愛齊科技 (ALGN) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Align Technology's first quarter 2006 financial results conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to introduce Ms. Barbara Domingo, Director of Investor Relations. Ms. Domingo, you may begin.

Thanks. And welcome to everyone on the line. If you haven't received a copy of our press release, please go to the Investor Relations page on our Website at investor.aligntech.com. Before we start the call today, I'd like to make some comments on forward-looking statements. During this conference call, we may make forward-looking statements relating to Align's expectations about future events, products and its future results. Including statements regarding expected financial results for Q2, 2006 and fiscal 2006.

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 statement.

Factors that might cause such a difference include but are not limited to; risks that are detailed from time to time in Align's periodic reports filed with the Securities and Exchange Commission. Including but not limited to; its annual report on Form 10-K for the fiscal year ended December 31, 2005, which was filed with the Securities and Exchange Commission on March 1, 2006 and its 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 for comparisons to previous quarters. Most of these items, together with the corresponding GAAP numbers and a reconciliation to the comparable GAAP financial measures, where practicable, are contained in today's financial results press release, which we posted on our Website at investor.aligntech.com, under financial releases. And have furnished it to the Securities and Exchange Commission on Form 8-K.

We encourage listeners to review these items. Additionally, we've posted a non-quarter GAAP and non-GAAP revenue model on our Website at investor.aligntech.com under historical financial data. Please refer to both of these downloadable excel spread sheets for more detailed line item information. With that said, I would like to introduce Align Technologies' President and CEO, Tom Prescott. Tom?

Thank you Barabara. And welcome to our shareholders and friends who are listening today on the phone and through our Website. Align got off to a solid start in the first quarter. At an operating level, we made significant progress. As expected, case volumes expanded significantly. This trend was anchored by a increasing number of orthodontists returning to more significant usage and utilization. Gross margin performance was strong, even in the face of our significantly lower pricing environment and increased Invisalign Express mix.

And operating expense management was very solid, offset by a significant and necessary spike in OrthoClear related legal expenses. All in all, Align is on track with our expectations to grow volume, manage expenses, deliver solid value to our customers, return to sequential quarterly revenue growth this year. And as we exit 2006, restage meaningful year-over-year growth in the top line. Over the next few minutes, Eldon and I will comment further on key metrics or financial results to provide a bit more detail.

Before we break down the operating metrics for the quarter, I want to step back and reiterate or principal strategies for success in today's marketplace. Winning in this marketplace will be measured by strong and continued growth in case starts and a continued dominance in market share. This success will be achieved by delivering a superior product, supported by comprehensive service and support in an environment of customer partnership.

The key elements off our strategy include; extending our clear product leadership, superior manufacturing, extensive clinical education and attractive rational pricing model. These elements will resonate in our discussion today and should provide a framework as we discuss both results and plans in this and future updates. In the first quarter, case shipments increased 8% sequentially and 25% year-over-year to 36,700. Ortho cases were up 9% to 14,000 cases, from 12,800 cases in Q4. 27% of ortho cases were Invisalign Express cases. We shipped 18,500 cases to GP's, up up 6% from Q4. 33% of these cases were from Invisalign Express.

On the international side, case shipments were up 10% sequentially to 4,200 cases. In Q1, we trained 700 GP doctors, bringing our total base of total trained GP's to 18,900. 14,500 of them or 77% have used the product. We are on track with our plans to train and certify around 3,000 GP's this year. In Q1, 12,000 doctors worldwide sent in cases. 1,600 of these doctors were first time submitters. The number of U.S. orthodontists submitting case was 3,000, an increase of 200 over last quarter. And 7,600 U.S. GP dentists submitted cases, an increase from 7,300 last quarter.

Out of the 36,700 doctors trained worldwide, 24,900 doctors have treated with Invisalign. And 27,600 or 83% of those have generated multiple cases. Utilization has increased from previous quarters. For Q1, U.S. ortho utilization was 4.8. U.S. GP was 2.6. And international was 3.3. In total, more than 415,000 patients have started treatment with our product. We've manufactured over 18 million aligners. Now, we know that progress in expanding case volume and increasing utilization won't be perfectly linear.

That said, I would like to point to what we believe is behind these metrics. First, the Invisalign product, both full cases and Invisalign Express for simple cases is an outstanding system that has gained wide adoption among doctors and widespread recognition among potential patients. We deliver quality products, service and support every single day to the thousands of offices that routinely let us be a part of their practice.

Second, our outstanding sales and support teams in the U.S. and around the world are back to full strength and starting to come up the experience curve. If you recall, during 2005, our sales coverage was significantly disrupted by a new competitor. We have not just recovered from that; we have made the team stronger with outstanding talent, motivation and clear field organization leadership. As we rebuild relationships, as this team really learns the business, we should be able to generate real growth.

Third, this nascent market is still growing as the strong response to our demand creation and branding initiatives demonstrate. As product performance, clinician confidence and consumer acceptance all continue to improve or grow, this potentially enormous market will offer opportunities to stake out and defend market leadership positions.

Now, for a few highlights from Q1. And a good place to start is with our sales and marketing teams. In all areas, these teams hit the ground running and delivered significant case volume growth. Some to expansion of customer base but primarily through increased utilization. We expect this effort and impact to continue throughout the year. We rolled out another wave of our advertising campaign, which we call Bloom, designed to further develop our Invisalign brand and to generate awareness, activity and leads for our key practice partners.

