愛齊科技 (ALGN) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you standing by.

Welcome to the Align Technology, third quarter, 2003, financial results conference call. [OPERATOR INSTRUCTIONS] I will now like to turn the conference over to Barbara Domingo, Director of Investor Relations of Align Technology.

Please go ahead ma'am.

Thanks Kathy, and welcome to everybody on the line.

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

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

During this call, we may make 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, 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 statements.

Factors that might cause such a difference include, but are not limited to, risks that are real from time to time in Align's periodic report filed with the Securities and Exchange commission, including, but not limited to it's annual report on Form 10-KA for the fiscal year, ended December 31, 2002, which was filed with the Securities and Exchange Commission on August 13, 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 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 refer to as pro forma financial measures.

Most of these items, together with the corresponding GAAP numbers, and a reconciliation to comparable GAAP financial measures where practicable, are contained in safe financial results release, which we've posted on our web site at www.invisalign.com.

Under corporate information, investor relations, earnings press released and half furnished [ph] to the Securities and Exchange Commission on Form-8K.

We encourage listeners to review these items.

Additionally, we have posted an 11 quarter GAAP and non GAAP revenue model on our web site at www.invisalign.com, under corporate information, investor relations, financial history.

Please refer to both of these downloadable Excel spreadsheets for more detailed line item information.

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

Tom?

Thank you Barbara, and welcome to our shareholders and friends who are listening today on the phone, and to our web site.

We are very pleased with the progress we have made this year.

During the third-quarter, we achieved a significant milestone, as we recorded a small profit, on a non-GAAP basis, which speaks to the effort the team has made in building a sustainable business.

We also delivered a positive cash contribution to the business, and look forward to generating sufficient cash from operations, to sustain our balance sheet in the future.

As the courtly numbers show, we are demonstrating solid execution of a winning strategy, and believe we are on the right path to build a great company.

While we still have much to do, our operational capabilities have improved dramatically as seen by our improving gross margins, revenue growth of 96% year over year, and a successful management of our spending, which is now in line with our revenue growth.

All these efforts have led to better than expected revenues in our first non-GAAP profitable quarter.

That said, we are a long way from being satisfied, and we will not stop here.

We're totally committed to becoming the most important part of our customers' practices, helping them provide outstanding clinical results, for happier patients.

Eldon will take you to the numbers in just a moment, but let me first give you some top and bottom-line highlights.

We reported 34 million in revenues for the third-quarter of 2003.

This is an increase of 16.5% over last quarter, an increase of 96% over the same quarter last year.

Our net profit, and I cannot begin to tell you how happy I am to use that word, profit, on a non-GAAP basis was $1.2 million, or 2 cents per share.

Let me now take you through some key operating metrics.

Both the orthodontist and GP dentist channel revenues in cases continue to increase.

Despite the summer months, in the third quarter, where orthodontists traditionally see more children and adolescents, we still saw a sequential increase in the ortho channel of 14% to $19.6 million.

GP revenues sequentially increased 38% to 9.4 million, and 57.5% of total revenues came from orthodontists.

During the third-quarter of 2003, we received orders for approximately 19,700 new cases, an average of 308 per business day, which is an increase of 9% from a previous quarter.

Put this very significant revenue ramp in perspective, our average cases received, for business day, for Q3 of last year was 200.

We shipped almost 19,900 cases to customers this quarter, an increase of 12% over the previous quarter.

Finally, I'd like to share some case volume and channel statistics as we try to do on each call.

Approximately 6500 doctors worldwide submitted cases during the third-quarter, compared to 6000 last quarter.

A number of orthodontists have been in cases with 3500, up slightly from 3450, last quarter, almost 3000 GP dentists have made cases compared to 2600 last quarter.

Additionally, we train and certified over 1050 new GPs in the US during the third-quarter, bringing our basis certified GPs in North America to just under 8500, and just under 80% of our North American clinicians, and close to 70% of our certified docs worldwide have submitted more than a single case.

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

Eldon will discuss the financials, and provide guidance for next quarter, as well as fiscal years 2003, 2004, and 2005.

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

Eldon?

Thanks Tom.

With a quick reminder, our third quarter press release, a filing of the same document are available on our web site, as Barbara mentioned.

Similar to last quarter, we will provide GAAP performance, then follow it up with non-GAAP performance.

As Tom briefly mentioned, third-quarter revenues were $34 million, up 6.5% from last quarter, and 96% in the same period a year ago.

Third quarter revenues by segment were 19.6 million.

For US ortho, 9.4 million for US GP, and 3 million for international.

These channels represent 57.5%, 27.7%, and 8% of revenues, respectively.

Worldwide training, and other revenues were $2 million.

International revenues were slightly lower than the second quarter, due to the tradition holiday period that our European customers take in the summer.

Despite this, and the after mentioned practice of orthodontist, seeing more children than adults during the summer, global revenues were at the upper end of our previous guidance.

GP channel continues to be our fastest-growing channel, as we train GPs, and they begin submitting cases.

Gross profit for the third-quarter of 2003, as reported under GAAP, was 20.6 million, where 16.5% of revenue compared to 6.8 million, or 39% of revenues for the third-quarter 2002.

Sequentially, this compares to a gross profit of 16 million, for 54.6% of revenues, for the second quarter of 2003.

The increase in gross margin is primarily [indiscernible] to continued manufacturing, process efficiencies, improved cost absorption related to increasing volumes.

