愛齊科技 (ALGN) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Align Technology second quarter 2007 financial results conference call.

At this time, all participants are in a listen-only mode.

A brief Question & Answer session will follow the formal presentation.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms.

Shirley Stacy.

Thank you, you may begin.

Good morning and thank you for joining us everyone.

I'm Shirley Stacy, Director of Investor Relations.

Joining me today is Tom Prescott, President and CEO, and Eldon Bullington, VP and CFO.

Before we begin, let me cover some housekeeping items.

We issued a press release today detailing our second quarter financial results via PR Newswire and First Call.

This press release is available on our website at investor.aligntech.com.

This conference call is being audio webcast and will be archived on our website for approximately 12 months.

A telephone replay will be available today by approximately 8:30 A.M.

Pacific Time through 8:30 P.M.

Pacific Time August 8th.

To access a telephone replay, domestic callers should dial 877-660-6853 with account number 292 followed by pound and conference number 227478 followed by pound.

International callers should dial 201-612-7415 with the same account number and conference number.

As a reminder, the information the presenters discuss today will include forward-looking statements including, without limitation, statements about Align's future events, product outlook, and expected financial results for the third quarter and full-year fiscal 2007.

These forward-looking statements are only predictions and involve risks and uncertainties such that actual results may vary significantly.

These and other risks are set forth in more detail in our Form 10-K for the fiscal year ended December 31, 2006 and for the Form 10-Q for the quarter ended March 31, 2007.

These forward-looking statements reflect beliefs, estimates, and predictions as of today and Align expressly assumes no obligation to update any such forward-looking statements.

Please also note that on this conference call we will provide listeners with several financial metrics determined on a non-GAAP basis for comparisons to previous quarters.

Most of these items, together with the corresponding GAAP numbers and a reconciliation to the comparable GAAP financial measures, where 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 SEC on Form 8-K.

We encourage listeners to review these items.

Additionally, we have posted a 10 quarter GAAP and non-GAAP revenue model and supplemental financial slides on our website under "Historical Financial Data." Please refer to these files in more detailed information.

And with that, I'd like to turn the call over to Align Technology's President and CEO, Tom Prescott.

Tom?

Good morning everyone.

We're glad you took the time this morning to review our second quarter results and our outlook for the rest of 2007.

Before I go any further, I do want to welcome Shirley Stacy, our new Senior Director of IR.

Shirley recently joined our team from Brocade Communications.

Welcome, Shirley.

So let's get right to the results.

Very clearly, we're pleased with the quarter.

During Q2, we shipped approximately 55,000 revenue cases, which drove record revenues of $76.6 million.

We also shipped nearly 8,000 free Patients First cases, as we completed this program and brought it to a close with a total of 24,000 cases overall.

Significant volume, along with outstanding gross margin performance, yielded major improvements in operating margin, reaching over 21% on a non-GAAP basis.

We are not likely to be consistently linear business given seasonality and other factors, but this quarter really demonstrates the strength of our business and the operating leverage in our model created by strong growth.

Eldon will provide a few highlights on the numbers momentarily, but first let me remind you of our goals.

Our key goals are one, to generate strong top-line growth and extend profitability.

Two, to continue to expand our customer base while fine-tuning our demand, creation, and brand-building efforts.

Three, to develop and deploy GP-specific and ortho-specific product platforms.

And four, to evolve our manufacturing platform enterprise systems and core processes to improve efficiencies; and 5) to complete shipment of all Patients First cases.

We've made significant progress in all areas.

And as I had mentioned in my opening comments, we have now completed the Patients First cases and demonstrated our ability to scale our manufacturing platform to handle surges in volume.

Now that we have nearly doubled total shipments over Q2 of last year and demonstrated the ability to recapture and grow OrthoClear volumes, as well as rebalance our lead times, there is no longer a need to discuss recapture rates by the relative level of incoming receipts.

All right, now let's talk about the drivers of that strong Q2 performance.

We continue to see expansion in our customer base, both newly trained and repeat submitters, as well as progress in utilization growth for orthos, GPs, and international, as well as solid demand at the consumer level.

During Q2, we certified 1,500 new GPs in the U.S., including 100 from university programs.

Adding in 100 orthos trained in the U.S.

and 300 doctors trained elsewhere in the world, we added a total of 1,900 new doctors in Q2 alone.

We continue to see strong interest in becoming an Invisalign-certified doctor and are increasingly focused on recruiting doctors with real interest in successful integration of Invisalign into their practices.

In addition to these certifications, we also delivered multiple continuing education events.

We held our third annual international summit and our third annual GP summit where we delivered high energy, clinically-intensive programs to a combined audience of 1,300 doctors and staff.

As a result of these education efforts and hard-work from our field sales team, we grew utilization from orthos to 5.3, among U.S.

GPs to 2.7, and among international doctors to 3.4.

Driving utilization growth over the long term is one of our key objectives.

Going forward, the primary lever for greater adoption and integration in the practice will be product performance, what we call the user experience.

Much of our Research and Development focus is aimed at creating a dramatic evolution in this user experience to renew GP-specific and ortho-specific platforms, as well as a range of new offerings that better meet our customers' unique needs.

ClinAdvisor, the first step towards a new GP platform, was previewed last October, piloted and beta tested over the past 6 months, and has now been launched nationally.

