愛齊科技 (ALGN) 2007 Q1 法說會逐字稿

Lades and gentlemen, thank you for standing by and welcome to the Align Technology First Quarter 2007 Financial Results Conference Call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to introduce Matt Clawson of Allen & Caron. Mr. Clawson, you may begin.

Thank you, Diego. And welcome to everyone this morning who's joined us. If you haven't received a copy of our press release, please go to the investor relations page on our website at investor.aligntech.com.

Before we start the call today, I'd like to make some comments on forward-looking statements. During this conference call, we may make forward-looking statements relating to Align's expectations about future events, products, and its future results, including statements regarding the expected financial results for the Q2 and full year of 2007. Any forward-looking statements we make during this 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, 2006, which was filed with the Securities and Exchange Commission on March 12, 2007 and its quarterly reports on Form 10-Q. Align undertakes no obligation to revise or update publicly any forward-looking statements for any reason.

Please also note that on this conference call, we will provide listeners with several financial metrics determined on a non-GAAP basis for comparisons to previous quarters. Most of these items, together with their corresponding GAAP numbers and a reconciliation to the comparable GAAP financial measures where practical, 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 Securities and Exchange Commission on Form 8-K. We encourage listeners to review these items.

Additionally, we have posted a nine-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 Technology's President and Chief Executive Officer, Tom Prescott. Good morning, Tom.

Thanks, Matt. Good morning, everyone. I'd also like to thank our investors for taking time this morning to review our first quarter results and our outlook for the rest of 2007. We're pleased with our progress. So let's get right to it.

Due to significant increases in volume, along with some positive effects from product mix, Q1 was a record quarter with revenues of $63.8 million. We shipped more than 45,000 revenue cases plus 12,700 free Patients First program kit cases. Significant improvement in operating margin yielded a welcomed return to profitability, which has been a very important objective for this management team.

Eldon is going to provide some highlights on the numbers, but first, let me remind you of our goals for the year to keep things in context. And then I'll share some of the underlying drivers for the quarter's strong performance.

Our key goals for 2007 and beyond are to generate strong, top-line growth and now extend our profitability to continue to expand our customer base, while fine-tuning our demand creation and brand building efforts, to develop and deploy GP-specific and ortho-specific product platforms, to evolve our manufacturing platform, enterprise systems and core processes and to complete shipment of all Patients First program cases.

I'll start with an update on that last goal and the impact of wrapping up the Patients First program. Doctors originally registered 30,500 former OrthoClear patients under the program. As of March 30, which was the last day to submit treatment forms, doctors had actually submitted 24,700 cases. Based on the terms of the program, our final commitment to provide free replacement cases will be 24,700, approximately 5,800 cases fewer than our original expectations.

During the first quarter, our operations team did an outstanding job of ramping up capacity to address the volume of Patients First program cases, as well as strong demand for new revenue cases. Align shipped 12,700 Patients First cases in Q1 for a total of 16,300 to date. We expect to ship the remaining 8,400 cases by mid-Q2, slightly ahead of our original schedule.

Over the past two quarters, we have discussed a potential impact of recapturing case volume left behind by OrthoClear. We have closely monitored their recapture as it's grown over the past several months and we believe it has recently leveled out. Even though doctors have alternatives in treating their patients, it appears Invisalign is being selected around 60% of the time in these practices or around 5,000 cases per quarter. We don't see the value in discussing this as a key metric for the future, given that these are now Align customers. So from this point on, we will focus our discussion on our overall customer base and growth.

As a result of the Patients First program cases and stronger than anticipated incoming case receipts in Q4 and in Q1, manufacturing capacity was constrained in our treat facility in Costa Rica. Increased demand is definitely a good problem to have, but in this situation, it is a problem that has stretched our cycle times over the past 5 months, and as we predicted at the end of 2006, created a backlog of cases. Now that we have brought additional capacity online and the majority of Patients First cases have shipped, we expect to get our cycle times back towards normal by the end of Q2.

So as we reduce our cycle times and get back in the balance of incoming case receipt volumes, we will see a benefit to case volume, revenue, and most importantly, to customer satisfaction.

It is very important as you are attempting to model our case volume trajectory to recognize that the compression of cycle times and reduction in backlog will have a near-term positive impact on case volume and revenue in the second quarter. Eldon's going to address the specifics with you, but it's important to note that some of our expected Q2 revenue will result from a conversion of our case backlog and not solely from natural or organic growth. Our project revenue for the second half of 2007 reflects a return to more normal business patterns and may look a little less extraordinary than the first half of the year. The best way to analyze our overall growth will be at a total year basis due to the unique issues of the past few quarters.

Now, getting back to the drivers for Q1 performance and future growth, our goal is to create and satisfy demand for Invisalign treatment, generating top-line growth around 30 to 40% annually with solid and improving operating margins. Given the progress we made in Q4 of 2006, and the first quarter in 2007, I believe we are on track for getting this done. The underlying drivers for this growth include expansion in our customer base, both [train] and submitting docs, solid progress and utilization growth for Ortho's GPs and international and continuing strong demand at the consumer level.

During the first quarter, we certified 1,300 new GPs in the US. We trained a total of 1,800 new doctors worldwide. This is a strong start for what is typically a softer quarter for training. We seek continued strong demand for certification and are raising our expectations for training to around 4,500 new doctors in North America this year. On top of that, we see some incremental expansion in our European base of doctors that over time will support and sustain the strong growth we've experienced there.