Total operating expenses, reported under GAAP, were 22.3 million for the third-quarter fiscal 2003, in line with our expectations.

This compares to 24.6 million for the same quarter one year ago, and 24.1 million for the second quarter of 2003.

Operating expenses for the third-quarter, declined compared to the second quarter, and primarily were not occurring expense of 1.4 million related to sales tax matters, and one million of AAL annual meeting expenses, both of which were recorded in the second quarter, and discussed on our second quarter call.

These reductions were partially offset by approximately 1 million of incrementally legal expenses related to litigation matters, during the third-quarter.

At loss with the third quarter as reported under GAAP was 2.1 million, for 4 cents per basic and diluted share.

Compared to a net loss of 17.8 million were 38 cents per basic and diluted share, for the same quarter a year ago.

A net loss of 7.8 million, or 13 cents per basic and diluted share, for the second quarter of 2003.

Now let me take a couple of minutes, and take you through results on a non GAAP basis.

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

Reconciliation of these non GAAP financial majors to the comparable GAAP financial majors is included in our financial data for the third-quarter, fiscal 2003, which are included in the press release attached to the Form 8-K, we filed in the SEC - with the SEC earlier today.

Total stock based compensation for the third-quarter of 2003 was $3.4 million.

Compared to 4.4 million in the second-quarter of 2003, and 5 million in the third-quarter of 2002.

In the third-quarter of 2002, we also recorded 1.8 million of restructuring charges and operating expense, one year ago.

Non GAAP gross profit for the third-quarter of 2003, was 21.2 million, or 62.3% of revenue, above our guidance to 60% to 62%.

This compares to 8.1 million or 46.8% of revenues for the third-quarter of 2000, and 16.6 million or 56.9% of revenues in the second-quarter of this year.

Non-GAAP gross profit for the second-quarter of 2003 excludes, approximately, $600,000 of stock based compensation.

As I previously mentioned, improvements in gross margin were a result of increase in manufacturing process efficiencies, and [indiscernible] utilization.

Non-GAAP operating expenses were 19.6 million for the third-quarter of fiscal 2003, compared to 19.2 million for the same quarter one year ago, and 20.5 million for the second-quarter of 2003.

Non-GAAP operating expenses for the third-quarter of 2003 exclude 2.8 million of stock based compensation.

As Tom mentioned, for the first time, we reported a non-GAAP net profit of 1.2 million dollars, or 2 cents per basic and diluted share for the third-quarter of 2003.

This profit compares to a net loss of 11 million, or 24 cents per basic and diluted share for the same quarter 1 year ago and a net loss of 3.4 million, or 6 cents per basic and diluted share for the second quarter of 2003.

The quick note on the top and bottom line performances related to the case [indiscernible] restatement we announced last quarter, that would be the restatement contributed 2.1 million in revenue and associated income in the second-quarter.

Now on to the balance sheet.

Cash equivalents and marketable securities, at the end of the third-quarter, was 42.7 million, compared with 41.5 million at the end of the fourth-quarter of 2002, our last fiscal year end. 38.4 million at the end of the second quarter of this year.

Sequentially, our cash resources marketable securities increased $4.3 million.

Contributing to the increase, was the timing of approximately 1.4 million in sales tax payments, targeted with the third-quarter, which we now expect to remit during the quarter.

Let me spend a few minutes on the remainder of the year, and review our guidance for 2004, 2005.

Q4 revenues are projected to be in the range of $34 to $36 million.

Fourth quarter business, long end, is expected to be impacted slightly, by the Christmas holidays, which is typically a slow period for our customers. [indiscernible] channel, GP channel, and international, are expected to comprise 56%, 30%, and 9% of Q4 revenues, respectively.

The remaining 5% approximates training and ancillary product revenues.

Big shipment volumes are projected to be the range of 19.9 to 21.2 thousand cases.

Q4 gross margins on a GAAP basis are projected to be in the 60.5% to 61.5% range. we project that gross margins will include approximately $500,000 of stock base compensation charged accosted revenues.

Excluding the projected stock based compensation gross margins on a non-GAAP basis, are projected to be in the range of 62% to 63% for Q4.

Operating expenses on a GAAP basis, are expected to be in the 21.5 to 22.5 million range for Q4.

On a non-GAAP basis, operating expenses, which exclude projected stock base compensation of approximately 2.5 million, are expected to be in the range of $19 to $20 million for Q4.

GAAP net loss, which includes stock based compensation, is expected to be in the range of 800,000 to 1.8 million for Q4, while non GAAP, net profit is projected to be in the range of 1.3 to 2.3 million.

For the full year, 2003, we're increasing our revenue projection to a range of 120 to 122 million, demonstrating year-over-year growth between 72% and 75%.

Orthodontist channel, GP channel, and international channel, are expected to comprise 59%, 26%, and 10% of 2003 revenues, respectively, with the remaining 5% approximating training and [indiscernible] revenues.

Base volume is projected to be in the range of 72.9 to 74.2 thousand cases.

On a GAAP basis, gross margins are expected to average 56.5% to 57% for the full year, based on projected revenue levels.

Correspondingly, non-GAAP gross margins with [indiscernible] stock base compensation, charged the cost of revenues.

As noted earlier, our projection to average in the range of 58.7% to 59.2% for the full year.

For the full year, 2003 operating expense, our GAAP basis is expected to be the range of 89.5 to $90.5 million.

GAAP net loss is projected in the range of 21.3 to 22.3 for the full year.

