愛齊科技 (ALGN) 2007 Q3 法說會逐字稿

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

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

A brief question-and-answer session will follow the formal presentation.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded.

It is now my pleasure to introduce Shirley Stacy of Align Technology.

Ms.

Stacy, you may begin.

Good afternoon and thank you for joining us.

I'm Shirley Stacy, Senior Director of Investor Relations.

Joining me today is Tom Prescott, President and CEO; Eldon Bullington, Vice President and CFO; and Ken Arola, Vice President of Finance and Corporate Controller.

Before we begin, let me cover some housekeeping items.

We issued two press releases today via PR newswire and First Call; one detailing our third quarter financial results, the other announcing that our CFO, Eldon Bullington, will retire in December and that Ken Arola has been designated to succeed Eldon as Align's new CDO.

Both press releases are 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 5:30 P.M.

Eastern time through 8:30 P.M.

Pacific time on Novembers 7.

To access the telephone replay, domestic callers should dial 877-660-6853 with account number 292 followed by pound, and conference number 227480 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 fourth 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 our Form 10-Q for the quarter ended June 30, 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 has been posted on our website at investor.aligntech.com under Financial Releases and have also been furnished to the SEC on Form 8-K.

We encourage listeners to review these items.

Additionally, we have posted an 11 quarter GAAP and non-GAAP revenue model and supplemental financial slides on our website at investor.aligntech.com under Historical Financial Data.

Please refer to these files for more detailed information.

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

Tom?

Thanks, Shirley.

Good afternoon, everyone.

Thanks for joining us today to discuss our Q3 results and outlook for the remainder of the year.

Let's begin with the highlights from Q3.

I'm pleased with the financial results for the third quarter with revenues in line with the outlook and EPS $0.04 higher than expectations.

We shipped approximately 52,000 cases for a revenue of $71.5 million; an increase of 46% from the same quarter a year ago.

Continued improvement from operations and stable average selling price or ASPs resulted in stronger than expected gross margin of 74.6%.

This, combined with lower than expected operating expenses, yielded an operating margin of 11.7% and EPS of $0.13; a significant increase in earnings as compared to the same quarter a year ago when we reported a net loss per share of $0.16.

Our Q3 financial performance was good but we aren't satisfied with the level of new case receipts generated during the quarter.

We experienced greater than expected seasonality in Q3 which affected all of our customers, but some more than others.

On a sequential basis, case shipments decreased 9.5% for U.S.

orthodontists and 4.3% for U.S.

GPs.

Q3 case shipments for international doctors were in line with expectations and increased 2% from Q2.

Utilization rates for Q3, which decreased sequentially to 4.9 for U.S.

orthos, 2.6% for U.S.

GPs and 3.1% for international doctors.

While we anticipated seasonality in Q3, we believe that the momentum we saw in Q2 would more than offset a typical seasonal slowdown.

However, this past summer was not typical; especially considering the slower than expected uptick in case starts, which persisted well into September, past the point where we usually start to see cases pick up again.

In our efforts to ensure customer satisfaction in Q2 by completing the Patients First Program and clearing the backlog, we did not focus enough effort on filling the pipeline for new case starts.

We are addressing these issues and are now seeing growth in new case receipts.

We expect further progress and anticipate growth in receipts through the remainder of 2007.

Q4 case shipment volume will be lower than our prior outlook, which is largely related to the new case receipt shortfall we experienced during the last several weeks of Q3.

However, the trajectory of case receipts has picked up pace as we return to normal levels, and we remain confident in our long-term outlook.

In fact, overall interest in Invisalign continues to grow and remain strong as evidenced by record levels of consumer interest and lead generation through our website.

During Q3, qualified leads were up over 50% compared to Q2 and over 100% when compared to the same quarter a year ago.

This type of increased activity and interest expressed by consumers is consistent with the high level of Invisalign focused activity being reported at dentist and ortho's offices, and reassures us that the market demand is still very strong.

We also see continued interest and demand from doctors.

During Q3, we certified 1,570 new doctors, of which approximately 1,220 were new GPs, 90 were new orthos, and 260 were new international doctors.

We will certify nearly 7,000 new doctors this year, which is the most we have ever trained and a clear sign of customer interest.

We recently announced that our clinical education program has received approval from the Academy of General Dentistry.

This means that continuing education credits for every existing course Align offers will be recognized and accepted directly by state organizations towards the licensing requirements of our attendees.

Previously, Align could only offer CEU credits through a third party.

Gaining this AGD approval is a rigorous process and we are proud of this achievement.

It's further evidence of Align's commitment to quality education programs and of the growing acceptance of Invisalign in the dental industry.

We saw more evidence of this acceptance at the annual American Dental Association tradeshow held this September in San Francisco with over 50,000 GPs and staff members in attendance.

