day sales and accounts receivable are estimated to average 72 days, while capital equipment requirements are anticipated to be in the range of $4m to $5m for the year.

Beyond 2003 we have provided guidance that revenues were estimated to be in the range of $140m to $150m for a 40% growth for 2004 over 2003, and in the range of $220m to $240m for 2005.

Pro forma gross margins are estimated to be in the range of 60% to 64% and 65% to 70% for 2004 and 2005, respectively.

Pro forma net income for 2004 and 2005 are estimated to be in the range of 4% to 8% and 10% to 16% of sales, respectively.

Pro forma net income excludes approximately 6m and 1m of noncash stock-based compensation for 2004 and 2005, respectively.

At this time the company is not contemplating, nor does it appear we would require, additional equity or credit facilities beyond what is in place.

Let me turn the call back over to Tom for a few final words.

Thanks, Eldon.

In closing, we have made excellent progress in delivering the results we previously committed to.

We expect this commitment for solid execution to continue, and our goal is to achieve profitability and to build the business as outlined in the guidance you just received.

Our customers are enthusiastic supporters of Invisalign.

Their patients are thrilled to experience great results firsthand.

Our employees are deeply committed to turning this great opportunity into company performance and, for my part, I look forward to this company performance translating into shareholder value.

That's it for our prepared comments.

Now we'll take some questions.

Ladies and gentlemen, if you'd like to register for a question, please press the 1 followed by the 4 on your telephone.

You will hear a three-tone prompt to acknowledge your request.

If your question has been answered, and you would like to withdraw your registration, please press the 1 followed by the 3.

If you are using a speakerphone, please lift your handset before entering your request.

One moment, please for your first question.

The first question comes from the line of Bruce Jacobs with Deutsche Bank.

Your line is now open, please go ahead.

Thanks so much, guys.

Congratulations on the quarter and thanks so much for all the clarity on the revenue breakdowns.

It's very, very helpful.

If I could just ask, first, I guess, Tom, I'm just wondering if, as you add new trained GPs mainly -- I assume that's where most of the new docs are coming from -- is there a fairly predictable pattern in terms of how their case submissions go and then, perhaps, in the same context, can you talk about what your training expectations are for that channel in 2003?

Sure.

First of all, thanks for your comments.

We are happy to see our progress, but we still have a lot of work to do.

We have seen some increase in adoption by orthos.

A few additional docs coming in, but a lot of the growth as we defined was from GPs.

What I don't want to provide is kind of an absolute framework for looking at adoption cycle, but it does appear that the timeframe for first use after training and a timeframe for ramp is substantially more favorable than we experienced with ortho.

Again, you have to go back quite a long time here to look at this.

I think you could make the case that there's different behavior in the doctors, but I'd also like to make the case that the company is better at executing on helping that doctor get trained properly, get started properly in their practice with the right sort of expectations, and getting Aligners to patients so the whole process is much more crisp at the doctor's office as well as for the patient.

So all that said, the general adoption by GPs is two to three times faster than we've observed over any historical segment of time, post training with the orthos.

Okay.

Now, on the orthos, can you just -- obviously, one of the challenges has been convincing the general population about how robust the technology is.

Can you just talk about -- I guess it would probably have to be more anecdotal than anything, but any progress you're making on that front?

Please clear up that question, Bruce, for me.

Specifically with the broader population of [inaudible] --

[crosstalk]

-- with respect to their perception of the applicability of the technology.

Okay, for orthodontists?

Exactly.

Okay.

I think when the company first began, it tried to say the product could everything for everybody and overreached clinically.

We don't have to do that.

The markets we're addressing are so large that I think we're very comfortable to operate within a framework.

If one orthodontist says we're appropriate for 20% of the available market, and another orthodontist says it's 50, we can certainly work with that.

What we see happening very dynamically as doctors get more experience, finish cases more easily, and get great results, their comfort with the robustness of the technology and the approach, as well as the finishing techniques, really expands.