Full year non-GAAP operating expenses, which excludes stock based compensation, and restructuring charges, are projected to be in the range of 76.5 to 77.5 million.

For the full year, non-GAAP net loss is projected to be in the range of 5.8 to $6.8 million.

Full year non-GAAP projections do not include stock base compensation of approximately $2.5 million charged to cost of revenues, and 12.5 million charged to operating expenses.

And $500,000 of restructuring costs charged to operating expenses, which were recorded in the first quarter of the year.

Let me move on to balance sheet projections for 2003.

We have consistently stated that we expect to be cash more neutral by the end of 2003, but with the last two quarters on our year-to-date basis, we have made a positive contribution, cash contribution to the business.

We believe we have been operating and will continue to operate as a cash staining business, meaning that we expect our cash collections to sustain our operations.

Traditionally, we have also been decreasing our debt.

While there be quarter to quarter cash utilization fluctuations, we believe that over the next year we will be able to sustain our cash position.

With that said, cash balances at year end are estimated to be in the range of 39 to 41 million, up from our previous guidance of 30 to 35 million at the end of Q4.

Q4 cash utilization is projected to be in the range of 1.5 to $3 million, DSOs are expected to average in the range of 55 to 58 days.

We project expenditures in the range 1 to 1.5 million for the remainder of the year.

Additionally, many investors have begun to ask us about depreciation.

Depreciation and amortization is expected to be in the 2.3 to 2.5 million range, for the fourth-quarter 2003, in the 9.2 to 9.5 million range for the full year of 2003.

For full year 2004 we previously guided revenues of $145 to $155 million.

For 2004, we're increasing this guidance to 155 to 165 million.

On GAAP gross margins are expected to be in the range of 63 to 65 %.

Net profit on a non GAAP bases is projected in the range of 3 1/2 to 5 1/2 %.

Our 2004 guidance request increased investments in research and development, marketing programs and our international business.

Stock based compensation, as previously noted, is expected to be in the range of $8 million for 2004.

Starting next year, we will begin to provide more detailed guidance information for the full year 2004, as we have consistently guided for 2003.

What I mean by next year is in the January time frame as we end our 2004 year.

At this time we're not changing our 2005 guidance.

To reiterate, revenues are estimated to be in the range of 220 to $240 million for 2005.

Non GAAP gross margin are estimated to be the range is 65 to 70 %.

Non GAAP net income for 2005 is estimated to be in the range of 10 to 16 % of sales.

Projected non GAAP net income excludes approximately $1 million of non cash stock based compensation in 2005.

To arrive at GAAP figures for 2004 and 2005 estimates, you will need to add back the stock based compensation to the figures I just noted.

One last note before I turn the call back over to Tom.

Last Friday, Align filed and S3 registration statement, for the shares that were bought in the private placement last year.

We had many questions on the registration statement this week, so I'd like to take a couple of minutes to explain the document.

As you know, Align completed a private placement of 9.6 million shares in November of 2002, approximately 1 year ago.

While the shares were issued, and as included in our total shares outstanding over the last four quarters, the resale of the shares was not registered.

Hence, the shares are not diluted to the current number of shares outstanding.

For the terms of the private placement, we are required to register the shares as soon as profitable, but not prior to November 20th of this year.

Once registered, these shares may be sold in one or more transactions, from time to time, by the selling stockholders.

Align will not receive any proceeds from these shares, and this is not to be construed as a primary authorin [ph].

As we have stated in the past, Align does not have any current plans to return to return to the capital markets.

Now let me turn the call back over to Tom.

Tom?

Thanks Eldon, now we have had a few notable events this quarter, what we have really done is to continue our focus on building the right foundation for a profitable, and lasting company.

This quarter, we increased our focused on driving improved utilization in our orthodontist channel, and continue our efforts in training GP dentists.

Both areas saw meaningful progress.

I'd like to walk through a few of those achievements.

Chronicle education and support is an important lever for great outcomes and ultimately revenue growth.

As specialists, orthodontists are our most important customers.

They establish the standard of care, evaluate new technologies and modalities for treatment, and fully appreciate the complexity of delivering outstanding results in this difficult arena.

During 2003, Align has been extremely committed to expand chronicle education in clinical support for our orthodontist partners so they can be confident about increasing their use of Invisalign in practice.

On a year-to-date basis, we have held over 50 Invisalign provider workshops, study clubs and doctor calls.

In turn, many orthodontists are becoming more comfortable with Invisalign as a part of everyday practice.

In most local communities, orthodontists work closely with GP dentists, to treat patients with malocclusion.

Yet despite their collective efforts, the majority of potential patients does not seek treatment.

It is essential to get the dentist, and their staff mobilized, to cost effectively access this huge population, most of them regularly see their dentist.

In that model, GP dentists, with appropriate skills and practices, educate patients if the cycle through routine treatment.

With the proper training, GPs can treat simple cases and refer more complex cases to their orthodontist partners, thus growing the overall market.

In effect, this is a core element of Align's strategy, to have orthodontists, as specialists, increasing utilization of Invisalign for a range of appropriate cases.

In short, going deep into their practices with the goal of becoming the most important part of their practice.

That provides the rationale for our extensive efforts in clinical education and support.

On a GP side, those clinicians that choose to treat simple cases, often [indiscernible] from the coaching informal support of an orthodontist partner.

In short, with the GP channel, we are going broad, with a goal of better patient education, awareness of malocclusion, and ultimately market expansion.

The numbers are compelling.

