愛齊科技 (ALGN) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Align Technology fourth quarter and fiscal year 2006 financial results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

It is now my pleasure to introduce Barbara Domingo, Director of Investor Relations. Ms. Domingo, you may begin.

Thanks, 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 the call today, I would 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 Q1 '07 and fiscal '07. 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 that are subject to risk and uncertainties and assumptions that are difficult to predict. As a result, the 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 SEC, 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 quarterly reports on Form 10-Q. Align undertakes no obligation to revise or update any forward-looking statements for any reason.

Please also note that on this conference call we will provide listeners with several financial measures determined on a non-GAAP basis for comparisons to previous quarters. Most of these items along with the corresponding GAAP numbers and a reconciliation to the comparable GAAP financial measures where [applicable] 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 to the SEC on Form 8-K.

We encourage the listeners to review these items. Additionally, we have posted a 12 quarter GAAP and a non-GAAP revenue model on our website at investor.aligntech.com under Historical Financial data. Please refer to those detailed downloadable Excel spreadsheets for more detailed line item information.

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

Thank you, Barbara, and thanks to our investors for taking the time this morning to discuss our fourth quarter and full year 2006 results, as well as our key objectives and expectations for 2007.

We are pleased with the progress we are making and I am looking forward to sharing our results with you today. Before we get started, let me give you a quick status on our Patients First Program cases.

Doctors registered a total of 30,500 Patients First Program cases in Q4 and submitted 19,000 treatment forms. Those doctors still have until March 30 to submit treatment forms.

In Q4, we were able to ship out 3,600 cases, even in the face of shipping out a record 39,000 in Invisalign revenue cases. The Operations team did a nice job of hiring treatment technicians in Costa Rica and ramping them up to address the additional volume. This takes time, as the process of creating digital treatment plans is highly complex and we want to ensure our team is creating plans at doctor's request.

We are right on track with expectations for ending production capacity and as this comes online, we will recover the one week delay currently impacting our normal cycle times for revenue cases and make even greater progress towards the Patients First cases.

At this point, we expect to ship the remaining 27,000 cases by the end of May with slightly more than half the cases in Q1 and the remainder in Q2. As you can imagine, it has been a real operational challenge to layer in nearly a quarter's worth of cases into our production line.

Let me now turn to Q4, which was extremely busy. We resolved and closed on the legal disputes with OrthoClear, rolled out the Patients First Program, launched the first step towards new GP and ortho-specific product programs -- or platforms, and regain momentum on (technical difficulty) [our case] volumes. In Q4, we shipped a record 39,000 cases as a result of solid growth in the U.S., Ortho, USGP and strong growth in international volumes. That volume growth translated into revenue of $55.2 million, a 13% increase over Q3 and 8% over the same quarter in 2005.

The volume growth in Q4 was driven by a tremendous sales effort while at the same time we helped doctors with patients in OrthoClear treatment get their cases registered and started. While we still have many doctors and patients waiting to get started, overall we are pleased with the progress. It still looks reasonable to recapture about 50% of the OrthoClear cases by the end of Q2.

Our base of trained doctors expand nicely from certification and university programs, and the number of the doctors submitting cases jumped sharply over Q3 by around 20%. We had a large number of new and returning Ortho start cases late in the quarter. Many of these customers were lower volume doctors and this skews the quarterly utilization numbers and explains the decline in Ortho utilization from Q3.

GP international utilization was flat. This short-term impact on utilization should recover in the quarters ahead as the business normalizes post-OrthoClear.

During Q4 at the [ADEA] in Las Vegas we introduced, released and then later in Q4, expanded on a pilot launch of ClinAdvisor, the first key element in a new GP-focused Invisalign system. The software features and user interface are intended to meet the specific needs of GPs.

In November, we hosted our fifth annual Invisalign Summit for over 370 orthodontic practices and nearly 1,200 doctors and staff members as well as faculty and chairpersons from 19 universities. During the quarter we also conducted over 50 certifications, provided workshops, and study clubs.

Let me now touch on a few key highlights from 2006 before taking a look at 2007. Those highlights have to begin with the effort and impact of our North America and international sales teams. Despite tremendous competitive pressure here in the U.S., the sales team grew volume by around 10% in Ortho and nearly 30% in GP.

This team is excited about the new year and is working with our customers to help them get the best smiles for their patients as they take their practices to the next level. They are positioned to generate significant top line growth in 2007.

The international team did a tremendous job in 2006, primarily in Europe, delivering volume and revenue growth of over 35% year-over-year. They are now transvisible in Europe and Asia, which are increasing consumer awareness and interest in aesthetics, appearance, and fitness; something we have been seeing here for several years. Consumers increasingly see media and press about the importance of an attractive smile.

In 2006, the marketing team worked a lot smarter, faster and better. We enhanced demand creation and brand building efforts became more cost effective. Lead conversion rates improved and our channel programs evolved to support our doctors with greater value.

We have previously discussed the strategic goal in establishing Invisalign as a valuable brand and leveraging that brand to our demand creation process. I'd like to share a few highlights now.

In 2006, we ran over 2,400 TV commercials on 20 different networks. We are in 20 different beauty, fitness, and lifestyle magazines with print media. Over 100 million households saw Invisalign TV or print ad. As a result, over 2 million people visited Invisalign.com or called our 800 number.