Activity in our booth was high and we generated significant excitement among existing practices, and registered more than 150 dentists for future certification courses.

We held our first ever certification course in conjunction with the ADA show.

This course sold out well in advance and resulted in around 80 new Invisalign certified GPs.

In Q4, we will continue our focus on key strategic initiatives for product development and innovation, especially for our new GP and ortho specific platforms.

We will expand existing pilot programs and concept testing for many of the new products in our development pipeline.

In the next few weeks, we'll announce a new clear Aligner base retainer system that combines the technology behind Invisalign with a unique set of benefits for patients.

Before I turn the call over to Eldon for some more detail on the financials, I'd like to review our key strategic goals.

For those of you who have followed Align for a while, this is probably starting to sound repetitive, but we believe it's important to continually assess our performance against our longer-term goals.

Our key goals are -- one, to drive 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.

In all of this our drive is focused on successful execution and we feel good about the progress achieved against our strategic objectives during the quarter.

Now changing gears, I want to take a moment to acknowledge Eldon Bullington's contribution to Align.

Eldon and I have worked together for seven years, the last five of which have been here at Align.

It's been a professional privilege and a personal pleasure working with Eldon.

His broad experience, dedication and high standards of integrity are apparent in everything he does.

He has brought strong leadership to the financial functions of our Company and built an outstanding finance organization.

I thank Eldon for his support of me and my fellow Board members and his contributions to Align.

I wish him every success and plentiful fishing as he heads into the next phase of his life.

One of the best measures of the strength of our finance team is that Eldon's successor comes from within the company.

I am very pleased to have Ken Arola assume the role of CFO upon Eldon's retirement.

Ken has been our Vice President of Finance and Corporate Controller since he joined Align in August 2005.

He's a finance veteran with over 25 years of experience in medical device and technology companies.

Prior to joining Align, Ken spent 14 years at Adaptec, where he was most recently the Vice President of Finance and Corporate Controller.

Ken was also acting CFO twice during his tenure at Adaptec.

Ken will ensure continuity in our financial leadership team and bring tremendous energy to this new role.

Many of you have already met Ken, but if you haven't, you will certainly get a chance this fall as we embark on our regular scheduled investor road shows and conferences.

And with that, I'm going to turn the call over to Eldon.

Eldon?

Thanks, Tom.

Now let's review our third quarter financial results in more detail beginning with the income statement.

Q3 revenues of $71.5 million were within our outlook of $70 million to $72 million.

This reflects growth of 46% compared to the third quarter last year and a decrease of 7% sequentially in a seasonally slow period.

For Q3, blended ASPs reflecting the mix of cases between full Invisalign and express, volume rebates and case refinements were $1,320, down just slightly from Q2 but better than expected due primarily to less volume discounts.

Our Q3 GAAP gross margin of 74.6% increased one percentage point from Q2 and was better than expected.

The sequential in gross margin reflects continued manufacturing efficiency improvements, lower freight and fulfillment costs, and fewer new clinician certification events during the quarter compared to Q2.

Year-over-year gross margin increased 8.8 percentage points due mainly to the effect of improving operating efficiencies.

On a GAAP basis, Q3 operating expense was $44.9 million.

Operating expense was better than expected, primarily due to lower sales compensation costs and international administrative costs.

Sequentially, operating expense increased $2 million.

On a non-GAAP basis which excludes stock-based comp, Q3 operating expense was $41.8 million.

Q3 GAAP EPS of $0.13 per share was significantly above our outlook of $0.07 to $0.09 per share.

This compares to $0.19 per share in Q2 and a net loss of $0.16 per share in the same quarter last year.

Q3 non-GAAP EPS of $0.17 per share was above our outlook of $0.11 to $0.13 per share.

This compares to $0.23 per share in Q2 and a loss of $0.13 in the same quarter last year.

Q3 EPS benefited from strong gross margins and lower-than-expected expenses.

Taking a quick look at the balance sheet, cash, cash equivalents, marketable securities, and restricted cash were $110 million compared to $64.1 million at the end of 2006, demonstrating continued positive cash flows.

Q3 DSOs were 58 days for the current quarter compared to 55 days in Q2 and 60 days in the year-ago quarter.

Now let me turn to our outlook for the fourth quarter and full year.

This is also in our press release so I'll only touch on a few highlights.

As Tom described in his earlier comments, our baseline entering into Q4 was lower because the number of new case starts received during the latter part of Q3 did not ramp as quickly as expected.

Q4 has historically been a stronger quarter and while the current rate of new case starts has picked up, we will not have the pipeline of case receipts to meet the level of expected Q4 case shipments provided on our last earnings call.

When we take this all into consideration, our outlook for Q4 in fiscal 2007 is as follows.

