愛齊科技 (ALGN) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Align Technologies Second Quarter 2006 Financial Results Conference Call. (Operator Instructions.) It is now my pleasure to introduce Barbara Domingo, Director of Investor Relations. Ms. Domingo, you may begin.

Thanks, Dan, 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 website at investor.aligntech.com.

Before we start today, I'd like to make some comments on forward-looking statements. During this conference call we may make forward-looking statements related to Align's expectations about future events, products, and its future results, including statements regarding expected financial results for Q3 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 SEC on March 1, 2006, and its quarterly reports on Form 10-Q.

Align undertakes no obligation to revise or update publicly any forward-looking statement 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 have posted on our website at investor.aligntech.com under "Financial Releases," and have furnished to the SEC on Form 8-K. We encourage listeners to review these items.

Additionally, we've posted a ten-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 spreadsheets for more detailed line item information.

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

Thanks, Barbara, and welcome to our shareholders and friends who are listening today on the phone and through our website. We're quite pleased with our steady progress in Q2. As expected, case volumes expanded across the board, especially in Europe, where we had our best and strongest quarter ever.

Gross margin performance was solid, even with a higher mix of training revenue. And operating expense management was right on track during the second quarter, even after absorbing legal expenses associated with the OrthoClear litigation.

Through the end of the first half, Align's overall performance has been on track to grow volume, manage expenses, and deliver meaningful value to our customers. Over the next few minutes, Eldon and I will comment on key metrics or financial results to provide a bit more detail behind that performance.

Before we break down the operating metrics, I want to step back and reiterate our principal strategies for success in today's marketplace. Over time, winning will be demonstrated by continued dominance in market share, growth in volume, and, ultimately, an ability for us to create financial leverage from that volume growth. Our success will be achieved by delivering a superior product supported by comprehensive services and support.

The key elements of our strategy include extending our clear product leadership, leveraging superior manufacturing and clinic--and extensive clinical education, as well as an attractive rational pricing model. Through the first half of the year, we made progress in all of these areas.

In the second quarter, case shipments increased 6% sequentially and 26% year-over-year to 38,700. Ortho cases were up slightly to 14,200 cases from 14,000 cases in Q1. 26% of ortho cases were Invisalign Express. We shipped 19,500 cases to GPs, up 6% from Q1. 33% of these cases were from Invisalign Express, consistent with the previous quarter. And International had its best quarter ever with 5,000 cases, up 19% from Q1.

During Q2, we trained 1,000 GP doctors, bringing our base of total trained GPs to 19,900. 15,300 of them, or 77%, have tried the product. We are on track with our plans to train and certify around 3,000 GPs or more this year. During Q2, 12,500 doctors worldwide sent us in cases. 1,200 of these doctors were first-time submitters. The number of U.S. orthodontists submitting cases was 2,900, down slightly from last quarter. And 7,800 U.S. GP dentists submitted cases, a slight increase over last quarter.

Out of the 38,000 doctors trained worldwide, 26,100 doctors have treated with Invisalign and 84%, or 21,800 of those, have generated multiple cases.

Utilization is trending upwards nicely, especially in our base of experienced doctors. During Q2, the average utilization per U.S. ortho was up to five cases. U.S. GP remained at 2.6, and during Q2, international was up at--up to 2.9. Last quarter, in Q1, we incorrectly reported international utilization at 3.3. It should have been 2.7 for Q1.

Through the end of Q2, more than 450,000 patients have started treatment with Invisalign branded therapy. And just last week, we announced that we have now manufactured more than 20 million Invisalign aligners. That is a huge milestone and accomplishment for us. It's a testament to our scalable manufacturing process, one of our competitive advantages.

Our Q2 results were very solid even in the face of the combined effects of pricing, mix, and competition. I'll come back in a few minutes and comment briefly on these competitive dynamics after I highlight a few accomplishments in the second quarter.

The right place to start is with the market, our customers, and the patients they serve. During Q2, our [Bloom] advertising campaign continued, and we saw a resulting increase in qualified responses and lead activity. As we increasingly focus our marketing efforts on more experienced doctors who want to partner with Align, their practices benefit from increased leads, better conversion rates, and patient starts. All other practices benefit from the prospective patients that are more knowledgeable and motivated, and thus, easier to convert.

A key element of our strategy involves building on our leadership in clinical education and support, along with integration into university programs. During Q2, we held more than 200 clinical education events, including 47 GP certifications, 9 Invisalign provider workshops, 2 Costa Rica study club events, and numerous local study clubs. We now have a significant presence in 27 universities and are committed to reach all 52 in the U.S.

In Q2, we continued to make strong inroads with major dental schools, orthodontic departments, and strategic partners. This fall, we'll have our first Partnership Certification One with Dr. Pete Dawson in the Dawson Center for Advanced Dentistry. We're also working very closely with Dr. Irwin Becker from the Pankey Institute. These doctors are two of the most respected opinion leaders in dentistry today and we are working closely with them to develop specialized Invisalign treatment protocols, as well as teach those to dentists around the country. This is a very big deal for the dental community, and demonstrates not only our clinical leadership, but also that Invisalign treatment is moving towards becoming a standard of care.

In an additional strategic partnership, we have strengthened our relationship with the ADHA, the American Dental Hygiene Association, and we were recently awarded their educational excellence award in hygiene education, as well as being invited to join the ADHA Industry Advisory Board. And, of course, we just finished our Second Annual Invisalign Summit for GPs, where we hosted almost 400 practices and more than 1,400 attendees for the latest training in clinical and practice development content over several intense days. These practices have now returned home with a fresh commitment and new clinical tools to make Invisalign a greater part of their practice.

On the R&D and new product development front, we are committed to winning in the market by establishing clearly superior products and offerings differentiated by the user experience. There is a huge effort underway at Align to create, develop, and deliver the product technology necessary to make major improvements in the ease of use and the predictability of Invisalign branded aligner therapy.