Further, over 400,000 potential patients searched for an Invisalign doctor. Since we kicked off the 2006 Bloom campaign, our advertising framework, we have seen a 200% increase in consumers reporting that they sought additional information about Invisalign after seeing ads. Our process for converting this interest into leads and leads into cases has gotten tighter and as a result, our overall conversion rates have increased significantly.

We know that leads don't turn into case starts overnight. Our demand creation programs create leads and activity in the doctor's office that in turn directly translate into case starts over time.

There is no question that we have started to tap into the enormous latent population of potential patients with the desire for a better smile and the financial resources and motivation for making that happen. There is little question that Invisalign is also helping to reposition the value of orthodontic treatment and to overcome the stigma associated with traditional treatment methods.

With increasing frequency we hear about celebrities, sport stars and others in a public eye mentioning their Invisalign treatment. For example, in the February 7 issue of Elle Magazine, supermodel Gisele discusses how she wears clear Invisalign braces to correct an issue with her smile.

Alongside our successful efforts to expand the market and create demand, our programs to support the GP and Ortho channels had to evolve. During 2006, we implemented a new pricing structure, simplified our channel support programs, and expanded our volume-based and loyalty-based rebate programs. These programs help spur growth in many practices, focusing discounts through rebates to our largest and most dedicated customers has paid off.

Clinical education was another key element in our progress in 2006 as we conducted over 400 certifications, provided workshops and study clubs, reaching thousands of doctors and staff with the goal of increasing their confidence to get greater results with Invisalign. We helped three major Invisalign Summits -- a European Summit and a GP Summit last summer, and an Ortho Summit last fall where in each case thousands of doctors and staff participated in a high impact, high energy, peer-to-peer education in clinical training. These attendees returned to their offices with renewed focus and the confidence to enhance their Invisalign practice.

During 2006, we extended the reach of our university programs. Now we are in 35 of the 52 dental schools in the U.S. and many outside the U.S. This is a strategic effort focused on integrating Invisalign into the mainstream of dental and orthodontic education even before doctors get into practice.

On the R&D and new product development front, I previously mentioned ClinAdvisor, our first step towards creating a GP specific Invisalign product. We are very pleased with the learning from our pilot launch to around 25 practices and have now expanded the pilot to over 100 offices. The goal here is that you play a turnkey system for the GP, making it easier to select simple cases, simplify the diagnostic and setup process, and ensure great results -- all with less time and effort.

Additionally, a large amount of effort was invested in re-writing the entire ClinCheck code base and application so we can more easily add functionality in the future. Our overall technology development strategy integrates the delivery of new product platforms for GPs and Orthos as well as the related product realization technology so that our manufacturing system and enterprise systems do not just scale with growth but begin to help us generate financial leverage from that growth.

During 2006, the Operations team not only delivered solid gross margin performance in the face of volume challenges, they implemented a number of important steps which will continue to support scalability as well as reduce product costs, improve quality, decrease cycle time and improving margins.

An example here includes the consolidation of our SLA technology into the wireless aligner fabrication facility, which was accomplished in early 2006, right on schedule and on budget. This process change has actually taken approximately two days out of our overall cycle time. We have actually seen cases ship out of Juarez on the same day the ClinCheck was approved by a doctor. On top of that, the manufacturing team has responded very well to the capacity challenges we took on with the Patients First cases.

As a final highlights for 2006, I have to point out the critical and important victory over OrthoClear with a successful resolution. From the very beginning of this chapter, Align's strategy was twofold -- compete intensely in the marketplace, demonstrating superior products and value to customers, while implementing a very hard-nosed legal strategy. We knew the successful legal prosecution of these matters was mission-critical for our shareholders. Despite substantial expense due to its scope and great complexity, we were confident our legal position was strong. Our legal team did an outstanding job here and we end the year with an even stronger intellectual property position and prospects for the future.

Turning our attention to a few key priorities for the new year, all I can say is what a difference a year makes. Our goals in 2007 are straightforward -- first, we're going to generate meaningful top line growth and continue the path to profitability using that momentum to regain the kind of growth we believe is possible -- around 40% per year.

Second, we're going to develop and deploy a new Ortho-specific product platform while extending the GP-focused ClinAdvisor product features and functionality. By the end of 2008, we will have achieved real critical mass around very different GP and Ortho product platforms.

GPs want the simplicity of a turnkey system to select the right cases and ensure great results. Orthos -- they need a robust set of tools that gives them greater predictability, wider applicability and more control. Most orthodontists want to reduce the technique sensitivity of today's Invisalign. They just want to plan and deliver treatment with Invisalign like they do with brackets and wires. That's our goal to give them that capability.

As we develop and deploy new versions of the Invisalign product, we're also going to evolve the manufacturing platform and enterprise systems. Those steps will ensure scalability and support operating margin improvement along with better quality and reduced cycle times.

Fourth, we are going to continue to drive the expansion of our customer base while incrementally increasing our demand creation and brand building efforts. We expect the overall U.S. marketing spend to grow by around 15% while inside of that, consumer spending programs here will grow by over 30% -- again, focused mostly in the U.S. In parallel, we will initiate similar consumer efforts on a much smaller scale in appropriate European countries as we continue to see opportunities for strong growth.