For Q4, we expect case shipments to increase 28% to 33% year-over-year and be in a range of 50,000 to 52,000 cases.

We expect ASPs to be in line with Q3.

We expect revenues for Q4 to increase 26% to 31% year-over-year and be in a range of $69.5 million to $72.2 million.

We expect Q4 GAAP gross margins to be slightly lower than Q3 in a range of 72.5% to 73.1%, primarily due to the effect of lower volumes across our fixed cost structure and higher training costs.

As expected, we added sales staff during Q3, ending with 131 sales staff in the U.S.

and 30 in Europe.

We expect to add approximately 20 to 25 sales staff in the U.S.

and 2 to 3 in Europe in the near-term, most of them during the fourth quarter.

This reflects an increase to U.S.

sales headcount over our previous estimates as we expand coverage and practice support.

In addition to headcount-related expenses, we expect to continue investment in product development, systems, and infrastructure projects and marketing programs.

In Q4, we expect GAAP operating expense in a range of $46.4 million to $47.3 million.

For Q4, we expect GAAP EPS to be between $0.06 to $0.09.

We expect non-GAAP EPS to be between $0.11 to $0.13.

For fiscal year 2007, we expect revenue to increase 36% to 38% year-over-year and be in a range of $281.3 million to $284 million.

We expect case shipments for fiscal 2007 to increase 35% to 36% year-over-year and be in a range of [202,000] to 204,000 cases.

We expect fiscal 2007 GAAP EPS to be between $0.49 and $0.51.

Non-GAAP EPS is expected to be between $0.63 and $0.65.

The difference between fiscal 2007 GAAP and non-GAAP EPS is stock based comp expense, and the reversal in Q1 of a portion of the Patients First Program cost.

We expect stock based comp expense in Q4 to be approximately $3.4 million and we expect full year stock comp expense to be approximately $12.2 million.

From a balance sheet standpoint, we expect to continue to generate positive cash flow and expect to end 2007 with $115 million to $120 million in the bank.

We are not anticipating any new debt at this time.

Before I turn the call over to the operator for your questions, I'd like to update you on the status of our patent re-examination process, which we expect to be completed by the end of the year.

As we have disclosed previously, eight of our patents were submitted to the re-examination process in 2005.

As of today, one has come completely through the process and a certificate of re-examination has been issued for the patent with a total of 42 claims; 26 more claims than issued in the original patent.

The patent office also recently notified us of their intent to issue on six patents and we are expecting to hear back on one remaining patent.

Once the entire re-examination process is completed, we believe that the claims that emerge will be much stronger considering the close scrutiny of the patent office.

We are confident that our extensive patent portfolio combined with our broader strategic initiatives will effectively deter a wide range of potentially competitive orthodontics, products and processes.

Finally, as Shirley and Tom mentioned, I'm headed towards retirement and this will be my last earnings call.

I will be retiring as the CFO of Align in December.

In the interim, Ken Arola and I will work closely together with the executive team to ensure a smooth transition.

I want to thank our investors for their support over the years and all of our employees for their hard work and continuing dedication.

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

(OPERATOR INSTRUCTIONS).

Taylor Harris, JPMorgan Chase and Company.

So, first question.

Tom, can you just go through the sequential weakness that you saw relative to your expectations?

I think you commented that sales staff, et cetera, was busy with the Patients First Program through the second quarter.

Maybe you could spell that out a little bit for us and just let us know, do you think, was this a patient issue?

A practice issue?

A sales issue?

Help us out there.

The simplest way to answer the question is all of the above.

We had the normal seasonality that we expected and based on our run rates in Q2, thought we could drive through a little bit better -- didn't.

Secondly, I think as I described, sales force, after focusing for about three quarters on managing backlog and turnaround and expediting of cases, moved their focus away from generating case growth in a lot of practices where they were waiting on cases.

And we didn't see it as clearly and we didn't get our foot back on that gas at the timeframe we needed.

That contributed as well.

And I think finally, it was more of a practice issue than a patient availability issue.

And what we heard anecdotally from practices all over the country is, patients were taking longer, there were longer summers for families.

Practices were closing down for a week or two longer and it was a longer, slower summer.

And when all that -- when the normal brackets activity for a younger kid before school gets going, jams into fewer weeks at the end of August, we really felt that in spades.

So from our perspective, when we expected to see uptick occur, the latter part of August, early in September, it took some number of weeks later to happen.

That was different.

And we certainly didn't see that coming.

So that's what I'm talking to.

Okay.

And I think what may surprise people more than the third quarter was just that the fourth quarter looks like it's weaker than you thought it would be previously.

And normally we get a sequential uptick.

So can you maybe just explain how long does it take to work a start through the system?

And when exactly did you start seeing that pick up back to normal levels of case start growth?

So, again, it's really just a cycling process.

