愛齊科技 (ALGN) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Align Technology third quarter earnings 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 and Corporate Communications.

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 our third quarter fiscal 2010 financial results press release today via global news wire and first call which is available on our website at investor.aligntech.com.

Today's conference call is being audio web cast and will be archived on our website for approximately 12 months.

A telephone replay will be

available today by approximately 5.30 PM eastern time through 5.30 PM Eastern time on November fourth.

To access the telephone replay, domestic callers should dial 877-660-6853 with account number 292 followed by pound and conference number 358000 followed by pound.

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 about Align's future events, product outlook and expected financial results for the fourth quarter of fiscal 2010.

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 the fiscal quarter ended June 30th.

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

Please also note, that this conference call 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 are 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 been 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 reconciliation and our third quarter conference call with slides on our website under quarterly results.

Please refer to these files for more detailed information.

With that I would like to turn the call over to Align Technology's President and CEO, Tom Prescott, Tom.

Thank you, Shirley.

On the call today, I will cover some highlights from the third quarter and provide an update in our strategic initiatives.

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

I will come back with closing comments and open the call up to your questions.

Q3 was a good quarter for Align with revenues, gross margin, operating margin, and EPS all above our outlook for the quarter.

Q3 key shipments were within our guidance, but the lower end of the range, reflecting growth from the North American Orthodontist and the international doctors, offset by greater than expected summer seasonality.

This softness has persisted into the fall, especially among our North American GP customers who have reported lower dental visit and reduced demand nor premium procedures, which we believe is due to lower than expected case submissions for Invisalign as well.

It also appears the elimination of the case requirements announced in Q2 contributed to lower case submissions among some customers.

In hindsight, the stronger than expected results we saw in Q2 across our customer channels, including low volume GP's, masked the slow down among those practices that were striving to reach 10 cases per year.

We were probably too quick to believe the proficiency program was completely behind us.

It now appears that the potential impact initially described on the Q1 call in April regarding our uncertainty of how customers might respond to the elimination of case requirements, has taken longer to play out.

Having said this, we continue to see interest from many GP's who want to make Invisalign a bigger part of their practices as well as other GP's who want to add Invisalign to practice.

We will continue to work to expand the GP customer base.

As we discussed previously, our strategic focus is in driving adoption of midline into adopting practices, while expanding our customer base in North America and internationally.

Let's review the key metrics that measure our performance.

Utilization rates are what we call same-practice sales of our product and a number of new doctors trained.

In Q3 total utilization decreased slightly on a sequential basis and increased year over year to 3.6 cases per quarter.

This reflects a decrease of 1% sequentially, and increase of 18% from Q3 a year ago.

By customer channel, Q3 utilization was unchanged for North American Orthodontist International Doctors at 5.8 and 3.8 cases respectively.

North American ortho utilization remains solid, but many practices have indicated they are working harder to get business and close cases.

North American GP dentist utilization decreased sequentially from 2.8 to 2.7 cases per GP, reflecting less usage across most levels or tiers, as compared to Q2.

In addition, there are fewer low-volume GP's in Q3 than the prior quarter.

On a year over year basis, doctor utilization of Invisalign increased across all customer channels, up 18% for orthos, up 16% for GP's and up 9% for international doctors, reflecting continued adoption of Invisalign into practice.

During Q3, we trained 825 new doctors, down from 960 in Q2, given the fewer number of training courses offered during the summer months.

Of those trained, 550 were North American doctors and 275 were international doctors.

I will shift now to our strategic initiatives and remind you our strategy has a series of key initiatives we typically discuss each quarter.

The first is to accelerate product in clinical innovation, which includes new products and significant evolution in features and functionality, such as the recently launched Invisalign G3.

Second, continually working to enhance the customer experience which we typically address through evolutions in those customer phasing systems.

Third, increasing the effectiveness of our consumer demand creation process and extending brand awareness.

And finally, continuing to drive international growth principally in Europe, while opening up additional new markets around the world such as China.

To start with product and clinical innovation, I will provide a brief update on the overall teenage orthodontic market segment and our Invisalign Teen product.

We are pleased with our continued progress in the overall teenage segment.

In Q3, teenage patients 19 and under, using Invisalign products, increased 11% sequentially and 24% year over year for a total of 16.4 thousand teenagers or 25% of total worldwide volume.

This is compared to 23% of worldwide volume in Q3 2009, and 21% of total in Q3 2008, the first full quarter that included shipments fort he Invisalign Teen product.

In addition to gaining share of the teenage segment overall, we are also focused on increasing the number of younger patients, especially 11 to 15-year-olds that represent the bulk of teen orthodontic case starts.