How are we doing? Well, through our Company Website in Q1, qualified responses are up over Q4 by 53% and qualified leads are up by 54%. Great progress. As far as our extensive clinical education and support is concerned, we held over 150 clinical education events including 26 GP certifications. We also conducted a number of select orthodon'tic certifications, as well as numerous study clubs and provider workshops.

This is a very busy time for us. A great time for us. As we prepare for the major orthodontic conference, AAO, held in Las Vegas starting next week. We are also preparing for our second annual European summit in mid-May, which will host our top clinicians and practices in Europe for intense program of Company focused and peer-to-peer clinical learning. On top of that, we will host our second annual GP summit early in July for the top GP practices here in North America. We have not formally opened up registration, and yet We have several hundred practices pre-registered, representing over 500 attendees.

There is great excitement about these outstanding programs and the positive impact participants bring home to their practices. Also during Q1, our operations team completed the planned move of our SLA, stereolithography, processes and equipment to our aligner fab facility in Juarez. This well planned and executed effort came off without a hitch, even in the faces of volume increases we experienced in Q1. The benefits from this move include cycle time reduction, as well as quality and process improvement savings that will support gross margin expansion.

During the first quarter, the R&D and information technology teams delivered a series of internal facing software and systems improvements. Including expansion of what we call our MES software capabilities in Juarez. This dramatically enhances our ability to manage the aligner fabrication facility and paves the way for additional automation. Throughout our manufacturing environment, we continue to development software enhancements, drive process change and implement scalable automation technology that enables better quality at a lower cost.

On the R&D new product development front, we have focused our efforts on clinical and technology research, which is the front end for more sweeping product development initiatives. We have previously discussed a few near-term product enhancements. These include; integration of Invisalign branding directly onto the aligner, a compliance indicator, as well as next generation material. Integration of Invisalign branding directly onto the aligners represents an opportunity to further differentiate our product to doctors and to provide confidence to consumers that they are getting the quality they requested by name. We expect to start shipping Invisalign branded aligners by this fall.

Now for the compliance indicator. After seeing this feature in clinical use and given the broad variations in the patient population, it's clear that we need to be complete about directions for use in monitoring. It will be an excellent tool for doctors to monitor patient compliance with Invisalign branded aligner therapy. Given the additional clinical work to define those directions for use, we now expect to launch this in Q1 2007. As far as the new aligner materials are concerned, as we evaluated moving from pilot production to full deployment in our aligner fab facility, it became clear that the best way to deploy this new material was to integrate this product performance improvement along with a number of process improvements and changes in our automated aligner fab line.

In making a decision, we will optimize the impact both on product as well as manufacturing environment. We now expect to launch this change early in Q1 2007. On additional consideration here for all of our product development initiatives, is the incremental effort and discipline necessary to ensure we were compliant with FDA Class 2 Device Guidelines. We will keep you posted on these projects.

There is a huge amount effort for R&D and technology development focused on extending our product leadership. Our goals are to evolve the current Invisalign system, making it even more clinically robust, increasing the ease of use and expanding the base of potential patients. We have previously described BPT, or bracket positioning template, as a step towards opening up the large base of complex cases both here and outside the U.S. for what we call combination treatment. We continue to focus on this goal of creating an Invisalign line combination product and have learned a great deal from clinical experience with the beta product.

It's not clear, at this point, if we will move to development our current BPT approach into a product offering or drive to our ultimate goal of a combination of product. Accordingly, since this is a research and clinical development program, we are not going to discuss it in the same context or detail as our near term product enhancements, features or offerings.

As I look back at the first quarter, I am pleased with Align's leadership and our ability to focus the organization on our critical imperatives. I'm certain we are on track to execute a winning strategy. I believe we will extend our product and market leadership, becoming a much more important part of our customer's practices. And in the process, deliver significant increases in growth and the kind of outstanding returns you expect from the Company. I'd now like to turn over to Eldon.

Thanks, Tom. Just quick reminder, our first quarter press release and 8-K filing of the same document are available on our Website. Both GAAP and non-GAAP financial tables and a reconciliation of GAAP to non-GAAP financials are included in our press release. And historical tables have been provided on our Investor Relations Website under financial history.

Before I review the financials, let me briefly touch upon Financial Accounting Standards 123R. As you know, all public companies, including Align, have implemented FAS 123R governing the expensing of stock options beginning in 2006. We will call out the impact by category as a non-GAAP item.

Let me move on now to our financial results for Q1. First, Q1 revenues as Tom mentioned, were 48.9 million. Down 4.4% from the same period a year ago and 4.4% from last quarter. First quarter revenues by segment were 17.3 million for U.S. ortho. 22.5 million for U.S. GP. And 7 million for international. These channels represent 35%, 46%, and 14% of revenues respectively.

Invisalign Express revenues included in these numbers were 2.8 million for U.S. ortho and 4.6 million for U.S. GP. Worldwide training and other revenues were 2.1 million. Blended ASP's, not including Invisalign Express were approximately $1,480. ASP's were slightly below our January guidance, as a result of higher participation in our volume discount programs. ASP's for U.S. ortho, U.S. GP and international were $1,420, $1,406 and $1,680 respectively. These numbers are posted on our Website under additional information.

Revenues included a $1.9 million benefit associated with our case refinement policy change last June. GAAP gross profit for the first quarter of 2006 was 34.6 million or 70.8% of revenue, compared to 35.7 million or 69.7% of revenues for the first quarter of 2005. This also compares to a gross profit of 34.5 million or 67.3% of revenues last quarter. Included in cost of revenues for Q1 was 148,000 for costs associated with stock option expensing pursuant to FAS 123R.