During the first quarter, we had solid improvement in overall utilization rates with a growing base of participating clinicians. Ortho utilization increased to 4.8, driven by continued growth among our most committed practices. GP utilization turned it up to 2.6 on a larger base of customers and international was consistent at 2.8. As you know, one of our key company objectives is to enhance utilization. Our highest priority is to drive evolution of the current Invisalign product and the technologies that enable utilization growth.

To that end, we are working to create and deploy GP dentist- specific and Ortho-specific product platforms and a range of new offerings, which will improve the overall user experience for our customers. We're making significant progress in the customer-facing software and systems, as well as internal product realization technology, in particular, on continued increments of manufacturing automation.

We previewed [ClinAdvisor], the first element of our new GP platform at the ADA Conference last October. Since then, ClinAdvisor has undergone a series of pilot tests and beta releases to refine the product. ClinAdvisor will help newly certified and less experienced doctors learn how to assess and select appropriate cases, given their current experience and skills. This should boost the early confidence and clinical success of new users. ClinAdvisor will be integrated into our certification level on training and rolled out broadly to our customer base before the end of Q3.

Additional elements for the GP platform in development including goal-based treatment and integration of systematic capabilities to categorize case complexity. These new capabilities will be tested, refined and staged for release later in 2007 and into early 2008.

The new Ortho platform currently in development will provide increased predictability, wider range of clinical applicability and greater control through a set of software tools, designed to take full advantage of the orthodontist as a specialist.

We are confident the improved features in user experience for Orthos and GPs will increase and sustain utilization over time. We expect to have significant, visible progress on the GP platform by early 2008, and on the Ortho platform by end of 2008. I look forward to sharing greater details with you in the coming months.

Let me reiterate that we are very pleased with our progress to date on key strategic initiatives, as well as our Q1 performance. I'm proud of the efforts and impact made by the Align team. We are completely focused on our goals for the year and will continue to execute our plan for even greater impact in the future. And now, I'll turn it over to Eldon. Eldon.

Thanks, Tom. Just as a quick reminder, our press release and 8-K filing of the same document are available on our website. If you haven't seen them yet, the 9-quarter historical tables and the slides of our metrics are in our financial history section of our website.

As you know, since we have expanded the content in our press release, I'm not going to focus on a lot of detail. However, let me spend a couple minutes talking about some key trend information.

So let's take a minute and look at Q1 results. Q1 revenues of S63.8 million were higher than the outlook we provided in January. Revenues grew 16% sequentially and 30% compared with the first quarter last year. Contributing factors were higher Ortho and GP channel full Invisalign case shipments and training revenues. We continued to see a mix shift towards full Invisalign cases in the US, which we believe is the continuation over the trend we saw last quarter after adjusting protocols and removing cancellation fees prior to ClinCheck approval. Approximately 15% of the 45,000 cases shipped were Invisalign Express. Training revenues reflect the stronger than expected demand for certification courses with, as Tom mentioned, 1,800 new doctors added worldwide during the quarter.

Blended ASPs reflecting the mix of cases between full Invisalign and Express, volume rebates and case refinements were $1,340 for the quarter. ASPs were approximately $30 higher than expected, due primarily to the mix-shift toward full Invisalign cases. For full Invisalign cases, ASPs were $1,450, slightly higher than expected, due to international contribution.

GAAP gross profit margin of 72.5% increased 3.7% sequentially while increasing 1.7% year-over-year. This was due mainly to the effect] of the volume increases and some improving operating efficiencies. Non-GAAP gross margin was 72.9%. On a GAAP basis, operating expenses were lower than expected due to a $1.8 million reduction in Patients First program costs.

As you recall, we accrued $8.3 million in the fourth quarter last year for the cost of the Patients First program, based on 30,500 registered by qualifying doctors as of December 31, 2006. The program stipulated that registered cases had to be submitted to Align by March 30th of this year. As Tom discussed, only 24,700 cases were submitted by that date. The $1.8 million reduction in costs represents the true-up to reflect the cost of producing a lower volume of cases.

Excluding the impact of Patients First program cost reduction, GAAP OpEx is relatively flat sequentially and up approximately 3% year-over-year. In line with our expectations, the first quarter reflects increased media advertising and marketing programs in both the US and Europe, increased R&D spending on technology initiatives and reductions in G&A expense associated with legal and litigation. On a non-GAAP basis, which excludes stock-based comp and Patient First program costs, operating expense was down 2.5% sequentially and up approximately 2.5% year-over-year.

GAAP net profit for the first quarter was $0.10 per share compared to a loss per share of $0.27 last quarter and a loss of $0.08 per share a year ago. Non-GAAP EPS was $0.11 per share compared to a loss of $0.01 last quarter and a loss of $0.04 a year ago.

Let me take just a brief moment on the balance sheet. Cash, cash equivalents, marketable securities and restricted cash was $65.7 million compared to $64.1 million at the end of 2006. During the first quarter, we repaid $3.5 million of the debt outstanding against our credit facility reducing the outstanding balance to $8 million. We expect to repay the remainder of the balance during 2007. Overall, accounts receivables management was good with DSOs at 54 days for the current quarter.

Let me take a couple of minutes and let's look at our business outlook for the second quarter and the full year. Again, our outlook for the quarter and the full year are in our press release, so I'll just touch upon some of the highlights. For Q2, we expect sequential revenue growth of about 13% to 16%, or $72 million to $74 million. We expect case shipments to grow about 18 to 20% sequentially to 53,000 to 54,000 cases.