One small additional item regarding our business in Asia-Pacific. Tomorrow afternoon we will issue a press release that details our decision to move to a distributor approach for the smaller country markets in this region. This agreement excludes countries like Japan, China, India, and Korea, where we will continue to evaluate our alternatives for expansion. The impact of this change is not material from a revenue or an income perspective, but I bring it up because it continues to highlight our strategy of focusing on our highest priorities to create the greatest impact.

And fifth, we are going to complete the shipment of all Patients First cases by the end of Q2 and ensure those patients and their doctors get the great service, support, and results they're looking for when they started their treatment.

We are all very excited and enthused about 2007 and beyond. Our vision and strategic direction is clear to all employees. Our priorities drive most of our activity and our focus is on ensuring great execution.

I do look forward to sharing our progress with you as 2007 unfolds. And with that, I will turn it over to Eldon. Eldon?

Thanks, Tom. As a quick reminder, our press release and 8-K filing of the same document are available on our website. I hope you like the new look of our press release and if you haven't seen them yet, the 12 quarter historical tables and slides of our metrics are in the Financial History section of our website. Since we now have more content in our press release, I won't go into as much detail on the call. Rather, let me give you some information.

Taking a quick look at Q4 -- first Q4 revenues of $55.2 million were higher than the revised outlook we provided in December. During the quarter, we saw fewer Invisalign Express cases than we originally expected. 17% of the 39,000 cases shipped were Invisalign Express compared to the 25% we expected. A couple of contributing factors were a clarification of clinical protocol surrounding Express and the removal of cancellation fees prior to ClinCheck approval on full Invisalign cases. We believe these actions helped doctors better determine the applicability of each product and remove concerns they may have had with financial penalties.

U.S. Ortho comprised 32% of revenues; GPs were 44%; and international was 17%. Invisalign Express accounted for 9% of total revenues. Blended ASPs, as you know, are a function of the mix of cases between full Invisalign and Express along with the effects of the volume rebate program. Blended ASPs for the quarter were $1,320, approximately $70 higher than we expected, primarily due to the Express mix shift I discussed a moment ago. For full Invisalign cases, ASPs were $1,445, slightly higher than expected due to the international contribution and slightly lower volume discount participation.

Revenues also included a $1.1 million benefit associated with our case refinement policy change back in June of 2005. The vast majority of this policy change has been reflected in our financials as we close out 2006. We will not be calling this out as a specific item going forward.

GAAP gross profit margin increased 1.5% from last year to 68.8% from 67.3%. This was mainly due to efficiencies and operations along with higher fixed cost absorption. Non-GAAP gross profit margin increased almost 2%. Operating expenses on a GAAP basis were much higher than expected due to the OrthoClear settlement and associated costs of $14.3 million. This $14.3 million consists of the $8.3 million for the cost of the Patients First Program we accrued in the fourth quarter and a charge of $6 million of the $20 million we paid to OrthoClear. The remaining $14 million of the $20 million paid to OrthoClear was associated with the value of the non-compete agreements which were capitalized on the balance sheet, to be amortized over five years beginning in the fourth quarter.

On a GAAP bases, OpEx was up 66% to $56.1 million from $33.8 million in Q4 of 2005. On a non-GAAP basis, which excludes stock-based compensation and Patients First Program accrual and the $6 million OrthoClear settlement charge, OpEx was up about 18%.

GAAP net loss for the fourth quarter was $0.27 a share, compared to earnings per share of $0.01 last year. Non-GAAP net loss was $0.01, again compared to an earnings per share of $0.01 a year ago.

Let's take a quick look at the full year of 2006. Revenues were down 0.5%; more importantly, case shipments were up about 22%. Revenues were flat to down due to the change in our pricing that took effect in the fourth quarter of 2005 and the expansion of the volume rebate program.

We were at the high end of our expectations for case shipments closing out the year. U.S. Ortho for the full year was 33% of revenues; U.S. GP was 45%; and international comprised 16%. Invisalign Express was 13% of total revenue for the full year.

GAAP gross profit margin was down about 0.5%. Non-GAAP gross margin was down about 30 basis points. Margin pressure was primarily related to the price changes we implemented back in Q4 of 2005. OpEx, as I noted earlier, was affected by the settlement with OrthoClear. For the full year, GAAP OpEx was up 27% and non-GAAP OpEx was up 11%.

The largest component of the non-GAAP increase was OrthoClear legal and associated expenses. OrthoClear legal and associated expenses were $19.6 million for 2006; an increase of nearly $10 million over 2005.

GAAP net loss for 2006 was $0.55 per share compared to an earnings per share of $0.02 last year. Non-GAAP net loss was $0.19 compared to an earnings per share of $0.02 a year ago.

Taking a quick look at the balance sheet -- cash, cash equivalents, marketable securities and restricted cash at the end of Q4 was $64.1 million, compared to $74.4 million at the end of 2005. Remember that we borrowed $15 million from our credit facility at the end of Q3 to facilitate the payment to OrthoClear, and that payment was made on October 16. We repaid $3.5 million of the $15 million in December and expect to repay the balance during 2007. Day sales outstanding were pretty consistent at 55 days, closing out the fourth quarter.

Let's take a moment and look at the business outlook going forward for 2007. Our outlook for the first quarter and full year are in our press release, so I'll only touch upon a few highlights.

