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Executives

Shirley Stacy - Senior Director of IR

Tom Prescott - President and CEO

Ken Arola - VP and CFO

Analysts

Taylor Harris - JPMorgan Chase

Mark Mullikin - Piper Jaffray

Derek Leckow - Barrington Investment

Matt Dolan - Roth Capital Partners

Spencer Nam - Summer Street Research Partners

Seth Waugh - Deutsche Bank

Anthony Ostrea - GMP Securities

Isaac Ro - Leerink Swann & Company

Align Technology Inc. (ALGN) Q1 2008 Earnings Call April 29, 2008 4:30 PM ET

Operator

Welcome to the Align Technology first quarter 2008 financial results. 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 Ms. Shirley Stacy of Align Technology. Ms. Stacy, you may begin.

Shirley Stacy

Thank you and good afternoon everyone. I am 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 two press releases today via PR newswire and First Call; one detailing Align's first quarter fiscal 2008 financial results and the second release announcing that the Board of Directors has authorized up to a $50 million stock repurchase program. Both press releases are available on our website at investor.aligntech.com.

Today's 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 May 14, 2008. To access telephone replay, domestic callers should dial 877-660-6853 with account number 292 followed by #, and conference number 280015 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 about Align's future events, product outlook and expected financial results for the second quarter and full-year fiscal 2008 including future years' effective tax rate. These forward-looking statements are only predictions and involve risks and uncertainties such that actual results may vary significantly. These and other risks are set forth in more detail in our Form 10-K for the fiscal year ended December 31, 2007. These forward-looking statements reflect beliefs, estimates and predictions as of today and Align expressly assumes no obligation to update any such forward-looking statements.

We have also posted a 9-quarter GAAP revenue model and financial results webcast slides on our website at investor.aligntech.com under quarterly results. Please refer to these files for more detailed information.

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

Tom Prescott

Thanks Shirley. Good afternoon, everyone. Thanks for joining us today to discuss our Q1 result. I am pleased to report another good quarter for Align and a solid start to fiscal 2008.

Let's begin with a few financial highlights.

For the quarter, results were better than our outlook across all our key metrics. Net revenue was $74.8 million. Case shipments were 51,800. ASPs were $1,380. Gross margin was 73.8%. Operating margin was 6.2%. And EPS was $0.07. These better than expected results were driven primarily by higher ASPs and expense management.

From a customer perspective, case volume mix was roughly the same as Q4, with a very slight shift from international to U.S. Ortho. Q1 revenue for U.S. Orthos and GPs increased in the mid-single digits sequentially and International was relatively unchanged from Q4.

On a year-over-year basis, International led our overall growth with an increase of 54.7%, reflecting the continued accelerated base of growth outside the U.S. and the positive effects from foreign exchange rates.

All in all, it was a good quarter. As we move forward, we remain focused on the three critical levers that are driving our business; product innovation, adoption growth and consumer demand.

Let me talk about each of those levers for a moment starting with product innovation.

Product innovation is the most critical of our three levers for achieving growth. On the product development front, we are now through our quarter of general availability of Vivera Retainers. We believe we have made good progress to-date and have seen greater whole-practice conversion than anticipated. In fact, the adoption rate is very encouraging, with more than 50% of our orders in Q1 being reorders rather than new trails. We will continue to focus on expanding trial of Vivera across our customer base and driving whole-practice conversion, such that Vivera becomes a meaningful portion of our customers' Retainer business over time.

Another new product that we are excited about that we are excited about and believe will increase our share in orthodontic practice is Invisalign Teen, which is currently in pilot. We launched the pilot to several hundred orthodontists in February and are gaining tremendous insights from their use of the Teen product.

Based on initial feedback, we are planning to add new clinical protocols and software to the pilot version to broaden the clinical applicability, including new software and set-up tools for our Treat operations in Costa Rica.

In Q2, we expect to expand the pilot to include a larger group of our most experienced Invisalign orthodontists in anticipation of a staged release later this year.

We are also pilot testing Invisalign ClinAssist, which is designed primarily to help newly certified in low volume Invisalign GP dentists to increase utilization and become frequent users more quickly. The pilot consists of two groups of GPs, newly certified along with more experienced Invisalign doctors.

Insight gains from the pilot indicates that ClinAssist is working well for its primary target of newly certified GPs. Doctors in the second group experienced Invisalign GPs have told us that given their greater experience and confidence with Invisalign, they're less likely to use ClinAssist for simple cases. In fact, they want to be able to apply ClinAssist's streamlined approach to more difficult cases to improve efficiencies within their busy practices.