Early feedback tells us it really helps newly certified and less experienced doctors select appropriate cases based on their experience and skill set, which is exactly what we were hoping to achieve.

In addition, a number of docs are using ClinAdvisor as a chair-side selling tool during patient consultations.

This software has been integrated into our new GP certification program, which launches nationally this fall.

This program has been tested and will be rolled out broadly as a key element of our customer utilization growth strategy.

We continue to move forward in concept creation, development, and beta testing of other key elements for the GP platform and the ortho platform and will have more to share with you before the end of the year.

We're very pleased by our strong Q2 performance as well as the progress made on these key strategic initiatives.

Our team members know that we have a lot of work to do and understand it is the quality of their execution that will lead to superior business results.

We are focused on ensuring that our customers get great outcomes for their patients, after all it's their success that leads to continued growth in shareholder value.

And now I'll turn it over to Eldon.

Eldon?

Thanks, Tom.

Now, let's review our second quarter results in a bit more detail beginning with the income statement.

Q2 revenues of $76.6 million grew 20% sequentially and 44% compared to the second quarter last year.

Revenues were higher than our outlook of $72 to $74 million.

Our strong performance this quarter was driven by slightly higher volumes, increased training revenue and higher than expected international ASPs.

Consistent with our outlook, approximately 15% of the 55,000 cases shipped in Q2 were Invisalign Express.

As indicated on our April call, Q2 shipments included approximately 4,000 cases and associated revenues of $5.2 million from the reduction in backlog and cycle times caused by the allocation of capacity to the Patients First program during Q4 of last year and Q1 of this year.

For Q2, blended ASPs, reflecting the mix of cases between full Invisalign and Express, volume rebates, and case refinements were $1,330.

For full Invisalign cases, ASPs were $1,430 and international ASPs were $1,630.

Our Q2 GAAP gross margin was 73.6%, increasing 1.1 percentage points sequentially and 4.6 percentage points year-over-year.

This was due mainly to the effect of volume increases and improving operating efficiencies.

Q2 non-GAAP gross margin came in at 73.8%.

On a GAAP basis, Q2 operating expenses of $42.9 million were lower than expected, due primarily to a one-time $1.6 million credit for an insurance reimbursement of legal costs associated with OrthoClear and the timing of European sales and support costs, which didn't ramp as quickly as we had planned.

On a non-GAAP basis, which includes -- excuse me, which excludes stock-based compensation, Q2 OpEx of $40.3 million increased 3.9% sequentially and 6.1% year-over-year on an absolute basis.

As a percentage of revenue, Q2 non-GAAP OpEx decreased 8.2 percentage points sequentially and 18.7 percentage points year-over-year to 52.5%.

GAAP net profit on a diluted basis for Q2 was $0.19 per share, compared to $0.10 per share last quarter and a loss of $0.04 per share a year ago.

Q2 non-GAAP EPS was $0.23 a share, compared to $0.11 last quarter and a loss of one penny in the same quarter a year ago.

Q2 EPS benefited from higher volumes, strong gross margins, and lower than expected expenses.

Taking a brief look at the balance sheet, cash, cash equivalents, marketable securities, and restricted cash in total were $82 million, compared to $64.1 million at the end of 2006, demonstrating positive cash flows.

During Q2, we paid off the remaining $8 million of the debt outstanding against our credit facility.

Q2 DSOs were 55 days for the current quarter, compared to 54 days in Q1 and consistent with 55 days in the year-ago quarter.

Let me now turn to our outlook for the third quarter and full-year, which is also in our press release, so I'll only touch on a few highlights.

Before I get into the details, I want to remind you of the factors we outlined on our last earnings call that we said would affect the second half of 2007.

As I said on the last earnings call, Q3 case shipments were expected to be down slightly from Q2 shipments.

This is due primarily to the effect of working through the case backlog and reduction in lead times in Q2 that I discussed a moment ago.

If we subtract the approximately 4,000 cases of backlog shipped in Q2, we get a baseline of approximately 51,000 cases, which can be used to provide a more apples-to-apples comparison for our Q3 outlook.

In addition, our Q3 tends to be a seasonally slower period for case starts and new doctor certifications because it corresponds with summer vacation and holiday periods in both the U.S.

and Europe.

All right, given these factors, our outlook for Q3 and fiscal 2007 are as follows.

For Q3, we expect case shipments to be in the range of 53,000 to 54,000 cases.

While that is down slightly from Q2 on an absolute basis, it is up slightly from Q2 using the 51,000 case baseline that I mentioned previously.

On a year-over-year comparison, Q3 case shipments are expected to increase in the range of 48 to 51%.

Our outlook for ASPs is consistent with the assumptions used in our last update.

And as I indicated previously, we expect ASPs to be down slightly in the second half as more doctors qualify for higher levels of volume rebates.

In Q3, we expect ASPs to be down 2 to 3% compared to Q2.

We expect revenues for Q3 to be $70.3 to $72.2 million, compared to the $76.6 million in Q2, which includes the conversion of the backlog cases.

We also expect somewhat less in training revenue as we conduct fewer training sessions during the summer months.

On a year-over-year basis, we expect Q3 revenues to increase approximately 43 to 47%.

With increasing clinician participation in case volumes, we continue to target adding quota and carrying sales staff.