In addition to strategic direction, we have also been working on specific product improvements that I would like to update you on. This morning, we announced the launch of Invisalign branded aligners. Aligners shipping as of August 1, 2006 will have the Invisalign logo laser-etched onto each aligner way back where the molars are. This logo confirms to the doctor and to the patient that they have received authentic Invisalign aligners. We believe this will aid greatly in this newly competitive market. Patients are walking into doctors' offices asking for Invisalign treatment, and now there will be no question that they are getting the quality they requested by name.

We've also discussed the compliance or wear indicator. We are on track to release this feature in Q1 2007, which will give doctors an excellent tool to monitor and better manage patient compliance with Invisalign branded aligner therapy.

As far as the new aligner material, we are on track to begin shipping aligners with this new material in Q1 of 2007. This next generation polymer is more conformable and delivers more consistent force over a longer period of time than anything out there today. Better conformance and more consistent force applied will likely mean more predictable movements and better clinical results. We'll keep you posted on these developments and the other major strategic project--product initiatives, and look forward to sharing significant progress when ready.

As far as a legal update is concerned, virtually all of the publicly available information regarding our extensive legal battle with OrthoClear is out there and you've seen it. While we are spending a significant amount of money, we feel we are getting our money's worth.

Now let's talk about the competitive environment as we see it today. There are a lot of great things going on inside our Company. Continued good execution of our strategy will further widen the lead we have in the market. That said, we're still working to create a company that can compete with anyone anywhere.

In the near term, we expect to feel effects of competition in the U.S. market. Let's take a look at the market as we see it today. Combining both the orthodontist and GP channels, Aligns' overall dollar share of market is more than 90%, and our overall unit share is more than 85%. This external and independent share analysis confirms our internal models and estimates. Align's fundamental business is in pretty good shape. Additional market research and survey data indicates that almost 90% of doctors prefer Invisalign. We are winning in this marketplace despite the efforts to disrupt our progress.

When competition first launched last year, they went right after our highest volume orthodontist customers. Many of these orthos, enticed by lower cost and a promise of similar or better quality, tried the competing product. During Q3 of last year, we especially saw disruption as doctors tried the product. We believe many doctors found it to be an inferior product and realized the value that Align provides to their practices. In Q4 and in Q1, we saw increasing numbers of these high volume orthos returning to Invisalign and bringing the bulk of their case starts back to us.

With the limited widespread adoption this competitor has been able to achieve among high volume experienced orthodontists, they began approaching lower volume ortho practices . We believe that the same product performance, quality, and service advantages, which were key to regaining momentum with higher volume orthos, will extend to the lower volume practices. That said, we expect lower volume practices to experiment with competition, especially given the special pricing and discounts that are being offered to them.

We believe this cycle of gaining trial, but not sustaining widespread adoption, will repeat itself among GP dental practices as they target this group of our customers. We believe GPs, because of their lower volume, may take some additional time to realize the substantial advantages in the Invisalign offering, and may take several more quarters to cycle through this process. That said, we do believe there are likely to be some price sensitive segments of the market that may remain with the competition.

On the basis of these competitive issues, we've decided to be a bit more conservative about the volume growth we previously forecasted for the second half. Perhaps we are being conservative. All the same, I wanted to provide some guidance for--I wanted to provide some context for the guidance Eldon will give you in a few minutes. Guidance that will be down a bit for the second half. It's a tough message to give you, especially when we delivered solid progress in Q2, but we have to call it as we see it. We will do our best to over perform against this revised guidance.

All in all, I am pleased with the organization's ability to meet a price-based competitive challenge head-on in the orthodontic market. Today, we face a similar tactic in the GP dental market. As we have been through this cycle in the Ortho channel, we believe we are much better prepared to face the disruption in the GP channel. In addition, we've been planning for this effort with GPs and we'll be rolling out programs to further broaden the gap between Align and any competition.

We are as excited as we ever have been about our long-term prospects to restage growth and regain profitability, and we are completely committed to changing the way orthodontics is done today.

Eldon?

Thanks, Tom. As a quick reminder, our second 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." In our discussion of Q2 results and the 2006 outlook, differences between GAAP and non-GAAP financial data result from the expensing of stock options under FAS-123R beginning in January of this year.

First, Q2 revenues, as Tom mentioned, were 53.2 million, down 1.3% from the same period a year ago, and up 8.8% from last quarter. Second quarter revenues by segment were 17.7 million for U.S. Ortho, 24.1 million for U.S. GP, and 8.3 million for International. These channels represent 33%, 45%, and 16% of revenues, respectively. Invisalign Express included in these channels--channel revenues were 2.8 million for U.S. Ortho and 4.9 million for U.S. GP.

Worldwide training and other revenues were $3.1 million, which is approximately 1 million higher than we anticipated. Blended ASPs for full Invisalign cases, not including Invisalign Express, was approximately $1,495. ASPs were higher than our April outlook as a result of lower than anticipated volume rebates and staff discounts. ASPs for U.S. Ortho, U.S. GP, and International was $1,425, $1,475, and $1,685, respectively. ASP data, both including and excluding Invisalign Express, is posted on our website under Additional Information for your reference.

Revenues included a $2 million benefit associated with our case refinement policy change in June of last year. The impact of this policy will continue to benefit revenue, diminishing sequentially into the first half of 2007. GAAP gross profit for the second quarter of 2006 was 36.7 million, or 69% of revenue, compared to 37.3 million, or 69.2%, for the second quarter of 2005. This also compares to a gross profit of 34.6 million, or 70.8% of revenues last quarter.

Non-GAAP gross profit for the second quarter was 36.9 million, or 69.4% of revenue, compared to 37.3 million, or 69.2% of revenues for the second quarter of 2005. This also compares to a gross profit of 34.8 million or 71.1% of revenues last quarter.