Non-GAAP gross profit for the first quarter was 34.8 million or 71.1% of revenue. Gross margin was approximately 7 percentage points higher than our January guidance, due primarily to a -- in part to a $1.5 million loss accrual cost recovery, resulting from improved case refinement costs. And in part, to realization of our aligner fabrication process improvements sooner than anticipated. Operating expenses on a GAAP basis were 39.8 million for the first quarter of fiscal 2006. This compares to 33.5 million for the same quarter one year ago and 33.8 million for the fourth quarter of 2005.

Operating expenses were higher than expected, due to higher legal fees associated with an increase in OrthoClear litigation activity. Q1 includes approximately $5 million in OrthoClear related legal fees. Excluding approximately $2.1 million due to expensing of stock options in Q1, non-GAAP operating expenses were 37.8 million. Sequential spending growth resulted from the legal fees just mentioned and our 2006 media advertising program. GAAP net loss for the first quarter was 4.8 million or $0.08 per share, compared to a net profit of 1.9 million or $0.03 per share in the same period a year ago and a profit last quarter of $528,000 or $0.01 per share.

Total stock based compensation for the first quarter was 2.2 million. Excluding this, non-GAAP net loss was 2.6 million or $0.04 per share. This compares to a non-GAAP net profit of 1.9 million or $0.03 per share for Q1 of 2005 and $500,000 or $0.01 per share last quarter. Again, a full non-GAAP income statement and a reconciliation of GAAP to non-GAAP financials are available in our press release.

On to the balance sheet. Cash, cash equivalents, marketable securities and restricted cash at the end of Q1 of 2006 was 71.9 million, compared to 74.4 million at the end of 2005. Additionally, DSO's were 59 days.

Let me move on and spend time on guidance. The key objective for our business in 2006 continues to be utilization in case growth across all categories of our business. Both from the perspective of channel, ortho, GP and international, and product. Full Invisalign and Invisalign Express. Q1 results are indications that Invisalign Express, simplifying prices for full Invisalign cases, and introducing volume based discounting is moving the business in the right direction.

Pricing and discounting will mute revenue growth in the short-term. However, success in growing volumes positions the business for a strong future. While we were experiencing losses in the first half of the year, we expect that increased volumes and prudent spending will return the business to profitability in the second half of the year.

I will spend a few minutes on the second quarter and update our guidance for full year 2006. Again, I will provide GAAP guidance and reconciliation to non-GAAP guidance for your comparison purposes. Case shipment volumes are expected to be in the range of 38,000 to 39,000 cases for the second quarter, an increase from Q1.

We expect that Express cases will comprise approximately 30% of our overall case volume. We expect Q2 revenues to be in the range of 49 to 50.5 million. Ortho channel, GP channel, and international Invisalign cases are expected to comprise 28%, 38% and 13% of Q2 revenues respectively. 16% to 18% of total revenue will come from Invisalign Express cases. The majority of this, or 60%, will come from GP's. The remaining 4% approximates training and ancillary revenues.

Blended ASP's, not including Invisalign Express, are expected to be approximately $1,425 to $1,450 for Q2. The sequential decrease in ASP's for Q2 reflects the effective increase in customer participation in our discounting programs and international price changes that will help us ensure our value proposition remains competitive. Revenue also includes case refinement impact of approximately 1.9 million for Q2.

Q2 GAAP gross margins are projected to be in the range of 69.2% to 70%. Gross margin includes approximately 200,000 of stock option expense charged to cost of revenues. Adding this back, non-GAAP gross margins are projected to be in the range of 69.5% to 70.5%. Q2 gross margins reflects a 600,000 of case refinement loss accrual recovery.

Product cost improvements related to the transfer of SLA from Santa Clara to Juarez, Mexico and continued cost efficiencies recognized by consolidating aligner fabrication into the Juarez facility. Q2 GAAP gross operating expenses are projected to be in the range of 41.5 to 42.5 million. Sales and marketing, R&D and G&A represent approximately 50%, 12% and 38% of operating expenses respectively.

Operating expenses include 2.3 million of stock option expense. Of which 26%, 13%, and 61% reside in sales and marketing, R&D and G&A respectively. Excluding the stock option expense, we would arrive at non-GAAP operating expense of -- a range of 39.2 to 40.2 million. The sequential increase in operating expenses results primarily for market research, systems enhancements, Europe staffing and industry events, including the AAO and our second annual European summit.

This guidance also reflects OrthoClear related legal expenses in a range of $4 to $5 million for the quarter. GAAP net loss is projected to be in the 6.7 to 7.7 million range for a loss of $0.11 to $0.12 per share for Q2. Bottom line impact of stock option expense is estimated to be 2.5 million, resulting in a non-GAAP loss of a range of 4.2 to 5.2 million or $0.07 to $0.08 loss per share.

Let me turn to guidance for full year 2006. 2006 revenue is projected to be in the range of 204 to 210 million. Ortho channel, GP channel and international Invisalign cases are expected to comprise 28%, 39% and 12% of full year revenue. Invisalign Express cases are expected to be 16% to 18% of revenue, with the remaining 4% approximating training and ancillary products.

Case shipment volumes are projected to be in the range of 159,500 to 163,500 cases. We expect that Express cases will make up approximately 25% to 30% of full year cases. Blended ASP's, not including Invisalign Express, are expected to be 1$,400 to $1,420 for full year and include full year case refinement impact of 6.8 million. ASP's for the full year are approximately $65 per case lower than our previous guidance. Reflecting expected higher levels of participation in our volume discount programs and international pricing.