So you would get a very different answer from a doctor that has been doing this for two years on a range of cases than you would from a doctor that was just getting started.

So we accept the fact that's our responsibility to move doctors through that process, and we think, over time, that it will sort itself out but, fundamentally, we aren't trying to portray that Invisalign has to solve every problem.

It's a great addition to the armamentarium [ph] that they use to treat malocclusion and, frankly, that said, it's a little easier for them, then, to map this into the biggest part of the population that never gets to see them -- the adults and others that have mild, moderate malocclusion.

Great, okay, and a last quick question -- end-user pricing -- any changes of note there or is it pretty stable?

No, not really.

It's pretty much the same.

We do have some different product pricing, if you will, with a little bit of mixed shift to GP to simple cases, but the end-user pricing evolves a little bit based on the market dynamics.

Where there are more doctors that are trained and competing in Invisalign, they tend not to charge as great a premium relative to braces.

Great, okay.

Congrats, again, guys.

I'll jump back in queue.

Thank you.

Thanks, Bruce.

Your next question will come from the line of Duygu Akyatan with Bear Stearns.

Your line is now open, please go ahead.

Hi, congratulations on the great trends and very good results for the quarter.

I wanted to get a sense of how much in expenses have you now removed from the system as part of your cost-cutting restructuring efforts?

Have you reinvested some of this back in the business and what do you think the outlook on that front is for the next 12 months, and are you thinking about putting that back in the business again?

And also, can you give some thoughts on the advertising campaign?

You know, as you continue to drive growth, your views on that?

Thank you.

So let me maybe tee up the broader question, and I'll ask Eldon to come back to some specifics, and then after he's finished, I'll come back and talk to advertising specifically -- for direct-to-consumer advertising.

First, we, in total dollars in terms of taking cost out of the entire platform, if you looked at Q2 run rate spending and total cost base, we've taken somewhere in the neighborhood of $15m to $16m out of the company if you annualize that year-over-year.

So if I go back to Q2 of when I came in, 2002, compared to where we are today, that's about what we've taken out.

That is net of around $4m effectively that we reinvested from some of that takeout back into North American sales and marketing, where we've added somewhere in the range of 30 sales reps.

We have actually increased spending on some programs.

So, certainly, we think that was a good decision to make to continue to foster the ramp in revenue and adoption that we are now seeing.

We had some very early trends we were looking at back then that led us to that decision.

Maybe what I'll do is ask Eldon to speak specifically to spending rate and annualized view of that for '03, and then I'll come back and try and comment on direct-to-consumer advertising.

No, I think, Tom, relative to what you just pointed out, as I mentioned earlier that we're looking at our overall operating expenses in the range of $17m to $18m a quarter exclusive of any stock-based compensation, and it's going to be fairly consistent quarter to quarter.

We'll have a little bit of blips here and there, particularly in a quarter that's centered around where there's a major conference or major event.

So as Tom said, we did some reinvestment, particularly back in North America sales and marketing, but that spending is pretty much cast and will be fairly consistent point-to-point, quarter-to-quarter across the year.

There's not going to be any huge spike or huge ramp in our spending rates as we go from quarter-to-quarter throughout the year.

So back to the question around direct-to-consumer advertising, and I guess in the context of the expense question you asked, are we doing enough to make sure we continue to expand the business or are there any increments to spend required to continue to grow?

As Eldon just described to you, we are fully funded marketing programs to the extent we believe we need to, and I think in round numbers we will do approximately $7m to $8m this year in direct-to-consumer spending in advertising media.

Again, we do that during the year on national cable type spots, very cost-effectively, and because of that our cost-per-lead has come down pretty significantly.

So this spending level that we're discussing includes, still, a very significant percentage of spending on direct-to-consumer as well as a mix of other very significant professional spending on programs in channels in ortho and GP.

Thank you.

Sure.

Your next question will come from the line of Adam Galeon with JP Morgan.