Q2 case receipts were strong, even as we described working off the backlog.

Q3 revenue and financial performance was very, very strong.

For us Q3 was a terrific quarter.

The problem is on the case receipts side, the summer took a little bit longer.

Our case receipts turnaround came later, so the front end of our pipeline was a little dryer.

And that whole wave just propagates through Q4 shipments and is a direct result of what we described as a lowering of our volume expectations in Q4.

Now, the second part of your questions, maybe even more important is, we did see, late September and early in October, very nice turnaround in case receipts.

And we basically have the kind of activity in offices and pipeline flow that we would expect.

It was some number of weeks later that we'd normally expect.

And that wave just goes right on through our Q4.

Okay.

So, I heard you say that in your mind there's no change in your longer-term growth outlook.

Can you just -- does that mean around this 30% case growth that we're seeing you would think can persist into 2008?

Well, Taylor, yes, we think that first of all, the reasons behind our long term confidence in kind of a 30% growth in general for volume in the business is this huge underpenetrated market we've got; the kind of activity doctors continue to describe in their offices, and requests for Invisalign as well as the expansion in base with doctors wanting to get going.

We see the continuing strong demand from consumers and demand creation efforts.

And if you go back and calibrate on our historical unit volume growth going back even to 2003, we've -- historically, this business on a unit growth basis has been around 30% or above.

And so those factors give us reasonable comfort that that is a reasonable long-term target.

Okay, great.

And let me just ask one last question.

You mentioned the (technical difficulty) [15%] increase in qualified lead.

How long does it take for one of those leads, I assume that's a website, to drive into a case?

Well, we look at the tail of that activity as being as long as 12 months.

Sometimes they turn into case starts within weeks.

It's not really a hit on the website.

We have many, many more of those.

These are people that have actually given us their names, signed on, asked to be matched to a doctor and a practice, asked us to follow up with them.

They've given us personal information of theirs.

And so this is someone who has indicated a purchase intent, a timeframe and all that.

And that is, if you go back over several quarters, this kind of strong growth in consumer activity has been continuing unabated over the last year and a half, roughly.

Matt Dolan, Roth Capital Partners.

Just following up on the new case order outlook into Q4, maybe asking it a different way.

Can you give us an idea as it relates to market segment?

Are you seeing anything -- you mentioned adolescent patients -- are you seeing anything, either in the orthodontist or the GP segment that is kind of a red flag for you?

Nothing other than what we have always seen.

It's just that the period of slowness lasted a bit longer.

Period.

Nothing out of the normal course for us.

Okay, great.

And then as you look forward to drive those case orders up, can you give us an update on your DTC campaign, now that's been in full swing for 2007?

Are you getting any meaningful feedback there?

Is that starting to work?

Is that something that we should look to scale up in '08 or cut back and focus more on the direct sales model?

Well, in general, let me talk about in 2007.

The lead flow information I gave you is a very direct result of that kind of focused activity in an incremental spend in 2007.

That will be continual -- it will be on the air and out in some print media through around Thanksgiving.

And then we pretty much go off the air just because of the crowd of holiday advertising and whatnot.

We will be back on in a more or less normal way into 2008.

And it's too early to talk about guidance and our direction.

But I think it would be reasonable to assume incremental efforts in our go to market initiatives and incremental efforts in demand creation as we move into 2008.

That said, our conversion rates have continued to grow over the past several years.

That means the -- an increment of spend is we're getting more case starts out of that.

And so all of that, shall I say, progress with those investments gives us confidence that an increment of spend returns very well.

So nothing out of the ordinary that you have seen.

We should be on through around the end of Thanksgiving and then we will look at next year as a whole new thing.

Okay.

Very good.

And finally, on the margin side, it looks like your guidance implies operating margins coming back into the single digits after being in the double digits for a few quarters here now.

Any comments on the heels of your longer-term growth outlook, where that could head?

Is Q3 more normal?

And Q4, it sounds like it had some one-time events in it?

Matt, this is Eldon.

I think Q3 was probably a pretty good profile for where we were at.

We're a little bit heavier on training in the fourth quarter so that puts a little more into the cost of sales line.

We're continuing to work on some of our projects in Q4.

So, yes, the margin on a percentage basis drops back a little bit.

But you're seeing where we are at in Q3 and into Q4 is probably more into the zone of where we are in the short term versus the big operating margin for all the reasons we talked about in Q2.

But I think that's kind of circling where we are bracketed at this level in the business.

Okay, thanks, everybody, and Eldon, best of luck.

Derek Leckow, Barrington Research.

Just have a question on some of the expenses, some of the projects you said you were kind of picking up in Q4 and also for next year.

Can you talk about your capacity utilization in your manufacturing plants?

And do we still see that those have plenty of room for growth or do you have to add any capacity in 2008?