It is important to note that approximately 4,000 case shipments and associated revenue of $5.2 million included in our Q2 outlook represent a reduction in backlog and cycle times as we recover from the allocation of capacity to the Patients First program during Q4 of last year and the quarter we just completed.

With Patients First fulfillment being completed during Q2, we expect new case delivery cycle time to move toward normal levels by the quarter end. We expect the mix between Invisalign full and Express shipments to be on par with what we saw in Q1 and remain at that mix for the remainder of 2007. We expect other revenues to be flat sequentially, reflecting continued strong training event participation.

We expect ASPs to be down approximately 2% to 3% compared to Q1 due primarily to the increased volume discount participation and increased case refinement revenue deferrals related to increase in full Invisalign case volumes.

With increase in clinician participation and case volumes, we expect to add quota-carrying sales staff and add additional marketing programs beginning in Q2. We currently have 117 sales staff in US, which includes 12 region managers and we have 28 staff in Europe. We expect to add approximately 10 sales staff in the US by mid-2007. With our increased outlook on volumes and clinician participation, it is imperative that we keep pace with the field coverage.

In addition to the sales staffing, operating expenses will pick up sequentially. Two of our three Invisalign Summits are occurring in the second quarter -- the US GP Summit and the European Summit. Also, we will continue picking up the pace on our media programs and our R&D initiatives as previously discussed.

On a GAAP basis, we expect EPS of $0.10 to $0.12 in Q2 and we expect non-GAAP EPS of $0.15 to $0.17. We're not going to discuss the second half of 2007 in detail, but I do want to provide some perspective on how we expect case deliveries to evolve.

Sequentially, Q3 shipments are expected to be down slightly when you take into consideration the clearing of case backlog during Q2 that I just mentioned and the summer and holiday periods in the US and Europe. We then expect the pace of case shipments to pick back up in the fourth quarter.

Now with that said, for the full year of 2007, we expect revenues to increase 30% to 35% to $268 million to $278 million for the full year. Case shipments are expected to increase 33% to 37% to a range of 200,000 to 206,000 cases. During the course of the year, we do expect that more doctors will qualify for higher levels of volume rebate, which in addition to the factors discussed for Q4, will have an effect on ASPs. Both ASPs including and excluding Invisalign Express for full year 2007 will be down slightly from 2006.

With increasing revenues and gross margins, we expect substantial improvement in our bottom line for the full year 2007. GAAP bottom line is expected to be between an earnings per share of $0.30 and $0.38. Non-GAAP EPS is expected to be between $0.46 and $0.55. The difference between the two is stock-based compensation and the reversal during Q1 of the Patients First program costs, as I just described.

We expect stock-based comp expense to be approximately $3.2 million in Q2 and we expect full year stock-based comp expense between $12.7 million and $13.8 million for the full year. As I said earlier, we do expect to pay the borrowings from our credit facility during the course of the year. And to that end, we expect to end [2006] with a range of $82 million to $87 million in the bank.

Now let's go back to the operator for some Q and A.

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

Good morning, everyone.

Good morning, Tao.

Good morning, Tao.

Just a few questions here. So obviously, very, very nice quarter, nice upside. I'm trying to figure out in our model, where do you think Express ends up panning out because that obviously had some nice benefits for Q1. And you mentioned these are the right levels, but they have been trending down and I'm thinking, is 16, 15% the right level, or is it closer to 12, 10% down the road and as we're looking at the 2008?

We're not talking about 2008, Tao, at this point. But we think that the former is the right answer. We think that we've approached that mix that's pretty stable, given where we are. And that's what we reflected in our outlook for the rest of the year.

and now are you seeing them either -- is it the newer doctors coming on board that start doing the Express mix and then -- in a higher percentage -- and then that starts to shift as they get more experienced?

I don't know that that's the case exactly, Tao. It's all over the map. Do we have -- we have Orthos that use Express for every simple cases and might pop a segmental bracket on at the end just to tweak a tooth or something and we've less experienced doctors that try to leave with it for very simple cases. I would say, though, that our advice to newly certified doctors is, probably, to start with a regular full Invisalign because their ability to assess the full case complexities are a little less when they're just getting started. So I don't think that a GP out of the gate starts necessarily with Express. We really focus them on selecting the right straightforward, simple to moderate case.

Okay. And Tom, you mentioned a little bit about the new products for each of the specific channels. Maybe, not going super in-depth in the products themselves, but maybe what needs the orthodontist would require in, sort of, a new type of Invisalign and the same thing for the GP. What are some of the gaps that you expect to sell?

Sure. Tao, the primary gaps are dealt with the fact that today Invisalign, both full and express, kind of goes right down the middle between the very different and specific needs in ortho and that GP has. The ortho wants greater predictability. They want wider applicability, so when they do build Invisalign into practice and patients come in looking for it, they can be comfortable when they get those cases done. And today, some orthodontists still feel it's only for the simplest cases. And they want greater control. And the evolution of software and tools and offerings for orthos will seek to address those very specific needs and we are out and testing of concepts and applications as we speak.

And there's -- and as I'm comfortable giving greater visibility of that we'll be happy to show that and talk about it. On the GP side, we're a bit further along and ClinAdvisor is a first step that we're now getting ready to roll out very broadly. I think I said before the end of Q3 and it's -- importantly, it's a very good front-end, especially fro our less experienced, newly trained doctors. And it's also going to migrate up into university education as a set of tools and it becomes an important part of streamlining our new certification one program, which will be compressed down by a day and involve a lot more pre-work and online and interent-based education before they come. But ClinAdvisor starts to help them select the right cases and support them as they get going. And so, cleanAdvisor is a first step for the GP towards being a trusted advisor, a clinical resource, and leading them more towards a turn-key solution.