By our estimates, in the US alone, there are well over 70 million potential patients that routinely see their dentists, suffer from malocclusion and could benefit from Invisalign. [indiscernible] and as I've already mentioned, we trained over 1000 GP dentists in the third-quarter.

While we are committed to training around 5000 GPs each year, I believe we may fall slightly short of a total number.

However, the most important part of the equation, is how the GPs are tracking, in terms of submitting cases, and working to help expand market. 37% of U.S. cases received in the business, were from GP dentists, and over 60% of those cases were received from GPS, that had submit cases in the previous quarter.

Future growth in volume from this broad channel will be driven by bull [ph], certified GPs, and increased utilization by GP practices on those less complex cases.

Additionally in the third quarter, we had almost 800 new GP Dennis [ph] submit cases, about the same as last quarter.

Another development in clinical education is that Align nat [ph] is now offering continuing education or CE credits to our clinicians through our online clinical education center.

As you may recall, Align launched the clinical education center in April of this year.

We continue to enhance the center, and provide highly relevant, and important information for our doctors.

Continuing education credits which were offered to the New York University Dell [ph] school, are indicators of the efforts Align has made in ensuring ease of use for our customers.

Doctors can now spend an hour or two online, rather than traveling to receive credits, to save them time and money, at the same time, they are receiving valuable information and training on cases, as well as tips and techniques for providing outstanding service and clinical results for their patients.

The credits our clinicians received at the Online Clinical Education Center, are counted as part of the 25 credits they need every year to maintain their credentials.

We also launched our second level certification courses in the third quarter.

For GP dentists who have already been certified, and have previously submitted cases, we are not offering what we call Circ 2 [ph] classes.

These seminars provide in-depth information on treating slightly more complex cases.

Circ1 clearly focuses GPs on the identification and treatment of class 1 mild crowding [ph] cases.

Circ 2 will allow the GPs to expand very slightly, and consider a broader range of patients.

This has been well-received by clinicians, and we expect to continue providing more of these classes in the future.

On the research side, there are numerous clinical studies involving Invisalign in the pipeline, we will share as they become published.

This quarter we did see paper released in the peer reviewed Journal of American Dental Association.

This was a 3 paged analysis on orthodontic treatment with a series of removable appliances.

In Costa Rica, we complete our move to a larger facility in September.

This team in Costa Rica is responsible for our digital dental lab, where we do 3-D modeling to create treatments, based on the doctor's prescription and input.

The move went very smoothly, and we believe we now have the space to expand our operations in order to meet increased demands in the future.

Looking ahead.

We have some great programs happening in the fourth quarter.

The American Dental Association Conference and Trade Show is currently underway this week in San Francisco.

We are excited to participate in this major annual meeting for GP dentists.

In November, we will hold our third annual Invisalign summit.

During this event, we invite our top orthodontists for a weekend of intense training, sharing of best practices, and fun.

We have numerous speakers discussing all aspects of Invisalign treatment, practice management, and staff empowerment.

This year, we expect to see clinician attendance up almost up 60%.

And one last notable event.

This morning, you may also have seen a press release we issued on the Phoenix Awards.

The Pheonix Awards are presented for outstanding achievement in the medical device and diagnostic industry, to individuals and companies.

Align Technology was selected by hundreds of industry CEOs, to win the Emerging Growth Company award for 2003.

We're very honored to have received this recognition, and be included in the company in a group of past winner, including Pheracent [ph] Arthur Pure [ph] and Vivics [ph], all of which are outstanding companies.

Now that we have achieved profitability on a non-GAAP basis, we believe we are entering a new phase of alliance development as a company.

We are totally committed to helping our customers achieve outstanding clinical results, with happier patients.

As we continue this focus and execute on our operating plan, the path to GAAP profitability becomes clearer.

We intend to share with you our broader strategies, which will include stepped-up investments in R&D, marketing development, and international growth, and how we will integrate these efforts into a plan to elevate Align into this next exciting phase, during our year-end conference call on January 29.

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

Thank you. [CALLER INSTRUCTIONS] The first question comes from the line from Rick Wise from Bear Stearns.

Please go ahead with your question.

Hi, good morning everybody.

A couple of questions.

First, I just want to make sure I'm clear; is your net margin guidance lower than you previously gave?

My impression is that it was higher, and maybe I am remembering incorrectly, but if so, how much of that relates to higher R&D spending, or litigation costs?

Can you give me some perspective on that?

Yes, your alert as usual.

We are -- when we originally gave a framework for 2004 revenue gross margin, and non-GAAP net income, we have incorporated into it it's revised view of 2004, significantly increased spending in R&D, to accelerate new tools, to do a lot of things in the R&D side that we are going to provide a little more detail about in the January call.

Maybe what I'd like to do is hand it to Eldon to be perhaps a bit more precise about the magnitude there.

Yes, Rick I think Tom handled it fairly well.

We have guided I believe a range of 7 to 11% on the bottom line in our previous guidance, on a non-GAAP basis, versus the 3.5 to 5.5%, and Tom stated it very precisely, that our evolution of revenue continuing to improve at the gross margin line, really as we have evolved, and seen our cash management and cash utilization evolve this year, that as a business we fell that it's improved, and in a prudent to do as Tom just stated, and that is focus on the importance of R&D and marketing programs, and focusing on the international business, in 2004, as we roll the foundation to grow and evolve from that point.

Rick the punch-line is, we still feel we're just barely scratched the surface of opportunity, and we intend to make a few reinvestments here in tools and core processes, so that we can drive -- continue to drive very aggressive scaling of the business in '05, and beyond.

