愛齊科技 (ALGN) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Align Technology Second Quarter 2003 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 "1" followed by the "4" on your telephone.

As a reminder, this conference is being recorded, Thursday, July 24, 2003.

I would now like to turn the conference over to Barbara Domingo, Director of Investor Relations.

Please go ahead ma'am.

Thanks, Irene.

And welcome to everybody on the line.

If you haven't received the copy of our press release, please go to the investor relations page on our website at www.invisalign.com.

Before we start the call today, I would like to make some comments on forward-looking statements.

During this conference call, we may make some forward-looking statements relating to Align's expectations about future events or future results.

Any forward-looking statements we make during this conference call are based upon information available to Align as of the date hereof.

Listeners are cautioned that these forward-looking statements are only predictions and are subject to risks and uncertainties, and assumptions that are difficult to predict.

As a result, actual results may differ materially and adversely from those expressed in any forward-looking statement.

Factors that might cause such a difference include, but are not limited to risk at better detail from time to time in a live periodic report filed in the Securities and Exchange Commission, including, but not limited to, it's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, which was filed with the Securities and Exchange Commission on March 27, 2003, and it's Quarterly Reports on Form 10-Q.

Align undertakes no obligation to revise or update publicly any forward-looking statements for any reason.

Please also note, that on this conference call, we will provide listeners with several financial metrics determined on a non-GAAP basis, which in the past we referred to as pro forma financial measures.

Most of these items together with the corresponding GAAP numbers in a reconciliation to the comparable GAAP financial measures where practicable, are contained in today's financial results press release, which we have posted on our website at www.invisalign.com, under corporate information, investor relations, earnings press releases, and have [inaudible] to Securities and Exchange Commission on Form 8-K.

We encourage listeners to review these items.

Additionally, we have posted both GAAP and non-GAAP revenue model, which include the effects of Align's planned restatement of it's financial results for fiscal 2001, fiscal 2002, and the first quarter of fiscal 2003 and the recorded second quarter 2003 financials on our website at www.invisalign.com under corporate information, investor relations, financial history.

Please refer to those downloadable excel spreadsheets for more detailed line item information.

With that said, I would like to introduce Align Technology's President and CEO, Tom Prescott.

Tom.

Thank you, Barbara.

And thanks to our shareholders and friends who are listening in today on the phone and our website.

We have made some significant announcements today and I would like to make sure we have sufficient time to discuss everything, still have time for Q&A.

As we did last quarter, I'll first talk about some of our operating metrics, Eldon will discuss our financials, and I will come back and comment on our accomplishments last quarter and our plans to the near future.

We are very pleased with progress have continued to be intently focused on delivering the business goals we laid out in prior calls.

Behind the numbers, we continue to focus on helping our customers deliver great result to their patients.

Our goal is to become a most important part of their practice.

We will accomplish that and ultimately build a great company as we develop the capabilities to be operationally excellent.

While we have still much to do, our results should indicate that we are on the right path.

As you note in our press release, the reported record revenues this quarter of $29.2 million.

An increase of 27% over last quarter, an increase of 86% over the same quarter last year.

Additionally due to very solid operating fundamentals and good asset management, we.

We reported our first quarter of positive cash contribution.

This was a great quarter for us, despite the negative effects of our plant reallocation and restatement of revenues between the accounting periods.

Just to give you a quick background, since Eldon will go into more detail momentarily, we will be adjusting the timing of the recognition of approximately $9 million in net revenues associated with sale of case refinements about or what many customers called detailing or finishing which would occur at the end of each case.

The restatement will reallocate revenues from fiscal 2001, fiscal 2002, and the first quarter fiscal 2003 to remainder of 2003 and fiscal 2004.

Let me emphasize this is simply summary of reallocation of revenue and profits from prior to future periods.

At the end of day, if the total revenue that we will realize in the sale of case refinements remains the same.

Additionally, this reallocation restatement will in no way affect our cash balance or cash flows.

As demonstrated by our solid second quarter results, which came well within our guidance even incorporating this change in account practice.

Our business fundamentals continue to strengthen as we drive towards profitability.

Naturally, our business model will continue to evolve as our market expands over the coming years and we will continue to respond to these changes in proactive, yet financially conservative manner.

This is what our customers and investors expect from us.

The national team has committed to doing the right thing for all of our constituents.

With that said, let me take you to give some key operating metrics.

We saw revenue increase in both our US authorized and GP, dentist customer channels.

The Ortho channel increased 17% from last quarter with revenues of 17.3 million over GP channel generated revenues of $6.8 million an increase of 47% from last quarter, 59% of total revenues came in from orthodontist.

During the second quarter of 2003, we received cases for approximately 18,000 new cases - we received orders excuse me put for approximately 18,000 new cases on an average of 282 cases per business day and we've shipped just over 17,800 cases to customers during the same period.

These cases include the backlog we experienced in Q1, as we described in our previous conference call.

We work diligently to balance the backlogs from the first quarter early in the second quarter and were able to bring our orders and shipments and cycle time back to a normal balance.

Eldon will discuss this in detail shortly.

Shifting gears, I'd like to share some case volume and channel statistics with you.

Approximately 6000 doctors worldwide submitted cases during the second quarter compared to 5500 last quarter.