In Q3 the average age of our teenage starts was 15 and a half, which was unchanged from last quarter.

We expect the average age of teenage patients to get younger as our penetration in the segment continues and Invisalign Teen practice is designed to do just that.

InvisalignTeen, which includes specific features that are intended to treat younger teens with mixed ambition.

In Q3, Invisalign Teen volume increased 11% to 7,590 cases or 12% of total volume from 6,810 cases or 10% of total volume last quarter.

On a year over year basis, Invisalign Teen was down slightly from 7,850 cases reflecting the change in the teen promotion that went into affect in Q1 of this year.

We're pleased with our continued progress and growth in both the teenage segment and the teen product, but we are not completely satisfied because we know there is still a lot of room to gain significant share with Invisalign.

Shifting to our most recent product announcement, during the Q2 call last quarter we previewed the launch of Invisalign G3.

Our collection of innovation that has been engineered to deliver better, more predictable clinical results and make it easier for our doctors to treat more complex cases.

As part of this launch, significant improvements in enhancements were made in our customer facing systems.

The Invisalign doctor site and ClinCheck software to make it easier for our doctors and staff to communication their treatment plan, reduce claim check treatment plan revisions, and manage account details.

I am pleased to report Invisalign G3 was successfully launched on October 11, in North America and will be available internationally in Q2 of 2011 internationally.

I won't go into all of the details on today's call, as I know many of you have already reviewed the press release issued on August 16th, and some of you even dialed into the ask the expert call, we hosted for our customers on October 1st.

Invisalign G3 is the largest evolution in our history, touching every product in virtually every system at Align.

And I am extremely pleased and proud of the hard work demonstrated by our employees to achieve this significant milestone.

We believe the new features and overall improved performance of Invisalign G3 will have a positive impact on utilization and continue to support more widespread adoption into our customers practices.

Following the G3 ask the expert call, 91% of the 4,000 doctor attendees said they had confidence in Invisalign, and 86% said they would recommend Invisalign more going forward.

Pretty amazing.

In addition, by the end of the first week of availability, over 75%of doctors were reviewing their treatment plans using the new ClinCheck 3.0 software.

To date, there are over 215 cases for 190 doctors utilizing the new precision cut features, meaning they were quickly trying these new features on more complex class two and class three cases, which is exactly what we had hoped for.

In Q3, we continued building awareness and driving action to our integrated consumer marketing platform of traditional media, event marketing, and digital and social media.

Under traditional print and broadcast media, we just launched a brand new teen commercial that targets moms with teens in the household.

You may have already seen the twins' TV spot, which is airing primarily in prime time.

The goal of the commercial is to raise mom's awareness there is an alternative to metal braces and prompt them to learn more.

The commercial will be supported with print ads in major women's magazines through the end of Q4.

Invisalign Teen was also featured in many regional parenting magazines and on TV news segments across the country with doctors serving as experts to offer parent's tips on providing the right treatment for the child.

As part of the effort, Invisalign Teen was included in a summer satellite media tour that reached parents in 14 market and garnered nearly 10 million impressions.

Under event marketing activities, designed to reach potential patients, where they live and play, we partnered with Fox for the 2010 Teen Choice Awards.

As the premiere sponsor of Fox's Teen Choice Awards, which aired on August 9th to over two and a half million viewers, Invisalign received significant consumer exposure.

A big part of the strategy was to leverage our partner with Fox on-line which resulted in a 125% increase in Invisalign Teen website visits and a 40% increase in Invisalign Teen Facebook fans.

Q3 also marked the official launch of Invisalign's studio.

A new entertainment-based marketing platform to create excitement for Invisalign Teen.

The studio is an actual orthodontic practice in Beverly Hills, staffed by one of the most experienced local orthodontists.

We have already recruited a number of celebrities as Invisalign patients and they will begin to participate in a variety of marketing activities over the next couple months, including public relations efforts with the press and social media activity on-line to promote the brand.

If you want to hear more about our progress in the area next week at our analyst meeting.

A shift to international, Q3 was a solid quarter with growth both sequentially and year over year.

Q3 case volumes of 16.2 thousand or 24.5% of worldwide volume increased 2% sequentially and 34% year over year.

The sequential increase reflects increased volume from the Asia Pacific region and normal summer seasonality, particularly in the southern European countries such as Italy, France, and Spain.

The year over year increase reflects strong growth in core Europe of note, Spain has had a strong year and was up over 100% in Q3, albeit on a small base.

Q3 international revenues of $23.2 million or 24% of total increased 5.5% sequentially and 25.8% from the same quarter last year.