A follow-up on that.

Does it suggest -- I'll say it more positively, are you going to stay profitable in every quarter going forward, and especially in the early part of next year, as you make up -- make this stepped up investment, or does this change the quarterly flow?

Rick again, we'll get into more granularity in January.

But, our intent as we go forward, is to run the business in a growth pattern, and to continue on a going-forward basis, with a non-GAAP profitable profile.

Not to beat a dead horse.

So, you'll profitable EPS non-GAAP every quarter going forward, obviously as best your can, circumstances permitting, is your expectation?

Based on our current projections, yes we expect to [inaudible] into 2004 on a non-GAAP profitable basis.

Okay and last question, sort for two market questions that have been doing some channel checks lately, both with the orthodontists and the GPs.

Two things; one, still hearing a lot of complaints on pricing, that the dayliners cost a lot of money for them.

Just curious how you combat that, and your reaction to that; and how you deal with that.

And second, we're hearing more about a smaller competitor who is offering some very limited technology for a limited number of cases, but hearing more about that, it's a lower price point, it can do less, but can you talk about those 2 issues, and how you're combating them?

Let me do those in reverse order if I may Rick.

And the first reaction is imitation is the sincerest form of flattery.

So, I think we've really shown some people some things about very different ways to move teeth.

At the core of what we do, you know the first orthodontists that thought about using materials other than bands and brackets, wrote on this topic, some of them almost 40, 50 years ago, when plastics were first showing up, and new technologies were emerging, they didn't visualize the combination of digital technologies that give it life and make it predictable and reliable and cost-effective.

We think there's going to be continuing interest and effort, as we continue to grow the market, and we are confident that our IP Shield and our competencies are going to allow us to harvest the kind of return for our shareholders that they expect, and we expect to get.

So I -- we fully expect to see people try to find ways to bring products to market, that will mimic or try to do what we've done, and we will both respond in the market, and we will respond as we need to in other ways to ensure that we do that.

So, we think that's a good thing, and the market is just so darned big here, that it's going to attract interest from lots of places.

Big companies, small companies.

I think the second part of what you asked about was pricing, and we are priced substantially higher, than what braces and brackets cost, for an orthodontist.

And we've had numerous pricing studies done, third party research done, that continued to support the view, that because of the efficiency of chair time, and the interaction with -- between the patient and the orthodontists, that the orthodontists that develop experience with this product, can be substantially more productive, and therefore can generate perhaps 2 times or more as much revenue per labor hours they invest in Invisalign, versus brackets and braces.

And this is a function of much shorter visits, because the actual adjustments being made, the teeth are being moved by the appliances at the doctor's direction, versus the doctor and their staff actually making adjustments in the office.

On top of that is the fact that we isolate movements; only a couple of teeth move in very precise magnitude each time, versus a lot of teeth moving once they make adjustments.

These things all work together, to say there's really something here.

So yes, I think that the product is a premium price product at this point, but it also delivers the performance.

And given our very, very small penetration, again 50 some odd thousand cases in North America, on a base of 2.5 to 3.5 million, we've still got lots of room to grow, before we think we run into any issues there.

Thanks a lot.

Sure, thank you Rick.

The next question comes from the line of Bruce Jacobs.

Please go ahead with your question.

Thanks for taking my question, congratulations on your first profitable quarter.

Glad to see it.

Thank you, Bruce.

First question I wanted to ask was about the numbers of submitting U.S. orthodontists, and while the general practitioner number has been rising pretty rapidly, it seems that the U.S. ortho number has just been growing only modestly, and I'm wondered if you could comment on what your expectations or understanding you're not going to guide us by line item there, but just in a big picture sort of way, what should expectations be?

And will you see some acceleration in the number of submitting U.S. orthodontists?

Well, you know we've talked about this consistently, the company -- we don't expect dramatic expansion in the numbers of orthodontists submitting.

We aren't seeking that at this point.

We -- the company if you go back, trained all comers in the orthodontist channel, back and really I think we did the last orthodontist certification 2 to 2.5 years ago.

The certification were free, there was a lot of buzz in the industry; and an awful lot of orthodontists came to see what it was all about.

Half of them, fully half or a little more, have never submitted a case, or roughly half of them have never submitted a case, out of the 7500 or 7700 that originally got trained.

So, what we're most interested in, over the next year or 2 at least, Bruce, is in the U.S. is working with those orthodontists that have submitted cases, that are submitting cases, so an orthodontist that submits one a month, we'd like to move to three a month; and one that's submitting 2 a week, we would like to move to 5 a week.

And really, so we can become more and more important, hopefully the most important part of their practice.

So our focus is not to expand the number of U.S. orthodontists submitting.

Our focus is to increase utilization, so that this becomes a more and more important part of their practice, and we're getting real traction there.

So that's what I have called going deep, a few minutes ago on the call.

Driving for depth into a very focused channel.

At some point when we think we're really getting there, I think we will make real efforts to reach out to those orthodontists that aren't currently using us, and find ways to try to approach them, and attract them into using this for treatment.

At the same time we're making stepped-up efforts, to get involved and integrated, into university centers, so that orthodontists coming out of school can be trained on the use of digital techniques Invisalign, which currently is not the case.

Most university orthodontic programs do not included Invisalign in their curriculum, and over time we're going to work on fixing that.

So again, our focus is on increasing utilization, and orthodontists, in the orthodontists channel.