The number of orthodontists in submitting cases were up slightly to 3450 orthodontists from 3300 last quarter and almost 2600 GP dentists submit cases compared to 2200 last quarter.

Additionally, they have been trained and certified almost 1300 new GPs in the second quarter, bringing our base of certified GPs in North America to over 7400.

Year-to-date, we have trained approximately 2100 new GPs against our goal of training approximately 5000 GP dentists in 2003.

At this point, I'm going to turn the call over to Eldon Bullington, our CFO.

Eldon will discuss the financials and provide guidance for next quarter as well as the fiscal year 2003.

After Eldon, I'll come back and talk about a few other significant achievements during the quarter, and then we'll take some questions.

Eldon.

Thanks, Tom.

We've a lot of ground to cover today, but before I get started, let me outline what we will go through.

I will first give you some background on the Case Refinement Revenue Reallocation and Restatement and the accumulative effects of the reallocation.

We will then go through our financial results for the second quarter on a GAAP and non-GAAP basis.

To give you a better understanding of our growth and business performance, and to give you basis on which to compare previously reported financials and we'll also provide the effect of the restatement on the financials and the results that we would have reported had it not been for the revenue reallocation.

I will then cover the balance sheet and I'll complete my discussion with some guidance for upcoming periods.

I have a lot financial data to go through so please bear with me.

Also as a reminder, we had posted a 10 quarter financial model for both GAAP and non-GAAP financials on our website at www.invisalign.com in the investor relation section for you to refer back to if you miss any these numbers.

Also our Second Quarter Financial Results press release and in 8-K filing of the same document are available on our website.

So before we get into the financials, let me begin with some background on the reason for Align's planned restatement and the related amendment of our 2002 10-K and our first quarter 2003 10-Q.

Align will implement reallocation of revenues and restatement of our financial statements on the basis what are known as case refinements.

As you may know a case refinement is needed when aligners are prescribed by clinician in the later stages of a case for patients needing tooth movements beyond the original prescription.

On May 1st, we initiated the new pricing structure for our case refinement product.

The price for case refinement is now included in the overall price of each case that is sold.

This new pricing structure was implemented as the result of feedback that we've received from doctors in the current market with similar finishing product offerings in the frequency of case refinements being ordered by clinicians.

Before the implementation of this new pricing structure, we do not include a case refinement in the price of each case sold.

We charged for case refinement separately. $50 of the case refinement was purchased at the beginning of the treatment period in $250 it was purchased during the course of treatment.

Accordingly, we differed $50 in revenue and accrued any anticipated losses related to the cost, producing and delivering each case refinement that was purchased at the beginning of the treatment period.

The $50 in revenue was differed until the refinement was utilized or upon case expiration.

Since the case refinement product was established in June of 2001 and this two tier pricing structure was adopted, sales of case refinements in utilization by clinicians have been higher than anticipated when the accounting treatment for the differed revenue associated with the case refinements was originally determined.

We reviewed our new pricing structure to ensure proper accounting and compliance with newly adopted rules under EITF 00-21 governing the fair value of revenue in multiple element arrangements.

In conjunction with this review, we re-evaluated the accounting principles contained in SAB-101 as they applied to our previous two tier pricing strategy.

As a result of this reevaluation it was determined the revenue that should have been differed in prior periods was $250 for all refinement orders rather than the $50 charge for the case was purchased at the beginning of the treatment.

Our restated financial statements will reflect this appropriate deferral amount.

The impact of the restatement reduces revenues in fiscal 2001, fiscal 2002, and the first quarter fiscal 2003 by 1.6 million, 5.7 million and 1.8 million respectively.

Conversely revenues will increase by 4.1 million in the second half of fiscal 2003 and will increase by 5 million in fiscal year 2004.

With that said let me move on our quarterly financials, I will first discuss results on a GAAP basis, followed by a non GAAP summery.

As Tom mentioned net revenues for the second quarter of 2003 increased 86% to 29.2 million from 15.7 million for the same quarter one year ago and increased 27%, sequential from 23 million in the first quarter of 2003.

Prior to the case refinement revenue restatement, net revenue would have been 30.2 million for the second quarter of 2003.

An increase of 75% over previously reported revenues for the second quarter 2002 of 17.3 million.

And an increase of 22% over previously reported first quarter 2003 revenues of 24.7 million.

As Tom briefly mentioned second quarter revenues were positively impacted by the balancing of caseload from backlog we saw in the first quarter.

As we discussed on last quarters conference call, we had a backlog in some cases due to the higher incidence in promotional cases in May 2002 and early 2003.

We worked through this backlog early in the quarter, and this contributed to the sequential growth we are reporting this quarter.

Second quarter revenues by segment were 17.3 million for US Ortho, 6.8 million for US GP, 3.2 million for international.

These channels represent 59%, 23%, and 11% of revenues respectively.

Worldwide training and other revenues were 1.9 million for the quarter.

Revenues prior to the case refinement revenue re-allocation, second quarter revenues would have been 17.7 million for US Ortho, 7.1 million for US GP, 3.5 million for international, and 1.9 million for training and other revenues, bringing total revenues prior to the revenue re-allocation to 30.2 million.

As we expected, we saw the highest rate of growth in our GP channel consistent with the growing base of trained and submitting GP clinicians.

Total case shipment volume as Tom mentioned for the first quarter was approximately 17,800 cases.