Sequentially, gross margins are down slightly due to higher training costs. And as you may remember in the first quarter, we recorded a benefit for case refinement loss accrual recovery totaling 1.5 million. Consistent with our outlook, we recorded a 700,000 benefit to gross margin in the second quarter to complete the loss accrual recovery. Year-over-year gross margins were relatively constant, as lower ASPs were offset by product cost improvements.

Operating expenses on a GAAP basis were 40 million for the second quarter of fiscal 2006. This compares to 36.1 million for the same quarter one year ago and 39.8 for the first quarter of 2006. Operating expenses and marketing programs in the research and development area were lower than expected, contributing directly to the bottom line. Q2 includes approximately 5.3 million in OrthoClear-related legal fees.

Q2 non-GAAP operating expenses were 37.9 million. This compares to 36.1 million for the same quarter a year ago and 37.8 million for the first quarter of 2006. The bottom line GAAP net loss for the second quarter was 2.6 million, or $0.04 per share, compared to a net profit of 538,000, or $0.01 a share, in the same period a year ago, and a net loss last quarter of 4.8 million, or $0.08 per share.

Q2 non-GAAP net loss was 344,000, or $0.01 a share, compared to a non-GAAP net profit of 538,000, or $0.01 a share, in the same period one year ago, and a net loss last quarter of 2.6 million, or $0.04 per share.

On the balance sheet, cash, cash equivalents, and marketable securities and restricted cash at the end of Q2 of 2006 was 69.9 million, compared to 74.4 million at the end of 2005. Additionally, DSOs were approximately 55 days.

Now I'll spend just a few minutes on the third quarter and update our guidance for full year 2006. Again, I will provide a GAAP and non-GAAP outlook for your comparison purposes. As Tom alluded to a few moments ago, we're reducing our full year case volume outlook due to what we are seeing in the competitive environment, reducing outlook for the full year by approximately 13,000 cases.

The reduction in our volume outlook is centered primarily in our U.S. GP business, partially offset by growth in International. As a result, our full year revenue outlook is being reduced by approximately $8 million, reflecting the volume reduction, partially offset by an improved outlook on ASPs in the second half of the year. These changes are incorporated in the outlook I will cover.

Case shipment volumes for Q3 are projected to be in the range of 35,500 to 37,300 cases. We expect that Express cases will comprise approximately in the range of 25 to 30% of our overall case volume. We expect Q3 revenues to be in the range of $47.5 to $50 million. Ortho channel, GP channel, and International cases, including Invisalign Full and Express, are expected to comprise 31%, 50%, and 14% of Q3 revenues, respectively. The remaining 5% approximates training and ancillary revenues. Approximately 15% of the total revenues are projected to come from Invisalign Express cases, of which two-thirds are expected to be derived from the GP channel.

Blended ASPs for full Invisalign cases, not including Invisalign Express, are expected to be approximately $1,455 for Q3. The sequential decrease in ASPs for Q3 reflects the effect of increasing customer participation in our discounting programs. Revenues also include case refinement impact of approximately $1.6 million.

Q3 GAAP gross margins are projected to be in the range of 64 to 65.5%. Gross margin includes $200,000 of stock option expense charged to cost of revenues. If you add this back, non-GAAP gross margins are projected in the range of 64.3 to 66%. Sequential decline in Q3 gross revenues reflects the impact of lower ASPs, the aforementioned loss recovery recorded in the first half, and approximately $600,000 of one-time costs related to some equipment retirements we expect to record in Q3.

Q3 GAAP operating expenses are projected to be in the range of 40.3 to 41.3 million. Sales and marketing, R&D, and G&A represent approximately 48%, 12%, and 40% of operating expenses, respectively. Operating expenses include approximately 2.3 million of stock option expense, of which 30%, 13%, and 57% 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 38 to 39 million.

Sequentially, we expect to see some increase in R&D supporting our development initiatives and G&A supporting business process reengineering efforts, partially offset by reduced spending in marketing programs. This outlook also reflects OrthoClear-related legal expenses of $4 to $5 million for the quarter.

Q3 GAAP net loss is projected to be in the 8 to 9.5 million range, or a loss of $0.13 to $0.15 per share. Bottom line impact of stock option expense is expected to be approximately 2.5 million, resulting in a non-GAAP loss of $5.5 to $7 million, or a $0.09 to $0.11 loss per share for the quarter.

Now let me turn to guidance for the full year. 2006 revenue is projected to be in the range of $196.5 to $202.5 million for the year. Ortho channel, GP channel, and International cases, including Invisalign Full and Express, are expected to comprise 33%, 47%, and 15% of full year revenue, with the remaining 5% approximating training and ancillary products. Approximately 15% of total revenues are projected to come from Invisalign Express, of which two-thirds are expected to come from the GP channel.

Case shipment volumes are projected to be in the range of 146,000 to 150,700 cases. We expect that Express cases will make up approximately 25 to 30% of full year volume. Blended ASPs for full Invisalign cases, not including Express, are expected to be approximately $1,465 for the full year, and include case refinement impact of $6.7 million.

Full year GAAP gross margins are projected in the range of 67 to 67.5%. Gross margin includes $700,000 of stock option expense charged to cost of revenues. Adding this back results in a non-GAAP gross margin projected to be in the range of 67.3 to 67.9%. 2006 GAAP operating expenses are projected to be in the range of $161 to $163 million. OpEx is consistent with our previous outlook.

Sales and marketing, R&D, and G&A represent 51%, 11%, and 38% of operating expenses, respectively. Operating expenses include $8.8 million in stock option expense, of which 32%, 15%, and 45% reside in sales and marketing, R&D, and G&A, respectively. Excluding the stock option expense, we arrive at a non-GAAP operating expense of $152 to $154 million for the year.