Okay, that's a fair answer.

A couple more quick ones, I'll jump back in queue.

Would you be willing to give us the breakdown of submitting orthodontists, by U.S. versus, or at least give us the number of submitting international clinicians?

The numbers get a little bit messier, because in many markets outside of the U.S., there's not a firm line between orthodontists and GP.

Bear with me for just a second.

The total number of submitting docs worldwide at the end of Q3 was about 6500, and I would say that the lion's share of those, probably around 6,000, are probably -- so bear with me here.

So, 5,500 of those docs are probably U.S., and, I've already given you the that number of ortho docs, orthos that are submitting.

But that number was worldwide orthos, right?

That you gave earlier, 3500 was worldwide.

That is correct.

In North America, it's two-thirds plus that.

Three quarters of that.

I know you've increased your '04 guidance but you haven't done anything with '05 which is, I guess, presumably, when you would start to see some realization of the incremental spending you're doing in '04.

And I just wondered if you could put those 2 thoughts in juxtaposition with 1 another?

Well, we -- you know, as we looked at originally, if you go all the way back to July of '02, we stepped back and said, we've got to put this business on the right foundation, and we together a turnaround plan, go the business refocused, re-capitalized properly, and got just our heads down and started executing, we knew that the scaling that was possible for this business, we were going to want to go back and invest in new tools, capabilities, software, hope that we can use internally, to drive efficiency, and quality, and [inaudible] tools that will directly interface with the doctor.

Next levels of ClinCheck and [we call VIP], as well as a whole range of other technologies internally that will vector into supporting market expansion long-term growth.

So we knew that as soon as we could earn the opportunity to do that, we were going to try to circle back and feather some of those investments back in.

Given the continuing strong expansion of business, we're going to do that a little earlier than we thought, we believe we've earned our way to reinvest a bit more in R&D, and we're going to get going on that very quickly, and we also believe there is in an opportunity to go back cost effectively a bit more, market development, as well as making small incremental investments in Europe and in other places.

So I'm going to give you a lot more meat to chew on here with some of those elements when we discuss our year end results in January, but we really believe that we've looked at these projects.

They all have extremely strong paybacks and very IMPVs, and we believe it's absolutely the right thing to do, and we hope our shareholders agree with us because, we believe that they're going to get very, very strong returns in the form of continued increase in strong surging growth, and starting to get real operating leverage of the business, even as the products gets easier, better, more predictable for clinicians to use and that's the rationale again.

We'll give you a little better or more complete, perhaps, understanding in January.

That's fair.

Thanks guys, I'll jump back in queue.

Sure, Bruce, thank you.

Ladies and gentlemen, as a reminder to register a question, please press 14 on your telephone.

The next question comes from the line of Mark Figh from Interest [ph], please go ahead with your question.

Good morning, you kind of answered my first question a little bit, but I just want to go back over it, on the operating expenses of '04.

You know, in this quarter you obviously did an outstanding job on controlling the expenses with your revenues up as much as they were.

Can you just walk through the three lines quickly?

Where you just kind of holding back expenses because you wanted to get to that break even level?

You know, this quarter and what's the magnitude of the increases?

Should we see each of those lines, kind of -- what kind of magnitude increases next year?

Hello Mark.

First of all, we didn't hold anything back.

We were running the business, as we thought, and in fact between '03 -- between Q3, and Q2 so far, as we've indicated for Q4, we've absorbed several millions dollars of increased litigation expenses beyond what we had projected, so, and, we had to absorb in, as we're now in Q2, sales and use tax that we had not seen in business.

So, the spending levels that we have seen and delivered, are actually worse because there are some things that we didn't anticipate, or understand fully and we dealt with them, so we haven't held things, or stop paying bills, or squeeze our way to profitability.

We're running the business as we think it needs to be run properly.

These investments forward, which maybe I'll ask Eldon to provide a little bit of detail on the extent out there, are what we believe to be good, strong, solid choices that make sense for the shareholders to accelerate and create greater leverage in the performance of the business.

So maybe I'll ask Eldon to comment on a few specifics.

The items that we talked about, I mean, I'm not going to get into the specific numbers for '04, as Tim mentioned, we're going to come back at our end of the year call, and talk more specifics, but the point that we mentioned, that on an absolute basis, you will see increased R&D spending.

If you look at our business over the last -- this year and last year, you've seen R&D spending be relatively flat.

That hasn't been because we've been restraining the business, we've been doing what we feel we need to do to go forward and evolve the business, but we feel that we've hit a point and time that is time to pick up the pace there so you will see, on a go forward basis , an absolute increase in R&D spending.

Both sequentially, and an up-tick as a percent of revenue, we feel that the right thing to do for today and that's the right thing to do to build a business for tomorrow.

Also, we are going to pick up the pace on this and some selected marketing programs, based on what we've experienced as a business in the past, and the success that we've received from different types of marketing programs.

Specifically, I'll mention direct and consumer advertising, and we're going to pick up the pace as we go forward, on an incremental basis, and as we have been saying in this business for some time now, in our communications publicly, that we look at 2004 as to be a period of time that we will renew focus on our international business and accordingly we will pick up the pace on our spending.

As we've been doing our business planning here over the last number of months, and really setting the keel for our plans going forward, that's basically the conclusions and the decisions that we've come to in the business, and what we feel as the prudent thing to do on a forward basis.

The second question is, I just want to confirm some of the guidance you gave that I couldn't write quite that fast.