A 16% increase over the 15,400 cases we shipped in the first quarter of 2003.

Gross profit for the second quarter of 2003 as reported under GAAP was 16 million or 54.6% of revenue compared to 5 million or 31.7% revenues for the second quarter of 2002.

Sequentially, this compares to a gross profit of 11 million or 48.1% of revenues for the first quarter of 2003.

This increase in gross margin is primarily attributable to the continued benefit of cost reduction initiatives and improved fixed cost absorption related to increasing volumes.

Despite, the negative impact of approximately 400,000 or 1.5 margin points due to the charge for used tax on production materials resulting from a state tax audit during the course.

Prior to the case, refinement revenue restatement gross profit for the current quarter would have been 16.5 million or 54.6% of revenue.

This compares to previously reported gross margin of 6.5 million or 37.6% of revenue in the same period of a year ago and 11 million or 48.1% of revenue last quarter.

Total operating expenses reported under GAAP were 24.1 million for the second quarter of fiscal 2003 compared to 25.2 million for the same quarter one year ago and 21.5 million in the first quarter of 2003.

The re-allocation of case refinement revenue does not affect operating expenses.

Operating expenses for the second quarter include charge of 1.4 million -- in connect with sale -- in connection with sales tax for which the company decided not to pursue collection from its customers.

The company discovered during the quarter, the customers sales tax was not withheld in several states rather than collecting the tax withholding in the current period and risking damage to customer relations in future business potential, t.

The company made the decision to incur the liability on behalf of the effected customers.

Additionally, approximately 1 million in expenses were incurred during the quarter related to our participation in the annual AAO conference held in May of this year.

These items were the primary drivers of -- operating -- operating, expense, growth between the first and second quarter of this year.

Net loss for the second quarter as reported under GAAP was 7.8 million or 13 cents per basic and diluted share compared to a net loss of 20.3 million or 44 cents for basic and diluted share for the same quarter one year ago and a net loss of 10.7 million or 19 cents for basic and diluted share for the first quarter of 2003.

Prior to the case refinement revenue restatement, net loss would have been 7.2 million compared to the previously reported net loss of 18.8 million in the second quarter of 2002 and 8.8 million for the first quarter of 2003.

Prior to the case refinement revenue restatement net loss for basic and diluted share would have been 13 cents, 40 cents, and 15 cents for the second quarter of 2003, second quarter of 2002, and the first quarter of 2003 respectively.

Now, let me take you through the results on a non-GAAP basis.

Non-GAAP financials differ from GAAP financials in that we exclude the effects of non-cash stock based compensation from cost of revenues and operating expense.

The reconciliation of these non-GAAP financial measures with the comparable GAAP financial measures is included in our financial data for the second quarter of fiscal 2003 which are included in the earnings release attached to the Form 8-K we filed with the SEC earlier today.

Total stock-based compensation for the second quarter of 2003 was $4.4 million.

Non-GAAP gross profit for the second quarter of 2003 was in line with our pre-restatement guidance of 16.6 million or 56.9% of revenue compared to 5.8 million or 37.2% of revenues for the second quarter of 2002.

Sequentially, this compares to gross profit of 11.8 million or 51.2% of revenues in the first quarter of this year.

As previously mentioned, gross profit in the current quarter deeply impacted by $400,000 or 1.5 margin points due to a charge for used tax on production materials, resulting from the state tax started during the quarter.

Prior to the case, we find the refinement revenue restatement, non-GAAP gross profits would have been 17.2 million or 56.8% of revenue compared to previously reported non-GAAP gross profits of 7.3 million or 42.6% of revenues in the second quarter of 2002.

This also compares to previously reported non-GAAP gross profits of 13.6 million or 55.2% in the first quarter of 2003.

Non-GAAP gross profit for the second quarter of 2003 excludes $700,000 of stock-based compensation.

Non-GAAP operating expenses were 20.5 million for the second quarter of fiscal 2003 compared to 20.2 million for the same quarter one year ago and 17.5 million for the first quarter of 2003.

Non-GAAP operating expenses for the second quarter of 2003 exclude 3.7 million of stock-based compensation.

Non-GAAP operating expenses for the quarter were approximately 1.5 million -- higher than the previous -- higher than our previous guidance, due primarily to the previously mentioned 1.4 million sales tax issue.

Non-GAAP net loss for the second quarter was in line with our guidance at 3.4 million or 6 cents per basic and diluted share, compared to a net loss of 14.5 million or 31 cents per basic and diluted share for the same quarter one year ago and a net loss of 5.9 million or 10 cents per basic and diluted share for the first quarter of 2003.

Non-GAAP net loss for the current quarter included 1.8 million for the previously mentioned sales in use tax matters.

Prior to the case refinement revenue restatement, non-GAAP net loss for the second quarter of 2003 would have been 2.9 million or 5 cents per basic and diluted share compared to previously reported net loss of 13 million or 28 cents per basic and diluted share in the second quarter of 2002, and compared to the previously reported net loss of $4 million or 7 cents per basic and diluted share in the first quarter of 2003.

Shifting to the balance sheet; cash, cash equivalence, and marketable security for the end of the second quarter was 38.4 million compared to 37.3 million at the end of the first quarter of this year.

An increase of 1.1 million compared to cash burn of 4.2 million in the first quarter of this year.

Our cash performance for the second quarter was substantially better than expected primarily due to cash collections.