Invisalign Light, which replaced Invisalign Express outside North America, and includes up to 14 sets of Aligners and continues to grow nicely across international and had a strong up tick in Asia Pacific and Japan this quarter, again off a small base.

Before I turn the call over to Ken, I would like to briefly comment on the additional news release we issued today announcing that we have received regulatory approval to market and sell Invisalign in China and will begin commercial launch in the second half of 2011.

This is a significant milestone, and we are very excited of the opportunity and growth potential for Invisalign in China.

Prosperous Chinese are increasingly spending on discretionary items, particularly high end luxury goods.

This, combined with increased spending on healthcare, oral health, and aesthetics makes China one of the fastest growing market opportunities for orthodontics over the foreseeable future.

There is still much work to be done to launch Invisalign in China.

We will go into more detail in our upcoming analyst meeting in New York next week, when our new VP of International, Richard Tomey will take you through our view of the tremendous long-growth opportunity.

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

Ken?

Thanks, Tom.

Now, let's review our third quarter financial results beginning with revenue.

Q3 net revenue of $95.9 million increased 2.2% sequentially from Q2 non-GAAP net revenue of $93.9 million, an increase of 21% year over year.

Recall that Q2 non-GAAP net revenue excludes the release of $14.3 million of previously deferred revenues for the Invisalign Teen replacement Aligners.

The sequential revenue growth reflects higher worldwide ASP's which were driven by lower deferrals associated with the teen replacement Aligners, lower levels of discounts and rebates, and lower case refinements.

On a year over year basis, Q3 revenue growth primarily reflects higher volume across all channels, with worldwide ASP's remaining relatively consistent.

Case shipment of 66.2 thousand in quarter 3 decreased 1.8% sequentially and increased 17.2% from the same quarter last year.

The sequential decrease reflects lower than expected cases in North America, particularly from the GPs.

As Tom mentioned, during the summer doctors experienced slower patient flow which had extended through the fall.

Additionally, some more volume doctors have not maintained their prior rate of case submissions that we believe is in the response to the elimination of the minimum case requirements.

On a year over year basis, case shipments were up significantly across all channels , especially with North American orthos and international doctors, which were up 23% and 34% respectively.

In terms of customer mix, Q3 revenue consisted of 38.3% for North American GP's, 32.

5% for North American orthos, 24.2% for international and 5% for non case revenue, reflecting a slight shift from North American GP's to North American orthos, and international doctors.

Q3 revenue byproduct consisted of 69.5% for Invisalign Full, 11.8% for Invisalign Teen, 9.3% for Invisalign Express, 4.4% for Invisalign Assist and 5% for non case revenue.

Now let's move on to gross margin.

Q3 GAAP gross margin was 78.1% compared to 80.4% in quarter two and 74.4% in the same quarter last year.

Gross margin for quarter two, 2010 reflects the Ormco impact from the release of previously deferred revenue for Invisalign Teen replacement liners and quarter three 2009 gross margin includes a charge of $1.9 million for royalties related to the Ormco settlement.

For Q3, non-GAAP gross margin was the same as GAAP at 78.1%.

This compares to Q2 non-GAAP gross margin of 77.

4%, which excludes the Invisalign Teen deferral impact and Q3 2009 non-GAAP gross margin of 76.8%, which excludes the Ormco royalty.

The sequential increase in gross margin was primarily driven by higher ASPs.

Additionally, we have fewer training courses during the summer and gross margin benefited from lower training revenue which carries nominal gross margins.

Q3 GAAP operating expenses were $53 million compared to $41.7 million in quarter 2, and $119.2 million in the same quarter last year.

Q3 operating expenses include litigation settlement costs of $3.3 million related to the Lizler class action settlement, which was announced earlier today in a press release.

Q2 operating expenses include an $8.7 million credit for an insurance settlement related to the OrthoClear litigation in Q3 2009 operating expenses include litigation settlement costs of $69.7 million related to the Ormco settlement.

For comparative purposes, non-GAAP operating expenses exclude the Lizler and Ormco settlement costs and the credit for the insurance settlement related to OrthoClear.

Q3 non-GAAP operating expense was $49.7 million compared to $50.3 million in Q2 and $40.5 million in the same quarter last year.

Q3 non-GAAP operating expense was relatively unchanged from Q2 and Q3 of last year and reflects lower than anticipated spending related to sales expense, international marketing programs, and lower than expected head count additions.

Q3 GAAP operating income was $21.9 million compared to $45.3 million in Q2 and a loss of $60.2 million in Q3 a year ago.

Q3 non-GAAP operating income was $25.2 million or 26.3%.