For Q1, we expect sequential revenue growth of 3% to 8% to $56.8 million to $59.8 million. We expect case shipments to grow about 7% to 12% sequentially to [41.6000 to 43.5000] cases. We expect the mix between Invisalign full and Express shipments to be pretty much on par with what we saw in Q4. We expect other revenues to be down sequentially by about one million reflecting fewer training events held in Q1.

We expect ASPs to be down slightly compared to Q4 due primarily to increased volume participation. We expect improvement in our bottom-line due to increasing volumes and the lack of spending on OrthoClear-related expenses. On a GAAP basis, we expect a loss of $0.02 to potentially breaking even in Q1. For the full year of 2007, we expect revenues to increase 16% to 24% to approximately $240 million to $255 million. Case shipments are expected to increase in the range of 22% to 27% to 182,700 to 190,000 cases. We do not expect any pricing changes in 2007.

During the course of the year, we do expect that more doctors will qualify for higher levels of volume rebate. We also expect to see an increasing number of Invisalign Express cases. Both of these factors will have an effect on ASPs. Both ASPs including and excluding Invisalign Express are expected to be down slightly from 2007.

With increased revenues, improving gross margins and efficiencies in OpEx we expect to see substantial improvement in our bottom-line for the full year 2007. GAAP bottom-line is expected between the loss of $0.04 and a profit of $0.07. Non-GAAP earnings per share is expected to be between $0.15 and $0.27. The difference between the two is stock-based compensation expense. We expect that this number, although only $2.5 to $2.8 million in Q1, will increase at a higher rate during the course of the year. We expect full year stock-based compensation to be between $12.7 million and $13.7 million for the full year.

As I said earlier, we do expect to repay the borrowings from our credit facility during the course of the year. To that end, we expect to end 2006 with approximately $54 million to $58 million in the bank.

Now let's go back to the operator for Q&A. Operator?

(OPERATOR INSTRUCTIONS). Tao Levy, Deutsche Bank.

Congratulations on a good quarter, you came in obviously ahead of your prior guidance and then the forecast for profitability in '07.

I just have a couple of quick questions. In the quarter, Express cases were a little bit lower than I would have thought. Maybe you can just flesh out some reasoning behind that?

I agree with you. We didn't expect to see the drop-off but really the primary reasons were as I stated on the call. At the beginning of the quarter, and it's based on our experience with the product, we did change and tighten up the protocols to effectively eliminate any confusion kind of on the boundaries of the product. I think that helps doctors in their selection process. And probably where you have an opportunity to look at it and look up to full cases, particularly for a higher volume of doctors where the differentiation in what they pay for a full case with the volume discount and Invisalign is less of a differentiation.

And also I think it is important that we drop the case penalty for cancellation out of the product prior to ClinCheck approval. That took any fear factor out of stepping into a full case and being potentially penalized. We had previously dropped that cancellation penalty on Invisalign Express prior to the fourth quarter.

Also, maybe if you could help us understand now that you've had some time to go through the OrthoClear statistics, you've had some time to see which doctors who are high-volume OrthoClear doctors -- can you let us know whether those high-volume doctors have started coming back to Align in a meaningful way? Or generally how you approach those customers.

Yes, we actually watched that very, very closely week to week by practice. And our goal is to get all those former OrthoClear customers back as totally committed Invisalign practices again. There's still a lot to work through from any of those customers that had a significant number of OrthoClear starts and we're doing everything we can to help them get their patients into Invisalign treatment with the Patients First Program. So there's still an awful lot going on. That's why I projected that we believe it's still reasonable to point towards recapturing 50% of that out in the Q2 timeframe. And literally, it is all over the map as they go through those effects in their practices. But again, our goal is to turn those practices into committed, happy, Invisalign practices and we are working really hard to do that.

And just your general sense, Tom, on sort of how receptive they have been -- the OrthoClear doctors obviously coming back and they left and maybe there was some bad blood between the OrthoClear dentists and you guys -- just maybe you could walk us through how that is progressing, how you're sort of making amends.

I don't know about bad blood, but what we're working very hard is -- they got into a situation and it certainly wasn't of their own making. They wound up with another company that exited the business suddenly. So what we are trying to do is focus on helping them get their patients back into Invisalign treatment -- the more rapidly we can get that done and get through this mountain of Patients First cases, the more quickly we can get their patients enthused again. We've got letters from patients that say, I had to wait, it was lousy, I sent a nasty letter, thank you so much, I'm excited to get going again.

So we think as we work through that process and we get everybody going again, we will have a better view of what the other end of the pipe looks like. Right now there's still some of these higher volume OrthoClear customers that had 100 and more patients stranded. And as we get at them, I think it is easier to see. On that basis, we're still being what I will call thoughtful about what our ultimate recapture rate is with those practices. And on that basis I still think 50% of their existing volume before they left is a reasonable number to start with.

And Eldon, maybe you can provide us some thoughts on SG&A and operating leverage as the business starts to go through 2007. Clearly a few years ago [there was] certainly spent a lot on the marketing front. Is there an opportunity to move through 2007 and 2008 where the dollars on a marketing front stay relatively flat and we get better leverage out of that?

Well, over time we definitely are focused on getting better leverage out of our operating expense. Probably as you look in 2007 there's a couple, three key points that we are focused on there. Sequentially you're going to see a little bit of growth in the sales and marketing area -- it is going to be focused in a couple of areas. In the U.S. we will invest a little bit more in our media expense and particularly in Europe, as you have seen the growth and success that we have had there, that we're going to be picking up the pace in our investment in sales and marketing and start doing some media work in the European theater. That is going to be the two drivers sequentially that you're going to see in the sales and marketing area.