Day sales outstanding improved from 62 to 55 days between the first and second quarter.

I will discuss our forward-looking view of cash in a minute.

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

Our forward-looking view is discussed on an as restated basis, which includes the case refinement revenue reallocation.

I will highlight the impact of the revenue reallocation by relevant category.

Q3 revenues are projected to be in the 32 million to 34 million range.

Ortho channel, GP channel, and international are expected to comprise 57%, 27%, and 11% of Q3 revenues respectively.

The remaining 5% approximates training and ancillary product revenues.

Case shipment volumes are projected to be in the range of 18.8 to 20,000 cases.

Included in Q3 revenue is approximately 1.9 million of additional revenue related to the case refinement revenue reallocation.

Q3 gross margins on a GAAP basis are projected to be in the 58% to 60% range.

We project the gross margins will include approximately 600,000 of stock base compensation charged to cost of revenues.

Excluding the projected stock-base compensation, gross margins on a non-GAAP basis are projected to be in the range of 60% to 62% for Q3.

Operating expenses on a GAAP basis are expected to be in the 22 million to 23 million range for Q3.

On a non-GAAP basis, operating expenses, which exclude projected stock base compensation of approximately 3 million, are expected to be in the range of 19 million to 20 million for Q3.

GAAP net loss, which includes stock-based compensation is expected to be in the range of 3 to 5 million for Q3, while non-GAAP bottom line performance for the quarter is projected to be in the range of break-even to a loss of 2 million.

Q3 net losses reduced by 1.9 million related to the case refinement revenue adjustment previously mentioned.

For the full year of 2003, we are increasing our revenue projection to the range of 116 million to 120 million, which includes 1.3 million increase on a net basis related to the case refinement revenue restatement.

The orthodontist channel, GP channel, and international channel are expected to comprise 59%, 25%, and 11% of 2003 revenues respectively.

Case volume is projected to be in the range of 69,000 to 73,000 cases for the full year.

On a GAAP basis, gross margins are expected to be in the range of 60% to 62% by year-end and are projected to average 55% to 57% for the full year based on projected revenue levels.

Correspondingly, Non-GAAP gross margins, which excludes stock-based compensation charge to cost of revenues, as noted earlier, are projected to be in the range of 61% to 63% by year-end and are projected to average in the range of 57% to 59% for the full year.

Included in full year gross profit is an increase of approximately 1.7 million related to the case refinement revenue restatement.

The incremental gross profit related to case refinement revenue reallocation improves margin performance by approximately 1.3 points.

For the full year, 2003 operating expense on a GAAP basis is expected to be in the range 88 million to 91 million.

GAAP net loss is projected in the range of 21.5 million to 24.5 million including the benefit of the 1.7 million related to case refinement revenue restatement.

Full year non-GAAP operating expenses, which exclude stock-based compensation and restructuring charges are projected to be in the range of 74 million to 77 million.

Increased operating expense guidance since our Q2 call results primarily from the previously mentioned 1.4 million sales tax matter recorded in Q2 and anticipated increase in legal expenses related to existing litigation matters of approximately 1.3 million and additions to our GP sales force.

For the full year, non-GAAP net loss is projected to be in the range of 6 million to 9 million including the impact of the aforementioned 1.7 million case refinement restatement impact.

Full year non-GAAP projections do not include stock-based compensation of approximately 2.2 million charged to cost of revenues, 13 million charged to operating expense and 500,000 of restructuring cost charged to operating expenses.

Consistent with guidance given last quarter, we're projecting to achieve non-GAAP profitability during the fourth quarter of this year.

Projected full year net loss will be reduced by 1.7 million as a result of the case refinement revenue reallocation.

Let me move quickly the balance sheet projections.

Q3 cash utilization is projected to be in the range of 4 to 6 million reflecting growth and accounts receivable and planned capital equipment expenditures.

DSOs are expected to average approximately 62 days.

We also project capital expenditures in the range of 2 to 2.5 million for the quarter. 2003 full year cash utilization is projected to be in the range of 6 to 11 million.

We expect to be cash burned neutral by the end of the year.

Cash balances at year-end are estimated to be in the range of 30 to 35 million higher than our previous guidance with no additional borrowings or draw down of lines of credit.

Last quarter, we also provided guidance for 2004 and 2005.

Revenues are estimated to be in the range of 145 to 155 million for 2004 and 220 to 240 million for 2005.

Non-GAAP gross margins are estimated to be in the range of 63% to 67% and 65% to 70% for 2004 and 2005 respectively.

Non-GAAP net income for 2004 and 2005 are estimated to be in the range of 7% to 11% and 10% to 16% of sales respectively.

Projected non-GAAP net income excludes approximately 7 million and 1 million of non-cash stock-based compensation for 2004 and 2005 respectively.

To arrive at GAAP figures for 2004 and 2005 estimates, you will need to add back this stock based compensation to figures I just noted. 2004 includes approximately 5 million of revenue and net profit benefit resulting from the case refinement revenue restatement.

Now, let me turn the call back over to Tom.

I think you're glad to that, aren't you?

Thanks, Eldon.

We've had a very busy, very product quarter, and I would like to touch on a few of the most significant achievements.

As Eldon mentioned, we participated in the annual American Association of Orthodontics conference in May.