2006 is expected to include OrthoClear-related expenses of $18 to $20 million. While we believe we have contained OC-related expenses to this amount, there are, as you know, a number of lawsuits happening, which--with a lot of activity happening in the back half of the year. That said, while we believe $18 to $20 million should be enough, there is a slight chance we could exceed this amount.

GAAP net loss for the full year is projected to be in the $24 to $27.5 million range, or a loss per share of $0.38 to $0.44 per share. Bottom line impact of stock option expense for the year is expected to be 9.5 million, resulting in a non-GAAP bottom line loss in the range of $14.5 to $18 million, or a loss per share of $0.23 to $0.29 per share.

Recapping on the balance sheet, we estimate our cash balance at the end of Q3 to be in the range of 65 to 67 million. We estimate our cash balance at year-end to be in the range of 63 to 65 million. DSOs are supposed to remain at a consistent level in the mid-50s. We project our full year capital expenditures in the range of $11 to $13 million, with full year depreciation and amortization expected to be in the range of $11 to $12 million.

Now let's go to the operator for some questions and answers. Operator?

Thank you. (Operator Instructions.) Our first question is coming from Tao Levy of Deutsche Bank. Please proceed with your question.

Good morning. A couple of quick questions. So if we could just focus on the reduction and on the guidance front, what specifically are you seeing OrthoClear do on the GP front? And is the reduction primarily at the GP level or are you seeing thus far in the third quarter a slowdown, also, in the orthodontic channel, above and beyond seasonality?

Tao, good morning. It is principally in the GP channel. And to put that in context, there's a--whereas there's a very clear segmentation by volume in the Ortho channel, in the GP channel there are fairly few high volume GP dentist customers. Virtually, the whole GP market is in the early stages of use and adoption and learning. So what's happened is they've gone out--I'll call it in a shotgun fashion, spreading around discounted and free cases and getting some customers to try the product, which is a rational and normal thing for them to do.

We think it's going to take a little bit of time for that process to work through with these less experienced customers and to recognize the--all of the values that we've got. So our game plan is to further improve our coverage, our effectiveness, our marketing programs, and some of the terms around that, to tighten up our whole Web program, the Bloom campaign. And ultimately, distinguish the difference between these two products through the technology and user experience. And we're pretty comfortable we can do that over the slightly longer term. We just think we see over the next few quarters less lift than we were counting on for the second half.

Okay. And--I don't know if Roger is on the phone. Maybe I could ask--I could maybe ask a legal update question. I know you mentioned a lot of the stuff is out there. But maybe if you could just give a very brief summary on what's going on on the ITC case, where we stand, and next data points?

So, Tao, I'll take a shot at just a very simple or concise legal update. As you know, this is a major strategic investment for us. We believe it's going very well. The ITC is the biggest current portion of that. It's tracking for a late 2006 hearing and their--the equivalent of a trial. Adjudication - that's going to go into sometime early in '07. And we think the right outcome from that whole thing is a Stop, and in fact, an Order barring importation of OrthoClear's product. And so, I think from my perspective, that's a very important event out there.

The second one down the line--so I'll stop there. There are several other matters. Does that answer your specific question on ITC?

Yes. I mean, that's fair enough. And then, Eldon, I know in the last call you had mentioned on a non-GAAP basis you might see a profitable quarter in the back half of this year. Is that--have we taken that out of the picture given the lower guidance?

Yes, we are, Tao.

Okay. So, I mean, is it fair to say early 2007?

We'll be back later in the year to extend our outlook. We're not there right now.

Okay. And on the new material that you're talking about that you're going to introduce next year, is that going to be--is that going to result in a clearer device, less [rigid], and essentially address some of the competitive advantages, which OrthoClear claims they have?

Well, I guess the first thing you've got to say and ask is in fact are there any clearer products. We certainly don't see the evidence that's the case, (A). (B) The material has certain specs and requirements for clarity that have nothing to do with the topographic way we build molds to make aligners from. But there are very clear specs for clarity and other things. The bigger advantages are resolving the perform--the individual performance of the aligner, its ability to deliver force or torque to the teeth and create movements on time. This polymer has substantially better properties for doing that and for reducing stress relaxation, which causes your liner to get loose before it should.

We think we stack up very well with any clear product out there in terms of performance, including clarity. So that's--that wasn't the principal issue here. It's really about performance in delivering force and torque more consistently over time. And that's where we're taking a pretty big step here.

Okay, great. Thanks.

Thank you, Tao.

Our next question is coming from Mark Richter of Jefferies and Company. Please proceed with your question.

Good morning, guys. I have a couple of quick questions. The first question is for Eldon. You mentioned that you may raise litigation expense guidance later in the year. What makes you believe that it might be necessary? And if you do anticipate this, why not just do it now?

Well, I didn't say that we expected to raise it. We're just trying to be as forthright as we can with the ebb and flow of activity and say that there might be a little risk to stretch that. But we're calling it as we see it right now, and we didn't raise our guidance in that area. But I just--Mark, I'm just trying to--we're trying to be as comprehensive as we can. You've seen a little bit of volatility in that area in the past and we think we know where we're at, but we're subject to a little of it in the future.

Perfect. Thanks. And then, as a follow-up to Tao's question on the GP softening, I mean, could you just--do you under--could you just give us a sense of how long you think this could potentially last? In other words, is this a two-quarter sort of disruption, or indicative of potentially something else?

I--it's a great question. We have--we believe we have pretty good insight into the process at work here. In fact, I think we've got pretty good insight into seeing how this competitor has kind of cycled through groups of customers, and seeing the initial trial, and then kind of, in most cases, the lack of real adoption behind that. We do I think, Mark, believe this is X number of quarters.