Obviously we are looking forward to not spending the level of money that we have in the past on the OrthoClear legal matters and associated expenses. So you are going to see us doing some redeployment and you're going to see a fairly healthy uptick in 2007 in what we are going to invest in research and development and evolving our product line.

But certainly in the long-term as you look over a period of years, we are very focused on getting better leverage out of our operating expense.

If I can actually tag onto that, the simple fact is, we are extremely satisfied with the returns we get for increments of spend in consumer. And as our conversion rates have improved and especially now as we go into '07 and beyond where we don't have a competitor kind of stripping off some of that growth, we do expect to start seeing productivity out of our sales and marketing spent -- greater productivity. We've already got it in volume last year. We certainly didn't get it in top line.

So we have explicitly described in presentations that our goal is to generate the kind of operating margins that a proprietary device company ought to be able to get. And we are very focused on getting there. We should head in that direction in '07 but get there in the out years.

Taylor Harris, JPMorgan.

It sounds like through the quarter you actually saw some pretty good progress on trends, maybe particularly on the volume side. So I would like for you to comment on that. And how did that affect the 2007 guidance that you gave? And maybe just a few comments, if you can, on how you formulated the '07 guidance, particularly on the number of cases side.

Well, you got a bit of a clue in our press release in late December where we explicitly described that because of the strong incoming case flow which we typically don't talk about because it's revenue event for us, it was putting more pressure on our ability to get at the pile of Patients First cases. So we have seen very solid demand as we laid out in that press release. We think that is a good thing, obviously. And our goal is to ensure that that continues.

In terms of coming to an operating plan in a guidance framework, I guess I would ask Eldon to comment on that, but we take all factors into account including our run rates and the current position in the quarter when we go out for guidance. But maybe Eldon can provide a little more commentary.

We're obviously coming off of a very turbulent period of time. One, we tried to take into consideration as we've talked about the evolution of what we think we can recover from the OrthoClear transition in addition to looking at the elements of organic growth that we expect to get out of our product line. And we also look beyond 2007 in terms of what is going to drive growth, particularly with the changes that we'll make to our product line. And looking across all the bands, both Ortho GP and certainly continuing our expectations with the international business, especially driven by Europe.

And then on the capacity side, can you just spell out for us, I know you talked about this some, where are you building out capacity right now? And will there, because of the Patients First Program, be excess capacity therefore leftover perhaps in the second half of the year? And just generally where are you on a capacity front?

The constraint -- so we manage capacity all over the business. We have not ever had to deal with a situation where we've tended to drop almost a quarter's worth of volume in -- and when you do that you find the bottleneck. Our bottleneck was strictly in Costa Rica. And it was with the available capacity of treatment technicians, dental technicians that have to be trained for about three months or so before we can have them working on cases unsupervised or in normal supervision.

So it literally took us roughly three months to start deploying the first waves of those. We have made very good progress I think. In our comments we described where we were. We have more than adequate capacity through the rest of the system. And we don't expect so much to have capacity left over once we polished off the pile; we've kind of chosen a path through this that will intersect with our view of expanding demand and volume. And these are not enormously expensive resources. So we don't expect to see this in terms of gross margin overhang in general or anything like that but we're trying to find our way through the need to staff up for Patients First and intersecting with the expected growth in volume and receipts as the year progresses. So again, it is kind of a linear programming problem here but we think we are on track to find that balance.

So you are saying you could have hired more treatment technicians just to burn through the Patients First Program faster, I guess, but that perhaps would have led to an inappropriate intersection of that and underlying demand -- is that what you are saying?

That is partly true. But the point is it's bringing more treatment technicians on in Costa Rica and we have brought on over 100 new technicians. There's also the leadtime to train and bring them on-stream. If you go back to the point in time we stated talking about the transition at the end of the third quarter, we talked about the 90 to 120 day window to just get started. And that time faces in based on when we got these people hired.

We're starting to see that volume come on-stream. Some of the initial groups are out on the floor now doing cases. And there's more of them going to be coming out of class. So it was a delicate balance of putting capacity in place to respond as quickly and reasonably as we could to the Patients First cases and at the same point in time not just dramatically overshoot. So we have a lot of excess capacity.

But the tough part was the fact that that was the gate that we were dealing with. The good news is that was the gate that we were dealing with. It is very valuable to human capital. So we didn't have to put a lot of new [iron] in place because the process we've set up in Juarez with the aligner fabrication is very flexible and responds very well with the short-term demands. But it was really a balance to try to calibrate, respond, and not be in a situation where we were going to have to deal with a dramatic excess capacity situation later in 2007.

And last question is, Eldon, can you tell us exactly what was spent on OrthoClear during 2006? And does that all go away in 2007?

In terms of legal and associated cost, Taylor, we spent $19.6 million; that you would find in our SG&A. And then we called out the one-time cost that we are booking of about $14.3 million. As far as of a closing out -- there maybe some small amounts of residual costs as there's come cleanup activities in the early reaches of 2007. But it is not going to be a large number.

The one item that will continue, as I mentioned, that we did have to capitalize about $14 million of the payment to be amortized over four years. You will see in equal increments about $2.8 to $2.9 million of that included in our G&A -- we're not calling it out as an extraordinary item. It will roll through and that's a five year amortization period.