Align had a very visible partners of this and most important trade show with a mood booth that emphasized clinical education, ensuring great clinical results.

The highlighted new products and programs and provide on line access so visiting docs could actually review their clean [clin] check in little real time with our staff, orthodontists and experts.

We received excellent feedback and it is certain that we're on track with our products, programs, and support offerings.

We have launched the online clinical education center in early April for OCEC.

This is an online resource of case studies for doctors including actual cases with accompanying photos and x-rays, the clean [ph][clin] check, the final case results in the unique treatment [changes] for each case.

This also includes tips and techniques, information on continuing education and reference information, including published clinical papers on Invisalign usage and manufacturing.

We have received very positive feedback from our customers as well about this development.

We also announced a partnership with the New York University College of Dentistry.

NYU will be integrating Invisalign training into their curriculum.

We are very pleased that NYU has adopted Invisalign as a treatment modality and is working with us on the training their students.

We are pursuing this approach as other major dental schools and we are reporting this progress when appropriate.

This quarter we formally launched our teen initiative.

We recently completed study on teen compliance and usage and found our teens especially when faced with other alternatives and have embraced usage and extremely complained in daily wear of Invisalign.

We have created teen marketing kit, new case books and other collateral materials for doctors to target their teen patients.

As the initiative is fairly new, we expect to update you on our progress in the near future.

A primary element in our goal is to create border adoption and increase utilization of Invisalign is clinical education.

We continue to improve and expand our educational offerings and support as we deliver Invisalign Provider Workshops or IPWs and study both domestically and abroad.

Our efforts to drive primary consumer demand are beginning to pay off to match our channel development initiatives with the right kind of consumer product positioning and lead regeneration.

Looking ahead we continue to focus on three primary efforts.

First, we are committed to earning our way to becoming the most important part of our customers practice.

We will do this by helping them achieve great clinical results, as well as helping them to extend their practice and improve their profitability.

Second, we will become operationally excellent.

This will both enable a profitable sustainable business foundation as well as support meaningful acceleration of our business models, when we are ready.

And finally, although we are very early in the process of establishing and positioning Invisalign as a brand concept in consumers and professionals minds.

We believe we have long term opportunity to build an outstanding franchise and create highly needed and valuable new brand.

With that said, I will like to turn the call back to the operator for some questions.

Thank you, ladies and gentlemen, if you would like to register 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 the first question.

Our first question comes from the line of Rick Wise with Bear Stearns.

Please proceed with your question.

Hi, good afternoon, seems like that you are guiding us too fast '04 growth both of the lower end and higher in the range of giving it since March 25, I think it was more 18% or high teens growth rate what you were guiding us to before.

What has changed, what's giving you more confidence this is the training that the operational issues or might just missing the boat here?

I don't think we are missing the boat, what we've really done I think Rick is been pretty consistent over the past three quarters as we continue to gain more confidence with our ability to scale the business to both train, introduce new doctors to Invisalign and as to start driving the utilization model.

We have kind of incremented our guidance upward as we become more confident of our abilities to deliver, so are just-- as we increased last quarter our view of Q3 and remainder of '03 at that point in time we left '04 alone and '05.

As we specifically guided a little bit North this time our Q3 and our Q4 kind of primary operating growth and we all also layered in as Eldon already described the implications of the real occasionary allocation statement of prior period revenue.

So I think what you are seeing in '03 specifically is both confidence in the expanding business and guidance there plus some piece for the restatement dynamic, which Eldon detailed out.

As far as '04 its -- we haven't fundamentally raised that dramatically we've mostly layered in the effects of the restatement in '04 and Eldon may be if you want to be a little bit more precise about it.

No that's correct and we've taken the base revenue up slightly and then there is above a $2 or just over $2million impact in the fourth quarter as we mentioned on the call about a 4.1 million impact in the second half of the year related to the restatement and approximately 2 million just over $2 million of that is in the fourth quarter

Crosses the netting out against that with the negative impact of the first part of the year.

Right.

But I think what we - I think we already are projecting very solid growth in '04 and again as we as - we don't want to go much further than that as the levels of the relative appreciation of' 04 and '05, as we approach '04, we probably will get more detail about -- about their guidance.

But we're - we continue to be very comfortable with - though in building the business and making this thing go.

Just a follow-up, GP revenues are clearly going faster, although from a smaller base then the ortho.

Can you give us some prospective on where that percentage might mix - might be exiting '04 or in second half of '04?

Do you expect it to be 50:50 or some sort of Color?

And just remind us, is there any difference in the profitability of one channel versus another.

The first thing is, I guess I am not comfortable giving you an absolute kind of exit rate of channel, and these things will be a bit dynamic over time.

But the practical matter is - I guess the way we think about this is -- our orthodontists are our most important customers because they establish the standard of care.

They are the ones who did the most complex cases, and we continue to drive utilization growth net in that channel.

We really just-- maybe refresh the size of the relative opportunity there.

As we described once before, we did around 33,000 cases -- 34,000 cases last year in North America in the orthodontist channel, out of a total of somewhere between 2 million and 2.5 million new case starts and so, we are still hugely fastened on that opportunity as a huge growth driver.

I think that will come in a very predictable organized way as utilization increases and as doctors expand our share of practice.

There are a fix number of those doctors and we are focused on them.