Full year GAAP gross margins are projected in the range of 68.7% to 70.1%. Gross margin includes approximately $800,000 of stock option expense charged to cost of revenue. Adding this back, non-GAAP gross margins are projected to be in the range of 69.1% to 70.5%. 2006 GAAP operating expenses are projected to be in the range of $157.2 to $160.2 million.

Sales and marketing, R&D and G&A represent 50%, 12% and 38% of operating expenses respectively. Operating expenses for the year include $9.2 million of stock option expense. Excluding this $9.2 million of expense, we would arrive at non-GAAP operating expenses of $148 to $153 million.

2006 is expected to include OrthoClear related expenses in the range of $18 to $20 million. Approximately $8 million higher than our full year guidance last quarter. GAAP net loss for the full year, is projected to be in the $14 to $17 million range for a loss per share of $0.22 to $0.27 per share. Bottom line impact of stock option expense for the year is estimated to be $10 million, resulting in a non-GAAP bottom line loss of 4 to $7 million or a loss per share of $0.06 to $0.11.

Taking a quick look at the balance sheet, we estimate our cash at the end of Q2 to be in the range of $64 to $66 million. We estimate our cash balance at year end to be in the $65 to $70 million range. DSO's are expected to average in the mid-50's.

We project full year capital expenditures in the range of 13 to 16 million, depreciation and amortization is expected to be in the $11 to $12 million range for full year 2006. We will now go to the operator for questions and answers. Operator?

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Tao Levy with Deutsche Bank. Please state your question.

Good morning, everyone. Just a couple questions here. Maybe you could -- I know you mentioned on the call, Tom, but maybe you could go through as a percentage of say the 100% being maximum efficiency for productivity out of your sales force, out of the new guys, where do you think they stand today?

We don't have a meter on them, Tao. But what I would say is describing what we talked about on the last call, we think it will be the better part of the full year before we feel this whole new team is fully productive. That said, they are making progress and on they're track with our expectations and I think we are starting to see some of that.

Great. And maybe you could also talk about the Class 2 change from the FDA? Is that -- does that apply to all invisible-type braces or is it specific to you guys? There was some discussion in the marketplace about OrthoClear not really being a Class 2. They were going to retain Class 1. What's your understanding of the FDA's decision here?

Our very clear understanding from the FDA is this applies to all such appliances and we are conducting ourselves completely in accordance with that view.

Okay. Would your expectations include OrthoClear's product as well?

The FDA has been clear to us any such device is going to be covered exactly the same way.

And Eldon, on the refinement part for the gross margin, so that's -- so excluding that the gross margin that would have been upper 60's. Is that the right way to look at it and if so when do the refinements -- when were we fully anniversaried?

They will be starting to slightly tail off as we go through the year and should completely go away in the early part of next year. It's just a matter of, as the cases have all closed out, that refinement adjustment slowly goes away.

Okay. And then just lastly, on the net loss for the full year on a non-GAAP basis, what was that again? I'm sorry. You went fairly quickly there.

Sure. Tao, the GAAP net loss for the full year was a range of 14 to 17 million. Or a loss per share of $0.22 to $0.27. The bottom line impact of the stock option expense was $10 million. That leaves you with a non-GAAP bottom line range loss of $4 to $7 million or a loss per share of $0.06 to $0.11.

So, if I do the math right -- is it possible in the back half of the year you're expecting to be on a non-GAAP basis profitable?

That's consistent with what I said in the earlier part of my discussion, that we are looking to be non-GAAP profitable in the second half of the year.

Perfect. Thanks a lot.

Our next question comes from Mark [Richter] with Jefferies & Company. Please state your questions.

Hi, guys, this is Mark in for Ryan. A couple quick questions. First, congratulations on a good quarter. First question is, U.S. orthodontists seem to be returning, utilization is increasing. What do you think is driving this?

What I believe is driving it is several things. First, the combination of a better product, better service, better support. Secondly, having coverage in place, starting to come up the power curve and rebuilding the relationships. Third, the entire value proposition, the adjustments we made in the broad pricing change for all Invisalign full cases. And I think we don't talk in detail about this, but the wider spread participation in volume rebating programs really signals their interest in having Invisalign be their partner.

We've taken away an awful lot of reasons that they were looking to try another product. Anecdotally, they tell us they don't think the product worked as well as they thought it would -- as when it was first shown to me. So, we believe we've got the right package and we believe -- we saw this trend starting to occur late in the fourth quarter. We talked about it a bit on our year end call and we said that was one of the expected milestones for progress that we expected to see unfold. That has in fact occurred. And we look for that to continue throughout the year.

Perfect. And can you talk about OrthoClear for a second. Are you seeing -- and to what extent are you seeing them in the GP channel and what is preventing them from gaining traction there? Is it your consulting services? Maybe providing a little more color there would be helpful.

Well, certainly we don't prevent anybody from going anywhere. But what we said in our year end call was that we did expect and had seen already OrthoClear start spending more time over in the GP's. We expected that to occur. We were prepared for it. As part of staffing properly with our field team, they spent a lot of time. OrthoClear is out there trying to go after the GP's that we've trained and certified. And we increasingly are pushing on our value proposition, which comes with all the training, all the support.

For a GP that doesn't have fixed appliance business to fall back on to finish cases they struggle with, if they can't get the case done with that product, then there is going to be a problem. We have had some customers come back to us and purchase Invisalign Express when they say they are having trouble finishing cases with the other product. So, I do think that this is going to play itself out over a period of time. OrthoClear appears to be committed to being out there in the marketplace and we're going to see them. So, our team is committed to winning in the marketplace. And although we do expect some disruption over a period of time, we think this will steady itself out throughout the course of the year.

