愛齊科技 (ALGN) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Align Technology third-quarter 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; and Ken Arola, Vice President and CFO.

Before we begin, let me cover some housekeeping items.

We issued a press release today via Globe wire and First Call detailing Align's third quarter fiscal 2009 financial results.

The 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 5:30 P.M.

Eastern time through 5:30 P.M.

Eastern time on November 5.

To access a telephone replay, domestic callers should dial 877-660-6853 with account number 292 followed by #, and conference number 333971 followed by #.

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

As a reminder, the information that the presenters discuss today will include forward-looking statements including, without limitation, statements of Align's future events, product outlook and expected financial results for the fourth quarter of fiscal 2009.

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-Q for fiscal quarter ended June 30, 2009.

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've 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.

We have also posted a set of GAAP and non-GAAP historical financial statements, including the corresponding reconciliations, and our third quarter conference call slides on our website at investor.AlignTech.com, under quarterly results.

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.

On the call today I'll cover some highlights from our third quarter and briefly review the progress we've made towards achieving our strategic initiatives.

Ken will follow with additional detail on our third-quarter financials and outlook for the fourth quarter.

Then I'll come back with some closing comments and open the call up to your questions.

Overall, Q3 was a very good quarter with better-than-expected results across the board.

Q3 revenue increased to $79.3 million on record case shipments of 56,500 driven by growth in both the Ortho and GP channels in North America and continued adoption of Invisalign Teen worldwide.

On a non-GAAP basis gross margins were 76.8%, operating margin was 14.4% and EPS was $0.13 a share.

Our financial performance really highlights the operating leverage possible in this business when we drive sufficient volume into our more productive cost structure, and it reaffirms the tough actions we took over the last 12 months.

We continue to make progress in our strategy of driving adoption of Invisalign worldwide.

This includes initiatives to continue product innovation, enhance the customer experience, improve the effectiveness of consumer demand creation and extend international expansion.

Before I review each of these, let me briefly provide an update on two key adoption metrics we track, the number of new doctors trained and utilization rates, or what we call same-practice sales of our product.

During Q3 we trained a total of approximately 800 new doctors, down from Q2, given fewer training courses during the summer months due to holiday and vacation schedules along with continued conservatism on the part of GPs, who may be a bit hesitant to add new services.

Of those, approximately 500 doctors were trained in North America and 300 were new international doctors.

Our approach to new doctor education continues to evolve.

Our emphasis is on helping newly trained doctors integrate Invisalign into their practice more quickly and successfully in the weeks after training.

For example, our new CE 1 course now focuses primarily on Invisalign Assist, which is the only Invisalign product that includes built-in product support throughout treatment and was designed to meet general dentist demand for an instructive, integrated approach to case selection, monitoring and finishing.

We believe that our focus on Invisalign Assist gives new doctors the features, support and confidence they need to achieve success with Invisalign as they are building the experience with this new treatment modality.

Total utilization for Q3 increased sequentially and year-over-year to 3.1 cases per quarter.

In North America utilization rate for orthos increased about 5% from Q2 and approximately 2% from the same quarter last year.

For GPs utilization was also up about 5% from Q2 but decreased slightly from the same quarter last year.

Internationally, utilization rates in Q3 were down sequentially as expected, given the summer holiday schedule throughout much of Europe.

On a year-over-year basis, international utilization increased approximately 11%, consistent with strong growth in the same quarter last year.

Overall, Q3 volumes reflected good sequential growth for both North American orthos and GPs, particularly among lower-volume doctors, who have been a key focus of our proficiency requirements.

North American GP volume grew nicely this quarter, with the highest sequential growth since the second quarter of 2007.

Many of our GPs are beginning to reengage with Invisalign and have shown great progress and potential.

North American ortho volume also grew sequentially, and for the first time since Q1 2008 showed positive year-over-year growth as well.

Invisalign Teen is providing a real opportunity for us to reengage with orthos and is resulting in continued steady adoption.

The summer months are the busiest for North American orthos because a large portion of teenage and pediatric case starts occur between June and September.

Heading into this summer our goal was to compete and win a portion of those new case starts with Invisalign Teen, and we're pleased with the progress we've made.

Internationally, Q3 is a seasonally slower quarter, due primarily to summer holidays in Europe.

However, international volumes increased slightly from Q2, reflecting continued growth in Asia-Pacific.

On a year-over-year basis international grew 33% and made up 21% of total volume.

I will now move to an update on product innovation, starting with a brief review of the new and enhanced product features that we announced in Q3 for all Invisalign products.

The significant product improvements we rolled out for extrusions, rotations and root movement are designed to overcome barriers to utilization and deliver better results across a wider range of cases.

New aligner features along with significant clinical upgrades in our software and protocols incorporate best practices frequently requested by doctors.

We believe that all these improvements will give doctors greater confidence in what they can achieve with Invisalign and help deliver the outcomes they expect.

In Q3 total Teen case shipments increased 32% sequentially to 14% of worldwide volume, up from 11% in Q2.

In North America approximately 370 new orthos were trained on the Teen product during Q3, bringing the total to 2800 or roughly 80% of our routine Ortho customers in North America.

The number of first-time Teen users continues to increase steadily, and the repeat rate among doctors that tried Teen for the first time in the prior quarter increased to 76% in Q3, up from 74% in Q2.

Those adoption metrics are consistent with our view that orthos will steadily Invisalign Teen into their practice over time.

Internationally, approximately 235 new orthos completed the Team product training in Q3, for a total of about 1600 doctors trained.

We expect Teen uptake in international, especially in Europe, to be a bit slower as our consumer demand programs are not as broad in scale and scope as in North America.

In addition to Teen, we continue to make solid progress with other new products.

In Q3 total Invisalign Assist cases increased 25% sequentially to approximately 3% of volume.