We ended Q2 with 118 sales staff in the U.S.

and 27 in Europe.

We expect to add approximately 12 to 15 sales staff in the U.S.

and 8 to 10 in Europe during the second half of the year.

In addition to sales staff in the U.S.

and Europe, Operating Expenses will pick up a bit sequentially.

Compensation costs related to sales commissions and performance incentives, business infrastructure projects and information technology, and supply chain management will be the primary drivers of incremental spending in the second half of the year.

We expect Operating Expenses to be up approximately $1 million on a full-year basis compared to our prior outlook.

On a GAAP basis, we expect Q3 EPS of $0.07 to $0.09.

We expect non-GAAP EPS of $0.11 to $0.13.

For the full-year 2007, we're raising our outlook for revenue slightly and expect a year-over-year increase of 36 to 39% for a range of $281.6 to $286.8 million.

Case shipments year-over-year are expected to increase 37 to 39% to 206,000 to 209,000 cases.

For the full year, ASPs are fairly consistent with our prior outlook, up slightly due to Europe currency exchange rates.

Fiscal 2007 GAAP EPS is expected between $0.43 and $0.49.

Non-GAAP EPS is expected between $0.57 to $0.63.

The difference between the two is stock-based compensation expense and the reversal of some Patients First program costs in the first quarter.

We expect stock-based comp expense in Q3 to be approximately $3 million and we expect full-year stock-based comp expense to be approximately $11 million.

From a balance sheet standpoint, we expect to continue to generate positive cash flow and expect to end 2007 in the range of $105 to $115 million in the bank and we're not anticipating any new debt at this time.

Finally, one point I want to touch upon, a number of you have been asking about our tax planning strategy and what our effective tax rate will be in the future.

We are currently evolving a worldwide tax strategy, taking into account the potential benefit from our international operations, to allow us to minimize our effective tax rate.

We can't yet determine the period at which this plan will take effect; however, when it does, our goal is to have a GAAP effective tax rate in the range of 32 to 37%.

Now let's go back to the Operator for some Questions & Answers.

Operator?

Thank you.

Ladies and gentlemen, we will now be conducting a Question & Answer session.

(OPERATOR INSTRUCTIONS) Taylor Harris with J.P.

Morgan.

Thanks a lot guys.

I just wanted to focus, first of all, on the composition of your submitting doctor base or your revenue-generating doctor base.

Are you seeing differences in growth rates across the different levels of volume-generating physicians?

And if so, can you maybe characterize that for us?

Just to make sure I understand your question, Taylor, good morning.

Within segments by volume or some other manner are there different growth rates, adoption rates that we --?

Yes, exactly.

And how does that make you feel about your price point strategy, your volume, your discount-based strategy?

The answer is yes, we absolutely see a wide range of frequency of submission, of adoption cycle, etc.

and the more experienced doctors -- well, we have two things going on for sure, the more experienced doctors that have gotten over the learning curve are much more frequent submitters.

I would say the other factor that's going on, the doctors we have trained more recently in the last year or so, as our programs have improved and evolved, there's a -- we're seeing a general trend of shorter cycle of getting started and a quicker ramp to what we'll call reasonable adoption.

But what I would say, both in ortho and in GP, among the more frequent submitters there is strong, consistent growth in utilization.

And that there's a very long tail with low volume submitters.

If you compare the growth rate of your highest volume submitters, how does that compare to the overall case volume growth rate?

The -- in general, the core adoption in the more frequent submitters is much higher, which is why the numbers in utilization -- one of the reasons why the numbers in the overall utilization numbers we provide don't move as quickly, they're really affected by the very large denominator and the new doctors reporting into the mix.

Okay, but just to be clear, you're growing cases faster in your highest volume category than overall?

Yes.

If we were going to report on a number like same-practice growth, you would see that with segmentation.

Okay, great.

And in the past you've given a number on the new submitting doctor or the number of submitting doctors in the quarter and I don't think you gave that this quarter.

How has that trended, just so we get an idea of potential backlog?

Taylor, we, this is Eldon.

We provided that for three quarters and the reason why we did was while the Patients First conversion was going on we wanted to make sure, operating in a backlog position, that you have some insight into the flow into the business.

The reason why we've stopped doing that is because the Patients First program is over, our backlog is rebalanced, so we'll stick to a ship sight indicator.

But basically the evolution where you see the number of docs shipped to evolving is indicative of the flow entering the business.

Okay, great.

And, Tom, as you mentioned, there was a big increase in doctors trained this quarter, more so than we thought there was going to be, and I think you indicated in your comments that you were pleased with the quality of the doctors you were training, in terms of their willingness to really adopt the technology.

Is that -- are you trying to mandate that in any way?

And how do you have a sense of real interest level among the new trainees?

Well, Taylor, the -- we look at this in several ways.

The first thing is we are out now in an organized way seeking doctors that have a real interest and qualify that interest.

I would say if you go back several years we pretty much took all comers.

It's not that we would turn someone down per se, but we make much more serious efforts to qualify and to kind of try to affirm that they have real interest in integrating Invisalign to practice.

We're less interested in training revenue and getting started with them, we are much more interested in building a long time -- a long-term partnership with them.

So I would say it's maturation of our training programs, it is better segmentation and targeting of doctors, and it's -- maybe we're reaching a tipping point with relative awareness and interest in bringing Invisalign into practice.