Your line is now open, please go ahead.

Hi, guys.

Hey, Adam.

Congrats on all the progress on the expense lines and thanks for the level of detail.

I think you answered most of my questions already.

But, Tom, if I heard you correctly, it sounds like the number of submitting docs grew 50% in the fourth quarter from the third quarter and, like Bruce said, a lot of that probably came from GPs, but presumably the GPs -- I don't think you did a lot of training in the fourth quarter.

So why was the fourth quarter such an inflection point?

Are you doing anything now that you weren't doing before the quarter?

To answer that specifically and make sure we get the numbers right, the real big increase was from a year ago.

The total growth in docs submitting was up 800 total from 4,200 in the third quarter total to 5,000.

I think when you look at GP, it's much sharper, and most of that growth is coming from GPs.

The specific reason is that we did a lot of training, and we trained close to 5,000 -- 4,000 doctors, GP dentists, last year -- very few orthodontists, since most of that market had been reached and trained, for better or for worse.

So most of that growth and exposure came from training.

Again, we will train another 4,000 to 5,000 this year as well, and probably closer to 5,000, and so that's an important program and focus for us.

As I think I said earlier, the dynamics appear to be more positive, and I think having a GP dentist go through much more detailed training -- it's now two days instead of one day -- it's far more hands-on, and they will start their first case having much more experience and knowledge than, say, docs – [inaudible] dentists were or orthodontists were trained a year, two years, or three years ago.

So the training product has finally gotten far better.

When they do their first case, we make sure we have a sales rep with them there opening up the box, walking them through the process, kind of a fast start that we stumbled into as a bit of a best practice, and so we've put a significant focus on making sure that, from the time they open that box and start the first case, they are much more likely to have a successful outcome with the entire process.

So I think the number of new docs is -- there are so many cases -- absolutely tracks to the training of those GPs and then I think the increase in submission rates relative to time since training is a function, both of some maturity of the product in the marketplace as well as the company's gotten better at doing its thing.

Great, and one follow-up on pricing.

I think we all based our revenue models on a two-tier pricing strategy.

Is that still your strategy -- the single arch versus double arch?

That's correct.

Okay.

And nothing fundamentally has changed in our offerings picture, so far.

Okay, thanks.

Sure.

Your next question will come from the line of Wade King with Wells Fargo.

Your line is now open, please go ahead.

Good afternoon, it's actually Ed Shenkan filling in for Wade -- a quick question about clinical studies, gentlemen.

Do you have ongoing clinical studies to expand utilization for late adolescents and the more clinically challenging cases, and what would be the timeline for publication, maybe, you know, in journals?

Sure.

There are a whole -- first of all, it's a class one device in our framework, our regulatory framework does not constrain us from expanding the labeled use and indicated use.

We're very responsible about that, and as we seek to do that, we do that in all the right ways.

That said, we've got a large range of serious R&D [ph] going on and clinical development going on with some major centers around the country, including a major study at the University of Florida that some initial results have come out of very positively in a whole range of dimensions.

There are some compliance studies that were undertaken by the company and a range of other things to look at mid- and late-adolescent use for compliance and for other effects, and the results from those studies led us to introduce at our so-called "summit" last November in Las Vegas for a thousand or so of our largest submitting customers, a big conference we hold annually for them, to introduce this teen program.

And we're initially having very good success with that, and the anecdotal and broader clinical evidence is coming back that the compliance is going very, very well with those mature adolescents and teens.

So part of the problem with long-term clinical studies is they have to go on after maybe a two or three-year course of treatment would end and then have follow-up after that.

So there are a series of studies going on that we won't have final results on for a number of years, but in the meantime, there are lots of smaller-scale articles and journal kind of things happening that are giving clinicians comfort in moving forward with their own teen initiatives.

Is there anything coming up in the near term -- in the next quarter or two -- that we should be watching for?

You know, it's a great question.