In addition to the new enhancements for all Invisalign products announced in September, and additional features have been added or enhanced to Invisalign Assist, expanding its capabilities and giving doctors the confidence and control necessary to treat a wider range of patients.

While overall penetration of Invisalign Assist is still small, it's meaningful to us to help get new practices going and with new and enhanced features, Assist can be a big part of accelerating Invisalign integration utilization in a practice that is just getting started.

On the consumer marketing front we continue to be successful with programs that more effectively and efficiently generate demand or pull for Invisalign.

I'll highlight a few areas of interest from Q3 as well as our plans for Q4.

In conventional media we have become more efficient in our approach and have spent less money year-to-date while maintaining total overall lead generation.

You should see us on air in major markets across the country until the Thanksgiving holidays.

On the public relations front you've probably seen Invisalign in more print editorials and TV talk shows recently, which have generated great public awareness and complements our conventional media strategy.

In Q3 Invisalign Teen was prominently featured as part of a back-to-school media tour in 10 markets across the country.

And in Q4 we'll leverage the national orthodontic health month for both teen and adult-focused Invisalign editorial content.

In terms of event marketing, our goal is to be out there were teens work and play.

This summer was very busy for us as we took Invisalign Teen on the road to some of the hottest attractions for teens and their parents.

First, we hit the U.S.

Open of Surfing in Huntington Beach, which attracted 500,000 spectators and created over 37,000 brand impressions from our what makes you smile booth.

We also participated in the Portland, Salt Lake City and Orlando Dew Tour stops, which had over 150,000 combined attendees and created more than 21,000 brand impressions.

At every event local Invisalign-trained doctors were on hand to discuss the benefits of Invisalign Teen, offer discount coupons for treatment and generate leads.

In the fast emerging social network environment we continue to engage with the blogosphere and with specific social and working sites.

In Q3 Invisalign Teen hosted an exclusive regional mom blogger event in San Francisco, which was a big opportunity for us to highlight good clinical evidence and educate online communities about the benefits of Invisalign versus traditional treatment.

As a result, Invisalign is up to more than 1200 posts in the active mom blog network with 500 plus new posts in the last three months alone.

These mom blog hits have generated nearly 900,000 consumer impressions to date.

Looking ahead, you will continue to see Invisalign in digital and broadcast media, showing up in online communities in high-impact regional and national events as we look for more ways to position Invisalign as cool, innovative and effective, especially to teens and their parents.

In addition to these exciting events and activities, we are also working on another initiative that has high impact on consumers as well as our customers, the Invisalign brand itself.

Invisalign was launched commercially in 1999 and over the past 10 years our product brand has evolved significantly as we have continued to innovate and add new features and functionality to the Invisalign system.

Yet, many of our earlier branded marketing materials are still out there, invisible to consumers and customers.

In addition, the in-market use of Invisalign brand image has been inconsistent and, in some cases, modified or misused by well-meaning customers.

Over the past year we have conducted extensive brand research with customers and consumers to better understand what influences Invisalign adoption and utilization, including brand identity.

The research identified an opportunity for us to reposition Invisalign around its core value proposition.

With continued execution of our strategic initiatives and several new products in the market, now is the time to evolve the Invisalign brand image into a simpler, cleaner and more modern look and feel, one that visually appeals to consumers and doctors alike.

Over the coming months you will begin to see our new branding appear in marketing materials, advertising and customer collateral.

Now I'd like to spend a few moments on the updates we announced last month, the Invisalign proficiency requirements, which included a news designation for doctors who meet the annual requirements and an additional six-month qualification period in 2010.

The Invisalign proficiency requirements launched June 1 required every Invisalign provider in North America to achieve at least 10 shipped cases and 10 Invisalign-specific CE credits each calendar year to maintain active account status.

We know that a doctor's confidence and proficiency levels with Invisalign are a direct reflection of his or her case experience with Invisalign.

We want every Invisalign provider to be one we can comfortably direct a prospective patient to with an expectation of knowledgeable treatment and a great outcome.

To date, we are pleased with the effort many of our customers have taken to reengage with Invisalign.

Our Q3 results demonstrate real progress towards the proficiency goals, particularly for customers who have averaged less than 10 cases a year.

At AlignTechInstitute.com, where we have more than 250 hours of online instruction available at no cost to doctors, CE course completions are off the charts, indicating that customers are getting valuable training and want to reengage.

Case shipments from lower-volume doctors contributed nicely to our growth this quarter, and most importantly many of these practices are starting to see the positive effect of building their practices with Invisalign with new sources of revenue and a growing number of happy patients.

Doctors who meet or exceed the proficiency requirements by the end of 2009 will benefit from a new addition to Align's consumer marketing programs, one that encourages prospective patients to seek out Invisalign-preferred providers.

Starting in January 2010 a new preferred provider designation and in-practice signage will be awarded to doctors who meet the Invisalign proficiency requirements for 2009.

We will begin highlighting this designation on the Invisalign website and in consumer media and online ads.

The preferred provider designation will reflect the new Invisalign branding that I just described and clearly identify those doctors who have achieved the Invisalign proficiency requirements.

For doctors or practices who are unable to meet the proficiency requirements this year but have at least one case shipment and one CE hour, we are offering a one-time additional six-month qualification period that will enable them to secure their Invisalign provider status for 2010.

We believe that the additional qualification period will give doctors an opportunity to realize the full value of the recently announced product improvements and therefore gain greater confidence in Invisalign.

Align remains committed to the proficiency initiative and to helping doctors be successful with Invisalign, whether that means recognizing their achievements or giving them a little extra time to experience what new and improved Invisalign can do for their practices.

We are listening to our customers and know that many are working hard to reengage with Invisalign and reach the proficiency requirements.

Ultimately, we hope every customer achieve those goals.

Before I turn the call over to Ken, I would like to briefly comment on the settlement agreement we reached with Ormco Corporation during Q3.

We are pleased to have resolved the ongoing litigation with Ormco and are excited about the prospects for incremental growth that this new relationship offers.