This is compared to $22.4 million or 23.8% in Q2and $11.4 million or 14.4% in the same quarter last year.

The sequential increase and non-GAAP operating margins reflects higher gross margins and lower spending.

Q3 GAAP diluted earnings per share was .22 cents compared to .42 cents in Q2 and a loss of .72 cents in the same quarter last year.

Q3 non-GAAP diluted earnings per share was .25 cents compared to .21 cents in Q2 and .13 cents in Q3 of last year.

Now, let's move on to the balance sheet.

Cash, cash equivalence, and marketable securities were $280.1 million.

This compares to $186.5 million at the end of 2009.

In Q3, we generated roughly $37.6 million in cash from operations, compared to $42.6 million in quarter two and $10.8 million in the same quarter last year.

Q3 DSO's were 60-days unchanged from quarter two and down slightly from 62 days in the same quarter last year.

Now let's turn to our business outlook for the fourth quarter of 2010.

There are several factors that I would like to outline that contribute to our view of Q4 case shipments and revenue.

First, we have seen a moderate reduction in effort primarily among North American GPs following the elimination of the minimum case requirements.

Second, we had a slower than expected summer in North America, again particularly for GP dentists.

This trend has persisted into the fall and lead to lower case received from which Q4 shipments are generated.

Third, we expect Q4 international revenue to benefit somewhat from exchange rates compared to quarter three.

Lastly, we are being thoughtful about our near term consumer sentiment and the potential impact on dentist visits and high-value procedures, especially given the slow down we have recently seen.

With these factors in mind, we expect Q4 case volumes to be in a range of 61.5 to 63,000 cases and a revenue of being $90.5 to $93 million.

We expect Q4 gross GAAP margin to be in a range of 76% to 76.5%, a sequential decrease in gross margins primarily reflects the cost for the Invisalign Ortho Summit, which will be held November 5th and 6th.

Beginning in Q1 2010, continued educational fees are recognized in revenue and the cost of the educational progress being accounted for in process (inaduble).

As a result, in certain quarters when we have major customer events like the summit, gross margins will be unfavorably impacted.

These educational activities are highly impactful and extremely valuable to provide customers with access to the latest Invisalign education resources and enable them to network and gain available insight on treatment techniques and practice development ideas from their peers.

This year's ortho summit sold out on the first day o f registration, and we will host a record number around 1800 orthos and their staff.

To a lesser extent, Q4 gross margin will be impacted by lower volumes and the introduction of Invisalign G3 which includes the ability to slow down tooth movement and increase treatment time for certain cases.

The new features in G3 are expected to add some additional passive Aligners to each case, which will increase cost of good sold in the near term.

However, over time we expect G3 features to drive revenue growth in the business by improving predictability of treatment outcomes and reduce the need for case refinements, warranty, and miscourse corrections.

We expect Q4 GAAP operating expenses to be $51.5 to $52.5 million.

The sequential increase in Q4 operating expense reflects increased spending in international sales and marketing including head count additions delayed from quarter three.

Commercialization activities associated with the launch of Invisalign G3, and pre commercialization activities in China as we set up and staff our new office in Shanghai.

In quarter four, we expect operating margin to be in the range of 19.1% to 20% and earnings per share to be in a range of .15 to .17 cents.

In quarter four we expect the effective tax rate to be approximately 28%.

From a cash position, we expect to pay minimal cash taxes as we can utilize the net operating losses on our tax returns.

We expect diluted shares outstanding for Q4 for to be approximately 78.5 million shares.

From a balance sheet perspective, cash on hand at the end of quarter four is expected to be approximately $295 to $300 million.

Now before I turn the call back to Tom, I would like to briefly comment on our long-term financial model targets, which were communicated at our last analyst meeting in November 2008 and were intended to provide a framework for the business over a three to five-year period.

Over the past two years, we have made significant progress toward these goals and have consistently delivered financial results at the high end or slightly above our long-term model ranges.

As part of our annual strategic planning process, we evaluate the model and determine whether it is still appropriate in terms of expected top line growth, strategic investments and return to shareholders.

With our recent performance and long-term strategy in hand, we remain confident about our future and would like to update you on our new three to five-year review of the business.

Starting with revenue growth , the old range was 10% to 20%.

The new range is 15% to 25%.

The gross margin range remains unchanged at 73% to 78%.

Operating expenses , the old range was 55% to 60%.

The new range is 45% to 50%.

And for operating margins, the old range was 15% to 20%.

The new range is now 25% to 30%.

The new motto reflects our commitment for top line growth or driving leverage into the business.

Again, I would like to stress this is our new three to five-year deal of the business and not guidance for 2011.