In this industry there aren't really hinge points around clinical acceptance relative to clinical trials and R&D that there are in many other areas of medical devices -- interventional, cardiology, or stats or others.

The real issue is kind of this whole cycle of clinician, adoption, and then utilization and then expansion into more complex cases.

So we see, for example, rather than doctors deciding to change behavior based on a pivotal study -- in fact, we've done lots of studies and expected them to have big effects, and what doctors really want to see is their own firsthand experience.

So, in fact, the broader effect is just the large increasing awareness and experience and good outcomes that are being had by docs all over the country versus hinging, accelerating -- so -- in some ways it's better in some ways it's worse.

If we're going to get a great finding from an R&D study, that might accelerate things, but from my perspective, I'd rather have a business that's very organic, that grows in a very linear way, practice by practice, all around the country, all around the world, as doctors become more familiar, and they get more predictable results, and that's really what we're dealing with here.

Tom, thanks very much for your color [ph] and congratulations on a good quarter.

Sure.

Your next question will come from the line of Lenny Brecken [ph] with Brecken Capital [ph].

Your line is now open, please go ahead.

Thanks, guys.

I just wanted you to maybe run down the revenue breakout again for the quarter, and what was the -- you guys gave out an estimated operating margin for '04 or a net margin for '04?

Okay, Lenny, let me back up, and the first item is, I'll restate --

No, we're not going to use the word "restate" here.

All right -- I will repeat -- no pun intended -- I will repeat Q4.

Our Q4 net revenues were $22.4m for the fourth quarter of 2002, and what I stated there, Lenny, on the breakdown, was 14.9m for U.S. ortho; 2.9m for U.S. GP; and $2.1m for international; with the remainder being training and other miscellaneous revenues at $1.6m.

Now, for next year, the margins that I stated -- I'm assuming you're alluding to gross margins --

-- I think he was looking at operating margins or maybe both.

Well, let me repeat both -- if we back up and take a look at 2003, again, I stated that revenues were in the $100m to $105m range, and I stated that gross margins would be in the 51% to 53% range for Q1, and the 59% to 61% range by year end and, for the full year, 55% to 57% for the full year.

Now, that's on a pro forma basis, gross margin.

What I stated from the standpoint of total --

I was actually just looking for '04 -- what the gross margin and operating margin, if you gave guidance, what it was?

I'm sorry, Lenny, I thought you were alluding to 2003.

What I stated for 2004 on revenues in the $140m to $150m range was looking at pro forma gross margins estimated in the range of 60% to 64% for 2004.

Those are operating margins or net margins?

What I stated then for on a net income basis, again, on a pro forma basis, was in the range of 4% to 8% -- that would be profit.

All right, the reason why I asked is the revenue breakout again -- your revenue guidance is essentially sequentially flat, and what did you do, about 14.4 in ortho last quarter? 14.6, roughly -- and that would -- so I'm trying to ask whether you're being conservative, because you haven't had a flat quarter in your company's history, revenue-wise -- well, you had, but that was sometime in '01.

But in recent, you've been ramping your revenues consistently, and I'm just curious to see, one, why the ortho this quarter was quasi-flat and, going into next quarter, whether you were being conservative in assuming that the revenues are going to be flat sequentially?

I'm going to try as best I can to answer it.

We actually had solid growth in ortho quarter-over-quarter, Q3 to Q4 of this year.

We had indicated, in some prior guidance, that we expected to have not dramatic growth in Q1, this quarter we're in now, simply as a function of the way the pipeline works, the way that many of our doctors' offices shut down around Christmas, and the total days available for receiving cases, if you will, based on our doctors' practices, are constrained.

So if you think of it, cases we're receiving after the first week or so of December are really feeding the January shipments.

So we've tried to set reasonable expectations.

To get dramatic growth in Q1, we would have to have outstanding growth in per-day-received case growth.

We're showing a very solid case growth per day of received solid growth in average cases per received for business day in Q1.