Over the next seven years we will collaborate exclusively with Ormco to develop and market a combination orthodontic product that targets the millions of people with more severe malocclusion that won't accept or start treatment with wires and brackets alone.

Our goal is to tap into these unmet needs and get more people to say yes to orthodontic treatment.

It's too early to go into any specific details on what we are internally calling combo, but as we get closer to a commercial availability we'll talk more about the product and the opportunity.

Suffice it to say that we are pleased to be working with Ormco on a solution that will enable us to compete for a segment of the market that can enhance our penetration into the broader market world.

I will now turn the call over to Ken for more detail on our third-quarter financials and our outlook in Q4, and then I'll come back for a few closing remarks.

Thanks, Tom.

Now let's review our third-quarter financial results, beginning with the income statement.

Q3 revenue in shipments both grew sequentially and year-over-year, despite the summer months being a seasonally slower period for Align.

Q3 net revenue of $79.3 million and record case shipments of 56,500 increased 4% and 7%, respectively, for quarter two.

The sequential revenue growth reflects the overall increase in case volume, partially offset by an increase in deferred revenue associated with new products such as Teen and Assist.

The Q3 sequential growth in case volume was driven by North American GPs and orthos who are working hard to meet the proficiency requirements as well as continued progress with Invisalign Teen.

On a year-over-year basis growth was strong internationally with case volume up 33% and revenue up 22%.

The revenue growth rate reflects the unfavorable impact of foreign exchange rates as the dollar has strengthened against the euro from the same period last year.

Q3 revenue by channel consisted of 43% for North American GPs, 29% for North American orthos, 23% for international and 5% for non-case revenue, which includes the retainer business, training revenues and ancillary offerings.

Before I move on, I'd like to take a moment to discuss the Ormco settlement in which the Company issued 7.6 million shares and paid $13.1 million in cash to Danaher.

For accounting purposes the settlement was valued at $76.7 million, as the shares issued carried certain restrictions and thus a discounted value.

Of the $76.7 million, $69.7 million was recorded in quarter three operating expenses as a one-time settlement cost.

The remaining $7 million was characterized as a prepaid royalty to be expensed to cost of sales from the date of the settlement through the end of Ormco's 444 patent.

With that, let's move onto gross margin.

Q3 GAAP gross margin was 74.4% compared to 76% in quarter two and 75% in the same quarter last year and included $1.9 million for Ormco royalties.

Additionally, stock-based compensation expense was $359,000 in quarter three compared to $406,000 in quarter two and $437,000 in the same quarter last year.

Excluding Ormco royalties Q3 non-GAAP gross margin was a record 76.8%.

The increase in non-GAAP gross margin was driven primarily by the favorable impact from higher case volumes.

Q3 GAAP operating expenses were $119.2 million compared to $51.7 million in quarter two and $50.7 million in the same quarter last year and included $69.7 million for Ormco settlement costs.

It also included stock-based compensation expense of $3.6 million compared to $3.9 million in quarter two and $4 million in the same quarter last year.

Excluding the Ormco settlement costs, Q3 non-GAAP operating expenses were $49.5 million compared to $51.3 million in quarter two and $48.5 million in the same quarter last year.

The sequential decrease largely reflects the timing of several significant customer events.

In quarter two there were two events, the AAO Tradeshow and the European summit.

And in quarter three there was only one event, the North American GP Summit.

Q3 GAAP operating income was a loss of $60.2 million compared to income of $6.3 million in quarter two and $5.7 million in the same quarter last year.

Excluding the Ormco settlement cost and royalties, Q3 non-GAAP operating income was $11.4 million or 14.4% compared to $6.7 million or 8.7% in quarter two and $7.9 million or 10.5% in the same quarter last year.

On a year-over-year basis, Q3 non-GAAP operating income increased 44.5% or 390 basis points, reflecting top-line growth combined with improving operating efficiencies and our continued focus on expense management.

Q3 GAAP EPS was a loss of $0.72 and included Ormco settlement costs and royalties of $0.85 per share.

This is compared to GAAP EPS of $0.07 in quarter two and $0.08 in the same quarter last year.

Excluding Ormco litigation and settlement costs and royalties, Q3 non-GAAP EPS was $0.13 compared to $0.07 in quarter two and $0.11 in the same quarter last year.

Shares used to calculate the GAAP and non-GAAP EPS included a weighted average of the 7.6 million shares issued to Danaher during quarter three.

This is due to the timing of the share issuances during the quarter.

The full weighting of these shares will be reflected in quarter four.

Now let's move on to the balance sheet.

Cash, cash equivalents and short-term marketable securities after the $13.1 million cash payment as part of the Ormco settlement were $154.9 million.

This is compared to $110.2 million at the end of 2008.

In quarter three we generated roughly $10.8 million in cash from operations compared to $18.5 million in quarter two and $17.4 million in the same quarter last year.

Q3 DSO's were 63 days compared to 63 days in quarter two and 59 days in the same quarter last year.

In Q3 deferred revenue on the balance sheet increased by $4.8 million or 20.7% sequentially to $27.9 million.

This increase primarily represents the revenue deferrals associated with new products such as Invisalign Teen and Assist.

Now let me turn to our outlook for the fourth quarter of fiscal 2009.

For Q4 we expect revenues to be in a range of $77.5 million to $81 million on case volume of 57,000 to 59,000 cases.

This summer is typically the busiest time for ortho practices that have a high percentage of adolescent and teen patients.

This past summer was the first full summer we were able to actively compete for some of these teenage starts, and we are pleased with the progress we've made with teen growth, generating 14% of our worldwide volume in quarter three.

With the summer rush ending in September, teenage orthodontic case starts are typically flat to down in quarter four, in line with historical orthodontic trends.

While we are pleased with the continued progress of Invisalign Teen and expect to compete for a greater share of chair over time, in Q4 we are anticipating less teen growth due to these seasonal trends.