And those three things together probably make up what we're talking about.

Okay, and then one final question.

Any thoughts on your -- on just the operating margin going forward.

You -- Tom, when you had set some long-term goals, you had talked about a 20% operating margin and you're pretty close to that this quarter, over that on a non-GAAP basis.

So have you updated your thoughts on your operating margin goal?

Taylor, what I'd say is specifically no.

I want to point you towards what we've described as a long-term view and we've certainly proven that with the right volume in the business and running the business well we can deliver real operating leverage, but I think at this point in time we'd like to get quite a few more quarters behind us demonstrating consistent strong progress before we come back to that.

Okay, thanks a lot guys.

Thanks, Taylor.

Tao Levy with Deutsche Bank.

Good morning.

Good morning, Tao.

Good morning, Tao.

A couple of quick ones.

On the GP front, nice growth there and obviously if you do the quick math the percentage of GPs submitting out of the total trained picked up nicely this quarter.

Are the folks that are submitting, are they -- the increase, is that due to folks who are trained a couple of years ago and now coming up the curve or it's more sort of the more recent ones that are getting trained that are submitting more quickly?

Tao, it's both, but the driver is that with time doctors that have been trained, again reasonably infrequent submitters in the past, they're getting over the learning curve.

They're finishing cases, they're getting great results, they're having a reasonably easy time of marketing this to existing patients and they are attracting new patients to their practice.

So I think all of those things together are encouraging GPs to do more.

And the other side of the coin is, as I think I said a moment ago, where our training programs have involved, the new ClinAdvisor integration into our first level certification will help further.

We are seeing newly certified doctors start their cases sooner.

We are seeing the ramp a little bit faster.

These are all relative statements.

The ramp to adoption a little quicker in those newer trained cohorts of doctors.

So -- but the bigger effect is more of a widespread general slow but important increase in utilization growth across most cohorts of previously trained docs.

Got you, okay.

On the OpEx front, it seems a little bumpy this quarter.

And I don't know if maybe, Eldon, you can flush out this -- the insurance benefit that you had in the quarter and is that part of SG&A, the $1.6 million I think it is?

Yes.

And that, Tao, that is definitely one of the items that contributes to what you call a little bumpiness there.

Yes, the $1.6 million was an insurance reimbursement under the terms of our portfolio of insurance policies that allowed us to recover some OrthoClear litigation costs and that was credited to G&A.

Okay, G&A.

Okay.

And I think beyond that is, as our business evolves, the general track that we have talked about and the things that we're doing across our portfolio of activities and the impacting operating expense remains consistent.

Once in a while you encounter a little bit of timing as to whether everything is going to get done this quarter or the next quarter, but the overall general trend of activities in the business remains consistent with what we've been talking about for the last couple or three quarters.

Okay.

And on the European front, nice performance there as well.

You're adding more, I guess as a percentage, significantly more to your international efforts than domestically.

Can you just talk about the dynamics of the European marketplace and maybe at the same time maybe an update on Japan if you can?

Sure.

Well, I think the progress we're making in Europe is a direct result of the focused strategy we put in place there.

And Europe is not -- Europe is a geography, not a market.

What we really have to do is leverage a presence there and then focus on the 4 or 5 key countries that make the most difference.

And for us, that's Italy, Germany, not in order exactly, but Italy, Germany, UK, France, and to a lesser extent, Spain.

And then find cost effective ways to provide reasonable coverage to the doctors that have been trained in other countries.

It's not that these smaller market countries can't be big some day if the time and place (inaudible) says we have to make reasonable investments and provide good customer care.

So that focused strategy is we've pulled back resources in some areas, added mass in those markets where it matters, and continue to add mass, and we've been able to make the case to do some demand creation experiments and some initial direct-to-consumer marketing, primarily in the UK, which is working out pretty well.

We're learning a lot from that and we will evolve that over time.

So we're pleased with progress.

We have a lot more we can do in Europe and we're trying to localize the lessons learned here in the U.S.

So Europe is on track to do terrific things and to become a much bigger business.

Then we look at Japan, which is in a very different state.

We are taking a very thoughtful approach in synch with support from the Japanese Orthodontics Society who actually is embracing this technology, but our goal is -- we've trained about 400 doctors in Japan.

They are on track with our internal expectations and our goal is to have them, that smaller cadre of key doctors, mostly all orthodontists, get great case results on a lot more complex cases.

So as we get forward -- as we get ready to move forward in Japan, we're in a position to show real case results, some simple clinical studies, and real success.

And off of that base of experience we will then expand out to a much wider group of orthos in a series of ways.

But we've got a couple of years before we're really ready to step on the gas in Japan.

Everywhere else in the world, we're trying to find cost effective means to reach customers and prospective customers with interest, but do it in a cost effective way until those markets or countries individually have enough mass to do more with it.

Does that answer your question, Tao?

Yes, it does, thank you.

Okay.

Two more quick ones.

What's the average turnaround time now for a case that we should expect going forward?

For new case in patient?

Well, we typically are back to our published delivery times and we typically say it's about a month.

And the biggest determinate in that is how quickly the doctor interacts with getting the case posted, getting it -- the records into us and the proven clin check.

Literally, we've been able to turn around cases within a week.