Okay. And is it at all possible that they can eventually, down the road offer an Invisalign for kids?

I guess the answer is yes. We could potentially see that. Our bigger opportunity right now is to ensure that we're addressing the specific needs of our existing customers -- the patients they've got running in and out of their doors. And -- but there's nothing fundamentally preventing us other than some regulatory issues and all that from going there. But I think our bigger target in the near term is going after creating a great mainstream product for GPs and becoming a much more important part of the orthodontist world through a higher performing product. And that's why those are our two highest priorities.

Okay. And then just a last question for Eldon. On the taxes, any -- how should we think about that for the rest of 2007? You can kind of back into it based on the guidance, but maybe, just how we should think about that and also heading into 2008?

Tao, for 2007, fundamentally no different than we have been. The taxes that you're going to see are primarily statutory taxes. We have to pay a little bit of foreign tax, a little bit of state tax. So the tax posture will not change for 2007. and looking forward into 2008, that's still going to have to be assessed as to if and when we would release our reserves and roll the model over. So, definitely no change for 2007. 2008 -- that's too early to call.

Great. Thanks and great quarter.

Thanks, Tao.

Thanks, Tao.

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

Thank you. So, first few questions just on the quarter itself. The -- you mentioned that with OrthoClear doctors, you were on trend line now, I guess, for covering 5,000 cases or so a quarter. Is that how many you got in first quarter, or was it something less than that. I just want to gauge the -- what's going on in your underlying base business and then what you're getting from OrthoClear.

What we described Taylor is that it had plateaued around 60% or about 5,000 a quarter. In the -- I believe as we described at the end of Q4, when we did our year-end call, we told you it was pretty volatile. It was bouncing all over week-to-week, month-to-month and especially with the Patients First program activities going. So what we said is it's about 60%, or about 5,000 cases a quarter and we look at that now in effect as our new -- a new baseline for us that we're going to seek to grow.

Okay. So the upside you had in case volumes in this quarter, relative to your expectations -- did that come from OrthoClear business or your base -- your core, stable of doctors or a combination?

Both. The latter.

Okay. Okay, great. And on the pricing front, I think the last couple of quarters we've had the expectation that we were going to see ASPs [fix] down because of the volume discounting. And you keep on saying that that's going to come but it hasn't come so far. So, what's -- what has been keeping pricing up?

Taylor, the main event, as I mentioned, was the impact of the mix-shift between Express and full Invisalign. I mean, obviously, when you have a list rpice product from 750 to 1495, you flip that mix that will have a noticeable impact on your ASP. So in terms of the ASP staying higher than we expected, that was the primary event that you saw in Q1. Now, obviously, we said that we think that we're going to see some stability in the mix going forward. So as I called it, then I think we are going to see some volume discount impact. There was some volume discount impact going on within those numbers. It's just the mix-shift was the overriding factor.

Sure.

If I can add. We just rolled out a new advantage program middle-quartter of Q1 and it's an improved program. we expect more doctors to participate and that's what's reflected in an outlook that's a little more conservative if you will on price. Because we think it's a better program and in fact, we want a greater number of doctors to participate and get the opportunity for volume rebates.

Okay. That makes sense.

I think my math is correct, though, that sequentially, even if you exclude the express impact, you had ASPs to both Orthos and GPS pick up from the fourth quarter to the first quarter. Is that tie with what you guys have?

Yes. The other issue, if you recall back in the fourth quarter, that we had a one-time loyalty rebate that we recorded in the fourth quarter, which suppressed your ASPs in the fourth quarter. So if you're looking sequentially, you've got to take that into consideration also.

Okay. Makes sense.

And. Taylor, one other item, because I want to make sure everyone's clear on it that as you look forward in our numbers, I made mention of the fact that you're also going to see some impact of some case refinement related revenue deferral. And that will weigh on our ASPs going forward. And what I mean by that is we're seeing the rate of increase of our full Invisalign cases pick up as we have seen in the fourth quarter, the first quarter and moving forward through the remainder of the year. Now, what happens when you do that is our process is we defer a piece of revenue for every case -- for case refinement -- in the future. And then we have cases that are finishing up, either doctors are taking delivery of their case refinements, or the right to is expiring based on the timing of the case. So what happens is when -- we're shipping a higher and increasing rate of cases on full Invisalign. That means that we're deferring revenue at a higher rate at which we are recognizing it. Now, so the good news is the overall increase in volume and largely weighted towards the full Invisalign cases, but with the accounting which is consistent as we have done it, that is going to weigh for a period of time on our ASPs a bit.

Got you. So you'll pick -- I just a rate of increase issue. You'll pick that up at some point

That's correct.

On the -- your gross margin was obviously very strong in the quarter. And I'm just curious -- does -- from an accounting point of view, with the Patients First program and you running a lot more volume through the plants, does that help you on the margin side, with your reported numbers?

It does some, Taylor. It's not a huge effect, but it does some.

Okay. Okay, and then -- I guess two more questions outside of the quarter. We've heard some good feedback on the fact that you guys eliminated this cancellation fee for full Invisalign cases. And I'm -- I'd like for you guys to evaluate that decision from your vantage point in terms of the tradeoff between, obviously -- you're probably incurring some additional costs there, but hopefully generating some more demand. So, how do you evaluate that tradeoff?