But on a total basis, as we've built the year with that seasonality, we aren't expecting significant -- really big growth -- from Q4 total revenue to Q1 total revenue, and that's what we've described.

But the company has had a few unhappy surprises in the past, and so I wouldn't say we were being conservative, I'd say we're trying to articulate the right business plan and execute it well.

So let me just ask specifically -- I don't know if you'll disclose it -- what was the ortho number sequentially?

We didn't describe that in Q3.

We're trying to start to lay out a framework for breaking out lines of business, but we're not going to go back and do that historically.

All right.

Thank you very much.

Sure.

Was it up more than 5% sequentially?

What I would say is it was up very, very nicely.

All right, thank you.

Thanks, Lenny.

Your next question comes from the line of Bob Plevia [ph] with RJJP [ph].

Your line is now open, please go ahead.

Thank you.

Could you give us some breakdown on sales reps -- U.S. ortho, U.S.

GP, international today, and what you plan on in '03?

So let's again focus on North America here, not outside the U.S.

We have approximately 30 sales reps plus a small management structure supporting U.S. ortho, and we have approximately 30 sales reps in our GP dentist space again, plus a small management structure in the U.S.

And we may expand on that a bit piecemeal, but we think, for the time being, we've got the right focus, the right coverage, and the right support.

So we don't see significant increases in spending or support costs to make that work.

International?

We've not really described international in any significant detail because, A) I think, as Eldon described before, our view is it's significantly under 10% of our total revenue and, B) we've just gone through a very, very significant resizing in virtually all of our geographies so that -- let me just say that our focus has been on preserving feet on the street in every geography, while we really sought to streamline infrastructure and G&A elements of that spending, but we -- I don't think at this point in time, it's real meaningful for me to go into any detail about our international footprint in terms of sales force.

And how many additions were there in the fourth quarter?

To our U.S. sales force?

Yes.

We basically went from -- if I go back a bit further, to Q3, we had to go in a hurry and put a sales force in place in GP.

We had nobody out covering those customers after the termination of a distribution agreement we had with a former distribution partner.

So we had to move very quickly.

The first time those people actually were together, we had a group of about 15 that were able to hit the street but I would say not at significant productivity in mid-July.

We were able to get them up to reasonable productivity, I would say, by about the end of the third quarter, and we layered in roughly another 15 between the end of the third quarter and the beginning of the first quarter now.

So we now have 30 GP reps.

We've added one or two ortho reps to round out the team but, again, we believe we're deployed about right in North America, and that's part of the reinvestment we made in North America along with some investments in the professional channels to support that effort.

In looking at your R&D numbers, they seem to be flat to down.

What's your thinking there in the future?

Our business is actually -- R&D is captured in a couple of places here.

We actually have technology development that develops tools and systems for manufacturing and automation, and then we also have R&D, which includes clinical.

We have decided to be flat, and we took most of that structural cost out in July when we made those changes in Santa Clara and the rest of the company.

We are continuing that basically flat into next year, and I think, as we made choices about our focus and what we were going to do in the next 12 to 18 months.

And ultimately then announced that back in July, we agreed on a game plan, we agreed on the scope of the resources necessary to support that, and then we made sure those were in place.

That's what we've got now.

So that still is a fairly robust spend in terms of clinical trials, professional research and support, clinical development and a whole range of tools and automation systems to support the manufacturing process.

What I would say, as we become profitable late this year and into 2004, is we will look at reinvesting some of that profitability in small amounts, and taking the whole level of automation and productivity of the enterprise to the next level.

But I think our view is that we will talk about that in the future.

Bob, one thing I would also add to what Tom said is, you know, if you're looking year-over-year at research and development spending and see it go down, from those two points we also reduced some redundant engineering activities in the Middle East that are fundamentally were still covering the same waterfront in the business, but when you look year-over-year that's primarily -- the drop is primarily driven by the elimination of some R&D resources out of the Middle East that we cover in the business here in Santa Clara now.