So we're back to our normal availability and when we need to, for our customer situation, we can move heaven and earth to get something done very quickly.

Great, thanks.

And you filed an 8-K last night, some -- and then you terminated so, could you just comment on that?

And that's it for me.

Thanks.

Well, I think, Tao, I think the 8-K ought to speak for itself.

We don't comment on personnel matters and it's out there.

That's about all we ought to say about that.

Okay, thank you.

Thank you.

Mark Mullikin with Piper Jaffray.

Good morning.

Can you hear me okay?

Yes, Mark, we hear you fine.

Good morning.

Thanks.

I just want to delve into the Operating Expenses here a little bit more.

Clearly, the operating margin was very impressive.

And starting with the gross margins, can you maybe give us a little more color on what sort of capacity utilization you're running at and what sort of incremental spending you would expect going forward on manufacturing?

Well, Mark, as a matter of course, the way we look at capacity is through our major gates, our lead time on adding capacity is about 90 to 120 days.

So we try to modulate our capacity and what we invest in it in that regard.

As we've talked about over the last couple of the three quarters is we did have to do some ramping up, particularly in Costa Rica, to meet Patients First and that left us with a very comfortable margin of capacity out of Costa Rica.

We're in pretty good shape out at Juarez.

But on a go-forward basis, that's how we manage our capacity and we invest in it accordingly on an as-we-go basis.

So, I guess looking at this quarter's gross margin, is that level sustainable or even -- are there improvements that we could see going forward from this level, the mid-73 level?

From a standpoint of how we manage our operations environment, we have a portfolio of activities that we have been working on and will continue to work on that will provide incremental improvements to that process.

And our folks in Ops work very hard on that day after day to improve our process.

I think if you look at our outlook and the evolution of margins there, it gives you kind of a benchmark for where we've been and where we're expecting to go.

So you would expect to see some incremental improvement over time in our cost performance from a manufacture product perspective.

And at the same point in time, we talk about the evolution of our ASPs.

Both of those are at work, that look at our outlook there and you kind of see our view of the trend of gross margins.

Okay.

I guess is there any reason to think that the Patients First program would be driving that number higher than its sustainable rate though because more volume is running through the plant or is that really not an issue?

Not necessarily, Mark.

There was a little bit of benefit while we were running that volume through the plant over the course of the last three quarters, but, again, if you look at our view of the world on a go-forward basis, that was a very nominal effect.

Okay.

And really, just -- if I can amplify that, if we agreed with that same exact fixed capacity, if we had replaced those Patients First cases, which were put through the system at a fully burdened cost, if we replaced those with revenue cases, obviously the entire P&L would have looked even better.

Okay.

So it clearly helped with absorption, but from a contribution margin perspective, the business even would have been -- would have run hotter if we'd had full revenue case at capacity.

Okay, got it.

And then on sales and marketing, that came down quite a bit as a percentage of sales.

And you mentioned in your prepared comments that you didn't have some of the ramp in European sales and marketing that you were expecting.

Is that something we should expect in the third and fourth quarter, sort of sequential increases in sales and marketing as you do more of that in Europe?

Yes, you will see some increases, as I mentioned, both in the U.S.

and Europe that we're modulating our resources and our feet on the street to match the evolution of the number of docs that we expect to be doing cases and we try to maintain a reasonable balance of coverage of ratio of participating clinicians to sales territories.

If you look at our numbers, you do see some evolution of sales and marketing.

It did kick up a bit sequentially between Q1 and Q2.

And if you look at our outlook, we're expecting it to kick up a bit into Q3 and that's basically the driver.

And on the direct-to-consumer front, has that spending been at a relatively stable rate or did you scale back at all on that as you were trying to work through some of the Patients First backlog?

The answer is no.

The Patients First backlog had no impact on our game plan on direct-to-consumer advertising.

As we talked about coming into the year, we did pick up the pace on direct-to-consumer advertising in 2007 relative to last year and we have maintained on that course in addition.

As we previously mentioned, that we kicked off an organized DTC program in some geographies in Europe this year.

Okay.

And then just finally on the terminated head of IT, can you just tell me what his duties were, what his scope of responsibilities were?

He was responsible for the Information Technology Group and that was primarily an IT management role, our enterprise systems and such.

Was not directly involved in product development per se, rather the enterprise systems and related infrastructure to deliver them.

Okay.

And will you replace him or will the operating management head permanently take over that department?

We have -- are initiating a search for a new VP of Information Technology/CIO and we'll replace that current scope, largely as it is, and in the meantime we have a very senior member of the executive management team responsible for that group and providing leadership in the interim.

So we would certainly plan for little or no disruption, but that's where I'll leave it.

Okay, great.

Thank you and nice quarter.

Thank you very much.

Matt Dolan with Roth Capital.

Hey guys, good morning.

Morning, Matt.

Morning, Matt.

Eldon, to follow up on the sales and marketing question, I know we're talking on a dollar basis looking for a bump here in the second half of the year, but I think the question was phrased as a percentage of sales.

Is there anything you can give us there looking forward on that basis?

Well, on a -- if you look on an overall Operating Expenses basis for the long term, as we evolve and grow the business and if we're able to meet our longer-term goals, we expect our OpEx metrics will fall in line and as a percent of revenue generally improve over time.

From a sales perspective, sales and marketing expense, that would fall directly in line from that perspective.