I will provide more detail on our new long-term model at our analyst meeting in New York next week.

Now I will turn the call backover to Tom for

Thanks, Ken.

Our updated financial model reflects a more bullish mid and long-term view of our business.

That view is based on our strategic plan and confidence in the Align team's ability to execute on key strategic initiatives.

At the same time, we are going to actively manage the business carefully through what looks to be a softer near term period in the dental industry.

Through these challenging times, we have seen our orthodontist and GP customers react differently to the environment and therefore our approach to each needs to reflect those differences.

Our ortho customers react to tougher times by working harder among the referral sources like GPs, marketing in their communities, and taking revenue growth opportunities in products like Invisalign.

We are well positioned to continue our positive trends with teen segment promotions, Invisalign Teen products in the G3 launch that will make it easier for orthodontists to use Invisalign in more complex cases.

The GP scenario is a bit more complicated.

We know that during similar periods, our GP customers tend to be more passive rather than finding ways to grow revenue or recruit new patients.

We also know that some of the reduced activity and efforts in lower volume GP practices have followed the elimination of the case requirements in Q2.

Specific plans are in place to drive activity in the field within the resumption of growth among the lower volume GP customers.

We know there are still tens of millions of consumers that want treatment even in these uncertain times.

Our job is to better engage these GP practices to show them how Invisalign can contribute to a healthier growing practice and satisfied patients.

We are committed to strong execution of our strategic plan and know this leads to greater market penetration and increased shareholder value.

We believe we will continue to grow revenue in unit share at rates significantly above other orthodontic and dental peers and outperform the industry in general.

We have never felt better about our opportunities to build value in the business.

I look forward to discussing this in more detail next week at our analyst meeting.

With that, I will turn it back over to the operator for some questions.

Operator?

Thank you.

Ladies and gentlemen, we will now be conducting a question-and-answer session.(Operator Instructions).

Our first question is coming from Mr.

Matt Dolan from Roth Capital Partners.

Your line is open.

You may proceed with your question.

Good afternoon.

Maybe we can just walk through the quarter.

Sounds like there were two variables at work that we would like to get a little more detail on.

One being the proficiency case requirement having a lingering affect and the slow down on the dental visits.

Tom, can you help us maybe expand on those two variables as it relates to volumes intra quarter, and specifically what does your guidance assume happens to those two issues as we progress to the fourth quarter?

Thanks, Matt.

Those are the two primary factors as our other main channels , international and North American ortho or more or less on track.

Let me back up for a second.

In the North American GP it was a reasonably normal summer until we got into the later summer toward Labor Day and we just didn't get the normal bounce back in case starts and looking deeper into that there were a couple different factors.

One was that some of the practices that perhaps a year before were stretching and working harder to make the minimum case requirements, weren't stretching as much.

And then the second fact is they are reporting and saw a lot of this at the ADA, which attendance was down pretty significantly.

The relative traffic flow for dentists in much of the country is down a bit, and the demand for premium procedures is down a bit.

So, we can't quantitatively tell you whether these two factors play out in numbers, but they are captured in our guidance for Q4 because we exited Q3 with a lower case volume and entered Q4 with a lower case volume, and therefore, that's the track run.

Now, we expect to fix these.

As I said, there are plans in place, and there is a lot of positive things we are bringing to the GP's including improvements in the product, making it easier, including all kinds of promotion in the channel as well as the new advantage program that has been rolled out, and it is a good reason to get to 10 cases or more for the year.

That said, it's going to take a little time to move that, and all of that is captured in a complete way in our

So are you saying from what you saw at the end of Q3, you're assuming those variables remain relatively stable in Q4, is that another way to put it?

We expect to get back to growth, but we believe it takes some time.

All of those run rates are factored into our total view of guidance.

GP North America is the significant area that is creating this guidance change, this downward look.

Okay, Tom on the long-term guidance, maybe just looking at the margin opportunity, you pushed that up, not quite, but almost doubling it into the high 20s, again you hit that number on an adjusted basis here in Q3.

Should we be watching out for big infrastructure spent in the near term as opposed to the long-term models that may bring you down off the levels we have seen in the last three quarters, 23%, 24% and 26%?

No, we are not trying to telegraph any kind of nearer term implications.

We have been running well above a two-year-old financial model virtually every quarter.

And every time we are out with investors they ask if we will update that.

We were planning on doing that next week, so we thought we would preview that for this call.

We will run as best we can toward that model and in that model and over perform if we are able to.

But again, within a given quarter based on timing of spending and volumes in the business, it will move around within that window a bit.

The very short answer was there is no telegraphing of any nearer term activities in that range.

Okay.