In terms of the Ormco suit, do you have any idea of a schedule and have you -- did I miss something in terms of a reserve?

Let me just comment in very, very general terms on your specific question, and I guess as a general matter of policy, I'm not going to comment in any detail about any litigation we have.

I'll ask Roger George to probably repeat that refrain.

The only comment we made specifically was that we had, in our spending plan in our op-ex for '03, had incremented a bit more in G&A to cover the cost for that.

Specifically, we didn't talk about any reserves or anything else, but I'd like Roger, maybe, just to comment, as I did, on that.

Sure.

Just to follow up, and we don't comment on the content or the state of negotiations in any litigation.

With respect to schedule, no schedule has been set yet.

The complaint was only filed recently, and we have yet to file an answer and our counterclaim.

So that's about as far as we'd like to go there, is that fair?

Good.

Did you mention some numbers that you put in the G&A for the reserve?

No, we did not.

We just indicated that we put a little bit of an uptick in the G&A for that.

Okay, thank you very much.

Ladies and gentlemen, as a reminder, to register for a question, please press the 1 followed by the 4 on your telephone.

Your next question will come from the line of Lenny Brecken with Brecken Capital.

Please go ahead with your follow-up.

Hey, guys, can you give us some idea what your incremental operating margin on a dollar of revenue is?

Say, we look at -- what your revenue base -- so your expense base is pretty stable.

You know, sometime in the second half of next -- either second half of this year or next year, what would a dollar of incremental revenue mean -- how much of that would drop to the bottom line?

I think I'll let Eldon answer that, and I'm not so sure we want to get into much of detail, Lenny, but I'll dish it to him.

Lenny, from a standpoint of as we go farther -- obviously as we go farther in the year, into 2003 and beyond, we'll generate and drop at an accelerating rate more to the bottom line.

That's going to be driven by our growth in revenue, our efficiencies at the gross margin line, and restraining our operating expense.

As far as a specific percentage, I'm not going to call one out.

All right, but it seems like a lot of your operating expenses are pretty much fixed.

There's not a lot of variable in there.

Well, as I stated, as we go through 2003, our intent is to manage our operating expenses within a reasonable bound, and we don't see a significant uptick in our operating expense spending as we go through the year.

We're going to try to manage them smartly, and as far as improved contribution margin, then, as revenue grows and our efficiencies in manufacturing kick in, and we drop more margin to the bottom line that way, then that's a key driver to improvement in the business.

How much did -- this is follow-up on my prior question on seasonality -- how much was seasonality affecting the revenues this quarter?

I can't see a lot of kids going into -- if your age group does have some teenage factor, given with the school schedule, I can't see a lot of them going for this kind of product in November, either.

So I think the way we'd react to seasonality in very general terms is that there are a couple of very broad effects for young children, and those broad effects are that, in general, there are more cases started in the summer months when parents and kids have more time.

It's a general trend for kids.

Again, we don't treat young kids -- we don't treat adolescents unless they have mature, fully emergent dentitian [ph], and so that ranges on what age that might be based on the child and their relative maturity and size and all that stuff.

But the practical matter is we are less affected by that trend -- and the seasonality I spoke about a few minutes ago, was really a function of the holidays and the days that orthodontists' offices were open.

Many of them shut down their office for two weeks during the holidays because a lot of people don't want to go in during that period of time, anyway.

So having them open doesn't bring them much.

So, again, that's the seasonality that we spoke about, specifically relative to the number of days available from our customers' perspective, and it usually has a little bit of an effect in Q1.

At a rate level, we're very, very comfortable with very significant, very solid continuing growth, but the way we built our business plan was to take into account those fewer days of practice over the holidays for our customers, because that's what drives our business.

And that's why I think, to an earlier question, we indicated there wasn't dramatic growth from Q4 to Q1, but that we're seeing very solid progress.

Again, I'm not going to comment on Q1 other than the framework we've already provided for Q1 and the year.