The GP is - has more moving parts at the moment, because we are both moving quickly towards getting initial adoptions starting with this training dynamic, there is 120,000 to 140,000 GPs out there in the US and we are seeking to train a logical number of those each year, get them started this, the second thing that will happening in our focus is to have them do this simple straight forward cases and refer the complex cases to the orthodontists.

Our goal is to build this kind of market model where they all collaborate and journalist and specialists and generalists work together to take best care of patients and expand the total size of the pie.

So that there -- we haven't really had enough time yet to look at the utilization dynamics in GP.

What you are really looking at GP is newly trained doc doing those first 5,10, fifteen cases and getting started, so both of these are very important.

Coming back to your last question, specifically the product mix is very conducive to--Do you see simpler cases in you will but in most cases they are still forward treatment but there is really not material differences in profitability between the two channels.

Thank you.

Sure, Rick.

Thank you.

Ladies and gentlemen, as a reminder to register for a question, press the "1" "4."

Our next question comes from the line of Bruce Jacob with Deutsche Banc.

Please proceed with your question.

This is actually [Tao Levy].

Just a quick question, you mentioned that at the recent orthodontist meeting, you introduced some new products.

Can you just go over what those were?

Well we basically have a whole series of new programs, we have a series of new tools and ancillary devices, finishing techniques, programs that would broadly be called products.

We still have the primary core offering of Invisalign, although we are evolving the product mix a bit.

So, I think when I say is -- is -- when I say product, they are -- they are support products around the core product of Invisalign.

Perfect and also, can you give us the number of a first time GP that was submitting?

Within this specific quarter?

Yes, in the second quarter.

We described specifically the new--, one moment -- just a -- just to reiterate this was the first time the GP submitters.

Yes, first time GP seminars.

In the second quarter.

That number is about a little over 800 around -- around 815.

Great.

And also I noticed that on the orthodontist front, there are more -- more doctors now submitting cases, are these newly trained or these people that were trained previously and just all of the sudden are now realizing "hey this is a procedure that I need to offer to my patient's and I am starting to embrace it?"

Well, we haven't really been-- in US.

We continue in a very small numbers to certify orthodontist outside the US.

Again, internationally our focus is to drive utilization among the trained pool.

In US, we haven't done an orthodontic certification for probably 2 years and so, these are all orthodontist that have been certified for at least that period of time that -- that number -- I think I've described before Tao is this will vary a little bit over time.

There are doctor in [indiscernible][that will do] 6, 5, 6, 7 cases a year they might do 2 or 3 in a quarter and go a quarter without submitting, so this number changes a bit.

But I would say I general, we are starting to pick up some doctors who have come to the party a bit later and have been very conservative and have wanted to see over time how their colleagues have done with cases and to see how patients have finished and the results they've achieved, so we're perfectly happy to have people be conservative and to wait to see results in practice.

Again, we're still a very, very small part of the overall market.

So I think, it's a little bit of both.

I'd say we are moving towards the broader part of the market in Ortho at least.

Great, and on the financial side, the tax issue that was mentioned during the quarter where you guys took the charge, was that included in the non-GAAP numbers that you gave for the quarter?

Yes, it was, yes.

You would have done better without this problem or...

Well I'm just mentioning the fact that the amount was in there.

It's not a recurring event because we were dealing with that issue over a span of time in the business and obviously we have adjusted our system to properly collect and properly remit tax on a go-forward basis.

Perfect.

And now this is really a final question.

For -- the third quarter, rate if I heard you correctly that you were projecting a net loss on a non-GAAP basis of break-even to a loss of 2 million?

That's correct.

And I assume in the fourth quarter will be at least that if not better?

Well I didn't specifically mentioned the fourth quarter; we talked about the third quarter and then the full year.

Okay.

Perfect thanks.

I'll leave to leave the math to you.

Okay.

Thanks [Tao].

Thank you.

Our next question comes from the line of Adam Gaulian from JP Morgan.

Please proceed with your question.

Good afternoon guys.

Hey Adam, how are you?

Just a few quick things, first off you mentioned in litigation expense in the back half of the year could you just give us an update on the outstanding litigation?

What I'd like to do in general is just to remind listeners that there are two primary pieces to what we generally call litigation, one is a matter with a former distributor [inaudible]- the second is patent infringement encounters and counter suit on our part with [Cibron] and their subsidy [inaudible] and I ask Roger George to comment to the extent he feels we should.

Good afternoon everybody, I'm just going to reiterate what's there in our 34 act filings and what you'll see in the Q that will be filed in a few weeks.

The ORMCO case is being put on a slightly quicker schedule than we had initially budgeted for and as a result we are predicting that expenses for that will be higher this year we’re just pulling them in and if this gets [inaudible] - will be going into arbitration next month and we hope to have a result from that arbitration proceeding some time in October.

Okay.

After taking up on Rick's question we're projecting around mid 20's growth rate on sales on '04 and leaping to North of 50% on '05.

What's --what's driving that acceleration?

Well, we're not going to comment specifically I think Adam -- but I -- what I -- what we really try to build here is get the right-- when we refocus the business about this time last year, we tried that, we focused around our primary base of North America to build the right kind of sustainable growth platform to get the processes and systems in place for the company and will start early initiating our GP initiative and start building this complimentary model.

Our view of '04 and '05 is really framed by those initiatives that we started over a year ago and our ability to start the leverage those forward.