I think in terms of capacity in general, we're in good shape for 2008.

There are a few elements that we will add as we step into the year.

Obviously, we modulate technician capacity with our needs in Costa Rica and also make sure that we are staffed appropriately in Juarez.

There will be a few elements of equipment that we will add.

There's a few things that we may add related to some process improvement items.

But we expect no fundamental restraints on our capacity requirements for the coming year.

And I guess if you put this in context of what we've been through over the last year, we've pretty much demonstrated that even under great stress, we've virtually doubled capacity over a couple of quarters.

So I think we're pretty comfortable that we understand what we would have to do with any reasonable surge in growth in the business in any kind of reasonable timeframe.

Okay.

And then as it relates to capital spending then for next year, do I just continue to assume that that figure is constant or what are you thinking about there?

Obviously, we'll talk about that in more detail at the end of the year.

But you've seen us with a fairly consistent platform and there may be a few new elements.

But we don't necessarily expect to be building a new plant next year.

Okay.

And that brings up my last question.

You've got $110 million in cash here, I guess profitable from here forward, it looks like.

What are some uses of that cash do you think going forward?

I think we've had this discussion before with our investors.

At this point in time we believe that the best use of that cash is for reinvestment in this business as a great growth platform.

We continue over the long-term to have the kind of discussions you would hope for and expect with our Board to ensure we get the right kind of shareholder value creation.

And I would say for the near-term, you should expect us to continue to utilize that cash, build the pile of it further and continue to reinvest in growth.

Does that include acquisitions, then, Tom?

I think at this point in time we view that our best opportunity for becoming a great company and helping our customers achieve great things for their patients is if we evolve the product and company technology to accelerate the business, further improve gross margins, make sure we can deliver the kind of top line performance and bottom line performance you expect; if we can find technologies that could accelerate that progress, I think we might be interested.

But we're much less interested at this point in time about broadening the portfolio.

Because we think we have a multitude of opportunities for product line extensions and new products around the Invisalign core technology to generate the long term, very meaningful growth.

Okay.

Thanks a lot.

I appreciate it and good luck to you, Eldon.

Tao Levy, Deutsche Bank.

So, just to clarify and just hit this point one more time, as you saw the quarter unfold, I guess, September, the cases weren't coming in as you expect.

And then basically what you're saying is the curves just shifted out by a few weeks.

And now you're on a per sales a day basis.

You're back to where you expected to be a few weeks ago.

Is that --?

Yes.

So then we should assume coming off of this Q4, which maybe is a little light because of these reasons that sequentially the business should be better than in Q4 based on the trends that you're seeing today.

Is that a fair assessment?

Well, what I would say is we think the profile of the business is unchanged.

We are starting from a lower baseline than we expected to, coming out of Q3.

That was not in our expectations.

And so, our ramp rate looks very solid, as I think we said, the pace and the uptick in case receipts is what we expect now.

We are coming off a smaller base; we have to work through that.

And we'll be happy to sit down with you early in 2008 and talk about our full year view of that.

Okay.

And in terms of -- any area in particular where you saw a little bit of softness in the new cases received and on the GP side?

I mean, international looked pretty strong, sounds like there's an issue there, but was it more on the ortho side?

More on the GPs?

It was very much across the board and both the anecdotal feedback from practices and the data region by region pretty much support both; in some cases different reasons.

We had GPs across the board slower and certainly with orthos, that's exacerbated by the late summer effect as they're focusing on putting -- doing their adolescent and youth starts for fixed appliances.

So it's a little different effect but those are both traditional summer impacts.

It just persisted longer than we expected and anticipated.

Got you.

And on the pricing side, it seems like things are pretty stable.

Is that reasonable to expect going forward?

Yes.

Okay.

And then just lastly, as we start to think about -- for those of us who have been following the Company for a little while and you know, I go back a couple of years ago, and think about the shortfall that happened in the third quarter a few years ago and then -- not that this is the same.

Obviously, we had OrthoClear, that was developing in the background, but anything that I guess in retrospect in this quarter that you would have done differently?

And are we sure that there's not another OrthoClear developing among the sales force?

Well, the simple fact is that there's lots to learn over the past three years.

I think there's a specific second half of 2004, there were different effects going on.

The most significant effect -- and one of those at the time we didn't understand, which was there was a competitor we think kind of forming to get after us.

We certainly stayed vigilant and a little paranoid about everybody that could come after us.

We certainly don't perceive any of those risks that way at this point.

But we're -- can be very vigilant.

The biggest factor that got us in the second half of 2004 was we got way behind what is a reasonable territory size.

We were adding lots of GPs to certification.

We weren't increasing sales force fast enough.

If you notice from Eldon's comments where we're talking about incrementing up sales coverage in North America, that is tracking up to keep up with certification pace.