Okay, thanks. Quick question for Eldon. Could you break out revenue by channel excluding Express?

We gave the Express revenue.

Yes, we gave you the mix. Which period of time are you most interested in?

Mark, do you want Q1 or Q2?

Q1.

What we talked about was -- I will just reiterate quickly for you that full U.S. ortho total channel was $17.3 million. GP total was 22.5. Included in those numbers was for Express was 2.8 million for ortho. And Express included in U.S. GP was 4.6 million.

So the U.S. ortho excluding Express was 14.5. And U.S. GP excluding Express was 17.9.

Okay, perfect. Thank again. Congratulations on a good quarter.

Our next question comes from Taylor Harris with J.P. Morgan. Please state your question.

Thanks a lot. My question is just on the case volume growth in the quarter, which was definitely good. And it's being driven by Express. So -- right now at least. So, I would love to get your thought son has there been backlog pent-up demand for a product like Express that we are penetrating right now? And you still expect Express to back off from that 30% mix into your base over time?

Taylor, the first thing I would react to is that we don't just see it driven by Express. The reasons for those cases starting are a bit different. And they are different between GP's and orthos. If I start with orthos for a moment, for many since you started with Express I will take that. For many orthos they have a group of patients that over a period of time, they have proposed treatment, consulted with and then might range for full treatment at $5,000 or $6,000 or $7000 all the way6 down to treating a chief complaint, say some minor crowding in one of the anterior arches. Express has offered those orthodontists -- I will start with orthodontists, an opportunity to get at that very price sensitive slice that doesn't seem to want to go for full treatment.

So, in that perspective you might say that's pent-up demand or you might say that's purely incremental depending on how you want to look at it. But that has given them an opportunity to get after that with a very cost effective offering. Again, for ortho, on the full side, as we have adjusted our pricing and as they've participated in our volume rebating program, that's given them the flexibility to lead with Invisalign in many cases. Rather than go with Invisalign when a patient really pushes on only wanting to do Invisalign.

So, I think what that does is that gives the doctor more air cover on their profitability, confidence they can really make a good living on that. And more and more doctors are choosing to make Invisalign a bigger part of their practice. On the GP side, many of the GP cases that start anyways for those GP's that are not doing fixed any appliances are purely incremental growth to the market. Whether those Express or whether those are full.

On the Express side, what we see happening with GP's is; the successful practices that have really done a great job with this are in a consistent way educating their patients, their prospects as they get their normal cleaning, hygienic services, et cetera. And so they don't feel as compelled to close a patient at the point of that consultation. They have the opportunity to see that patient again in six months. And over a period of time they are educating the patient about the value of a better smile.

In that case, having Express gives them a great way to lead for virtually every patient that comes in for cleaning if they choose to do that. So, I'd say that the value proposition is right on track for both of those and. I would say in general GP is purely incremental. For orthos, hard to tell, depending on which you look at it. Does that answer you question?

Yes, it definitely does. I appreciate that. And I don't want to make you go into 2007 too much if you don't want to, but would you -- which you probably don't. It sounds like the growth rates between partial treatment and full treatment will start to normalize at least in the or the orthodontic channel within a year or so and perhaps not in the GP channel. Is that fair?

Well, no. We are just -- this still very, very little penetration to a very, very big market. So, normalize is kind of an interesting word.

By normalize, the growth rate will -- the differential between Express and full treatment.

We think they're both going to expand nicely. And I think if you look at GP's, for example, we believe in general over the longer period of time, Express will probably be a better -- a bigger percentage of starts than in ortho. You start to see that a little bit in this quarter. But again, we have every been pleased to see how significant Express has been for the orthodontic practices as well. So, we really don't want to talk about '07, other than what Eldon has described as view of how this business evolves during the year and the position we put ourselves in to kind of try and restage meaningful growth year-over-year on the top line as we exit '06.

Okay, maybe another way to ask it is, in the second half of this year I think you are guiding to Express being 26% to 30% of cases. How confident are you in that, or is it possible that just given the utilization among the GP community and the appeal there it could actually start going above 30%?

I think if we saw that happen we would view it as an opportunity. If GP's would expand their use of that product, we would love to see that happen. On the ortho side, it's a matter of Invisalign Express giving the orthodontists additional choices. And a product in a price range to decide if they want to broaden their spectrum of service rather than passing on a more simple case. So, we would love to see pickup in that area.

Great. Okay. And then one other separate question. On the legal expenses with OrthoClear, can you just tell us what has caused the $8 million increase there? And is that -- and how do you break down the 18 to $0 million a year in terms of internal resources and external?

Well first of all, this is a strategic decision to defend our shareholders' intellectual property rights. Secondly, the ITC matter, maybe as a centerpiece is a big complicated legal action. And so we look at it as being essential that we do everything in our power to conduct these matter professionally and well. So, if that means increasing our legal spending rest of the year, as we've done; we're going to manage that investment carefully and press on with the other key strategic initiatives parallel, as a business. That said, we're not going to -- we have given you a view of what the OrthoClear related spending is. There are other matters going on. But that is -- I would say the ITC case is probably the centerpiece of that spending.

Okay. But if -- and so if that weren't going -- if this OrthoClear litigation issue were not occurring, that's 18 to 20 million out of the P&L.

That is that correct.

Thank you, guys.

Our next question comes from Mark Mullikin with Piper Jaffray. Please state your question.

Good morning. I just wanted to maybe delve into the litigation expense a little more. Obviously, it's important for you guys to defend shareholder value, but what changed in the case that drove that $8 million increase? We knew about the ITC at the end of 1Q. So now, what changed that made it go up so much and how do we know that it's not going to go up more?