Give me some idea of what your caseload is in the 22 years of age and younger.

Right now we're not prepared to do that.

Again, we have just started our teen initiative, but until just recently, virtually all of our cases were very late adolescents or young adults and adults.

So the teen initiatives are all very new, and we're not quite prepared to start either, A) declaring success or, B) defining that as a separate segment.

Okay, thank you.

Sure.

Your next question will come from the line of Shakura Basu [ph] with Greenberg Healthcare Partners [ph].

Your line is now open, please go ahead.

Thank you.

Can you just comment, Tom, about the per-doctor usage rates, quarter-to-quarter?

And, I guess, a follow-up on the question that was discussed on seasonality.

I guess the second and third quarters of the year would be stronger, right?

Well, sure.

There's a couple of things -- again, seasonality -- if we were chasing all the young children that were getting started, the best time, from a parent's perspective, is to get them started when they have the hours available to get those cases set up, is in the summer when they're on vacation.

That generally -- as I think I was saying -- that was a broad trend for orthodontics, not so much a trend that Align has been dealing with, because we have been treating mature teens or young adults and adults.

We really haven't commented specifically on per-doctor utilization.

What I would say is the following -- is in our ortho market, again, we're still very new in the GP market, we're not prepared to -- given the significant dynamics there -- again, we've already laid out substantially more detail for the business than this business ever has.

I think we're committed to continuing to report on that, but I think, in general, what we could say is that we continue to see a profile that says roughly 65% of our revenue in ortho comes from 35% of our customers, and so that pattern just -- that whole pattern is growing vertically and, generally, you could say, across the board those doctors are increasing their utilization.

We see people, regardless of what their level of monthly volume is, generally continuing to grow that volume across the board.

Again, I'm not prepared to start commenting on that, and, as a model I know that would be useful to you, but we're still pushing on it.

So that's about where we go there.

I'm sorry -- a quick question -- a follow-up -- you mentioned that you gave guidance for '03 revenue.

You mentioned the first quarter.

Fourth quarter was slightly flat or whatever.

I'm just wondering, given your projections for the first quarter, what do you have in mind?

At what point would you look at the first quarter and start cutting operating expenses even further?

Or do you wait until the middle of the year to make that decision?

No, first of all, your specific question, we did provide a framework for Q1 results, and we don't expect Q1 to be down, but we provided a range of potential outcomes for Q1 that we're in now, and understand, again, that we see -- by the time we do this call now, we're well into half to two-thirds of our quarter in terms of pipeline.

But the practical matter is, we are projecting very, very significant growth for the year.

We're reflecting, in our business, we see significantly increasing utilization and increasing cases received for business day.

We are reflecting -- the only change in Q1 that would look to be less significant growth from the Q4 we just ended at 22.4 would be a fact that there are probably 4 to 5 fewer business days on the front end of that quarter that would lead to shipment volumes in this quarter we are in now.

So that's not a function of fundamental demand or utilization, it's a function of days that our customers have their doors open.

So, again, to your second part, that if the top line doesn't happen, how long do we wait?

I'm not going to speculate, but understand that we build a very tight business plan, and the whole team agrees on what the elements of that business plan are, and we monitor it daily, weekly, monthly, so that any changes that would have to be made is increase resources to support even more substantial growth than we talked about or to deal with the consequences of less growth than we were forecasting.

We're committed to the overall framework of this business plan, and we expect we can deliver on it.

Thank you.

Your next question will come from the line of Brian Horay [ph] with -- I’m sorry -- Averline Partners.

Your line is now open, please go ahead.

Hi, it's Aurelian [ph] Partners.

I have two questions.

Can you give -- I'm new to your company, so forgive me if these are elemental.

Can you give me some sense as to what you think is the population of total doctors in the two segments are that are reasonable prospects for your business?

Sure, welcome.