And then maybe lastly on the China initiative, can you give us any color on the magnitude of the investment you are going to be putting in as you go to launch late next year, maybe giving us a little on what the actual strategy is direct or distribution?

I will stop short of giving view strategy.

Richard Tomey, who is very season hand in this part of the world will be previewing that at a reasonable level of detail for the audience during our analyst day a week from today, actually, in New York.

I will tell you that it is an investment.

We are in investment mode, but t we have been in investment mode.

And we are metering these investments along with the rest of the business, as we have been even through the very serious downturn.

We continue to make the right investments our highest priority, and China is a high priority for us.

You will hear a bit more about that next Thursday.

Fair enough.

Thank you for the time.

Thanks, Matt.

Next question please.

Thank you.

Our next question is coming from the line of Mr.

Spencer Nam with Madison Williams and Company.

Your line is now open.

You may proceed with your question.

Thanks for taking my questions.

Just a couple questions on the outlook and also new product launch.

First of all, you know, it seemed like the Q4 outlook was somewhat predicted, somewhat unpredicted, and I was just curious how you guys have a handle on the long-term growth when the near-term outlook seems somewhat of a unpredictable situation?

Spencer, I guess there is two pieces that tie together.

I will answer the second part of it first, and then come back to how we think more broadly about the business.

We are out surveying our customers frequently.

We do bottoms up and top down forecasting across our customer base and our field organizations around the world several times a quarter, and we go in and do the same thing with consumers.

One thing that comes back to us again and again is that our customer base typically doesn't think about business forecasting.

That's especially the case for a GP practice.

They are, and I don't mean this in a bad way, they are more set up to treat those who come in the door for the conditions their primary complaint.

They think less about how do I drive the business forward and how do I think about initiatives I am taking now to create growth in my practice.

So even when we survey our customers, and they project growth or expansion, that doesn't mean they tie that out to a business plan and action and deliver on that.

Secondly, for a customer that is doing two or three a quarter perhaps or even less, for them if they do two instead of three, it doesn't seem like a big deal to them.

But at 4,000 or 5,000 customers do one fewer case, suddenly we have 4,000 to 5,000 to 6,000 cases that we were expecting based on what our discussions with them were to show up.

That's what you are looking at here.

A broad base of fairly low volume customers that have not come out of the summer with the advertent activity leading to case starts.

That's the second part of your question about visibility.

We work really hard, but yet we can't know when our customers don't look up stream.

We are working on figuring out a way around that.

Again, we have greater visibility into orthodontist efforts because they are a bit more pragmatic in market.

Back to the first part of your question, the long-term strategy, we put a lot of effort into building blocks of our strategy and have been successful over the last three, four, years at executing on those and delivering growth and progress in a business from the top line all the way down to the bottom line.

And so we have good visibility, good execution, and high confidence in that, and we do have a more bullish view of the mid and long-term even if the face of a more challenging drift of the GP, but we believe we will get that fixed.

That's maybe the second part of your question.

Yeah, appreciate that.

On the new product side with the Invisalign G3 and also the expansion into China, what are some of the strategies you guys are looking at how to push G3 into this somewhat of a choppy environment, and what kind of, the processes or precautions, if you will, are you taking moving into China while the established business may be going through some changes as well as some of these, under a somewhat of an unexpected fluctuations in business?

Well, those are two pretty, we look at them as related in some level.

But if we take a look at, there are three pieces there if I unpack it.

The first is what we are doing in China.

The second is what is G3's impact, does it help or hurt?

And the third is does G3, if I heard you correctly, help maybe the low volume customers?

I will set China aside for a moment.

G3 actually helps and we put a great deal of effort into pre announcing and pre training and ask the expert calls.

We have had great attendance by orthos and GP's on those calls, and not just on the original call, but they can do it on demand later.

We had an enormous poll upgrading of the new ClinCheck software, the new doctor site that replaced vip, and so we saw very rapid transition by high and low volume customers to the new technology platform.

And understand, these are clinicians that don't change easily.

So we were very pleased to see how quickly they pulled this technology.

We had orthos within the first day setting up very complex cases to try the new precision cuts feature as I mentioned a moment ago on the call.

To us, that's a home run because they are out testing and trying on a much more complicated class two or class three case.

These new features that would have been a hassle before.

On the G3 side we are hearing while it is a little daunting for the very first look, it is far easier to use for the doctor and the staff.

They are able to see their whole account at a glance

We believe, we went into this huge G3 evolution with eyes wide open.

The feedback across the board after we have gotten through the first week is, it looks like it really will help.