In '04, revenues 155 to 165, non GAAP profits, 3.5% to 5.5% of that revenue number, is that correct?

That is correct, that's what I said.

Okay, and stock base compensation, 8 million in '04?

That's correct.

Did you give a stock based compensation number for '05?

I didn't hear it.

Yes, it was $1 million.

And Mark, that the unwinding of the charges that were set in place with the January '01 IPO, it's again, it's 4 years tied to the length of the normal vesting cycle of the stock plan that get down with that pool, gets amortized over that 4 years post IPO, so it unwinds -- that set of charges unwinds in January of '05.

Thank you very much.

The next question comes from the line of Bruce Jacobs, please go ahead with your follow up question.

I just had a couple of quick follow ups.

Tom, what do we know now about seasonality, has your business growth normalized enough where you can give us some sense whether or not there's much seasonality to the revenue numbers you'll report in the quarters to come?

Well, you know, I'd love to say where that's smart Bruce, but we're still learning.

For example, Q3, we just reported, we rightly should expect that in the US orthodontic channel, that it should be very soft because, if you've been in an orthodontist's office with your kids, you'll know in summer it's mayhem.

Everybody crowds in for their first starts, the initial office visits take hours, and it's a very, very busy time for orthodontists when they're doing adolescents and kids.

Yet this year, we saw substantial expansion, and really positive growth in the orthodontist channel.

So, but I think at some point, we probably should expect a little bit of seasonality, as Eldon just defined, for two reasons in over the holidays.

1, our business is a function of number days, our doctors' offices are open.

It's just a fact that they're closed more days over the holidays than other normal quarters. 2, you certainly have the effect in Europe of a longer holiday season, and, so we typically don't expect, you know, huge breakout quarters in Q3 or Q4, yet we've seen solid growth the last two years, and we've indicated solid growth for Q4 this year, but I think, maybe the issue here is, Bruce, why we really aren't seeing so much variation.

We're still so small in terms of overall penetration. [inaudible] overall opportunity.

Tom, that was perfect segue into the last question I wanted to ask.

I thought you said you just had 2?

I did have 2 follow ups, but then I just asked 1, here's my second, which is, what's your current thinking on the total applicability for the technology?

I know we've usually thought about there being 2 million orthodontic cases in the U.S. annually?

I'm just wondering how you think about that now, and I guess if you're at an 80,000 a year case run rate right now, I just want to get a sense for what you think your penetration is into the clinically available cases?

Well, I'll [inaudible] back and give you a frame on what we've said before about our likely case finding for the year in just a second, and again, we'll do some conformation of that in a view of 2004 in January, but I'll let Eldon comment on our view.

The numbers that we see consistent, we've taken a conservative approach when we say 2.5 million annual starts.

We've seen numbers as high as 3.5 million in starts, in North America.

We use 2.5, and of that 2.5, we look at roughly 900,000 as kids, or young adults, and so that would mean, girls under 13, generally boys under 15, that are just, in general, unlikely to be great candidates for Invisalign.

Irrespective of the complexity of case, which also might slice off some chunks.

So if we're left with roughly -- if we take 2 million as annual patients starts, and we're left with 1.1 million, we believe, today, that we are mapping into around 800,000 of that 1.1 million patients today.

So any assumption that there's no market expansion, the assumption that it's really 2 million, instead of say 3.5 million annual starts, and the assumption that we've got a pool of 800,000 to get into, we're still very small penetration of that total population.

We've got lots of room to grow, so that's roughly a billion dollars worth of revenue potential for us on an annual basis, and our ASP and that 800,000 patients.

That's a billion dollars worth of revenue opportunity.

Now, we're not saying that we're going to do a billion dollars, but that says is that there's no near-term head room.

The second part of the equation that really gets us excited, and what we're talking about in the orthodontic industry, about orthodontists, is how do we get, how do we help physician now occlusion of something that people can do and treat, as part of their normal, oral health care, and how do we invite, what we think, are roughly 72 million Americans alone, that see their dentist regularly, that suffer from mild moderate or severe malocclusion into treatment that don't even currently seek it today.

So those numbers totally blow away existing market model, so would a quarter of those people ever seek treatment?

Would 20% of them?

Would 50?

Who knows.

What that says is the true primarily legs of our strategy are, 1, to drive utilization in the existing market space, there's lots of room for growth there.

We've described that at length, and 2, the long-term opportunity and a rational for starting to make some incremental investments in market development, and in systems and tools, and customer interface that will allow us to dramatically scale against a bigger opportunity.

We see long term -- you know, why there's no reason why millions and millions of more people can't see cost effective ways to treat mild, moderate, or severe malocclusion.

There's the clinicians [ph] out there that can treat it, there the infrastructure industry that's willing to support it, and we just think it's exciting, gets us up every morning early.

That answers my question, thanks a lot.

Maybe, before we get off it, I want to make sure we don't leave any facts hanging in the air.

I want Eldon to comment on what we've provided previously about the range of our likely cage volumes for the year.

Yes, just to reiterate, for this year the volumes were 72.9 to 74.2 thousand cases for the full year, which again, for the upcoming quarter was 19.9 to 21.2 thousand cases.

So, those are the numbers that are hanging out there.

Perfect, thank you again guys.

The next question comes from the line of Rick Wise, please go ahead with your follow-up question.

A couple more follow-ups, I'm just sort of playing with numbers as I look at the quarterly run rates relative to the sales guidance, and sorry to push on this a little bit but, I'm just saying to myself, your third quarter sequential sales were up 17%, and you just said to Bruce, I think, who knows about [inaudible] value yet, but just playing [inaudible] seasonality.