We called out a couple of percentages there just to give you a flavor of what -- as we evolve and grow revenue how that metric can be affected and how it was affected in the second quarter.

But from a spending perspective and a percent of revenue, right now our near-term focus is making sure that we're balanced and we have the resources deployed to serve our customers and to drive the business.

Okay, good.

On the GP side, just to look at that on two specific questions there.

We talked about the learning curve accelerating.

Do you have any idea of what the general timing of that learning curve is?

And secondly, once those positions have completed that learning curve, can you help us quantify, in any way, the difference in utilization of that cohort of GPs versus the newbies?

Well, if we go back, if we -- I'll answer the second question first.

If we go back and look at cohorts of docs trained in our earliest training, the greatest drop off of non-adopters is in that first year or two when we first do training.

And it's kind of obvious we weren't as organized, we weren't as prepared, and all that.

And if you look over the last two years where we've evolved our certification programs and our support programs, it's fairly significantly different.

Now we get -- we've gone up a bit in terms of being able to get what we'll call trial, doing a few cases, but the -- both the curve for adoption has gotten compressed and the percentage of doctors who integrated the practice.

Now, again, these are small numbers because our view of what a GP ought to do over the long term is roughly one a week.

We think -- that's how we've talked to them about it.

If this is something you can do in your practice, start a new case at least once a week, which is about the least frequently they do any other procedure in their office.

So -- and comparing that roughly 13 a quarter with what they do today, that's a pretty big jump.

We aren't there yet, but that's a long-term objective.

The leading guys are at kind of that 12, 13 a quarter?

We see GPs that are in excess of that that have really integrated into practice that are 100 a year and more, but they've been doing this for 3 or 4 years and have really adopted this into their practice.

Now, we don't have enough of those doctors yet, but our goal is to create a whole bunch of them.

The second part of this is if we looked more recently, and as we've pilot tested, like the new ClinAdvisor tool, and as we now look at how we've tested integration of ClinAdvisor into the new certification program, which is scheduled in a whole series of certifications this fall, we see very different behavior.

And, in fact, the new cert program, they literally have 7 -- there is actually a pre-cert program where they can get a discount on their full certification cost and they basically come in pre-trained.

They have to go through 7 cases, the assessment, the full setup using ClinAdvisor, as they literally work through that program.

We see so far with the testing very different behavior from those docs.

And, literally, when they get back to their office, they are confident to start cases.

That's -- we have yet to see how that will play out, but in the coming year, we would expect to see a continued compression at first use and then that initial adoption.

But we're certainly headed in the right direction.

I also got to come back and remind you that the denominator is so big here with all of the new doctors we're pouring in that the gross overall utilization numbers aren't growing rapidly, but inside that, when we look at our segmentation of same-practice growth, week over week, month over month, we see real change.

Okay, very good, now that helps a lot.

And then finally, at AAO, we saw some initial ideas relative to more customizable orthodontic-specific type of procedures.

Any updates there on when we could see something more official out of the company specifically?

Well, we, especially on the -- we're working really hard on the -- on both the next steps for the GP platform that go way beyond where ClinAdvisor is and we are working also in parallel with a whole new ortho platform that will bring greater control, wider applicability, and greater predictability for those orthos.

And we're not ready to talk about that yet.

We're out testing a bunch of things and piloting some technology.

When we're ready to -- when we get closer to when we're ready to show the world in an organized way, we're going to be excited to talk about that.

Okay, very good.

And then, Eldon, last one, you mentioned the effective tax rate and the goals there.

Any thoughts on when we'll be in a fully tax situation?

Is that possible in '08 or more likely an '09 type of event?

Matt, the answer there is no different.

We don't have a firm prediction on that, as always.

There is always a lot of conservatism that goes into making that call.

Okay.

For 2008, not sure.

2009 could be a likely situation if the goals of the business continue to evolve.

And at this point in time, we'll just have to watch that as time goes on.

Okay.

What I did try to do there is at least answer the question when folks ask.

When we do roll the model over, what would be the likely range of effective tax rate.

So at least we gave you that to chew on.

Sure.

Okay, great quarter, guys.

Thanks a lot.

Thanks, Matt.

Operator, before we get to the next question, let me remind everyone that we'd like to limit the number of questions please in the interest of time.

Go ahead, Operator.

Mark Richter with Jeffries & Company.

Good morning and thanks for taking my question.

Good morning, Mark.

In terms of thinking about ASPs going forward, you've talked in the past about eroding ASPs in your guidance.

Do you still think -- should we still be thinking about eroding ASPs, as it doesn't seem like that's been the case to date?

Well, as I mentioned that in the second -- looking at the outlook in the second half of the year, you should see some subtle impact from the adoption of docs because our point has been with our volume discount program is that, sure, we will give up a little ASP to drive volume in the business and incent docs to take the product deeper into their practice.

So you should see some of that over time and that's basically what we've laid out in the program.

I think I called out that you'd expect to see a couple of 3% impact on a go-forward basis.

And, Mark, if I could add one little comment.

Probably the single biggest focused effect here was actually the OC recapture.

As those higher-volume doctors have come back, they've been able to come back and quickly generate volume and that volume, after they've gotten to a level, has allowed them to get to a discount level.

So that's actually a positive effect.