Also, as new products like Teen increase, a greater amount of revenue will be deferred to the balance sheet, which will have an impact on revenue and gross margins.

As we have mentioned earlier, during quarter three we saw growth from both North American orthos and GPs, particularly among the low-volume doctors who have been a key focus of our proficiency requirements.

While we are pleased with this progress, it's unclear whether these low-volume doctors will maintain the same pace in the near-term, given the recently announced six-month qualification period.

We expect Q4 international volumes to grow sequentially as Europe comes off a seasonally slower summer period.

We expect Q4 GAAP gross margin to be in a range of 71.1% to 71.8% and include approximately $3.8 million for Ormco royalty expense.

Q4 non-GAAP gross margin excluding Ormco royalty expense is expected to be in a range of 76% to 76.5%, slightly down from quarter three, reflecting a higher level of deferrals, discounts and rebates.

In quarter four we expect GAAP operating expenses to be in a range of $49 million to $50 million.

On a sequential basis our continued investments in geographic expansion and media advertising will be offset by a decrease in Ormco litigation costs.

In quarter four we expect GAAP operating margin to be in a range of 7.9% to 10.1% and GAAP EPS to be in a range of $0.07 to $0.09.

Excluding the Ormco royalty cost of approximately $3.8 million in cost of sales, we expect non-GAAP operating margins to be in a range of 12.8% to 14.8% and non-GAAP earnings per share to be in a range of $0.08 to $0.10., In quarter four we expect the GAAP effective tax rate to be in a range of approximately 10% to 12% and the non-GAAP effective tax rate to be in a range of 33% to 36%.

We expect diluted shares outstanding for quarter four to be approximately 76 million shares.

This includes the full weighting of the 7.6 million shares issued for the settlement with Ormco.

From a balance sheet perspective cash on hand at the end of quarter four is expected to be approximately $170 million to $175 million, and DSO is expected to remain in the mid-60s.

Now I'll turn the call back to Tom for some closing comments.

In summary, I'm pleased with the progress we've made this quarter, particularly with lower-volume doctors in North America.

Our results demonstrate continued execution of our strategy as well as our under-penetrated position in that very large market we play in.

The actions we took last year to lower our cost base are enabling us to continue investing in our key strategic initiatives while driving overall profitability.

We look forward to updating you on our continued progress on the next earnings call.

And with that, let's go to the operator for some questions.

(Operator instructions) Tao Levy, Deutsche Bank.

Where do I start?

So many questions -- very strong quarter.

And obviously, it seems like Teen is off to a very strong start.

Your kind of tepid outlook for Q4, even though I think it's sequentially up -- is that around more the Teen adoption following the Q3 results, or is it on the GP side?

Well, I think there's a couple things.

I think Ken highlighted very well the normal seasonality around Teen.

We were able to compete for it, got a little bit more.

And we are pleased with that.

But historically, if you look at the ortho starts, they are lumped, you know, 40%-plus of them occur in those months.

So we expect a little less upside there.

In general, we see the business solid going forward but without some of that uplift we had in Q3 from that seasonality.

If you look in the quarter, what's also a little bit surprising is to see some of the other products hold steady as a percent, especially Invisalign Express, at about 15% of the cases.

What's driving the growth with the Express product?

I would have thought that would have tapered down a bit.

I think we spoke about this a couple calls ago, when the mix for Express was moving around a little bit, that our customers are working harder to get patients to start the case.

They come in, they want a better smile.

And they are presenting them with a full range of alternatives.

In some cases patients are electing not to undergo full comprehensive treatment but to work more on the anterior smile.

And I think that continues.

That underscores products like Express hanging in there pretty well.

And last question on the operating expense side, obviously you are showing very good discipline over there.

And even in your guidance you are looking for things to stay sequentially flat there.

Is that a set budget, so you said kind of like now or at the beginning of the quarter and you kind of stick to it?

There isn't too much flexibility?

And then, heading -- I know you're not going to give 2010 guidance.

But heading into next year, is this the operating margin structure that we should be thinking about for Align?

At this point in quarter four, we basically are now attaining the cost savings from the restructurings we did a year or so ago with the structural moves that we've made.

So that's basically what we are looking at four quarter four on an operating expense basis.

And as I think about things going forward, one of the things you've got to remember is that we have some lumpiness in our operating expenses on a quarter-by-quarter basis, based on significant events and trade shows that go on.

And we're also going to look at continuing investing in our strategic initiatives as we go forward and get the leverage out of those.

But we are forming our view of next year right now, going through our budgeting cycles.

And we are going to be prepared to share that with you in our January call for our quarter one guidance.

But I will say that we have achieved the cost savings we were anticipating, and that's built into our base of operating expenses in quarter four.

And obviously, we've had nominal legal expenses in quarter four related to Ormco, just winding things down.

Taylor Harris, JP Morgan Chase.

Tom, wondering if you could just start by talking to us about why exactly you decided to extend the proficiency program.

Sure.

Well, first of all, we see a lot of our customers really making great effort to try and make it.

And some of those customers that were in a one-to-four, one-to-six range were coming off of very low activity in practice to try to market Invisalign, to stay current with Invisalign, hadn't been to summits were workshops or provider training study clubs, things like that.

And so literally, after we got through the first maybe month or two of rollout, a lot of them had to make choices about whether they were going to try and put some effort in or not.

We saw a lot of people with our reps really engaged in those lower-volume customers.

As I said, the amount of activity, fortunately very scalable activity, for podcasts and the CE training on Align tech Institute pointed us towards they are really making efforts; on top of that, that they were working very hard with the reps to do practice building sorts of things.

So, with that in hand, we started coming to the view, after listening to a lot of them that if we gave them a bit more runway with that effort, they could definitely get there.

It's hard to go from one or two cases a year, where the hygiene staff in the office isn't really oriented to it, to where they are having those routine discussions.