So we will just need to know quarter to quarter you are going to have $750,000 or so of amortization expense that you are not calling out.

That is correct. And it wasn't quite a full quarter but that started in the fourth quarter and it's going to continue on now as you and I turn gray over the next four to five years.

Aren't you already gray, Eldon?

Oh, come on, be nice.

All right. Thank you guys and congratulations on a good quarter.

[Jeff Matthews, RAM Partners].

Congratulations. One question -- early results from ClinAdvisor -- are you seeing greater utilization in those practices that have it up and running?

So, we started in 25 and we had a hypothesis that the principal usage mode would be to use this to submit all of their cases. And one of the things we found was, they in fact wanted to even simplify it more than that and what they wanted was, many of these practices wanted, was a way to just push a button and say, here's the case, keep it green, using the green/blue/black kind of ski model. So as we went through a fast evolution with that input and we then released it to around 100 sites now, we are finding that doctors are using it for real-time as we had originally thought, for real-time discussions with patients at chair side and to improve their submissions. But a lot of them really simply want a way to say, here is a case, keep me green, and if it's is on the edge, show me what the trade-offs are.

So what our goal in having these limited releases and then staged rollouts is that where we extract learning from the earlier users, we can then implement that in the next release very quickly on a smaller base. So, so far we're getting really great feedback and I think the jury is still out on this hundred, but the net is that they are more comfortable using it and more comfortable discussing it at chair side with patients, which has always been an issue for GPs.

And so the ultimate hypothesis, which was that this would help get more GPs started more confidently, seems to be holding.

That is still right, again. But with a hypothesis it's either right or wrong or partially one or the other. It is still in pilot. It is still rolling out. And we aren't ready to fully release it for a broader set of staged launches but the hypothesis to get at confidence and selection of the right case and simplification of the submission process, and then monitoring for results is still right on track. And again, as we go out through '07, we will buildout around that initial core of functionality and features.

And then secondly in Europe, how big is that opportunity overall? Secondly, do you have IP protection in Europe? And third, do you have adequate sales coverage to take advantage of marketing?

Let me start with the first one. The size of the European market for dentistry -- forget orthodontics for a minute -- in Germany is roughly the size of the U.S. because of the prevalence and number of dentists and orthodontists and other specialists and use of precious metals and the like.

When it comes down to orthodontics, there's a lot of more complex cases treated by these highly engineering-focused German dentists and orthodontists. So the use of traditional treatment is still most of what they do. Although that said, a lot of those are adolescents, teens, etc. Adult treatment is not something that has really been sought and that is the area for growth that we are really trying to tap into in France, in the U.K., in Germany, in Italy, et cetera. And so we think there's a terrific long-term opportunity but we're approaching the point where we are going to have to do a little bit of market development. And that is why we're going to spend a little bit of money, we're not detailing the specifics, but a little bit of money on market development in those countries where it is appropriate.

And then coming to your third point is, do we have the right sales, distribution infrastructure? Part of why we have waited to do any kind of demand creation, even in a small localized way, mostly will be print for us, was because we wanted to make sure we had the right team in place and the right infrastructure in place. And we think we have that now, especially in the core -- the main countries in Western Europe. And so we now are in a position to capture the demand we think we can go create working with our customers and their practices.

So, over the last couple of years we have refocused on those practices that really want to make Invisalign an important part. And we now are in a position to help feed them with greater demand and more cases. And they are pretty excited about stepping it up.

So, again, it is not going to be step-function kind of growth, but we think the opportunity is to continue the kind of growth we have seen and maybe extend it a little bit.

And then finally if I might, you mentioned Asia. Not to get ahead of the press release tomorrow regarding the smaller territories where I guess you'll use a distributor, but you have talked about Japan in the past. And it's a more complex market I guess that requires more complex capabilities from you. What do you see there now? What's the market potential look like now in Japan and China?

Well, let's take Japan and China aside. Japan -- we have a small direct organization there. We have gone in, gained the support of key influential orthodontists and members of the societies there. We have tried to come into the country different from how the launch was done in the U.S. and interestingly, although there will be culture change and practice evolution in Japan, the industry's biggest challenge for orthodontics is that they have a smallish number of people that initiate treatment each year at a very premium price; the average case treated in dollars is $12,000 to $15,000 equivalent. And those are mostly highly complex cases.

So two things are going on. First, we started, tried to start well. We have clinical studies going on with key universities. We've got a small base of doctors that are doing a limited number of cases. We want them to get good case results and get to the point where they are finishing cases, so we have success to point to. We work in parallel to set up our internal infrastructure -- our clinical support, clinical training, customer support -- because that's very, very important in Japan, that as they bring up an issue you are able to be very responsive to it.

So before we scale that business, we want to make sure we have all those pieces in place. As we start to bring those into place, we will find the most cost-effective way to build the right size, go-to-market approach and then start to scale that business. At the same time that occurs, the yield of our product development efforts will start to catch up with that. As we build out this new ortho platform, some of the features and functionality which will really widen the applicability, which is one of our goals, will really very much intersect with the very direct needs of the Japanese market, where a much greater percentage of the population will have complex cases.

So we think we're doing all the right things to build the foundation. We are investing small amounts of money each year, stepping that up a little bit. When we believe we have gotten the intersection between product, the market readiness and we are ready to go, then we will find the right way to push out more aggressively.