Well, the way I describe it is we, in increasing our guidance we have reflected what we believe is the likely trajectory of spending, which more closely looks at what Q1 was doing. As you know, we've previously discussed the likely schedule for that process. That's most of the information we can really talk about is out there in releases. The stuff we can't talk about isn't going to be out there anyways. At this point in time, you have a full view of how we view the likely case of spending and it's a lot of money. It's also very important.

So, I don't believe at this point in time, as we've ratcheted up that spending view, we're going to get surprised. That what's behind that is it's a big, complicated case with lots of claims at issue and a lot of process going on. And we are committed to prosecuting that matter well. Again, this is the government pressing this issue against OrthoClear not the Company. In that process we have a lot of our own discovery to deliver and arguments to create. But we think we've fully baked in more than enough spending and would not expect to see that increase.

Okay. Fair enough. And relative to the new product development, you mentioned the development of a new material. Can you talk just a little bit about what the benefits are of that new material are and just how it affects your competitive positioning?

Well, I will talk in very general terms. We picked a couple of those elements out late last year, as we did a few investment presentations, to give examples of enhancements in the pipeline. There are many, many more customer facing and internal facing technology development projects. There are many more product development initiatives that we have not given voice to, especially in the context of an increasingly competitive world. But those were good examples of things that some things customers would see they would potentially solve problems.

So, on the new material, that has both internal benefits for manufacturability and we believe cost management over time. We believe quality will improve, meaning most directly fit. We also look at critical elements in material design. And this material will demonstrate substantially superior performance in a couple of very critical dimensions that will ultimately more reliably, predictably and over a long period of time deliver force or torque to teeth.

Meaning the movements the doctors want to express will be more likely to be expressed on time. The cases will progress more reliably and doctors will be more pleased. So, there are both meaningful product performance improvements in an improved material. And there are improved manufacturability elements, which is again why we moved it out a quarter or so, so we could take full advantage of some process improvements in Juarez to really get full advantage of that. So, that's one example of where we'll feel positive ripples, both out to the customer and across manufacturing.

Okay. And then just a little bit on the sales force if you can tell us how many reps you have in the O U.S. at this point and plans for adding or are we where we need to be at this point?

We are pretty stable with quarter. In fact, we've got a small training class coming in, in the next couple weeks with a handful. We've got about 107 on-line right now. I think it's up one or two over the end of the year. We've got a small class coming in. A few expansion territories and a few backfalls. So, we're incrementally tweaking that but there are no plans at this point, for large scale expansion. Our goal is to get this team up and running. We've got the leadership structure in place and we really want this team to -- our goal is to make it easier for them to do their jobs and then help them really starting getting productivity.

And then in Europe, in the commentary, you seemed to indicate some investment in Europe at this point. Is there is something going on there with the sales force with an expansion or are you trying to make -- in general are you trying to make a stronger push into Europe?

On a measured basis, we are starting to add some additional staff there. Primarily focused a few folks in sales and some marketing in customer support as their business grows. And that's pretty much in accordance with our plan.

Thank you very much.

[OPERATOR INSTRUCTIONS] Our next question comes from Anthony Ostrea with JMP Securities. Please state your question.

Hi, good morning, guys. A couple of questions. Tom, in your estimation, how fast do you think the total market for either full or simple cases are growing in the U.S.?

Oh, boy. We have a real hard time getting good quality third-party data on market here. There is some data with a fair amount of noise on the orthodontic side for annual case starts. And some data that exists for prevalence and incidence of malocclusion. Most of what we use create a view of both growth and total opportunity is all proprietary, that we've had to go out and extract from the market.

Maybe a way to think about this, Anthony, is there is -- if you start with the ortho market we view there is perhaps as much in the core orthodontics as 10% total growth in the orthodontic market in terms of patient starts. That is probably all-in including brackets and everything else. And again, clear invisible orthodontics like Invisalign leads is very, very new. So, what's going on is pretty solid growth in the overall ortho starts market.

I would take most of what's going on in GP, that we generate for growth, as totally incremental growth to the broader market. Since that's not really tracked and many of our GP's don't have any fixed appliance business, so anything they do is an incremental start. The thing that when people track market both in dollars and starts that makes it interesting is; an average brackets company that gets a start gets anywhere from $100 to say $250 participation in that case. We get anywhere from $750 to say $1,400 participation in that case. So, a start for us has much greater leverage.

If you look at our growth, we think that the healthy orthodontic companies are growing nice double digits and that's with brackets businesses. I would say that the estimate -- the third-party estimates I've seen for 10% to 12% overall growth in orthodontics is probably overstated. And it's probably understated more on the revenue side than it is the case starts side. Again, because of the leverage in our product, the top line value. Again for us, we are going to get volume growth first, growing into -- that will turn into revenue growth for us. Because we -- with the pricing changes and the mix issue with Express.

But going back to your original question, 10% seems like a pretty conservative number for case starts in the ortho space. And everything on the GP side is probably total incrementally to that.

And that's total market, not -- and you's expect to be -- you'd expect that invisible aligners would be growing faster than that 10%.

Much faster, yes.

Okay. And just on the international front, I think you had mentioned you were guiding to slightly reduced prices going forward, at least in '06. Can you comment on what essentially sparked your decision to reduce prices there?

Well, the two points that I was focused on there in talking about ASP's going forward; the one item that's pricing and it was a move in international consistent with the move that we made in the U.S. Was some simplification of the pricing structure and some reductions. That was in the international business. The second issue is; we see docs responding to our volume discount program and going into the higher levels of the volume discount program than they get a higher percentage discount and that weights down our average ASP. That was the two primary items I was discussing.