Sure. Taylor, we looked at it and we ran an experiment, if you will, even when OrthoClear was still in the business for our customers that were already signed up with the loyalty rebate program, meaning they were 100% committed to align. We saw very little difference in behavior, a cancellation rate, if you will, on that population with or without. Now, you could argue they were more experience doctors, most of them. So when we had the opportunity to take this away, we felt people were leading with express to preview that and to sell to patients and then potentially upgrading -- oftentimes, which involved some additional ClinCheck work anyways.

So we do have a little bit of extra cost. It's small and our cancellation rates have been -- cancellation of cases in effect that don't go forward, yet initial ClinChecks were prepared. So we looked at that as a very good investment for practices to show a patient explicitly what they can do. And we continue to watch and manage that, but we're very pleased with that. And I think what's it's done is it has reduced friction -- for lack of a better term -- for the selling process for the practice.

Okay. Great. And then, last question, Tom, is you talk about you goals for where utilization rates are going to go, particularly in the GP channel. I'm just curious -- when you think about stimulating demand and -- between consumer demand and GP demand, let's say -- where do you want to put the most focus. Where does the extra dollar, the marginal dollar of spending go to generate that demand? Is it on the consumer side or building up doctor's practices?

Taylor, it's integrated. And I think we're getting to the point where we can take an integrated approach to marketing, that we don't think about just demand creation. We think about demand creation in context with certification levels, our base growing and our coverage and product. And so those things have to be in sync. And so what I'd say is for an increment in one area, we look at an increment in another. And you see that very much as we've -- as Eldon reflected a view of slightly increased spending in the latter part of '07. we're going to put some increment of coverage out there alongside an increase in our growing base alongside an increment of demand creation in line with the product evolution coming. So, I believe those things are additive. We believe it's possible to create leverage versus looking at any one of these as an increment. But we do look at each one of these choices and the returns for those. They're best -- so far, from our view, they're best managed if they work together.

Great. Okay, thanks a lot.

Sure, Taylor.

Our next question comes from Raj Denhoy with Piper Jaffrey. Please state your question.

Yes, good morning, guys.

Unidentified Company Representative Good morning, Raj

Unidentified Company Representative Good, morning, Raj.

I wonder if I could follow up a little bit on Taylor's question on the gross margins. I guess you're expecting ASPs to fall a little bit here and then, I guess the overhead absorption kind of falls a little bit as well as the Patient First cases kind of flush out. Maybe you could give us some expectation for what your thinking the gross margin could be for the balance of the year.

Well, you can see what we said for the second quarter and then, relative to the full year, Raj, we're -- you're not going to see a lot of volatility in it, is what we're looking at. So you have a couple of things that work. You have some, as we always have, we've got a bolas of tweaks that we make to our programs and to improve our cost efficiency. We get the benefit of volume and then we've got some pressure on ASP. So when you look at our overall margins, I think fundamentally, you're going to see those factors weighing each other out. And you're going to see the ASPs kind of hang in that range. I mean what we said on a GAAP basis for the second quarter was about -- around 71.5 to 73%, and then full year, looking at about 71.5 to about 72.6. So all those factors, I think, is going to probably circle the gross margin at a fairly constant range.

Okay. Sorry, I guess I missed that granular when you gave it before. The other question, I guess, the balance of the Patients First cases -- the 7,000 that weren't ultimately submitted -- what do you think ultimately happens to those cases. I mean, do you think those are cases you'll eventually, at some point, recapture or are those patients that just won't get finished?

Raj, we're certainly trying to understand that. And anecdotally, we believe that a lot of these patients were very close to being finished. Many of these cases were in -- among the first wave of orthodontists that were off trying the product. They were generally simpler cases. And it's -- from what we can tell, it's all over the map. It's [facial] results finished where the doctor found a way to use a spring-retainer to get it done, didn't want to get the whole process started again, didn't want to wait a quarter or so to get that case going. It was -- they finished them in segmental brackets or something like that. So, it's all over the map and we spent half the quarter re-mining these practices because we knew the practices and the patients that there was an end to the program. The feedback was pretty consistent, you know. We're good to go. The other cases are in. And we understand that the program ends March 30th. So, we don't necessarily see them coming back as patients or an unmet need.

We do feel we've more than just kind of charged our objective to get these patients back in a treatment. From our perspective, while from an accounting perspective, it may be finished, we look at this as the beginning and we look forward to the next year or so as these doctors and practices get these patients finished with their treatment to get the smile they wanted. That's the value we have the chance to create. So, at some level, we're really just getting started, although I know the financial discussion has us just about finished.

Okay. Maybe I could ask a little bit on the patient advertising. I do apologize [if you gave some metrics and I was coming on and off.] Obviously, you've increased the amount of advertising you're doing. I think all of us have seen ads recently on TV and such. What are the plans for that program going forward? Do you think you might expand that? And I guess the [correlator] to that is with the increasing demand you are seeing, sort of across the board, what percentage -- or how do you sort of match that to [mad] increase to what you're doing on the advertising front?

Well, we -- first of all, Raj, we are incrementally -- we do experiments all the time with different mix and weighting. And we're trying to create a certain reach and frequency out in our demographic profile. And so we continue to do experiments in major markets and smaller markets. We're doing some experiments in Europe right now and are going to be doing for the first time some demand promotion and brand building there. So that will continue. I think as Eldon described in general with spending, we're going to increment up a little bit that marketing activity along with an increment of coverage in the second half. We expect those changes to be incremental in nature. We continue to improve conversion rates. We continue to get more efficient-effective about lead-creation and follow-through. And so I think all those factors run together to say we have a pretty good handle, even eliminating carry over of what an increment of spending on demand creation does for us in terms of case generation. And those are positive returns, so we're going to continue. But I don't think you should expect to see a big step function change. Instead, you should expect to see incremental investment along the way.