Long-term, we think Japan can be a very big market and a very, very productive market for us. This is not a short-term opportunity to impact revenue. This is a very careful, thoughtful, long-term direction that we are right on track with.

Raj Denhoy, Piper Jaffray.

A couple of things that stuck out in the quarter -- the number of submitting doctors jumped pretty handsomely; I think it was almost 14,800 in the fourth quarter. I'm curious if maybe you could conjecture as to why that sharp increase. Are these OrthoClear doctors that have come over? Is it a lot of trained surgeons now that have started to submit cases that hadn't previously? Or maybe you could just give some thoughts around that.

I just wanted to clarify as well -- you said that you saw an increase of about 200% in the patient leads, because of some of the recent advertising. Is that correct?

Those are two separate questions. Let me take the second one first. What we talked about was attitudinal surveying of consumers that talked about purchase intent. This is what is called a considered purchase, so that we really check in to see how our advertising is doing and how attitudes shift.

What we described was that year over year, we saw an increase of 200% since we kicked off this in the beginning of January 2006, our current campaign, a 200% increase in consumers reporting that they sought additional information about Invisalign after seeing an ad. In other words, our goal of the [bloom] campaign was to increase motivation, to bring them to invisalign.com and to get them down that process. So we absolutely had that goal.

So we had a significant increase in leads, and then a significant increase in conversion rates. But we didn't describe the numbers there. But in terms of purchase intent, there was a substantial inflection up, in terms of people that took next steps to find out more. Does that answer that question?

Yes, absolutely.

Okay. So then the first question had to do with this large number of docs, and there were really two effects there. One, I have some anecdotal comments that I will share, maybe, in a moment. But what was behind that is some of those were OrthoClear doctors. But remember, most of the OrthoClear doctors were already Invisalign doctors. What we really saw were people kind of coming back. Again, a lot of these were, relatively speaking, lower-volume doctors kind of getting back reengaged.

We just had a sales meeting here a week or two ago, and I really [poked at the refs]. What they are saying is that there were a lot of doctors in practices that were lower-volume submitters. With all the he said/she said going on in the marketplace, they kind of got turned off by that. I think some of these doctors are just, let's go get going with a few cases here. So that did, in fact, skew the utilization numbers a little bit, with a large number of low-volume customers. But we are glad to see people getting back in the game.

You have raised this in the past, but your ultimate goal of 40% annual growth in the business -- I think your guidance for this year is someplace in the 20% range, but obviously there's a lot of extraneous factors early in the year. I wonder if you could just expand a little bit on what gives you confidence you can get to that 40% target. I know you have mentioned things like product improvements and enhancements in the software and things. But do you really think that's enough to get you to 40%, or are there other things that have to happen as well?

We don't see the entire path perfectly to getting back to that run rate. We see 2007 as an important year to move back to restaging real significant growth. As the year unfolds, we'll have better visibility to this whole transition kind of post-OC.

But what gives us confidence is, even in the very difficult times where we had a competitor sapping some of our growth, we generated 22% volume growth. As we kind of anniversaried the pricing impacts, if all we did was generate that same kind of growth this year, with stable pricing in general, we're going to generate solid revenue growth year over year.

The second thing is we know, and we're comfortable because of all the work we have done, that the changes we're making in the product are exciting to customers. They impact the time they have to spend in setting up cases and managing cases, and they will extend the functionality and the applicability and the breadth of the number of patients they can offer Invisalign to.

So we know that those things are not necessarily 2007 effects, but as we get out into 2008 and 2009, and the impact of these collective sets of product changes really start to get going, what we see is the practices that get exposed to these things start to get very energized. On top of that, our programs are evolving where we increasingly, now, are funneling our market development activities into fewer practices that are most committed to converting them to Invisalign.

So as all these things intersect, as our lead conversion processes get better, as our product improves, as the huge latent population finds more and more willing doctors that are interested in doing Invisalign, we think all those things kind of line up. Again, I can't lay out any more than we have today, in terms of how that rolls out getting us to 40% and thereabouts, but we feel pretty comfortable that we can get at that kind of -- restage that kind of growth over time, and we are excited about getting back there.

Matt Dolan, Roth Capital.

Tom, on the utilization comments, looking at those being flat to down in the US, which to me suggests the growth coming primarily from new accounts -- and I know you touched on this a little earlier. But do you have any anecdotal feedback or actual percentage feedback on the number of former OC users that have come back and are ordering for the first time? Or are these new accounts coming from somewhere else?

It's both, plus existing relatively low-volume customers coming back. So I think, because of utilization calculated on shipments, not receipts, the way that the pipeline moved through the corridor, and the strong demand which we talked about in our press release in December, we wound up with shipments to docs. A lot of those were docs that have not been as busy in the game and that were lower volume.

Some of those were returning OrthoClear doctors. Some of those were new from certs where we have been pretty busy over the last couple of quarters. Some of those were from existing customers that were just lower volume.

Maybe, Eldon, you want to tag on that with some --

Yes. The one point that you made or one observation that you made, that's not necessarily just the driver of our volume. Granted, we had an uptick in low-volume docs, which could be somewhere OrthoClear return, could be some guys, as Tom characterized, that are getting back in the game. But that's a few hundred docs that are not submitting a high volume of cases. So that's not necessarily the key driver of our sequential volume increase.