And so what we wanted to do was, having gotten them started, we wanted to give those practices that were really making that commitment a realistic chance of maintaining their active status, and then push it over the line by next June.

That's the rationale.

And you did point out that you are certainly seeing an uptick in some of these low-volume GPs trying to make the cut.

Any way you can quantify what that impact was for us, here in the third quarter?

So I think Ken described and I described both in qualitative terms, not quantitative terms -- so we'll leave it there -- that we had a broad positive response from low-volume orthos and low-volume GPs across the board.

Again, the leading indicators we talked about originally started with engagement with our sales force and clinical team starting to get the education and then starting to do the practice-building things that would lead them to be comfortable with the product.

And at the same time, again, we rolled out the whole 1.5.

There's a whole big evolution, and this is a different Invisalign to work with.

So with that additional fact, we thought give them a little more time.

And we see them responding up and down the line.

So can you characterize for us what your expectations are, because this is important for us as we think about 2010 with how different groups of doctors are responding or will respond to the program.

You've broken it down into the super low-volume guys in the past, the mid-range, some of the people doing seven to nine.

Can you give us your latest thoughts on what those different groups of doctors are doing or, you think, are going to do?

Well, let me frame it this way.

We have not given any quantitative view of what's going on inside of those maybe large buckets, but we've had a very good response from -- I think the numbers were one to four and then five key to seven and eight to 10, in round numbers, were the groups of customers.

We've had a very positive response from the low-volume and the medium-volume, and the higher-volume docs are kind of just cranking along.

At any point in time, they can get over that 10 pretty easily with a little more effort.

So, again, we are still early in this process, especially by moving this out to June 30 of next year.

Our goal is to bring all these customers along with us and reintroduce them to the new Invisalign and the new features and the new capabilities and help them flourish in practice.

So we are working on that.

It's an everyday job, but I think we are getting good response from the lower volume and medium volume customers, in general.

I want to make sure I understood your comments on Teen.

Are you saying Teen is -- there are going to be fewer Teen cases in the quarter or the rate of growth is going to slow?

And then what percentage of those Teen cases do you think are actually adults?

So those are a couple of different questions.

The first part of your question, I think, has gone to our framework for describing summer seasonality relative to our expectations for Teen in Q4.

And then the second part, I believe, of your question had to do with a percentage of adults and teens.

I take the first one and just say simply, it's just a fact of the timing that a large portion of the annual orthodontic starts for pediatric and adolescent cases occur between June and September, just about the time they are getting out of school and just about the time where they go back to school.

And so I've seen numbers, 40%-plus of all the orthodontic starts occurred during those months.

So what we were describing is, as we never got to compete for those, really, before.

Now that we get to compete for them, now that that summer rush is over, we expect less of that upside potential, just because the normal volume of starts is back on.

That's the fact, and we haven't been at this long enough with Teen to have what I would call a good baseline for comparison.

This is the first full year that we've been able to compete for the summer months, and I think we are still a bit under-penetrated.

But in general I think we'll probably start to follow, over time, the general trend in the orthodontic starts in that community.

Does that make sense?

I'll stop there for a second.

Right, that makes sense, but you are still so early in the ramp of Teen -- as part of your guidance for the fourth quarter, are you assuming a higher number of Teen cases?

Well, what I would say is, the first part is absolutely true; we are under-penetrated in general, and we are under-penetrated in Teen.

All I'm describing is, it's a fact that the bulk of teen cases start in the summer months.

So there are still other starts that occur later in the year and in first and second quarter, but it's just a seasonality effect that we are describing.

So, by definition, it feels like it has -- there's a little less upside in that teen effect.

Nothing else going on besides that.

So the second part of your question had to do with percentage of adults and teens.

And I don't honestly have the numbers in front of me, and I don't think we've talked about them at a quantitative level.

One of the things we expect to see, with some doctors were accusing Teen on adults because of features -- either compliance indicator or lingual root torque or other kinds of movements they wanted to do.

Now that we've rolled those features on broadly for all of the Invisalign products, we are going to have to have probably a couple of quarters to see how that all sorts out.

We might, in fact, see them not use Teen for an adult where they would have.

But again, we are early in Teen.

We are very early in the rollout of 1.5, which has spread those features over Full and Express and everything else.

And so I guess we expect to see some movement there over the coming few quarters.

Matt Dolan, Roth Capital.

Tom, maybe a follow-up on the proficiency program and just thinking about next year.

The broader question is, are you expecting this to be negative, neutral or positive to the overall trajectory of the business?

I'm assuming not negative at this stage, given your feedback.

And then, maybe the second part of that question, going over to Ken.

As the utilization rate should go up under a proficiency program, how should we be thinking about pricing and high-volume discounting and, therefore, gross margin, as the program starts to take effect, on your actual numbers?

I'll start and then let Ken figure out how he can answer the second question without guidance.

But the first part is, we aren't far enough into finishing our planning for 2010 to look at all the factors that would contribute 2010 numbers, proficiency being one of them.

Let me point back to when we rolled this out June 1, we described that we didn't think it would have a material impact on our business this year.

So, while it's too early for me to talk specifically about 2010, if we were to isolate proficiency as a bit of a journey here to really engage customers so that they and their practice and their patients get maximum positive impact, then we believe there is a way to do that with minimizing the churn for the business as customers select in and select out.

I would expect, in general, as an isolated action that, likely to be a case in 2010, but there's other factors in terms of other timing of product rollouts and other kinds of things that are both positive and negative effects.

Again, it's too early to talk about that.

In general, we think proficiency covers itself as a tactical plan but as a long-term strategic program that makes sense.

I'll hand Ken the second part and see if he can impact the pricing issue relative to tighter, more engaged base.

Right now, our advantage rebate program really addresses doctors that are doing more than 12 cases a quarter right now.

So at this point, we are anticipating that we are going to keep the rebate program in place as it stands.