We're now keeping those in balance.

We expect that to be a healthy kind of fit.

That was the number one factor contributing to the second half issue we had in 2004.

As far as other competitive effects, we continue to be a bit paranoid, as I said, but we don't see anything specific at this time for a system-related product.

In retrospect, what we would have done to call this quarter, we didn't have any data when we did our last call in July that would have suggested that summer was anything other than usual and normal.

And so on that basis, I guess without better insight on seeing how the rest of the summer was going to play out, we would have said the same thing we did.

So all that said, always room for improvement and growth.

And as I said, we're not satisfied with our progress, even though Q3 from a financial perspective was a terrific quarter.

Would you have done anything differently, again in retrospect?

I mean, have the sales force focus on other areas or added more sales force earlier on?

Again, obviously with hindsight.

Well, again, even in Q2 as they were finishing handling off the ends of the Patients First cases and clearing backlog, that was their activity.

We told them that was the priority, to manage this churn at the doctor and patient level.

And our goal was to minimize impact on our customers or docs.

And we really couldn't shift gears on that until we finished the Patients First shipments and got cycle times back to a normalized mode.

So I don't know that we could have shifted gears much faster.

Perhaps we didn't see that it would take as long as it did.

But again, I think there's -- we'll continue to grow and do the best we can.

But it fundamentally is the summer affect lasted longer than we expected and I don't know how we could have seen that.

Okay.

Thanks a lot and good luck, Eldon.

Mark Mullikin, Piper Jaffray.

Congratulations, Eldon, on the retirement and to Ken on the promotion.

So just to go into maybe the demand side of the market a little bit more.

Do you attribute any of the shortfall just to general economic conditions with all the volatility that there was over the summer?

I mean, was there an element on the demand side that was just a fact of life?

Well, you know, we can't correlate any of this to anything at the consumer level.

I think the biggest answer there is, we just are so small in terms of penetration into a huge market opportunity that we probably don't track the broad economy yet.

That said, it's one of those things we really worry about.

We try to track other proxies for this behavior, if either for elective surgeries, for things like Botox, and I'll step back.

This is a considered purchase.

It's mostly paid for by the patient with some help from flex spending and dental insurance.

But this is still significant out of pocket expense for the patient.

So the simple fact is, we continue to see expansion in what consumers describe as their intent to purchase Invisalign; to get this service.

And that continues to grow.

And I talked about the qualified leads which is the first gate we go through to start to really turn that interest into case starts.

If I look at proxies like Botox, now, Allergan -- we're trying to look at industry leaders out there that have got products that address a segment of much deeper penetration than we have which might, perhaps if there's real fundamental slowness, show up sooner.

We haven't seen that yet.

So Allergan announces I think first week in November and over the last two quarters, they've raised guidance for Botox revenues for the year.

So we continue to search for and worry about broader effects on consumer.

We're unable at this point to correlate any of the things that happened in summer to that.

And in fact, anecdotal evidence at the doctor's offices for new consults and activity is very, very high.

So again, one of the things we worry about we can't control but that's where we are.

Do you know what percentage of your patients finance the feature and how they go about financing it?

When you ask patients, many of them think they finance it but much of that financing is done in effect through the doctor directly, where the doctor says, pay me this much now and I won't charge you interest.

And that's not really a third party financing event.

The last data I saw and we were having this discussion during ADA with a couple of financing companies was -- something like 10% to 15% and I -- those are the numbers we heard; I haven't seen them in print and I haven't seen them validated -- of cases get financed through third party players; CareCredit and others.

I have not seen that validated in any kind of third party data.

What that would say is it's still a fairly small amount of orthodontic treatments.

Okay.

And then on the operating margin in the quarter, clearly a pretty big swing quarter-to-quarter here from the second quarter.

What should we look for as the normalized operating margin over the next two years?

Just considering -- if you intend to continue to grow the top line at 30% or more, that's going to require spending obviously on sales and marketing programs, et cetera.

So, what's a reasonable progression for operating margin considering that you want to grow the top line at that rate?

Yes, Mark, just at the top of your question, as we discussed quite a bit on our call a quarter ago, the second quarter, certainly was a great quarter but it had its own interesting and unusual events, including a surge in revenue and volume related to clearing prior backlog that had accumulated because of the Patients First Program.

And it also involved a credit item where we had recovered some monies -- about $1.2 million or so on OrthoClear legal expenses.

So, moral to the story is the second quarter is not necessarily our benchmark for near-term operating margin.

If you look -- and as I mentioned on a previous question, that probably in the range of what you're seeing in Q3 and what we're projecting in Q4 kind of brackets the near-term levels.

Longer term, our view is if we can meet our goals of growing this business for the long-term at 30% a year that we've talked about, that we can settle into a goal of a 20% operating margin over time.