So, as we look out into '05, we see the opportunity to start to get some -- some incremental growth out of those investment that we were making today, I mean, hardly apologetic growth that we were saying already but we think there is solid opportunity forward.

So, again as we move forward we're going to be [able to put a little more] meat on those bones but -- but its basically showing starting to show the leverage, the investments, and the capabilities we're building today.

Okay.

One question on the quarter in would I be right in saying the tax expense in G&A and that 1 million for AIO was in -- sales and marketing?

That's correct, Adam.

Is that okay?

The sales in the -- the use sales -- the use tax that Eldon described was the growth margin effecting captured there.

All right.

Last question, if my memory serves me correctly at the time of the IPO I think initially the company was looking to shift Aligners in batches and you went to one bulk shipping.

Because the incident in refinements was so low I think 1% sounds like something changed there or was just that the complexity of the cases has got a little bit more difficult, what's the difference?

No.

Actually, I think if you go back to the history of the company, the company evolved their pricing and their business practices to meet customers need a number of times and at the time of the IPO, they had evolved to ship a complete case because the process it got in -- so organized and so -- kind of almost road rote it was very straight forward.

The first feature piece is that we evolved our offerings and our practices in accordance with kind of customers needs.

The way they use the product, they wants the product and in the course of doing that I thing as Eldon described in painful detail we went through in accordance with shifting to new accounting that's been issued.

I'll re-look at how we're doing it going forward as well as looking at how we've done in the past.

Through that lens under SAB-101 they conclude that we hadn't been carving out enough under those standards, even though our - our -- everybody at that time was certain that that was the right interpretation, so it’s always looking through the rearview mirror with the latest pronouncements and all that.

All that said is, there is nothing finally that's changed over the time.

Our -- our stocks or customers continue to buy case refinement perspectively and significant numbers of them use it, some don't, but case refinement or detailing or finishing is very normal part of straightening teeth, and it's the way the industry works and -- if -- if you had your braces you got to retainer at the end or you got tooling, tweaked with-- some other tools.

This is -- this is our offering to do that and instead of carving out as a separate product, we've now embedded it into our [full arch-treatment]treatment product pricing for the -- for the first round of refinement.

So that's -- the -- the only changes really that have happened are that -- that our practices have evolved to try and best meet our customers needs and react to their feedback, the intersection of that occurs with a change in accounting standards and the continuing interesting worlds of try to interpret what the accounting standards mean, but our goal here is to make sure that financial reader, we could have taken, perhaps a different path.

Our goal here is to make sure that financial reader had the most conservative accurate technically accounting accurate view of our actual results.

So, perhaps we may have taken a different track, but our goal was to build most credibility with financial reader and take the most conservative track related to the accounting literature and that's all we have done.

Great.

Thanks.

Sure.

Our next question comes from the line of [Ed Bacon] with Wells Fargo Securities.

Please proceed with your question.

My questions.

Number one is in the line of constraints for producing aligners and due to -- things keep getting better and better.

If you could talk a little bit about what those constraints might be if you are looking to expand it, and what the time line is because I know that sometimes been an issue in the past?

Sure.

Thanks, Ed -- there is -- there are practical constraints.

We faced some of those constraints at the end of Q4 of last year 2002 and in the early Q1 and that's largely-- that's what largely built up this backlog that we really didn't -- want to -- want to have.

The principal reason for that occurring was, there was a good problem they have that increase in volume, but this occurred right when we were transitioning our digital dental lab, if you well aware, our treatment ops facility from Pakistan, and UAE to Costa Rica and so we had hired a whole bunch of people, trained them and got them on line, but we weren’t able to handle the surge that we got as well as we wanted to, so -- we have -- we have got that thing organized.

We were running well.

We were well over 300 people down there that are very operational and that the increments of growth for us -- that will be perfectly able to respond but, we actually budget capacity expansion and have a weekly forecast meetings to look at it.

Our capacity at the major chokepoints are three.

One, our ability to get the case started here and scan things in a CT scanners and create the data models.

Two, to create the [indiscernible] that occurs here.

We got plenty of capacity to do that, and increments of capital provide us with increments of capacity.

Relative to our forecast, we've got plenty of window of opportunity and to add CT capacity, so that's fairly straight forward.

Secondly, in Costa Rica we need probably -- we used to stay 30 days, I said it will be more concerned and say, we need 60 to 60 plus days really bring a new treatment operator on to a lower levels of what they do and we have that kind of a window into our volume in general, so we should pretty well be able to flex with that.

Those are increments of growth and we feel very comfortable about our -- our base, our facility, and our access to people to be able to handle that and we've made the appropriate investments in resource and planned capital.

The third piece is the liner fabrication and combination of manufacturing improvements and adding the right kind of automation have allowed us to scale much easier down there and that's principally done at our partner down in Mexico, Juarez, so for increments of growth above what we forecast and above our surge capacity, we see very logical steps of either capital or human resource additions and we literally meet weekly and biweekly to make those calls and judgment based on what the forecast was and what's coming into the door.

So, we think it's a pretty linear path for us -- for the foreseeable future and along the track that we've described through '05 and we don't see any dramatic changes in our needs.

We've talked before in general about continuing to be serious about making this a highly automated manufacturing process that will scale even more easily and we continue to work on this in a very high priority.