We'll actually evaluate those rebate programs every year going into the year, so I wouldn't anticipate any significant changes, at least at this point in time; but if there is, we'll let you know about that.

As far as programs that doctors participate, for example, the teen discount programs, or Assist programs, we evaluate those every quarter and determine whether we want to continue running those programs or not.

And we'll continue to do that as we go through the first part of next year on a quarter-by-quarter basis.

So at this point all we can really tell you is you can kind of assume the same modeling as far as the way that's going to apply to the customer base.

Now, when you get to a smaller base, I think that's where we'll have to take, potentially, a different look at this.

Okay, that's great, thank you.

Can I maybe come back and build on what Ken just said?

I'm thinking, between the last question and this one, because you are going after elements that are part of our overall guidance.

And while we really aren't ready to talk about guidance, you're going after pieces of it.

I don't want to sound wishy-washy about our next year.

We just aren't there yet.

What I'd say at a high-level without giving guidance is, we think the economy continues kind of like it is, maybe a little better, maybe a little worse.

We believe we have an opportunity to build the business through this, but we're just not ready to talk about it.

So if we sound wishy-washy, it's only because you're going after elements of it, and it's hard for us to answer that without giving a broader framework on guidance.

Is that fair?

That's fair.

I'll skip the other question I was going to ask relative to that and just move to maybe your general thoughts on where we are, not maybe in terms of the general economy but relative to the Invisalign business, finally seeing year-over-year and sequential growth in Q3.

You've characterized the business as kind of a 15% to 20% grower over a long period of time.

Are we starting to kind of come out of what you'd call the trough, looking back now?

Maybe I'll take a shot, and Ken can add.

What I'd say is there was great uncertainty early in the year about how bad bad would be, and we've had -- and we took actions early to make sure we had the flexibility to survive really bad and, hopefully, that we called it right and we could continue to invest in the strategic priorities.

Having those strategic priorities come online for us in a series of new projects and key initiatives is starting to give us operating leverage in our cost structure, and -- as Ken described -- and, you are seeing impact from new products like Teen now, a full year in with 1.5, and more to come.

And in the meantime, we are funding future growth streams in places like China and other geographies, buttressing our growth in Europe.

So if I had to step back, I'd say we believe that if the economy stays like it is, we are prepared to go build the business into that.

And at the same token, if things got better we could maybe do a little better.

If things got worse, we could have some flexibility.

Maybe that's where I'll leave it.

Jonathan Block, SunTrust Robinson Humphrey.

Maybe just the first question.

I think you guys gave us a lot of color on some of the marketing initiatives around Teen.

I'm just wondering if you can give us a feel for maybe in terms of the amount, in other words, in dollars or percentages of what amount of your awareness spend, if you would, is specific to the Teen product now, with about 15% of your volumes.

Sure.

Without giving exact numbers, because we've given directional guidance on total spend, which you can see in the marketing line, we really haven't broken out details in consumer spend.

But in general, we are spending most of our PR effort and engaging in social networks and blogosphere, etc., on Teen.

We are spending -- most of our creative is in conventional media, TV, etc., is still structured around the normal Invisalign a dull, although we are putting tag lines on it, look for Teen.

Starting late this year or early next year, when we roll out, we expect some evolution to that.

And you'll see more of a shift for our conventional media to support the Teen message.

But as we stand here today, most conventional media is still -- the creative still supports the core Invisalign product.

I don't want to continue harping on the proficiency program.

Obviously, the numbers were more than there.

But just wondering, the original proficiency program like you guys laid out, it seemed like it was acting as a good initiative for the lower-volume docs.

You said it engaged some of them and got them online.

Then you went ahead and you altered it a little bit; I think it was the first week of October.

So can you share with us maybe some feedback or what you've seen?

Is it even further engaging some of the really low-volume guys that just said, you know what, under the original there was no way I was going to get there.

Now I see the Company is willing to work with me, and I'm on board.

You know, it's exactly that.

We listen to our sales force.

We listen to our customers.

We had a lot of people starting from basically a standing stop to say, how do I get going?

I would like to continue this; what do I need to do?

And literally, we've got roughly 140-150 reps out there calling on thousands of customers that are now making legitimate effort.

We legitimately want to give them a shot to get at it.

They got the CE credits in.

They are coming to study clubs.

They are investing efforts.

Their hygiene staff is starting to talk about the value that -- the health impacts of a better smile.

But it takes time when there's no effort in practice to get that rolled up.

So we're pleased to see that level of effort in so many customers.

And again, I think the way we've described it in the past is the metrics were positive, CE credits being used, people attending events, effort in practices reported by reps, and all these activities on a weekly basis.

And seeing that kind of groundswell, we thought, well, there are some people that have busted their tails and have now made it.

Are they going to be disappointed, now that we are giving more room?

The answer is, look, we are about doing the right thing for our customers and their patients.

And if we can bring everybody along and they need a little more time and they are making legitimate efforts, we are willing to do that.

And that's really what this is about, is just listening to a lot of our customers and wanting to help them get going.

And in parallel, it's in a time when the average dental visit is spending less money and in there for more basic services, it's awfully nice for some of these offices to start adding revenue and getting really happy patients.

And that kind of reaffirms their decision, then, to put the effort in.

So, again, we are heading in the right direction.

We've got two or three more quarters to go in this whole thing, but I believe it's in the direction of goodness.

Maybe just some housekeeping.

In terms of DSO's, do you expect that to stay at this low to mid 60s, even with international ramping?

And then also when do we start to really pull down on the deferred revenues from Teen?

Is that something where you see it in the beginning of 2010?

Are these kids losing those extra aligners, or do you have to wait for case completion in order to recognize the revenue?

So DSO's -- I would anticipate that those will still continue to run around the mid-60s, where they've been.

We have completed our transition down to Costa Rica with the credit and AR team, and they've done a very good job of getting up to speed to maintain those DSO's.