And certainly then see what we can do with it from there.

But as we've talked about it, our view has not changed.

And then just lastly, can you just tell us a little bit more about the nuclear retainer system?

Well, we're excited to roll this out here and to launch in the next few weeks, which will be a lot more information available for you.

But it's going to be based on the wonderful Invisalign technology and offer some very unique benefits for patients and practices.

And we think it's a nice little product line extension.

It allows us lots more -- it will start -- fill in the blanks when you guys say what do you mean by new products?

So I guess I'd like to leave it there for now and talk much more substantively with you in a couple of weeks.

And perhaps in our next investor conference we'll say some more about it.

Okay.

Very good.

Thank you.

Spencer Nam, Summer Street Research Partners.

Thanks for taking my questions.

Just have a couple of quick questions.

So it appears based on the Q3 phenomenon, it appears that this demand flow is somewhat sensitive to various factors.

I was wondering if you guys have talked about going forward this time next year, if something similar happens, how you guys think about addressing this so that there's a little more sort of a buffer or something that will help the Street to get a better sense of how the demand is flowing through.

Have you guys given some thoughts on that?

How you'd address this in the future?

Spencer, I think there's really two reactions I have.

The first is there will probably always, in this business, be a bit of some seasonality that will be difficult to work around.

And given that we build a custom, demand flow business, we're going to be -- we don't build, put into warehouse and ship to either end user or patient -- customer or patient; we build it when they want it started.

And that's going to be always dependent on the front end of that pipeline.

If I take Europe for example, they're out of their offices for well over a month each summer and a chunk of January.

In the U.S., it's a much more widespread effect; not all at the same time, but it is very much a reality.

And there's two things that can help that.

The first is, as we become a much more meaningful part of our average customer's practice, we will have some natural buffer we can build in during those summer months when they have to make priorities about the things that are most important to them in practice.

Today we're still, in many practices, not the primary focus.

So that's an opportunity for us to create some of the buffer you described.

The second thing is, coming out of what has been a very tumultuous seven, eight, nine quarters, I realize it's a difficult modeling problem for you guys, but we're very difficult for period over period comparisons right now.

We've said before we wanted to get through the Patients First shipments and frankly, to get those practices really back all engaged and have those patients get on with getting their great smiles.

That's still in process.

And really we kind of saw the physical end of deliveries in Q2, but we're now getting back to running our business and tasking our people in a way that isn't affected by that phenomenon as you described.

So there's going to be seasonality.

We'll do our best to manage through it and articulate that in our business outlook.

But I think we are getting towards the point where we will put the tumultuous past eight quarters or so behind us and become more normalized.

Appreciate that.

The second question is, this sales force addition that you just announced.

It looks like 20 to 25 new sales reps globally you'll be adding.

How should I think about that in terms of the overall sales force growth over the next several months and maybe couple of years?

I mean, are you guys getting to a point where you feel like you have enough to really accelerate the productivity per rep?

Or is there more room for the reps to come in, really open up territories?

It's both, Spencer.

And those are the two levers for progress.

We expect over the long-term significant productivity at the territory level.

We also expect -- one of our strategies is customer base expansion.

And as more doctors have indicated an interest to get certified this year, we've had to increment our rep hiring and training so that we could keep up with that.

The second part of that, what we talked about before, is that especially on the GP side, as the GP product evolves, today the rep has to do everything from frontline clinical education and support in practice to practice development and assistance in marketing.

As the product evolves, becomes simpler to use in that office and the learning curve becomes easier, the rep will be more productive and will be able to spend more time on practice development activities versus everything.

So those two things are largely tied together and that again reinforces the priority for the GP product platform evolution.

But to your question, we do expect progress in both areas over the next few years.

Quick follow-up question -- how long does it usually take for a rep to join Align and get to the average level of productivity or the accepted level of productivity?

I hate to tell you the answer, because it depends.

It depends on if they have previous dental experience.

It depends how clinical that experience was.

We have examples where a very qualified pharmaceuticals rep that covered dentist's office, periodontist's office, could learn elements of orthodontics quickly and drop right in and have relationships, in fact, in place.

There's other examples where people have come from selling [CAT-Cam] systems and computer workstations to Big Fortune 500 companies and they've had a longer learning curve.

We're hiring best athlete here.

But they've had a longer learning curve to understand how to add value and what the clinical technology is in the doctor's office.

In the worst case, I'd say it's six to nine months; in the best case, it's a quarter to two.

So I'd say six months for reasonable productivity is a pretty good target for us.

Anthony Ostrea, GMP Securities.

Tom, you mentioned in your prepared remarks you had a few initiatives to address the case starts.

And I'm not sure if I really heard you in terms of what those initiatives were.