The volume discount also is specifically measuring internationally, not the U.S.?

That's correct. The pricing change we made in the U.S. was last November. And the international price change is coming into effect at the beginning of -- really starting to see that effect at the beginning of the second quarter.

Got it. And then, Eldon, actually on your comments on being non-GAAP profitable in the second half, are you saying both Q3 and Q4? Or as a total Q3 and Q4?

Sometime in the second half.

Okay. And Tom, actually, would you be able to kind of break out how much of your current customers are in your discounting program? And given your comments on where that is headed, which is up, where you see that is going?

We haven't described the numbers behind that. We are very pleased with the participation. And beyond that the docs that are participating on an exclusive basis. So we're -- we haven't talked about numbers but we are very, very pleased with the direction and it's exactly what we wanted to have happen.

Is it -- are you talking about it going dramatically up or marginally up?

Just step-wise. But again, very consistent with what our plans and our hopes were.

Okay, perfect. Thanks.

Our next question comes from Derek Leckow with Barrington Research.

Thanks, good morning and congratulations on a great quarter. As we look at the orthodontic industry, we were seeing a huge market share shift switch towards aesthetic treatment solutions. And yours being one of them. I'm just wondering with the marketing that some the larger players are doing out there as well, do you see that that's also perhaps driving some business toward your solution?

That's a great question. There is not as much marketing out to the consumer for clear appliances, clear brackets, low profile brackets. But all of the major or the orthodontic companies with fixed appliances spend a lot of effort positioning those products as much more aesthetic to their doctors. We view the market moving to that and you should ask them. But it's our perception that kind of the lower, the more conventional brackets and wires are being picked up by the smaller share players out in the conventional fixed appliance business.

So, I think they are trying to move to a higher price point, higher value brackets. All these things are good for the consumer because there still remains this enormous gap between the interest and level -- the prevalence of malocclusion, the interest of consumers to have a better smile and still the very small number of people that start treatment each year. So, our goal -- and the more companies and technologies intersect with this, the more likely it is we get really significant market growth and category growth over a longer-term.

So, I looked at it as a really good trend. And I think complimentary to what we are trying to do.

And with Sybron, [Ormco] being acquired here, have you seen any interest or any activity regarding the sales reps that they have? Are they perhaps more interested at this point to look at perhaps joining your Company? Have you talked with anybody about that? wonder if -- you saw a couple reps here in the quarter. You had a 107. To me, that's a key part of your strategy is to grow your sales force because there are still people that you're not really marketing to effectively at this point. So, would you be -- can we expect to see that number of reps kind of increase over the next year? Is that part of your plan currently?

Well, if we go back to what we discussed in our Q1 call, Derek, we had originally viewed that the likely balance point for the sales force as we exited Q4 last year was going to be 115 to 120. As we really were able to fill out and rebuild the sales force, fill them out as the year progressed and we saw them starting to come up to speed a little bit; we felt like we had about the right number at about 105 or so. That's trickled up a bit to 107.

At this point we don't see -- we get to touch lots of talent out there. This is a pretty cool job for reps in the business to have. And we've got a very charged up motivated team. I think there has been a net upgrade in talent for this group. We don't see it going to 120, 103 any time soon. And the way we look at it Derek is; as we consider reaching a much broader group of say GP customers, over time we might think about how we reached them through partners versus building hundreds of sales reps out there touching everybody directly.

I think there's going to be a concentration of doctors that can best integrate Invisalign into practice that will make it an important part of their practice. And that's where our focused, direct coverage will probably evolve to go. And the extent there are more marginal non-routine users on the edges, we might seek over time to consider partners to touch those customers. But at this point in time, we're not ready to step on the gas and significantly increase the sales force. We think we are close to getting it right.

That's a very interesting comment you just made regarding the possibility of a partnership or joint venture. What sort of an arrangement do you have in mind there?

I'm not talking about any arrangements. I'm just talking about -- given your question about; would we add lots to reach lots more customers. So, all I've described is strategic direction, that says if we chose to reach a broader group of GP specialty customers, 130,000 plus out there, how would we do that? I'm telling you we're not going to build hundreds and hundreds of direct reps in our sales force. We would seek other ways to do that.

There are other companies out there with thousands of reps. So, that's an opportunity for you. Again,I just want to touch on the gross margin if I could, real quick. I know this call is getting kind of long. The gross margin accelerated quite a bit faster than I thought I would. And can you describe what's happening with regard to your Juarez facility and is there room here for additional uptick? I do appreciate the guidance that you gave. You gave good detailed guidance there. But maybe just talk a little bit about some of the drivers.

Well, I think what's happening is there is consistent with what we've talked about in the business for some period of time. We made the commitment to consolidate our aligner fabrication in our Juarez facility. As we've talked about the moving the SLA operation from Santa Clara to Juarez, was kind of the last key key card to play there to get it under one roof. So we now have the opportunity to work that bolus of initiatives to gain the economies and efficiencies as we put that together. And as we talked about in the past, those are step function improvements. And that's really the cornerstone of our cost improvements.

And Eldon, do you care to talk about the magnitude of that step function improvement that you kind of see out there for the next couple of years? Is there a range you could give us?

What we've talked about and you have seen the evolution in the guidance I've given you for 2006. And when we have further visibility at a point in time in the future, we will come back and talk about that in greater detail. But just in general, we continue to always explore opportunities to reduce our product costs, become a more efficient operation. And we don't expect to ever stop doing that.