So even with the growth internationally, we have some different terms internationally on payment structure than we do in the US, so we should be able to maintain it in those kind of ranges on a go-forward basis, which I'm very pleased about because, when you make a big transition like that with a credit group, you worry a little bit about those things.

But we had a good team transition, and everybody pulled together to make that happen effectively.

As far as Teen deferrals, with the replacement liners, we'll start recognizing that when the case is complete, since they are not using them.

We have to actually have about two years of experience before we can actually change our accounting methodology on that where we can recognize a portion of those retainers, if the teens aren't using them on a historical basis.

And we can demonstrate that.

So with the Teen product, for example, when we ship it, typically it will complete in case, call it about a year out.

And then somewhere between a year and probably add another six months to that is when you start recognizing the revenue for the Teen deferrals.

So if you think about when we started shipping Teen, last summer was the first commercial shipment.

We are starting to get some of those cases completed, so we are getting a little bit of take-back of revenues into the P&L, very nominal at this point in time.

That will start picking up into 2010 and into 2011.

Ben Forrest, Summer Street Research.

I was wondering, when you cut off low-volume centers, in some way you open up the door for competitive products to come in, whether it's slightly different product or maybe a slightly less expensive product.

Wondering anything you are doing to manage that in terms of new competitors.

Well, it's a great question, and I'm glad we've answered your other questions, Ben.

The simple fact is we are certainly aware of our competitive environment, and we've had competitors in clear aligners for a long time -- Ormco, Red White and Blue or Simply Five.

There's others, and certainly there's others out there.

And at some level, while we are mindful of the fact that they may be able to pick up customers that don't want to do more than one or two a year, what we have to be most concerned about is that the practice is ultimately successful with a product that is continuing to evolve, and 1.5 is a great example of that rollout.

It is a very significant change in software, in protocols and application of technology.

And if the practice isn't putting in some modicum of effort into staying up with it, and it's going to be hard for them to use the technology, deliver best results, be satisfied in their own right with having it in there as a service in their practice and then, secondarily, having patients be thrilled.

So while we know going in, eyes wide open, that making this choice -- and if we have to say goodbye to some customers, we hate doing that.

But what we are -- at the same token, we are making every effort to try and bring everybody along.

Now, we know not everybody will make the journey.

And they are -- look, A, we are not trying to tell them how to practice dentistry.

And, B, we want to make ourselves the best choice.

So the last thing we want to do is drive someone off.

But if, in fact, they choose to do something different, that is completely within their rights.

And we are going to do the best we can to compete for every one of those practices and have people asking for Invisalign.

(Operator instructions) Derek Leckow, Barrington Research.

On the new product enhancements and the training that you guys have been engaged in with doctors, to what extent do you think that may have led to a bit of pent-up demand or delay of case starts over the past couple of months here?

It's a good question.

Sometimes in medical technology, if people see something coming, they do change.

In this case, we think we surprised them with 1.5.

Certainly, we have been giving them a pretty steady diet of evolution and improvement.

There's several things going on at once.

What I'd say is, if there's an effect here, it would be very small but very positive.

And let me just tell you what I mean by that.

In the case of Invisalign Assist, our prior Assist product, which we featured in our new doctor training for GPs, it was very limited.

It was limited to how complex of a case and how exactly it could be used.

Now, with 1.5 evolution, all the features and technology available in Invisalign Full can be used for Assist.

It's just, the way it's structured, we try very hard to help new customers just use Assist for their first five or 10 cases because there's a lot of iterations for them and us to work together so they develop the experience and confidence.

After they've got about 10 cases in, they pretty much have explored all the software and a kind of a typology of cases.

So if there's an upside because of the change, it's because the expansion applicability in 1.5 hit Assist.

But that's a pretty small slice of our business, A.

And then, B, they didn't know it was coming.

So it wouldn't have been pent-up demand as much as it would have been that we've seen those new doctors now -- I think I can say it's about putting numbers on it -- coming out of those new certifications or those new Clear Essentials 1 trainings, using more Assist and getting started faster.

So that's a positive effect.

It's a small, but it's a positive effect.

Well, I guess essentially what I think I'm seeing here is that your addressable market for these products -- and I'm just going to address some of these more complicated, technique-sensitive cases -- wouldn't you agree that that increases the market size that you guys can address right now?

Absolutely.

Our strategy, as we've talked about it before, it rests on four pillars.

And product innovation, what we talk about is creating greater predictability and wider applicability.

Wider applicability goes to how complex the case mix we can go after.

And of course, our view differs from the most conservative clinician.

But again, part of our work here is to create clinical evidence and proof and explain the technology.

The second part is predictability, so that when, on a more difficult rotation or a movement, if the doctor could be more sure that movement will express as they've planned -- and that goes to the evolved techniques for placement and use of attachments, certain kinds of rotation approaches, the materials themselves -- if those movements are more predictable, they happen on time, then ultimately the case progresses very smoothly.

And that's really a lot of what 1.5 and what will follow is about.

That predictability is visible and easy to see from the beginning of the case on.

And then, secondly, we are able to address a larger slice of patients.

But again, orthodontics is a bit conservative.

They've got to see it for themselves, and they are less swayed by what they read or a clinical study.

They are more swayed by personal experience and say, boy, that case went really well.

So, again, there's a slow, steady adoption.

And we are perfectly happy on a wide base of getting that effect.

If the economy stays where it is, let's say, it seems to me that these utilization rates that we are seeing and the pace of 3.1 -- that's pretty much a low-water mark at this point in time, wouldn't you agree?

And so we should probably look at that as being somewhat easy to improve as more of these cases start to come through and come through with good results.

Do you think you can get up in the five's kind of category?

I'm going to react to your word easy, yes, piece of cake.

You've been banging -- I know you've been out seeing investors in the dental space.

It's a large, fragmented base of customers that have very strong views about how they want to practice and what they want to do.