Now, getting back to how we get activity and effort in the GP's offices will be blocking and tackling as we head through Q4 and reestablish growth going into next year.

China, we are going to take this great product evolution and that will be our starting point for our Chinese customers.

They are going to get the benefit of all the other progress we have made.

We are starting them at a very different evolution of where Invisalign is versus our North American and European customers we have had to bring along so we think that is just going to be net benefit.

Thanks, Spencer.

Next question, please.

Thank you.

Our next question comes from the line of Mr.

Jonathon Block with SunTrust Bank Incorporated.

Your line is now open, you may proceed with your question.

Thanks, and Good afternoon, guys.

First question, Tom, I believe this is for you, and it might be somewhat similar to some of the past questions, asked a different way.

When you mentioned some of the disappointment amending from largely the GP channel.

What I am trying to flush out here is, was it disappointing across the GP channel where utilization was below where you were expecting or was there a subset that essentially went to zero because they turned off Invisalign and may be trying a competet or?

The others hung in there and pulled down the entire mean, or was it just across the board patient, like is said, volumes weakened at dental offices and the mean all across sort of stepped down, if you would?

So, Jonathon, it is actually the latter.

We look at this, first of all, we can't speak for the whole dental industry.

We are seeing a slice of it.

We are certainly looking at the dental industry keenly and watching what the real benchmark companies do.

For us, it was across the board in every segment of our North American GP customer base.

Volumes were down as we expected through the summer.

They just didn't come back Labor Day and beyond, and that was the surprise to us.

As we dug into that, certainly what we heard in spades at the ADA a few weeks ago was that they were, traffic was slower.

A good example is, gee I have a patient that would have gone for a full mouth restoration and is doing individual tooth restoration.

People are pulling back a little bit and they are not doing premium procedures.

We can't quantify that today, but that's when we went looking for what's going on.

The second thing is there were some lower volume customers that dropped out during Q2.

If they would have done one or two in a prior quarter, maybe they disappeared completely in Q3, but we expect to see them again.

They are not gone forever, and there is no evidence they went to competition, none.

We think this is why, and I try to say as clearly as I could, we believe the strong results in Q2 in the GP channel, even though removed during the Q1 call in April we announced we were removing the minimum case requirement, we believe a little further past the proficiency program.

And we think really, not having to reach for the 10 cases a year probably was a factor in some of these practices.

With all of that rolled up together, that's what you see rolled up in the Q4 outlook.

So then just the second part of the first question because I want to make sure I'm clear on this one, you believe your share, your market share within GP is absolutely unchanged.

The problems are across the board where the weakness was felt across the board?

Absolutely.

Just second question, Ken, this might be for you.

You speak to the long-term guidance.

I realize that is not 4Q 2010.

You just got through of three quarters with hot margins bouncing around 23% and 26%, and you issue guidance for 19% to 20% in the fourth quarter, I believe non-GAAP.

So what's going on there?

I know you mentioned some one-time stuff, but is it really sort of start up costs in China costing you 300 to 400 pips?

Thank you.

You are talking quarter four specifically.

There are a couple things going on, one certainly with the volume drop-off in quarter four from a case perspective has impacts, obviously, on gross margins as well operating margins.

As far as operating expenses are concerned on a quarter to quarter basis, we were actually behind in head count additions in core Europe, and we have people on board now or signed up to come on board during the fourth quarter, so we will see that expense come into play.

And the international arena was also a little slow in advertising during the summer because of the holiday.

So they picked that up in the fourth quarter.

From China, we have been spending in China.

It has been a few head counts as far as expenses go, but if we look forward now we will be looking at getting an office space set up and those types of things.

We are not talking large dollars, but it does add to the overall increase quarter after quarter.

Fair enough.

Thanks, guys.

Thank you.

Our next question is coming from the line of Mr.

Drew Jones with Stevens Incorporated.

Your line is now open and you may proceed with your question.

Hi, guys, just a couple quick ones.

First, just shifting gears a little bit.

As we look at the teen product, what percentage of the mix do GP's make up?

And is that growing?

You know, Drew, GP's make up a small percentage of the mix of teen product.

It is a product that has been targeted toward orthos and even since we introduced the product it has been relatively flat on a quarter to quarter basis.

The growth in the teen product is coming from the ortho space.

Okay.

And then last one, obviously you guys have been pretty active on the promotional front.

As we look at that awareness and marketing span, and I don't think you will specifically break this out, but can you give us an idea how that is trending this year and your expectations going into 2011?

Yeah.

Now, this year I would say the way to think about the trend of spending is we have been relatively consistent over the first three quarters of the year, quarter four we go down in our advertising spend.

This year there has been a shift in advertising with the teen product.