That's what we wanted to do and it's consistent with our broader strategy.

Okay, perfect.

Actually, Tom, that is a perfect lead in to my next question, which is do you keep the data or do you have data on retention rates of former OrthoClear doctors that are in the physician program and whether they remain Align doctors post the conversion?

Yes.

And could you share that with us?

What we've talked about over the last couple of quarters is given that we're past what we'll call a transition, we've stopped talking about that as a -- we've kind of said -- we originally described we thought success would mean around 50% recapture and building by the end of this quarter.

We -- I think last quarter we said something more like 60% is what we had seen and we weren't going to talk about it as a going-forward matter, but as we talked about it at the end of last quarter.

And I think for practical reasons we consider this our base business that we're growing all of it together and it's more meaningful now to talk about our business base versus the specific performance of those doctors.

But, yes, we do have the ability to go back and look at each of these practices in any point in time.

And also, as we think -- and we've done this for a long time.

And when we have doctors that go participate in a summit, we look at what their behaviors of practice was before they go to an event and after and we use that as a partial gauge to measure payback in internal rates of return on different kinds of investments.

We judge the practices that attend study clubs, workshops, and other events that we invest in to ensure that we're actually spending well.

So we do look, and the reps look at, and our business looks at, these practices at an individual practice level and a wider segment level over all kinds of periods of time, week by week, month by month, etc.

I got you.

And guidance for the third quarter just seems a little bit lighter or I guess conservative based on the strong performance in this quarter.

I know you said seasonality plays a role in this, but is it fair to think about this as just being conservatism or can we maybe think about the 4,000 sort of case backlog that hit in the current quarter as a little bit inflating the second quarter or just could you help us understand sort of your thoughts around the third quarter?

Well, to your last point there, and it's why we tried to be careful last quarter to call that out and continue and pointed out this quarter that the second quarter was the quarter that we were concluding Patients First and that we were rebalancing our backlog.

And that's why we mentioned last April that we expected about 4,000 cases to roll through in Q2 in that regard and that's what we saw happen.

And so -- and that's why I called out that you can look at our relationship between Q2 and Q3 two ways.

You can look at it gross, and I called out last quarter that you might see it tip down a little bit, or if you normalized Q2 and back out those 4,000 cases, you may see it come up a little bit and that's very consistent with what we guided to in the third quarter.

To the first part of your question, we try to construct our business outlook as fairly as we know how.

We try to call it as we see it and we try to put every reasonable factor in there that we can.

So I'm trying to call it fairly and give you a range that we think is fair and I wouldn't say that I've necessarily put any Kentucky windage on it, where we call it as we see it.

Thanks, Mark.

Next question please.

Derek Leckow with Barrington Research.

Thank you.

Good morning.

Good morning, Derek.

How are you doing?

One question on new products.

You talked about these next-generation platforms.

I wanted to get a sense for whether or not these are going to be sort of add-ons to what the existing platform looks like or -- and also, just talk about your R&D spending and some of the projects that might lead you into other product categories altogether.

So -- I mean, I'll try and touch both of those.

I'd rather not speculate on where our product mix goes in the future.

We've got such a big opportunity in our existing core Invisalign space that every time we think about alternative choices, whether bolting out other business opportunities or anything else, we come back to our -- the highest NPV project for us is to fundamentally build adoption growth utilization of Invisalign in this huge untapped market.

So that's what has informed our product strategy.

It is what has led us towards the evolution of the GP platform.

And the GP platform, as it's evolving, for a consumer, for some people who are looking from the side, may look like Invisalign does today, but the user experience is just going to be completely dramatically different.

And what that means is we're rebuilding the software, the user interface, the fundamental way the product works for the doctor to dramatically increase ease of use and to take the burden off this huge learning curve and effort.

And as we've tested pieces of this and elements of software, this is informed by hundreds of thousands of case experience and clinical algorithms that are grounded on research.

And as we show and let doctors, dozens and sometimes hundreds of doctors, work through these new applications and tools, they literally say, whoa, this is -- it looks like Invisalign but it's completely different.

And I guess that's the reaction we wanted to have.

So we are -- I think Eldon has provided a view of this year.

We haven't talked about out years, but we continue to invest in R&D and technology development, clinical development, and product development that will yield this change for GP and ortho.

Those new platforms will give us the opportunity to introduce a whole series of new offerings.

Again, Invisalign, but in ways that our customers may want to buy it differently, bundled up, bundled down, for new kinds of features and ideas that better fit their practice, that better meet their needs.

So that is what the whole effort is about.

We haven't pulled the cover off very much of it and we really look forward over the next 12 to 18 months showing you a lot more.

Great.

Just on the R&D, it ticked up here to about 9% of sales on a 6-month basis.

Is that about where you want to hold it or are you going to hold it there on a dollar basis?

What should we think about in terms of R&D spending as a percentage of sales going forward?

Well, what you've seen happen is per our game plan.

And, as we've talked about that you would expect to see a tick up coming into this year, that has happened.

You wouldn't expect for the long term that you would expect to see that ramp, but we'll be sustaining our R&D at this level and maybe pick it up a little bit over the next couple of quarters.

Great, thanks a lot.

Good luck.

Thank you.

Anthony Ostrea with JMP Securities.

Good morning, guys, can you hear me?

Yes.

Yes, we can, good morning.