I understand that the curve had shifted maybe a few weeks, maybe at most a month, but you did something to really ignite those case starts.

Can you just maybe comment further on that?

The first thing is the normal seasonality kind of play itself out.

The second thing is, some very clear refocusing and re-tasking of our field and channel marketing teams to ensure that we were putting the right focus back on practice expansion and new consults and taking full advantage of the strong demand from consumers.

And in many practices -- and the roughly 4,000 to 5,000 practices that had Patients First cases were affected, but virtually all of our customers were impacted by slower cycle times and backlogs.

So this effect of having people waiting on cases was a very broad effect for our entire customer base.

And even for some of our most loyal customers that had five volumes, they were just as impacted as everybody else.

So, in many of those practices they weren't pushing as hard to get new case starts.

And the reps -- the field teams weren't driving for that same goal.

That has been very clearly corrected and we have confidence that our efforts are paying off and will continue to pay off.

And then maybe just as a follow-up to that.

You mentioned that you're potentially as we speak back at the level which you had -- back on a normalized level, so to speak.

Is there a way you can quantify that metric, so to speak?

Anthony, we've chosen for many years not to talk about the front end of our pipeline in general because our revenue event and our financial event for the Company is when we ship a case.

That's what we base all of our data and historical comparisons on.

And what we are talking about in relative terms here for information, because it's important you understand what's going on in the business is what played out for receipts flow.

You could probably start to infer what some of the numbers might be, but the simple fact is we think the important thing to focus on is the case shipment activity.

And when it's appropriate, either for capacity or backlog reasons or for shortfall reasons as we just described, we will give you a general framework on the front end of the pipe.

Got it.

Okay.

And --

Thanks, Anthony.

Next question, please?

Mark Richter, Jefferies & Co.

This is Josh in for Mark.

Thanks for taking my question.

Just wondering for one, just if you could give us some color on how your international business escaped the seasonality in the quarter and [then the strength] there?

And then secondly, sort of to revisit the abnormal summer.

But are you seeing any further traction from products like Red, White and Blue or [Simplified] or any of the other alternative esthetic orthodontic appliances out there?

I'll answer the second part, then I'll ask Eldon to talk specifically on international.

We don't, we haven't and at this point we don't expect impact from system type products.

Again, yes, if there's a description here it would be slightly paranoid and very vigilant.

And maybe I'll ask Eldon to talk about international and what's going on there.

Yes, Josh, the point in terms of seasonality in Europe is seasonality takes place there because of the cultural holiday periods that take place in Europe.

I mean, and fundamentally we didn't see any other extraordinary events going on during that period.

So, you can kind of see that that business had a good third quarter.

They ran relatively flat with the second quarter.

But there is some seasonality that takes place there because of the shutdown.

And you see the business flatten out a little bit during the third quarter and then you see a little bit of a ripple on into the fourth.

But what happened there is what we expected to happen.

Operator, we'll take one last question, please.

Isaac Ro, Leerink Swann.

Thanks for taking the question.

Regarding Europe, just a couple of questions there.

First, I thought it was a bit of a sequential dip in the number of new docs trained.

Can I presume that was sort of -- can we presume that was really due to seasonality and people going on vacation, things like that?

Absolutely.

It's basically in Europe they're down for fundamentally a month depending on the country during the summer.

So we don't even attempt to hold as many events there as we would in the first, second, or even before the Christmas holidays, the fourth quarter.

Okay.

And then secondly, you mentioned kind of about 30 guys direct over there and maybe adding one or two.

Do you think that's the right number of people to have over in that market for the foreseeable future?

Or is that really just speaking to kind of the numbers you think you'll have for the rest of this year?

Well, we just commented on near-term this year.

We've continued to refocus our efforts on core Western Europe; really five countries.

And as we start to grow that -- as we have started to grow it more meaningfully, we are going to incrementally expand that coverage with that focus.

So as we get into 2008 and we lay out our whole year, to the extent we continue to expand that, we'll be laying out some framework for you to think about that.

But that's just describing what we expect in the coming couple of months.

Okay.

And then last question on the new Aligner system.

Are you able to characterize, would that be a higher or a lower price product?

Anything like that?

What I'd characterize it as is a terrific product line extension that's going to give our customers their practices, as well as the patients something they really want and need in a way that really scales well, at a price point that makes sense for everybody.

How's that for not answering your question?

That's fair enough.

Thanks.

Thank you everyone for joining us.

This concludes our conference call today.

We look forward to speaking to you again at our upcoming conferences including the JPMorgan Small Mid-cap Conference on November 6 and the Piper Jaffray conference on November 28.

As always, our conference presentations and breakouts are available via audio webcast on our website.

If you have any questions, please follow up with Investor Relations.

Thank you and have a great day.

Thank you.

Ladies and gentlemen, this concludes Align Technology's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.