Our job is to become one of their best choices and then make sure we've got a set of tools and products that they want to use everyday.

And that's a long-term journey.

So what I'd say, in the near-term, just looking at that average number, there's going to be denominator effects and numerator effects.

I'm going to remind you of that, especially as we work through proficiency.

And we've got some moving elements in our customer base.

So what I would say is we will try to give you enough visibility inside orthodontic groups and GP groups so you can unpack that.

But I would expect a little bit of volatility in the average utilization number.

Over time, we believe having a more engaged, committed base of customers and evolving product line is going to do nothing but make utilization go up.

That's one of our core strategies.

Great.

Congratulations and thanks a lot.

Jose Haresco, Brean Murray.

Good afternoon, guys, and congratulations on a great quarter.

When you think about the utilization rates in the summer months, as you know already, they are remarkably stable.

Can you guys tease out at all how much of that was caused by some of these outreach programs that you guys had going, Invisalign Teen or a more generally positive outlook on the part of new users?

It's interesting when you talk about more positive outlook from our customers.

We do know that the doctors are still being shopped around out there and they are still having to work hard to sell their cases, both on the GP site as well as on the ortho side.

And you've seen orthos be pretty successful at that.

The utilization rates over the summer months -- I think you had a couple of things happening here.

One, it was our first full participation during the summer with Teen and we saw nice sequential growth with the Teen product, which certainly helped on orthodontic utilization rates here from a quarter-over-quarter basis.

And as you mentioned on the call, on the GP side of it, it's a broad base of GPs.

And when you have such a broad base of doctors doing a few cases here and there and they do a few extra during the quarter, it has some upward pressure on your utilization rates.

And that's what we saw during the summer months here as doctors were trying to strive towards the proficiency program.

So the other thing is, we do have some discount programs out there that they are taking advantage of and doing more cases and particularly with Teen and Assist, as doctors are coming out of training classes and doing their first 10 cases or so.

So I think that has more of an impact from my perspective than just general economic trends.

It's hard for us to calibrate that, but we do know, again, that doctors are still getting shopped around and having to work hard.

Ken, another follow-up question for you on the gross margin side.

You mentioned that in Q4 we have started to recognize some of those improvements that you did over the last year.

Over the long run, talking like two or three years out, what more can be done, if anything, to improve those?

And over what time frame would we expect to see those changes, if any?

We still think we have more room to improve our gross margins.

We have done an awful lot of automation in the factory, but there's still more that we can do over time.

And each year we are looking at those.

For example, right now we're looking at what we can do as far as 2010 with our annual planning cycle that we are starting.

So how we can drive additional efficiencies by handling operations either differently or different types of automation in the process.

And I think, if you look back to historically, you've seen the Company has done a superb job at that and improving gross margins up to where they are today, from the mid-60s of several years ago.

But each year the guys in operations are looking real hard at that.

And they'll find $500,000 here and $500,000 there, where they can make improvements or they can make structural changes, like we have over the past year or two, in moving more of the cost structure down to Juarez, Mexico.

If I can add to that, this is not just being looked at as a costing.

Sometimes a performance improvement in product, we've pulled that all the way through.

It also gives us opportunities to design it in a way that gives us margin improvement, so that we get an evolution that's positive for our customer and a way to simplify a set of processes either in Juarez or Costa Rica.

So we try to look at that as a system, not just as grinding cost out.

Just a housekeeping -- Tom, you mentioned -- we've talked about how 40% of the case volumes for teenagers tend to happen over the summer months.

Could you put that into a hard number for us so we all have the same base?

Is that 400,000, 300,000 kids, on average, in the US?

So I've seen numbers ranging -- I don't have the numbers at my hand -- that the American Association of Orthodontists has put out and the AJO has put out broad descriptions of what the flow of case starts looked like.

Since we aren't the market, we have a slice of the market, the big players talk about this more extensively than we do.

If we can find something, we'll get our hands on it and send you a copy.

But in general, the trend they talk about in orthodontics for starts is for adolescent and pediatric cases, the rush is June to September.

And that's some number around 40% of the total annual starts they do are in those three months or so.

But again, if we can find a couple of references for you, we'll shoot them to you.

I think the AJO has done this, and I think the AAO has had some data out there.

Last question, on the international front.

How should we think about you guys prioritizing all the different regions?

And could you just walk us through what those distribution models are going to look like in the various areas?

Sure.

We are pretty much -- we've been pretty transparent about what our priorities are, going back to our investor day a year or two ago.

And simply stated, Europe -- we continue to make investments to grow and extend in Europe.

I think Gil Laks and our team have continued to invest in further localization of the model, while we've gotten some leverage of that, and they continue to drive growth in the four or five major Western European countries -- UK, Italy, Germany, France and Spain.

And -- generally in that order.

And then and Asia-Pacific, I think, as Ken talked about on the volume side, we have a distribution partner over there covering many of the important but smaller country markets, doing a very good job of driving volume growth.

Again, it's not as big a business and we -- certainly, they get a piece of that revenue so you don't see as much of it on the top line, but very important to us.

They continue to build that out.

We reserve (technical difficulty) -- excuse me.

We prioritize several large country markets like Japan, like China and South Korea as markets we would reserve to direct support ourselves.

We are making investments in China.

We are in Japan and considering scaling.

And then in Latin America, the same way.

It's a smaller market.

We have a distribution partner down there.

And over time, we'll find distribution alternatives for, again, smaller but still attractive individual country markets in Europe, Middle East and Africa.

But again, the major direct footprints are North America and then four or five key countries in Europe.

There are no further questions in the queue at this time.

I would now like to turn the floor back over to management for closing remarks.

Well, thank you, everyone, for joining us this afternoon.

This concludes our third quarter conference call.

If you have any further questions, please contact Align investor relations.

Thank you.

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

You may disconnect your lines at this time.

Thank you for your participation.