Okay. And then just lastly -- the year I think you're guiding out as something in the range of 30 to 35%. It's going to be a little lumpy, obviously with the second quarter. But I think for the year, it should be in that low 30% range. As we look at here now, is that a sustainable growth rate? I know you've talked higher in the past. I'm curious if maybe you've sort of refined what you think this business can ultimately produce here on a top line growth rate, going forward in '08 and beyond.

Raj, we do believe that the, kind of, 30 plus to 40% range over time -- and we won't be linear, and we certainly won't be perfect, but we do believe a 30 plus % is sustainable over the longer period. And we have the combination of small current penetration with a very cool product, a huge amount of pent-up demand and a [latened] population of untreated or undertreated patients and evolving product platforms that make it more attractive to integrating into practice. We think those things together gives us the opportunity to build a much more sizable business.

So, I know you guys aren't going to touch '08 guidance, by any means, but is it fair then to use that as a marker for what we could expect here next year and beyond?

I'd rather just frame it the way I have Raj. As we get better visibility to the remainder of '07, we will refine '08 and out. But I think for now, we look at this as a business that can generate 30 plus % sustainable top line growth with the kind of operating margins that create real value for shareholders.

Fair enough. Great quarter.

Thank you, Raj.

Thanks, Raj.

Our next question comes from [Anthony Australio] with JMP Securities. Please state your question.

Hi, good morning, Tom, Eldon.

Good morning, Anthony.

Good morning, Anthony.

Anthony Australio Few questions here. Tom, maybe can you talk about where you are in terms of capacity, how you utilize [UR] and will you be, I guess given your projections for the year. And maybe as a followup to that, at what point would you need to start scaling up again?

Anthony, we are -- we really don't -- we have talked about capacity in the context of constraints and you could probably imagine with the 12,700 of the Patients' First cases and the 45,000 of revenue cases, that gives you a practical framework on current constrain level of capacity was for Q1. that total capacity continues to grow as we now have aligned, if you will, the production system to deal with the incoming case flows and dealing with the remaining pile of Patients First cases. And we think we've got the platform in pretty good shape. So we continue to manage a reasonable buffer of capacity in the business. We simply didn't have the ability to drop in 80% of a quarter's volume overnight, which is what happened with the 30,000 cases. And that's what stretched us. So our -- the primary factor here for us, Anthony, is to get back to our more normalized cycle times and get our practices back where, when they get a case in, they can see a ClinCheck at a certain time and they can expect to turn around and get their aligners at a certain time and schedule their patients accordingly. So we're -- by the end of Q2, we're going to be -- we think we're largely going to be back there, and that's the driver.

Okay. And then just touching on the cycle times, have you -- I guess, what's been the feedback on your -- what I call -- your current account base outside of OrthoClear docs, in terms of the [empty] cycle times that they've been seeing?

Well, the feedback from everybody was let's get this reduced. And we kind of went to them and asked them for their patience as we were working through the -- dealing with this very extraordinary situation. And for the most part, they said, "We understand." We were very open with them. And frankly, we went out in December with the press release to the investor community so we could talk very openly iwht our practices about cycle time expansion. And we're already seeing some improvement. We're going to see a lot more improvement in Q2 and our goal is to get back to where we were and have this issue go away completely. But it's been frustrating for our busiest practices to have to wait to get patients back in in months versus weeks. And we want to eliminate that issue.

Okay. And then in terms of utilization, nice increase sequentially. I guess, seasonally, Q1 -- in terms of utilization, should be higher than Q4. Maybe, can you talk about how much in utilization was what you'd see in terms of the seasonality and how much was above that? And maybe anything different you did or you focused on in the quarter wihc brought utilization up for both orthos and GPs.

Anthony, the comparison -- first of all, to the extent we see seasonality, it's typically a Q3 kind of an effect because in Europe, there's a great deal of holiday. And the doctors -- most orthodontists, take that month plus off and don't start new cases. In the US, it's a different effect. Typically, a lot of the orthodontist specialists, besides taking some vacation, start a lot of pediatric and kids case and that tends to crowd out some of the adult starts that they're doing. It's not a huge factor, but it's a factor. So, the extent there's seasonality in any of these utilization [measures], there's typically a Q3, now to Q4, Q1 issue.

The second thing, is I'd say for the near term, comparisons are pretty tough, there's so many moving parts right now. We had such a big expansion of doctors in Q4. We have so many other issues going on that I'd say I don't want to read more into utilization number. I think, as we described on the call, the core elements of GP and Ortho, both made progress. And we look at that as if we're bringing along the middle, then everything else is going to go with it. So, on the Ortho side are kind of our core frequent submitters, all grew nicely in the quarter. And that's a dynamic we want to continue. And good, healthy sign for the business. And on a much smaller level and a much wider base, the same thing happened on GP. So I don't want you to read more into comparison, because between Q3, Q4, and Q1, there's an awful lot of things going on that tend to skew those numbers.

Are your sales people making -- or spending more of their time on your -- with your current [inaudible] than getting new accounts?

No, it's a very consistent approach. We haven't changed. We've optimized coverage as we look at in 2007, but we're -- they have a very specific game plan about how they are to go about covering their territory and taking care of their existing accounts and building new practices. So nothing really has changed there. It's just things are settling down. We're getting back to business and good execution is occurring.