Great. And then finally, just on the shares outstanding that came down a bit here. With a was that related to, Eldon?

As far as the shares outstanding, if you -- when under the process that you use, when you are in a loss position, you use actual shares rather than fully diluted weighted shares. I think that's the driver there.

Got it. Thank you very much.

Thank you.

Thank you. Our next question comes from Kevin Kotler with [Boston]. Please state your question.

Good morning. Good quarter. As far as the gross profits go, Eldon, did you say on the call that the 71.1 -- you said 71.1% was because of some improvement. And I just was curious, just to be more clear. Is the second -- I know you gave second quarter guidance but is that improvement just a one-time thing that will carry across? Or are you -- again, I know you just consolidated facilities but it should still be incrementally improving?

If you tie together the projection we gave there that you are quoting for the second quarter and the full year, Kevin, that as I was just discussing; what we are seeing is a set of improvements and process efficiencies that we're getting with aligner fab under one roof in Juarez. So, I mentioned that we did have some one-time affect with our case refinement loss accrual recovery. But once that's washed through in the first quarter and additional 600,000 in the second quarter, which is making us a small contribution to that 71%. We were talking about up to around 70% for the full year. So, I think that gap that fills in there is a few step function efficiency improvements that we will continue to see throughout the year.

Okay. And then, Tom, the two products that were pushed out to the first quarter, in terms of the new material, the branding, that was originally expected in what, the second half of '06?

Yes. Well, the branding hasn't moved out. That's on track for the second half of the year. Product branding on the aligner, we said in the fall. And we've about a quarter for both the new material implementation, as well as the compliance indicator for very different reasons. Appliance indicator, so we can provide a really complete framework for the doctor to utilize it, given the broad variance in biology and how patients are going to be in using the product and all that good stuff. And again, consistent with FDA's expectations for a Class 2 Device Company. And then the second issue is material and probably take full advantage of that. We want to make some other process adjustments. The best time to roll that out is probably early in -- some time early to mid Q1. So, we're going to move that back about a quarter a bit more.

What I was trying to get at is just as far as news flow, besides quarterly conference calls, is there any other things -- if you don't want to be specific about it but other items that could be either new products or things that are announceable over the next several quarters?

We were going to try as best we can, Kevin, to give a view of the things that are significant, that are coming up. We will increasingly talk about them when we are closer into them. And they are -- especially the customer facing elements are product. And we are probably going to talk less about big research, longer term future, potential type elements. Again, there is probably going to be more clinical work here on some of these, given our view of Class 2 requirements. And so, we will try as best we can to give you a view of the things we think are significant that are going to change our view. And they will probably get captured in the form of guidance.

And the Class 2 thing, are you hinting that you might do like some broader clinical trials demonstrating kind of efficacy and maybe going into labeling? Is that some strategy that you have?

No. What we've said is we -- we already said when we went out with the announcement that the FDA had been in touch with us, that we believe we were fully compliant with all of their requirements. We think there is beefing up to be done in a variety of areas. And I think we want to make sure, as we roll out new capabilities, new products, new features that we are doing a very complete job of doing that prospectively. So no, it's not much behind the ordinary course of business but I think we are trying to be thoughtful and complete.

Last thing. Just on -- in terms of losing accounts, before they took sales people from you. Have they taken any other sales people from you, ortho -- I'm talking about OrthoClear? And then, two, if you look at the number of accounts you have, could you just talk -- comment about accounts that are converting away or converting to you from OrthoClear? Is there some balance sheet on that?

The first answer is, we have not lost any reps. We're stable. The team is pumped up and excited. The second answer is, we do keep close score of that at a practice by practice level. And behind -- as I think I said, behind the numbers that showed increased utilization a lot of those were -- where there was an acceleration of returning orthodontists especially. Over time, we hope to see that also with the GP's that have tried the product. But again, we will talk about that when we have that understanding.

We have time for just one more question.

Our final question comes from Shawn Fitz with Stephens Incorporated. Please state your question.

This actually Scott standing in for Shawn. I just wanted to ask a quick question about advertising spending and your advertising campaign. I know there is a bit of seasonality between the fourth quarter and the first quarter. Can you kind of give us what the magnitude for what advertising spending was in the first quarter versus the fourth quarter?

What we're the way we are running our campaign in 2006 is consistent cadence with last year. We kick off at the beginning of the year. We do the majority of our spending in the first three quarters of the year. We do very little spending in the fourth quarter. As far as overall spend for the full year, we are looking in the range of $6 to $7 million. That's spread fairly equally across the first three quarters of the year.

Okay. Great. And just one last real quick question. Can you give us the actual magnitude of what your refinement revenue was for the first quarter? Case refinement revenue?

That's not something that we specifically talk about or we specifically break out. Refinement revenue that we recognize in accordance with GAAP, which is either based on the delivery of the refinement or the expiration of the case, is blended into our channel revenue. And included on a weighted basis in our average selling prices. We don't call that out as a specific event. The case refinement revenue adjustment that I'm alluding to is based on a process and accounting change that we started last June. And we are just calling out as it happens the net change impact.

Okay. Thanks a lot for taking my question.

Thank you.

Ladies and gentlemen there are no more questions at this time. I will turn the floor back over to management for closing comments.

Thanks operator. Well, we thank you for being on this call. We will tie this up because we've run a bit over. We thank you for your time and we look forward to commenting on our continuing progress as we go forward. Thank you very much for joining us this morning.

Thank you. Ladies and gentlemen, this concludes Align Technology's teleconference. You may disconnect your lines at this time. Thank you all for your participation.