More specifically in the summer we came out with a new ad related to teens, specifically addressing moms and teenagers.

We have shift in spending from adults to teens.

And then things that Tom mentioned on the call like the Teen Choice Awards, and some of the things we have done around that and various event marketing activities has shifted some of that.

The overall spend has been, it typically falls off in ort quarter four and relatively consistent in the first quarters of the year.

We will share more next year when we start to getting into Q1 guidance.

We will go through our plan right now and will be looking at how we want to look at our advertising spend next year.

We have been spending on a mixed basis more toward digital and social media advertising as well as TV.

Right.

And I guess on an absolute dollar basis versus 2009, it is up?

We will probably be spending more on advertising, yeah.

Thank you.

Our next question comes from the line of Mr.

Robert Gold with Brigantine Advisors.

Your line is now open.

You may proceed with your question.

Thank you.

Hi, guys.

Just a quick question getting back to the demand factors at play here.

And I'm just trying to get a sense of are you really getting, are you seeing some of these patients just simply not being treated or do you get a sense they may be converting to wire and brackets?

And my concern there is going forward, are these potential Invisalign patients now no longer in the Invisalign pipeline, so to speak?

Well, again, since, well, first of all the summary , if I go back three or four years, summertime is when we got crushed in the ortho channel.

We continue to do well in the ortho channel and continue because the biggest chunk of starts for pediatric and teen cases occurs in the summer months when kids are not in school and mom and dad can get them there for their long series of appointments.

Whatever the market gives us, we are willing to take share, and we believe we again managed a gross share nicely this year.

We believe it will continue to be up above the ortho manufacturers.

They mostly reflect pure orthodontic business.

Our issue is on the GP side, and so in the summer typically GP volumes go down anyways.

A lot of the customers that GP's treat are adults and adults are not top of mind thinking of treatment in the middle of summer.

GP's offices are closed more.

Dental visits go down in general.

Normally it comes back after Labor Day.

It didn't this year.

A, we don't certainly on the clear liner side, if anything we gained share, even in a tougher market environment.

B, certainly that was the case in ortho.

We believe we took share from all the traditional brackets and wire manufacturers, and we believe growth rates will bear that out if you look at the ortho numbers.

Most of the orthodontic manufacturers to the extent they report news are only talking about ortho starts, and we grew very nicely, and our teen starts grew nicely in Q3.

And then the last point would be on the GP side there are very few GP's that do fixed appliances.

When a patient doesn't start it is probably because the GP and the office isn't geared to work on selling it.

When we calibrate with consumer demand and available patient populations, there are still tens of millions of patients out there who said they wanted a better smile and are poking around about how to find the right doctor to do that.

So, patients are there .

We are not lost share.

And this is a sideways drift in the North American GP channel for us that we are setting

Thank you.

Just one housekeeping thing, the tax rate for Q3 was pretty well below what I was anticipating.

Is there something behind that, is there an OUF shift or is there something there?

No, it is in the range of what we communicated last quarter on our guidance.

So 28% would be something in Q4 and then going forward?

Yeah, I commented on the call that it was going to be 28% approximately for the quarter.

Sorry, I just missed that.

And then finally on the G3 product, can you talk about what the impact is on the margins?

I know you said there was a little depression there from G3.

Sure.

With G3 one of the things we are allowing doctors to do is slow down tooth movement and it will add a few extra Aligners per case.

What we will be doing is offering up, what we are calling, passive Aligners.

So for example, if you have an upper arch that is using 20 stages of Aligners and a lower arch using 18 stages of Aligners.

We will add two passive Aligners to the lower arch so they have 20 stages for each arch, but two on the lower arch will not have movement with them.

They will just hold the teeth in place.

But it gives doctors better predictability on outcomes.

If I pile on for a second, that's actually an investment by us.

As we have tested it, we believe that overtime will lead to lower refinement rates, lower mid course correction rates, and ultimately higher net margins.

It is slowing down slightly very marginally.

Some cases with difficult movements, but ultimately lowering total cost of the treatment and increasing quality and predictability.

That's one of the bets embedded in G3.

And better economics at the physician level.

Absolutely, and less hassle factor for sure.

Great, thank you.

Thank you.

Thank you.

And thank you everybody for joining us.

This concludes our conference call for today.

We look forward to seeing you at our upcoming analyst meeting in New York on October 28th.

Other upcoming conferences including the Credit Suisse health care conference on November 10th or the Lizar conference on November 16th and 17th.

Thanks and have a great day.

Ladies and gentlemen, this concludes today's teleconference.

You may disconnect your lines at this time.

Thank you very much for your participation.