Then, following up on the cases submission data, obviously they were fairly strong in Q4. Can you just give us a reminder of what the leadtimes realizing revenues from those numbers have been historically, or what you have seen internally?

We have been, on average -- case cycle time in our business has been 30 or so days. What you heard us mention here is with the Patients First Program and balancing and allocating our capacity, because we are constrained in the first quarter. We have talked about that pushing out for a period of time by about a week, and then backing back down.

Real quick, just to remind you, the biggest part of that 30 days has typically been the time for the doctor to approve ClinCheck. The rest of the cycle for us has roughly been two weeks.

As we pull out the OrthoClear legal expense and look at essentially flat operating leverage guidance, is there any investment -- you mentioned the sales and marketing investment. Is there any investment on the sales force itself? Are you expecting any growth there? How should we look on that infrastructure?

We're not making any kind of significant changes there. I would say we're tweaking the model a little bit, filling out. We now expect that team to generate some productivity and generate some topline growth. I think they're in position to do that. So we don't see any significant changes, and probably the one exception would be some incremental investment in Europe, which they have kind of earned by their strong momentum.

How many reps did you go into the year with, domestically?

One moment. I will give you the exact number. We ended Q4 --

109.

-- with 109.

We're going to take just one more question, please.

Derek Leckow, Barrington Research.

A question on ClinAdvisor. [I used] the product at your last showing; it's a pretty impressive piece of software. I'm just wondering why, if I'm one of your 900 to 1,000 submitting GPs, why wouldn't that rollout take so long? Wouldn't that be something you want to accelerate?

It's a great question. There's a couple learnings for us. What we used to do when we would roll out, say, a new ClinCheck version -- doctors would come in Monday morning, and they would go, what just happened to my software? The doctors that were most intense users that would get the best benefit -- the reps already would have been talking to intensely about it, they would have done some pretraining. Doctors would be excited. They and their staff would be dealing with it. They would have a certain frequency of use that would quickly get them over the learning curve. What we found was this long tail of low-volume submitters -- it felt like they were back to square one and this was confusing new software.

So on a very, very broad base of customers we have now segmented by nature, by type and by practice, one of the learnings we have got is that increasingly, the clinically-focused software -- as differentiated, say, from things around VIP or that are broad enterprise-focused -- the clinically focused software, we are going to be doing -- kind of using best practices of current rapid cycle software development, where you do rapid development, you have hypotheses, you test, learn and redeploy based on changes. You can only do that fast cycling with small bases of initial users, so that you can manage, back up, pull software out, put back in, add functionality literally in a week, sometimes, test again. Then you move out.

So even when we get it completely finished -- let's say the current version of ClinCheck that we are currently testing in 100 sites, we have actually got a base of 20,000 GPs. So to roll it out to 20,000 GPs for us with a clinically intense user environment would be very difficult to support. Even the smallest bug would create significant customer challenges.

So what we're going to do is we will be rolling that out in a series of very managed waves, segmented by the nature of the practices. Certain practices have certain characteristics. So organized with the field and clinical support organization and customer care, we will roll out things like ClinAdvisor and, ultimately, the ortho-centric product in a series of waves to designated groups at a time, so that not all the orthos will see a new ortho product. Over a period of a year or longer, the whole group will see a series of waves. That way, we can manage the change we have to pull them through. That's the logic behind what we're doing, and it seems to be working so far.

So that's why it takes a little bit -- it's not like you can just ship out a package of the software and have them install it. You've actually got to train and get people up and running on it, and they have got to balance the disruption of that in their practice.

Yes, exactly. So imagine, now, especially for GPs, these are lower volume -- they are using it less frequently. The easiest customer here to work with is orthos. We go to the high-volume orthos, we pull them through the changes, we get them using it and bang, they are off and running. So it's a very different dynamic. It's frequency of use that really helps dictate comfort.

As you become a more sustainably profitable enterprise, two items on your P&L -- obviously, tax rate and perhaps the stock compensation expense philosophy might change a bit. What can you talk about regarding those two items?

Well, first off, stock comp, driven by the postulates that value it. What's underneath that is really the whole compensation and motivation structure that our comp committee drives for the Company. As we evolve as a company, that philosophy evolves. Obviously, the philosophy of our comp committee is in line with a lot -- is the view of how you use equity changes. Certainly, they are watching the boundaries on that very tightly. So that's going to be a driver, as will stock price, as will the Black-Scholes model. That may increase some over time, based on that activity.

As far as tax rate, the key driver there is right now, our taxes are primarily driven by just some state and residual international taxes. We're not in a classic full provision model. That is driven by a lot of judgment and the accounting fraternity, and when you get into a long-term sustained profit model, which we are anxious to get into. But that model is not going to turn over in 2007, and we will just have to evaluate on a year-by-year basis.

So you are probably going to assume a zero tax rate, then, as we go into the year, and then perhaps for next year, we go into the 10% to 20% effective rate? Is that about right?

Yes. Pretty much what you're seeing for this year and what is underpinning our guidance is the residual taxes is you have seen us record consistent with 2006. That is going to be relatively small. As far as beyond that, we'll call that out when it comes.

Well, I would like to close here briefly by thanking all of you for joining us this morning. We really do look forward to sharing our progress with you as the year goes forward. Have a great day. Operator, we're finished.

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