The annualized growth is at 68%, if I annualized your third quarter sales, that's 136,000,000, implying that, again, assuming no seasonality, that I get 21% increase or so in that 155%, 165% range.

The sales guidance seems awfully conservative and, am I missing something?

Oh man Bruce, or Rick, sorry.

I can remember a couple of call when I first got here, where I got beaten and pilloried for overaggressive guidance that we didn't achieve.

What we're doing first of all, is doing or best to run the business as best as we can, and we're not going to be perfect.

We're going to provide a more detailed framework to look at '04 at the end of January, we've raised our guidance, incrementally, every single quarter this year when we've announced results, and we're -- and so I don't want to let you talk me into jumping off into the deep end here, but, as the business continues to evolve to the extent we see, continued strong adoption acceptance and acceleration, we're going to revise our model but we don't -- we're on a journey here, and we think it's way too early to declare victory so I just if I have to have you poke me on something, that's an okay thing for you to poke me at.

Exactly, by the way, Bruce is the smart one.

I'm the good one.

I'm sorry, I don't have to hear about that, I'm sorry Rick.

I'm the good looking one.

Tax rate in '04 and '05, how should, thinking about, if you're profitable, as we're playing around with our models.

Is it likely you'll be paying taxes in '04 and '05?

Yes, I think, is the answer.

As we become profitable, and paying taxes is a relative term.

On a GAAP basis, we'll be starting as the business that evolves into a more profitable model, to be recording tax provisions on the book.

Obviously, the cash impact of that from an IRS prospective will be a different animal because of the tax referrals.

Also, under GAAP, at some point in the future, that's not determinable yet because there's a lot of moving parts that goes into determining what you're likely hood of profitability is, and at what point in time, and how you project that to determine when any of your deferred tax assets would need to go on to the balance sheet, we haven't made that determination yet, but yes, as we step into '04 and, bear with me and be patient, we'll provide more guidance out in January, but from a modeling prospective, you would expect to start seeing some tax provision in '04, probably by the time you'd get to '05, you would start to see a more normal type of provision hitting the income statement.

Okay, and last, a fishing expedition of a question. 6500 doctors are submitted, if I heard you correctly, in the quarter.

If I could look at the doctors, and when they trained, and how long they've been a part of the Align family, so to speak.

If I could break them down into -- it's like, the guys that have been trained for whatever, 4 years, and 3 years, and 2 years, and 1 year, and 6 months, would I be -- the guys that have been trained the longest, that's [inaudible] the longest, submitting more -- I mean, is there some sort of relationship that, encouraging relationship, with time and experience to the volumes submitted, or can you give us a perspective on those issues?

Yes and no, how's that huh?

I think that would be the answer.

Yes, great.

Let me give you a basic framework for thinking about this for orthodontists, and then let you know that there's some churn here because we have this dynamic that's going where there are, out of the three thousand, or so, U.S. orthodontists that are really active. 3500 that are active that do all the way from one or two cases a quarter, maybe skip a quarter, and do 5 or 10 a year, total, to orthodontists that are doing a rate of 300 a year, um, some of those orthodontists were trained very early, and got excited about it immediately, and have grown very linearly.

There are also orthodontists that started some cases, got frustrated in the early days of the company, with poor company performance, or some less than predictable outcomes, and as we were learning and they were learning, and went away, and some of those haven't come back, and some of them have.

What I would see in general, is we have found that our investments in channel support, in provider workshops and study clubs, and online, and real time clinical education, paid back very, very well, as we help facilitate acceleration of that learning curve.

Maybe think of this in a different way Rick, if I take probably 60% of our [inaudible] revenue comes from -- 30% or 6535 kind of a ratio, 35% of our orthodontists generates 65% of our U.S. ortho body improbably [ph], and if I take the top, say, 100 orthodontist and I look back at them sequentially for 8 quarters, virtually every one of them, they may go flat a quarter to every one that has been increasing.

Some of them have got along for awhile, they litigated fairly slowly in [inaudible], and then all of a sudden, their practice really starts to take off and they go through the roof, but in general, those top 100, or 200, or 300 docs, if I look back over the last 8 quarters, have all substantially expanded practice over time.

On the other hand, if I go back, 3 years say, and I look at the top 100, or so, docs three years ago, we've lost some of those docs that didn't put up with our lack of performance, 3 years ago, 12 quarters ago, and some of those docs have gone away, and a few have come back, so there's been some turnover here, so I can't really say it's when you were trained or started, it had to do more with inflection points in practice, and the kind of results they're getting, and how they are their peers are viewing the clinical outcomes and the patient satisfaction, and their confidence in using the product, so we can support that to a certain extent with education and training, and facilitation of spreading the vast practices, but the other day, treatment through orthodontists takes a year, a year and a half, and they have to see cases through to get satisfaction and comfort, so there's this logical path to expansion of a practice.

Our job is to make sure they have successful outcomes, and to make sure they get treated great, and that we're the best part of their practice, and that's the part we can control.

Thank you very much.

Thanks Rick.

Gentlemen there are no further questions, I will now turn the call over to you, please continue with any closing remarks.

Well, again, I'd just like to thank you for joining us this morning.

We're going to do our level best to build a terrific company, and we look forward to sharing with you our fourth quarter results in the full year on January 29th, thank very much.

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

We thank you for your participation, disconnect your lines.