We--as Eldon said, we're going to come back to you with a better view of 2007 at the right time. But we certainly--in the moment, we do not--we don't want to project where we were in terms of the lift we expected, specifically out of GP volume in the second half. We just think it's better to be a bit more conservative there. If we over perform against that, then great. But that's not our current view.

So we think this is literally that GPs will take a bit longer than orthos to recognize some of the performance advantages, some of the product differences, and all of the attendant support that's not there. And so, I think it's going to take a few more quarters than it took the orthos--the experienced orthos to see that pattern. Does that answer your question?

Yes. No, that's perfect. Thank you. And then, on the sales force, are you seeing any turnover to OrthoClear? And likewise, are you seeing any salespeople returning to you from OrthoClear?

On the last part of that, I'd rather not comment. On the first part, our sales force continues to get stronger. We strengthen it with a role here, a key person there. We haven't had any major steps in terms of structure or volume. It's just the normal kind of dynamic of building and improving a team. I'd rather not comment on what's going on in OrthoClear's shop. And I guess that's how I'll stop the question.

All right. Thanks. And then, the last question. On International, trends look strong. Could you just give us a better sense of what's happening and going on there?

Well, again, we've tried--we've--there were kind of a couple of stages to the European--mostly European growth. The first was to rebuild the basic business on a core group of customers and ensure that you get great clinical outcomes. We took to Europe the same approach we used here, which was to invest in good clinical education and good clinical support for the group of customers that were interested and committed to integrating Invisalign into the practice.

We've seen very good growth in core Western Europe, even though some of those economies in those countries have not been really consistent. And we think there are solid opportunities ahead. We're certainly going to have some choices to make about levels of investment and opportunities to further leverage growth. But pretty much across the board in the--in our major country markets in Europe, the team has done a very good job. And we're pleased by that.

Thanks.

Our next question is coming from Taylor Harris of JP Morgan. Please proceed with your question.

Thank you. I have a couple of pricing questions. So, Tom, first of all, can you talk about the sequential uptick in ASPs? That was a little surprising just--especially since you've got higher volume orthos coming back into the fold. Maybe talk about that a little bit. And then, Eldon, what does your guidance imply for ASPs by the end of the year?

So I'll take the first part of that, Taylor. And what I'll say is we've had great progress in attracting higher volume ortho practices back. We are getting the same kind of reaction as we move through the ortho community that tried the other product. Some of them as they came back they didn't quite--as they came back for volume, rebate program, and exclusivity, even, didn't go as far as we had forecasted in terms of their potential volume. And therefore, didn't go--their ASP affect didn't go as deep. So we were projecting even greater volumes from some of those practices that they didn't reach. And therefore, our ASPs were perhaps a little bit conservative for ortho.

On the GP side, it's less of a volume rebate because there's such a broad large number of relatively speaking lower volume docs. There's a number that can play in the rebate program, but they don't play to the same extent the very high volume ortho would. So I think as we now get back with the core ortho customers and really help them invigorate their practices and stretch for greater volume growth, I think we will see them participate deeper. But it was just that the volume rebate usage was a little less than we forecasted.

And maybe I'll hit Eldon to get back to the guidance question on ASPs for the rest of the year.

For the rest of the year what I incorporated into my discussion was in the back half we're taking our ASPs back up a bit. And that's not a result of pricing action. It's just we've got a little more time under our belt to see how our new pricing and participation in the discount programs are reacting. So that's the genesis of what's in there, but in the back half, as I mentioned, we have taken our ASPs back up a little bit, just strictly driven by the experience of what we're seeing now in terms of mix and customer participation in the programs.

Okay. So maybe just as a follow-up to that. As you guys have--it sounds like you've been conducting some pretty thorough market research recently. Is there any comment you can make on the price sensitivity between the two products out there? And is there a level of price premium that you're targeting getting to and staying at at some point over the next few quarters?

It's a terrific question, and it goes right to the point of competition. We believe we've already demonstrated a pretty substantial price premium--an ability to get that based on all of the extended elements of the product that we deliver every day. That doesn't even include what we're doing to help expand the market and help a doctor grow their practice. We believe that sorts itself out over a little bit of time once a doctor has had a chance to try the other product. And we, frankly, still have some very good doctor customers of our - orthodontists - that still use their product for, say, some very simple cases either because they got a great discount or because it's X percent better than our price.

So we think that will happen, but increasingly, customers that have tried both products are saying we are substantially better. We believe that gap is going to get much wider as we continue to evolve our product offering and our technology. And our goal is to leave everybody in the dust. Now at the end of the day, there's going to be some more price sensitive segments of the marketplace. And we think this competitor is going to find a few of those and they'll stick there. I don't like that, but I guess that's a reality every competition, every market has to deal with.

And over time, our first job is to widen the gap in performance between the products, so it's absolutely clear who is winning. And then, we can make choices about how to cover different price points with offerings and products and bundling and unbundling all of the things we do. But I think this is a great opportunity for us to kind of exercise our leadership position and evolve this marketplace.

So is the thought that you're going to give current pricing structures a little bit of time to play out and see how the unit share works out there before dropping prices further and closing that pricing gap?

I don't--at this point in time there is no thought given to dropping prices. What I think the answer is, Taylor, is to hit each of these segments with the right overall product offering. There may--I'll just give you an example. There may be value in unbundling some of the things we currently wrap together as the complete Invisalign system at some point for a very low-end customer. There may be some very different ways we can bring this product to the market, provide support, and all of those other elements. And I think over time we're going to have a chance to do some of that.

For the near term, we think the pricing structure we've got in place is working pretty well. And in fact the disruption we're feeling is it's pretty rational for any customer to take advantage of a terrific economic deal. And only after they try that are they going to be in a better position to make a choice about what they do with their business. They're out there--the competitor is out there working pretty hard to pick off some of that volume. We're reflecting that in the second half and we're--as a public company we've got to call it as we see it. But we don't--we think this is going to shake itself out over X number of quarters. And we think we're going to be able to show leadership in each of these segments over the longer term.