Perfect.

Two questions here.

One, Tom, I heard your comments earlier on your long-term operating margin goals.

Previously you said about greater than 20%.

I know you're not really prepared to kind of renew this guidance, but would you, I guess, agree to the statement that the true goal or your -- that operating margin goal should be higher than what you had thought it would be last year?

Oh, boy, you're trying to suck me into a (inaudible).

We're pleased that we've been able to show some real operating leverage out of the growth in the business.

It is too early for me to provide a more detailed view of the future.

I realize that that isn't what you want to hear, but the reality is we're making progress in this business.

I think we've demonstrated we can scale it and develop some financial leverage off that growth.

As we are able, on a sustained basis, to deliver the kind of financial performance that you expect and we want, I think we can come back and talk about that issue, but it's just -- it's too early for me to go there at this point.

Okay, and then just maybe on the new hires into the sales force, both in the U.S.

and O.U.S.

Maybe can you walk us through the timing of these hires?

You mentioned the total headcount, but will it come equally in Q3 and Q4?

And then, can you just remind us as to how long it takes these new sales hires to achieve full productivity?

Well, we're very aggressively out there hiring, but at the same point in time we're focusing on bringing very high-quality candidates in.

So I don't know that it will be perfectly linear between the third and fourth quarter, but if we get a bolus of very high quality candidates we'll bring them in sooner.

Other than that, you can expect that that will happen over the course of the second half of the year.

And once we bring them in, get them trained, it takes a quarter or two to get them on the ground established in their territories and up and running.

And that's -- one reason is we've seen the number of certified clinicians evolving.

That's why we're moving now to get these people on the ground.

Great, thank you.

Thank you.

Isaac Ro with Leerink Swann.

Good morning guys, thanks for taking the question.

Good morning.

Just regarding the international market and perhaps taking the UK as an example, could you tell us a little bit more about how you prioritize building the awareness in the patient demand and your DTC efforts versus maybe looking at how you can help educate the doctors about the economics and how the product can benefit their practices?

How do you weigh those two factors when you try to build that market?

Well, it's a great question because it goes to having a very organized plan.

We had to go back and rebuild our capabilities in Europe, including the UK, which means great coverage, better training and support, and scaleable infrastructure.

We got that in place over the last couple of years and with progress that team has earned the opportunity for continued investment in UK and submitting neighboring countries.

As we look -- as you look at the laws governing advertising and demand creation for medical devices and the like, they vary country to country and UK is probably one of the easier areas to do this in.

We decided to invest in learning and development to understand what differences existed from the U.S.

So we took the significant experience we've had in the U.S.

in terms of systems and approach, we localized some messaging for the UK, and we did mostly print and internet approach to drive, again, drive them to our website.

And as we look at progress with unique visitors, leads, and conversion rates, initially it looks to be very promising.

We've got a lot more to do there and there will be differences from how it works here in the U.S.

But the first thing is we had to have the right group of customers, trained properly, supported properly, and covered properly, before it made any sense to invest in broader growth and demand creation.

You see that anywhere we are.

Okay, great.

And, then, just regarding the balance sheet, you guys are going to have north, as you said, north of $100 million in cash at year-end.

Are you sticking to sort of -- I think last CapEx guidance for the year was between $12 and $14 million.

Is that still your plan?

And sort of how do you think of using that cash in '08 and beyond?

The second part is, is yes, and that's what you see on our business outlook summary.

Our position is we're pleased to be generating positive cash and our primary goal is to make sure that we have a cushion for business operations and any small opportunities as they may arise.

Okay.

And then just finally on the competitive environment.

Any changes to what you're seeing out there?

Are you running into anybody new?

What I would call our posture is aggressively vigilant.

We are trying to make sure we're keeping track of opportunities and risks around the world and if there is a balance between being paranoid about everybody and being confident, you're headed in the right direction.

That's kind of where we are.

But that's -- there has been no change from our perspective in what we see and know.

Okay.

Great, thanks so much.

All right, thanks, Isaac.

Operator, we'll take one last question please.

Jeff Matthews with RAM Partners.

Hi, thanks for fitting me in.

Good morning, Jeff.

Hi.

The congratulations goes without saying, but I'll say it.

And somebody mentioned that the third quarter guidance looked a little light, but what I'm looking at is anywhere from $5 to $10 million in revenue, higher than any of the street, so I don't quite get that.

But my question is this.

What do you expect to get out of the increased spending on IT and supply chain?

What are you gearing up for there?

Well, the -- as we evolve as a business, and as a relatively young business, it centers around maturation of processes and business efficiency.

The -- as we move forward, we get larger, we need to become more scaleable, we need to become more efficient, we need to do more things in more automated ways, we need to be more user friendly with the interface with our customer base, first and foremost.

That really centers the portfolio of activities that we're doing there.

And that's -- it's a similar theme in supply chain management.

As we grow and we become more diverse in the portfolio of services that we're acquiring, we need to get more sophisticated at it, we need to get better at it, and on one hand we're a long ways from Wal-Mart leverage.

But we're bigger than we used to be and we need to get better and smarter at how we procure.

Great.

Okay, good luck.

Thanks very much.

Thanks, Jeff.

Thanks, Jeff.

Thanks, Jeff.

Thank you everyone again for joining us this morning.

This concludes our conference call.

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