We have talked before, and I think there's a presentation on our website that may still be there after a recent investor conference, but we've talked before about the U.S. orthodontic population is in the neighborhood of 8,000 -- 8,800.

We have trained most of those doctors, roughly 7,700 of them, and around half of those doctors have submitted cases.

In the U.S.

GP dentist space, it's much larger and -- let me step back for a moment.Of that orthodontic population, we would love to imagine that all of them would do at least some Invisalign, but I think our view is, in the near term, to spend our resources and energy trying to increase utilization over the doctors that are submitting and using the product versus trying to get the other, roughly 50%, of those orthodontists that haven't currently adopted it into practice.

As far as GP dentists, we're just getting started.

The total population is roughly 120,000 GP dentists in North America, and I don't want to speculate on what kind of terminal point for adoption might be but, again, it's both an important channel for us for its own revenue.

We're approaching that channel differently from the orthodontists, but in a complementary way, and our goal here, and our belief is, that will be the most cost-effective way to drive strategic category growth in the overall market, long term, because the average GP has 1,500 to 2,000 patients in their practice, and they see those patients once or twice a year at least.

And our hope is, rather than having to spend very large sums of money on direct-to-consumer advertising, to help those customers take action and go seek advice from an orthodontist, we would rather have their trusted professional GP dentist give them advice about opportunities for treating malocclusion and be better able to recognize that malocclusion.

Our goal is that GP -- well, first of all, we're obligated to train about 4,000 to 5,000 GP dentists a year -- 5,000, I guess -- and for the next three or four years, based on some litigation that was held several years back before I got here, and we're going to continue to do that, and our hope is that -- and our belief is that they will do simple cases and then refer anything but a simple case to the orthodontist and, in fact, where we've piloted this, we've seen referral rates to the orthos in the area that are working with those GPs go up very, very significantly.

So I think this is the best way to get the 70m or 80m people out there in America that have malocclusion -- mild or moderate malocclusion -- that see their dentist regularly, that see their oral healthcare professional, engaged in orthodontics, because only about 2m of those people, and that includes roughly 50% of those are young kids, seek orthodontic treatment a year.

So it's the whole orthodontic treatment model is dramatically under-penetrated into what's possible in the population.

Okay, and how many of the GPs have you trained to date?

We've trained just a bit over 5,000.

I think about 5,300 with the 300 we trained in January, roughly.

So, again, we are just getting started there, and we've got a lot of work to do.

Okay, and one last question on this topic -- is there a substantial difference in revenue per case between orthodontists and the GPs?

Not dramatic, no.

Okay.

Okay, my other question was -- you gave some net income margins for '04 and '05.

Can you talk about what kind of tax rate is assumed with those margins?

In 2004, fundamentally, the tax rate is very, very small, and that would be just any marginal taxes that might pop out of foreign entities.

Obviously, if you look back at the history of our business, we have a good-size portfolio of carry forwards to work off, and as far as 2005, there are some taxes that we put into those numbers, primarily related to the foreign entities where we might start paying some taxes.

So net-net, 2004 is practically nil and 2005 it would be a small amount, but it would only be related to the international side of the business, because, again, we would be working off of carry forwards in the U.S.

So it was a 5% to 10% tax rate in terms of order magnitude, is that a fair assumption?

It wouldn't be more than that.

Okay.

All right, thanks very much.

Sure, you bet.

Thanks for your interest.

Ladies and gentlemen, as a reminder, to register for a question, please press the 1 followed by the 4 on your telephone.

Gentlemen, I am showing no further questions at this time.

Please continue with your presentation or any closing remarks.

Thank you, Operator.

Well, once again, thank you all for your interest.

It's late in the day, especially back East for participating in this conference, and we're committed, as I said earlier, to continuing this progress, and we look forward to coming back and reporting to you on that progress next quarter.

Thanks again.

Talk to you soon.

Ladies and gentlemen, that does conclude your conference call for today.

We thank you for your participation and please ask you to disconnect your line.