Great. And then, just one final set of questions is on the market share data that you referenced. Can you split that for us on a unit basis between the GP and Ortho channel, and then maybe tell us what you're seeing in terms of trends? And where does your guidance imply what those share are by the end of the year?

I am not prepared to provide that at this point in time for a whole set of competitive reasons. I can understand the interest. What I would say is that trends are positive in the Ortho and they are stable in the GP. We say a pretty big dip and you saw that--you could see it expressed in utilization, if you want to maybe imply it through our numbers in Ortho, where in Q3, especially last year, we had a pretty substantial drop-off. That also mirrored a very significant unit share decline for us. And that's substantially coming back.

I think as they work through and find a few price sensitive spots in the ortho community, they may be able to hang on to some of that. In the GP side, since the market is so broad and so wide, literally tens of thousands of doctors doing small volume, they're just shotgunning through that trying to find spots they can pick up some cases. So the overall unit share is pretty stable. Our price share is pretty strong, and that reflects discounting and low price I think on their side. But I'm--I guess to your original question, I'm not prepared to give the detail at this point.

Okay. Thanks a lot.

Thank you, Taylor.

Thank you.

Our next question comes from Raj Denhoy of Piper Jaffray. Please proceed with your question.

Good morning, guys.

Good morning, Raj.

Good morning, Raj.

Just a couple of questions actually. I think kind of following up on the last one, it sounds like the--while I appreciate the comments around the GP channel, it sounds like the Ortho channel has sort of stabilized. I mean, is that sort of what you're seeing? Because I noticed in the commentary you gave you said that you saw clinicians coming back in the fourth quarter of last year and the first quarter of this year, but you didn't mention the second quarter. So I'm just curious if maybe that's a reflection of the stability in that market that maybe you're starting to see now.

Yes. The specific answer to your question is yes, increased stability. What we've seen is--and if you were to segment the Ortho market by volume of cases submitted, the first place competition went after was our very high volume customers. It's a finite group of docs and they managed to disrupt us. That's why our utilization really dropped off. It was flat in Q2 and really dropped in Q3. As they tried that product for a quarter or two, it started coming back in Q4, then it accelerated in Q1, and now is consistent in Q2.

I think where they've--where we've seen them go is to cycle through groups of our customers trying to find a home. And we see them now in the lower volume ortho practices - those doctors that probably aren't as committed to Invisalign or any clear orthodontics in their practice. Some of those doctors are probably a bit more passive about it and they use Invisalign or an equivalent when a customer says, gee, I don't really want braces. I'm going to leave if you don't do them for me.

So I think they may find some price sensitive spots in that market to have a little bit of a home. But in general, we can see them actually cycling through groups of customers. And I think it's been a pretty consistent reaction. They hang on to some, but by-and-large, these docs that try the product find it's lacking in what they were looking for and what they expected.

And then, I guess--but then, your commentary on the GP channel. I mean, is that really just some conservatism on your part, I guess sort of playing what you saw in the Ortho channel out on the GP channel? Are you actually starting to see in the last couple of--last month maybe of the quarter that you're starting to see the trends go in the wrong direction there?

Well, so I think there's two things going on here. It's exactly the same cycling. We think after being out talking to lots of customers doing some research, and seeing what's going on, the less experienced orthos even and less experienced GPs are slower to recognize the differences between the product. They need a longer runway and a few more cases to see that. The high volume orthos are doing--literally starting cases everyday. It didn't take them long to recognize the performance differences.

For low volume orthos that are more price sensitive, for these very low volume--there's thousands of GPs that are still just getting starting. If there is frustration in their practice, they may not--some of them may go back and forth to us or OrthoClear, but they aren't necessarily putting more effort into building this into their practice, (a). And then, (b), we just think it's going to take longer for GPs to recognize the quality and performance differences.

So I think maybe we're being a little bit conservative, but we also see that behavior going on. And as our reps and our Management and survey data says, they're--they say, no, I'm not leaving Invisalign, but it's rational for me to do it if I get two or three free cases. Why wouldn't I go try that? And that might be their volume for the quarter. Again, if you look at average utilization for GPs, it's a handful of cases.

So if you get enough GPs that just try a couple of cases with a competitor on a very wide base, you get some interruption in our volume growth. And that's what we're seeing and that's what we're describing. So we do think it's a cycling process and we think there's a number of things we can do about that. But by the same token, we're not doing our job if we don't tell you what the heck's going on.

Sure. Fair enough. Just a couple other ones as well. The program you institute today - the etching of the aligners - is that a reaction to maybe something you're seeing in the marketplace - some clinicians may be switching products on customers? Or is that really just a preemptive action on your part?

That was very much the former, Raj. We actually had some baiting and switching and passing off - I guess would be the legal term - early in the process. We had some really egregious behavior. We had consumers calling us angry. And we came up with ideas where we could extend the branding outright onto the physical product. Again, we never thought about that much because when we were the only game in town it didn't really seem to make as much difference. So we worked very hard.

The--there's a very small percentage of the cases - because of extreme [dentention] in the molar area - that it will be hard to put that on there. But that's very much a reaction to extending the brand. So when a consumer gets on our website and finds a doctor, goes in expecting Invisalign, they can have the confidence that that's exactly what they're getting.

Right. And then, just one last one, I guess for Eldon. But the gross margin line--I know there was some extraneous costs in the--or actually I guess some recovery of costs in the first two quarters of the year. But the trends with you guys now saying it's going to be something on the order of 64 to 65.5 in the third quarter, is there anything we should be I guess overly concerned about with the trends there on the margin side? Or maybe you could just give a little more around what's happening on the gross margins.