Great. And last question before I head back in to the queue. On the international side, I think last quarter, you spoke about hiring a few marketing people there. Maybe can you talk about any attraction you're seeing on that front? And when might we start to see -- ?

You dropped off a little bit, Anthony. So this was international side for marketing and sales?

Sir, please press star 1 to re-queue yourself.

Anthony, I'll -- I think I heard -- if I don't hear your question, I'll play back what I thought I heard and seek to answer as best I can. What I heard you asking was about international expansion for marketing and sales. And we have incremented some coverage in Europe specifically, along with some marketing investment. We're just getting started with that. It's too soon to tell where that'll go. That's basically an investment in continuing to sustain the very strong growth we've seen in core Western Europe. So, I'll stop there on that question and hopefully I answered it.

Thank you. Our next question comes from Matt Dolan with Roth Capital. Please state your question.

Good morning, Tom. Good morning, Eldon.

Good morning.

Good morning, Matt.

Just a couple of quick follow-ups here. On the OC front, just looking at the percentage of those docs or could you give us any perception of how many of those docs have gone beyond the patients first program and have converted now to being full Invisalign customers -- number one. And the reason for the question is looking at express as it drops down as a percentage of units, I'm assuming that is partially the reason you have more OC docs coming in, ordering full procedures. So, secondly, is that assumption correct?

Well, the answer to your second question is no, I don't necessarily believe that is correct. And I ask that quickly and then I'll go back to the first part of you question. So, we've said before, and I think we still see it this way that drivers for mix-shift from express where it had been over the last year to where it is now and we think stable in general is three-fold. One -- middle to latter part of last year, based on research and clinical algorithms now can actually score case complexity internally and very quickly assess the movements collectively and individually so that we can say, "This is an Express case, or it's not." You can get it finished in 8 to 10 stages or you can't. And we're very -- we're quickly able to provide [SC] back to the doctor and then present them with either a reduced treatment option for Express or an upgrade to full.

The second thing is we have evolved our full case program so that tehre's a -- for the higher volume doctors with a rebate -- the difference between what they pay for full cases and express at $750 is smaller. And if you take those two as the primary factors, that's kind of what's going on to drive the mix-shift. We think it's a positive, stable thing. So I wouldn't say it's OC.

The question that you started with on the OC doctors is -- and again, we've got about 60% of that recapture back -- a lot of these were already our customers. And what they've really done is get back to growing their clear aligner therapy business. And we're helping them do that. So I think, in general, if there's a drop off here, it was the small volume, newly trained doctors by OrthoClear that aren't so sure they're committed to do this going forward. There's more to it than maybe they thought. And we're going to try and circle back and get all of them if we can, but I would say in the core group, we're taking care of them and helping them grow their practice again. And our goal is to help them get back and accelerate their practice success and therefore, we get to be a bigger part of it.

Okay. Very good. And then, finally, on the AAO meeting coming up, I think, in the next month here. Any product introductions or advancements we should be looking forward to?

You know what -- why don't you come to the show and you tell us what you think? But I think it's going to be a fun show for us. We have a lot to tlak about, a lot of new things going on. I've described in general that our -- that the big chunks of change in our Ortho platform are going to be more into late '07 into '08, so that's the way I'll answer that question.

Okay. Fair enough. Thanks, guys. Congratulations.

Thanks, Matt.

Thanks very much.

Our next question comes from [Josh Jennings] with Jefferies and Company.] Please state your question.

Good morning. This is Josh in for [Mark Rickter.] just first question was can you comment on any progress made in Costa Rica regarding the dental technican training and the capacity restrants down there?

Josh, we're pretty much finished with the expansion. By probably the middle -- a little past the middle of Q1, we had gotten the head count we needed in place and they were all coming online. As we speak today, our head count has expanded. It's stable and they're cranking. So we have -- what I would say is Costa Rica -- that expansion and that capacity expansion is permanent and it's in place and it's online. And so we have no issues there and that bottleneck no longer exists, other than the fact we're still chipping away at the roughly 8,000 cases that remained of the patients First cases, along with compression of the backlog -- reducing that and getting our cycle times reduced. That's going to take us the better part of Q2.

Great. That's helpful. Can you give us some color on why international revenue and utilization rates trended a little bit down in the quarter and how you see your international business trending going forward?

Nothing unusual going on there. The international business typically has a very strong finish to the year. The way some of their programs and doc performance goes, it's a very strong finish to the year. And it's not unusual for the start of the new year to be a little bit flattish in international. If you look back over last couple of years, sometimes yes, sometimes no. but, with holiday periods, et cetera, and the international community getting back and getting going again, they we're very much in line with our expectations and that's not an unusual business cycle. And if you look over time, their utilization has been relatively stable. And if you look sequentially form Q4 into Q1, it fits within that band.

Great. And the last question is do you have any insight -- do you see any traction with the [Denahearst] product in the market and do you know if they have it [procrested] all in developing a more competitive product with you Invisalign system?

Well, I watched -- let me put it this way. With any competitor, what I would say our posture is aggressively vigilant. We are keeping an eye on everything going on and I'd rather not comment more than that. But it's just getting out there on the market place. I'm sure we'll see it AAO and it's a 5-stage product. So we're going to keep an eye on anybody that's trying to do anything with clear aligners and react appropriately.

Great. Thanks for taking our questions. Congratulations on a great quarter.

Thank you very much.

Thank you.

Our next question comes from Spencer Nam with Summer Street Research. Please state your question.