So we don't see anything that worries us and we continue to work on all elements of that process.

Tom, it's a follow-up as you look towards fourth quarter -- so that you don't have the same issue, you had last year.

You've mentioned it takes about 60 days for this human capital to just come online obviously to hire them and train them -- you could see flexible spending accounts being used in the fourth quarter of this year and will get more aligners being generated than you predicted.

Now, what would you do -- and how would you deal with that problem?

Of course that's a good problem to have, but certainly you would be probably thinking it about now.

Well, we -- we spend a lot of time thinking about scenarios Ed, I don't want to comment specifically on what could or could not happen.

I think what I would say in general is -- is there was an intersection last year of very large number of GPs trained, we are just starting to come on line with those programs.

Some kind of[pent up] demand with the GPs have been trained before that and have now the right kind of support.

Change in the biggest thing that affected us there was this change we have made with moving all of our experienced -- hearts and minds from Pakistan, UAE and moving all that work to Costa Rica, where we had a whole bunch of new people and so we are in a least flexible way to respond that.

But we -- we worked this really hard to forecast, we do get a pretty good view, we talked to the field very, very regularly about what they are hearing from their customers and so, we again love to have increases in demand, but we don't expect to get caught short again.

We won't be perfect, but we are working really hard at it.

Thank you.

Sure.

Thanks.

Ladies and gentlemen, as a reminder, to register for a question, press "1" "4."

One moment, please, for the next question.

Ladies and gentlemen, as a reminder, to register for a question, press the "1" "4."

One moment, please, for the next question.

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

One moment, please, for the next question.

Ladies and gentlemen, as a reminder, to register for a question, press the "1" "4."

Our next question comes from the line of Lenny Bracken [ph] with Bracken Capital.

Please proceed with your question.

Hi, guys.

Congratulations on another good quarter.

Thanks Lenny, we thought we lost you there for a minute.

No I don't know what was going on.

I just wanted to ask you guys if you guys are going to come up with any upgrades on the software side in the next 6 to 12 months?

Well we - we have generally don't talk about what our internal plans are, again from, we continue to bring out changes and improvements in our customer interface and in our so-called VIP website and the [indiscernible] the doc-C.

We continue to test those in front of docs we continue to test new concepts with them, some we bring to market as they see, some we keep working on the same time we continue to intensely work on and invest in manufacturing software technology in two roles to support the enterprise and so it's a general practice Lenny,.

We’re at least consistent year, we don't - we don't like to talk about futures, I had rather describe the impact from improve two roles on our business results, so I hate to disappoint you, but I don't want to talk about what's behind the screen.

Okay, that's - that's fair.

Is there anything that would dramatically improve your -- your ability to turn around cases or improve your cost?

We think that they are--, what I would say in general that we will described is our goal is to have this to be the most important part of the docs practice and what that means is the more we can do to make these tools and systems easier for the doctor and their staff to use to imbed them more deeply in way they want to work, so that means that the tools to touch them and the systems they use in the way they want to use and we think it will help them do more cases that can be easier, and so the second thing is, so the answer is we don't see the dramatic changes we see lots of changes over time and lots of improvement.

The second part of it is, we have some very significant step changes in - operating performance and manufacturing improvement and - and what we said in general is where - we continue to work on bringing those manufacturing system changes in but - but we don't see those it's been enormous and dramatic, we see those against our base now helping to accelerate and improved cross margins in cycle times and things like that, so we are -just look for nice, solid steady continued growth on a top line on a gross margins and in management of op ex, so we can bring some of this bottom line-- returning on investors investments.

Thanks [indiscernible].

Sure.

Thanks, Lenny.

Our next question comes from the line of Ken Virgo [ph] with [indiscernible] Marketing.

Please proceed with your question.

Tom, congratulations on the great quarter.

You guys are doing a good job.

Thanks, Ken.

Just had a question, I know that a while back your first in your call you mentioned a collaborative efforts in the dental community between GPs and orthodontists I know there have been companies out there and some talk about providing services or having -- and encouraging others who provide services to GPs to help them plan cases.

How is that coming along, is that -- are you finding that necessary or GPs able to really do the cases on their own after your training?

I think Ken -- I think this is an evolving picture and there are -- our first most primary effort in what the company's responsibility is to train them, so what we have done is, we introduced Certification One, a whole new training program that really is a day and a half to two days, that our goal is for a GP to be able to leave there with the knowledge of how to start and do our straightforward, simple class one very mild fraud in[routing] case, we want them to do those simple cases if they are comfortable with them and then read[inaudible] for everything else for the orthodontist, their partners.

On top of that, we're trying to connect them market-by-market with orthodontists that have Invisalign experienced, so if they can -- so they can work together to build a market.

We're not aware of other players out there that are doing this.

There's a lot of people working informally and our job is to just help to facilitate broader market growth, so that's the best as I can answer at the moment.

Great.

Thank you very much.

Sure.

Thanks.

I am showing, there are no further questions at this time.

Please continue with your presentation or closing remarks.

Thanks operator.

Well, I will just like to thank you all for being on the call and working through us with both our -- what we think is a very positive story as well as some potentially complicating messages about the restatement that our goal is that you as a financial reader and investor get absolutely the most correct view of our business going forward and that's what our intention here to do was.

So, once again thanks for being on the call and we look forward to updating you next quarter on our continuing progress.

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

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