Sure. The--well, I'll tell you what you shouldn't be concerned about and that's our overall product cost performance. All of the stuff that we've talked about in the past is still out there and still actively evolving. One item, just to recap, is we did have the cost recovery in the first half, which 1.5 million in the first quarter, 700,000 in the second. That's--that was a benefit that contributed to our gross margins in the first half of the year. So that's over and done with. So when you shift into the third quarter, that's not replicating itself.

I mentioned we have some equipment that we're going to retire. That's not a trend. That's an event. But to your point, the other item - and it's an important one - is in our process, when we put capacity in place, and the capacity that we have out there, it's not highly variable. We make the investment in our technicians and our machine capacity. And within a particular range or band of volume that cost becomes very fixed. So when our volume is not evolving and the trajectory is not out there for a period of time, then that happens in margins. So at the end of the day in the third quarter when we say we're taking our volumes down a bit versus our prior expectations, that manufacturing cost or cost of sales stays relatively fixed.

Great. That's very helpful. Thank you very much.

You bet.

(Operator Instructions.) Our next question is coming from Anthony Ostrea of JMP Securities. Please proceed with your question.

Hi. Good morning, guys. A couple of questions here. I wanted to follow up on the questions on the GP channel. Tom, can you--and maybe you alluded to this, but at what point did you start to see some--I'll call it degradation in the units that the GPs have been sending to you?

Anthony, we started to see that view evolve a little bit in the middle of May, in the middle to late part of Q2, and have been--and in parallel with that have been doing a lot of work, some of which we were already working on and some other that we initiated to look at attitudes and preferences. And at the same time, trying to define this cycle of trial and adoption, or not adoption that was going on, both among orthos, as well as GPs.

That led us to believe that--and looking at what the competitor was trying to do to find a place to stick--felt that they were going very aggressively out to find any GPs they could get their hands on. And we felt there was likely to be a very similar cycle of trial, and then, adoption or not adoption. Our goal is to make sure it's not adoption. But given the very large number of small volume customers, their likelihood to act with a good deal in the short-term, and a little longer timeframe to get some experience with the product.

Again, many of them are just getting to know how to use invisible orthodontics anyways. We just felt it was prudent for us to start to evolve our view for the second half. And we'd certainly love to over perform against that, but at the same time, we felt we had to bring our volume view, especially--specifically for GP down in the second half.

And does that volume reduction reflect a--like half of the units that you would have expected on a per doctor level?

I'm sorry. Please repeat again, Anthony. A what of--?

If you were to think of it as each GP does a few cases a month, does the volume--does your change in guidance reflect like half of what you thought you would get in terms of volume from each of those--from each of those GPs? Or is it more a complete reduction in a good part of it--at least part of the next two quarters?

Sure. I think what it is is we had--Anthony, it's just flat at the end of the day. It's--we had planned for and we had described when we did our first call of the year--our Q1 and our year-end--or our year-end call for the end of 2005, when we gave 2006 guidance described the way we expected the year to evolve with building volume. What we're really saying is the second half, the volume won't build as much as we had hoped for, planned, and had built a business to view.

Okay.

So it's--and the issue is there's a huge number of GPs out there that have been trained that are just still in the very early stages of adopting the technology and integrating to practice. There's--this is not half or a third or some quantitative number. It's really [effect] of trial across a huge base where the competitor is trying to get through discounts and some free product and whatever out there trying to get a large group of small volume customers to try their product.

So we just think against that big wide base it's prudent for us to think about if they only do three a quarter, they could very easily soak up two or three of those cases with a trial of a competitor product. And if you take enough thousands of doctors that that's going on with, all of a sudden you've got a substantial difference in the volume view. And that's really what's going on. We're not getting the lift and volume growth in the second half in GP we had planned for in the business.

Got it. And then, is there anything you can do in the midst of that which--strategically, so that your kind of in their minds still? Or I guess what are you doing in the second half to either combat that tactic from OrthoClear or remain in the mindset of these GPs?

So the first thing I'll say is there are a set of tactical things we can do in the near term. And many of those are already in motion. Even given those things, we're being conservative about the second half. There are a set of strategic things which we're working on, which we think over the longer term will have a more profound effect.

I'll turn first to tactical. There's a whole set of actions. We haven't cut price. We're not throwing free product or spiffs or discounts out there. We're impacting things like terms. One of the things in GPs' minds in Express, they can set up a case, show the patient. If the patient elects not to go forward, there is no cancellation charge. We've seen a very stable cancellation behavior rate with GPs and orthos with Express. On full cases, the traditional terms were to have cancellation charges once we set up the clin check. And they couldn't--once they got the clin check finished and approved it, if they used that to help sell the patient, they were effectively on the hook for a significant portion of the case cost.

So we found that many GPs, especially being less experienced with this, wanted to use the clin check, wanted to show the patient the case, but were reluctant to commit to it. Now for those doctors that are exclusive to a line, there is no cancellation charge even for full cases - orthos or GPs. That's actually been a nice hook to get a number of doctors to come in and say, I want to be exclusive. There is no reason for me to do [the other]. I'm really not using that right now anyways. I tried a few cases. I'll be exclusive. There's no cancellation on full cases either. I really like that. That's been a nice little pop and we're getting some real traction there. And again, that's really important out in the GP space, although some orthos have reacted the same way.

There are a set of programs we're rolling out with the field. It's the way we focus them on groups of customers that have the most potential for growth, and probably driving past some offices where there's less potential. At the same time, on the strategic side, the way to win long-term is to make the gap so great between the user experience and the performance of the product, that there's simply no choice between what we can do and what any competitor can do. And we're really working very hard on stepping out with that.

So you--I updated on a few enhancements - small things. When we're ready, we're going to be happy to talk about a whole set of larger scale product and technology initiatives that we think make a big difference over the longer term. And then, if we bring this back down to the work we're doing in the marketplace to grow the market, using our consumer demand, our Bloom campaign, and our Web, we are further refining our process with how we use docs on the Web, how they get cases. Those doctors that will work with us exclusively and become key providers are going to get more than their fair share of referrals and support. Those doctors that want to play both sides of the street, it may not be a quid pro quo just to be on our Web and to get part of the benefit out of that marketing.