Thanks for taking my questions. Just a couple of quick questions here. Number one -- in terms of the new [inaudible] utilization as well as the utilization of the former OrthoClear dentists -- how quickly do they get to the average GP rate of 2.6 cases -- within 3 months, or how should we think about that?

Spencer, if you stand back and look at that population of docs, one important point is over 90% of those docs that were doing OrthoClear were already Invisalign certified. And certainly, the majority of them continued utilizing the product. So, in term of the cadence within their practice -- base line, that's not a radical shift in behavior and it wouldn't necessarily create a significant shift or expected shift in our near to intermediate term metrics.

Great. And so moving on to the cycle time issue, are you really able to measure cycle times in a fairly discreet way. It often gives you a high predictive power in terms of looking at the cases coming down the pipeline. And also there's a demand curve, I guess. The street basically missed -- in terms of the 2007 guidance -- street is basically off by about 20 million. And some of the estimates for 2008 are essentially turning into 2007 management guidance. Where did we miss the trend? Is that just our lack of understanding how you guys managed cycle times or is it did we just not quite understand the pent up demand that was being raised at the grass roots level?

Boy, I don't know how to answer that question, Spencer, other than to say we're just -- we've had so many things going on. I can certainly understand why the modeling for our business has been difficult. And we've tried to do everything we can to give full visibility to a broad range of data with our new approach. You're going to have to answer that question about why the view was different from what we see evolving here.

Okay, great. Well, final question I have is -- there's some thoughts that the sales and marketing efforts for a product like Invisalign is sort of a short-term sense in that you need to continue to invest in sales and marketing, especially to the end user customer base to generate above average growth, if you will. You guys had a very successful sales and marketing program last year to the end user consumers. How sticky has that effort been and in terms of looking forward, how -- do you feel like you guys will need to continue to rev up the investment in consumer education to continue to generate penetration into the traditional procedure base?

Well, I don't know if sticky is the word, but there is a very clearly demonstrated carry over for increments of spend on demand creation and we've been able to satisfy ourselves and And while we improve conversion rates, while we better manage lead flow, our job is to keep these things in balance. We go on and off the year in a very focused way with efficiently buying media in different forms and we can look at lead flowing activity and trace back case starts as much as eight months, ten months, 12 months after first contact was made, a patient came to our -- potential patient came to our Web site and registered. They give us their name and information and ask for a lot of follow-up and we have a dialog with them. So, we have a pretty good view of what the carry-over looks like, given an incremental spend in the period of time.

So, we -- so, I guess, what we think about it is we don't have this kind of necessary evil to keep throwing money at them and you keep their fire burning. What we are looking at is appropriate balanced increments of spending in all the areas with an evolving product platform, which can increase utilization and improve adoption in the doctors' offices with continued expansion and appropriate expansion of coverage to touch those doctors, as we grow to certified base, and then, with matching that with the right kind of growth in demand, so that we can harvest that at the doctors' offices. That's the integrated approach I was talking about a few minutes ago, and that's kind of where we are.

Great, excellent. Thanks very much.

Thank you.

Ladies and gentlemen, we have time for one more question. Our final question comes from Isaac Ro with Leerink Swann. Please state your question.

Hi guys, thanks for taking my question.

Good morning.

Good morning. First question, just as we look at tax rate potentially down the road, given your overseas operations, is it possible that you could see some kind of a tax shield as you get to a point where you are being -- avoid tax in the outyears?

Well, Isaac, obviously we haven't gotten there yet. For this year, you've seen the rate and actually I discussed that a few minutes ago on the call, so it's basically the statutory tax this year. I mean, beyond 2007, I mean, as a business, we assess what our alternatives are and what we think are prudent and credible and responsible tax strategy would be. So, the general answer is yes, we do look at our tax strategies and we will look at opportunities, if we look out in the horizon to optimize our tax rate.

Okay, great. And then, just on the share count, saw there was a little bit of a spike this quarter, wondering how should we think about the share count for the rest of the year?

You mean share count from a fully diluted perspective, or -- I am not sure I understand your question.

Fully diluted.

Well, fully diluted, I mean it's based on the calculation to make the determination so there can be a little bit of variability in that depending on stock price and a number of other factors. That's basically what's driving it.

Okay. And then, just finally, on deferred revenues that you mentioned having an impact on ASPs for the next couple of quarters, as I understand it, there's probably -- it seems like something like 60% of cases tend to require some kind of a refinement. Is that a fair kind of assumption for us to make? And then, kind of, could you give us some color on how the growth revenue deferral works when you record it in terms of --?

Let me start out with the last -- let me start with the last part there, that our accounting process, and this is consistent with what we've been doing for quite some period of time, is we defer some revenue on every case that shifts related to case refinement. Then, at some point in the future, we will recognize that revenue based on one or two events, either one, the doctor comes in and actually takes delivery of the case refinement, or if they never do, then we will recover that revenue when the case basically times out, which is based on the projected number of stages in the case plus a six months time period.

So, that's the mechanics of how we do that, and what I was talking about was the fact that we are seeing an increase in the pace of growth of our [full] cases. So, that means the deferrals are happening at a quicker rate for a period of time than the rate of case refinement revenue recognition. Now, as far as the pace of refinements, that's been relatively consistent in our business recently and we see case refinement being utilized about 50% of the time.

Okay, great. Thanks very much.

You bet.

Thank you. I would now like to turn the conference back over to Mr. Tom Prescott for any closing comments.

Thanks very much. Well, I would just say thanks again for joining us this morning. We very much look forward to sharing our progress with you as the year evolves, and we will keep in touch with you. Thanks very much.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..