We think over time that whole channel management issue is going to be tightened up much, more more, so we can get better conversion out of those practices that work with us. So there are a whole of levers we can pull on. The biggest one long-term is product and the whole user experience. And there's a set of short-term things we're working on in the meantime. Does that get at the issue you were raising?

Yes, it does. Thanks. I had just a few more quick questions. Regarding ASPs, I know there was a few questions on ASPs earlier. But how much volatility or variability is in that ASP number on a quarter-to-quarter basis?

Well, Anthony, as I mentioned, we've had a chance to learn some more after resetting our prices late last year and seeing the evolution in the first half of this year. So what we're calling out for the remainder of the year, I didn't throw a range out there because we think most of our variability is volume-related and that's what we called out. So we think what we're talking about for the second half of the year, we've--.

--Yes--.

--Called it as we see it and don't think there's going to be a huge amount of volatility there in the near term.

Okay. So when you say there shouldn't be a big or a significant volatility with that number, you are talking about up or down 5% or so in that ASP number?

Within a reasonable range.

Okay. And then, two quick questions on the legal front. I think you--well, you mentioned you're reiterating guidance for 18 to 20 million in legal expenses - could go higher. I think you said a tad higher or a bit higher. But will you be willing to quantify that if--how high that could go?

We called it as we--we called it as we best see it.

Yes.

We reiterated what we had said previously at 18 to 20 million.

Yes.

As you've seen in the past, we certainly had some volatility in that activity. We're just trying to communicate the best we know how, the best we can, that there is the possibility there could be some volatility there. We're calling out the number, but at the same point time, it's just saying is given the level of activity that--it could go a bit higher. But the range that we're calling out now financially is $18 top $20 million.

Okay. And then, last question. Tom, can you just give us some color on what you see in terms of the overall market for aligners? If you can, break it out by GPs and orthos. I think you had kind of alluded to it a little earlier. But could you give a little more color on that?

In terms of share, Anthony, or in terms of--?

--Not share, but total market growth.

Well, let me step back. Virtually all of the volume that's going on in GP is incremental market growth. And some portion of what goes on in Ortho is market growth. I think there's two ways I guess we think about this. The first is, we have - in orthodontics - we have a job to try and earn a share of chair, if you will, from the existing orthodontic practices that do brackets and wires. So we're competing for a new start alongside brackets and wires, especially in adults. That's one kind of a job we've got to get done. And we think we're doing a pretty decent job of that, but we've barely scratched the surface on a broader demand side out to potential patients.

On the GP side, virtually all of the volume that goes on with GPs for orthodontics is incremental growth to the orthodontic market. So there's that going on. I think as we build the market, as we really build orthodontists and GPs' capabilities to use invisible--to use Invisalign branded aligners, you're going to start to see more exciting market growth. I--market is probably easy growing right now 30% a year--20% a year. And it's--that's kind of mirroring our volume, if you will.

I think we're getting all of that. I think we'd be growing a little faster if it wasn't for this competitor. And our revenue line would be growing faster yet if we hadn't done the things we did last year to impact pricing and mix. So there's--there continues to be good volume growth in the market. But it's nothing compared to what it can be because the issue is the channel--the current adoption of this technique and the products that allow that is still at the very nascent stages. There is a huge number of patients. There is a huge amount of interest.

The issue is can a company like ours develop the market and develop the technology and crack open this opportunity? We believe we can, and that's why we remain really bullish about the long-term and really excited about our opportunity to get back to really exciting revenue growth and a very, very profitable company. I think we're working through some transitions right now, but market growth continues. It's mostly on the volume side today versus real revenue dollars, given the adjustments last year. But it--it's--I think we're continuing to be very bullish in the long-term in this space.

Great. Thank you very much.

Dan, we've got time for one more question.

Our last question today will be coming from Jeff Matthews of Ram Partners. Please proceed with your question.

Hi. Can you hear me?

Yes, Jeff.

Great. Thanks. Two questions, if I may. One, could you clarify what your sales force turnover has been this year to date versus a year ago?

Very, very small this year and all in the normal course of a rep leaving here, a performance issue there. Very much the normal course of business of a sales force. I think there's one gone--net one gone or something this year. Last year, we lost in the first quarter 17 of our very, very experienced orthodontic reps and that mirrored the launch of the competitor's product in the orthodontics space. But there's nothing else.

Okay. And then, I think we've beaten this GP thing to death. But if I step back and listen to what you're saying, it sounds like OrthoClear has failed in the Ortho channel and they're shifting their sites to the GP channel to see what they can do there. And six months from now we'll know a lot better what your total position in the marketplace is. But it sounds like six months from now, it's going to be a heck of a lot better than it was when they started this whole thing. Am I missing something?

Yes. We believe that's true. I'd add one simple qualifier, and that is we think they've also moved into lower volume orthos where they're seeking trial as well. Again, we can see them cycling through our customer base, but I think what you've described is--your words not mine, but pretty true.

And it just doesn't sound like they've retained what they've initially--where they've initially tried to make inroads. Is that--?

--That's--as a broad statement, that's correct. They've found--they've stuck in a few spots, but as a broad statement that's absolutely correct.

Okay. Well, good luck. Thanks.

Thank you very much. I guess that was the last question. It's a good place to jump off. I, again, thank you for your attention this morning on a very busy week or earnings releases. And we look forward to continuing to discuss the Company's progress with you in the weeks and months to come. Thank you very much. Operator?

Ladies and gentlemen, this concludes the Align Technologies Teleconference. You may disconnect your lines at this time. Thank you for your participation.