The clinical protocols in the pilot were limited to simple crowding and spacing cases, and its focus is resonating very well with newly certified GPs. However, these protocols in the company and software are not yet broad enough for the range of cases that more experienced GPs currently treat with Invisalign. Our original concept testing confirms that both target groups are appropriate for ClinAssist and we will evaluate moving ahead with a wider range of ClinAssist applicability in the context of other product roadmap priorities.

Bottom line, we are pleased with the initial feedback on ClinAssist, which is on track for late 2008, early 2009 launch and we are excited about the potential for ClinAssist to help newly certified GPs to the adoption cycle more quickly.

The second lever, this is key to our growth, has increased adoption to training and certifying new practices as well as increasing utilization of our products within these same practices.

In Q1, the year-over-year utilization rate was unchanged for U.S. Orthos, increased 14% for International and decreased 8% for U.S. GPs. The decrease for U.S. GPs reflects the large increase in the number of newly certified, low volume doctors over the past 12 months. We believe this also reflects some softness in the economy. To better support doctors through their initial and extended learning curve, we have implemented number of go-to market initiatives, including expansion of our sales force and significant investments in clinical education.

In Q1, we successfully launched AligntechInstitute.com, an interactive website rich in content and tools to improve treatment success for our doctors and enhance our bottom line. Today, this website has had over 43,000 visitors, of which half are first-time visitors, who had never been on our educational website before or registered for an on-line educational event with us.

We also introduced a new certification course called Clear Essentials I. Preliminary data for recent certification shows that doctors who complete this new course are coming up to speed and submitting cases faster than doctors who completed earlier versions of our certification training. This suggests that we are improving the efficiency of our processes and accelerating the additional adoption cycle in this line into practice which should help increase utilization rates over time as well.

By combining our new certification course, Clear Essentials along with the use of online pre-certification classes and the initiation of the GP training in Europe, we anticipate training roughly 6600 doctors in 2008 on a worldwide basis.

The third lever for driving long-term growth is consumer demand creation. We create awareness and motivation among millions of potential patients through our mix of media including television, radio, print increasingly web-based approaches.

While completing production of our new ad campaign which we called "A Small Changes Everything", we were off air for 13 weeks, from late November until late February, our longest off air stretched a number of years. Not surprisingly, qualified leads specifically from TV declined during that time period. However, only four weeks after launching the new campaign, our qualified responses were up nearly 140% over the same period prior to launch and our Doc Locator feature on Aligntech.com is being heavily utilized.

As we progress through the year, we will continue to increase the reach and frequency of our demand creation approaches. Early in the year, the mix is more heavily weighted towards TV. Later in the year, as the cost of advertising rises, we will shift the mix towards greater use of new web-based advertising approaches that we successfully pilot tested.

Together, product innovation, adoption growth, and consumer demand creation are helping drive long-term growth for Align. We are making progress on all fronts and believe that our continued focus on these critical levers, along with investments in other strategic initiatives, will help us capture a greater share of the market. Q1 represented a solid start to the year, but we have a tremendous amount of work to do still to fully execute our plans for the year. I look forward to sharing further updates with you next quarter.

And with that, I will turn the call over to Ken. Ken?

Ken Arola

Thanks Tom. Now let us review the first quarter financial results in more detail beginning with the income statement.

Q1 revenues of $74.8 million increased 3.1% sequentially and 17.3% year-over-year, and we are above the high end of our outlook. The sequential revenue growth reflects higher ASPs during the quarter combined with a slight increase in case shipments. For Q1, blended ASPs were $1380 compared to $1360 in quarter four. Quarter one ASPs reflect the impact from fewer volume rebates, the benefit of exchange rate associated with international shipments and the mix of cases between full Invisalign and express.

Q1 gross margin was 73.8% compared to 73.6% in quarter four and 72.5% in the same quarter last year, and higher than our outlook. The higher than expected gross margin benefited primarily from favorable ASPs. Q1 gross margin also included $400,000 in stock-based compensation expense, compared to $300,000 in quarter four and $200,000 in the same quarter last year.

Q1 operating expense was $50.5 million as compared to $48.4 million in quarter four and $39.2 million in the same quarter last year, and at the low end of our outlook. As a reminder, Q1 '07 operating expense included a credit of $1.8 million for the reversal of Patients First program cost.

The sequential increase in Q1 operating expense reflects a full quarter of expense associated with the expansion of our sales force in quarter four, go to market programs in North America and Europe and media costs associated with our new TV advertising campaign. In addition, we continued our investment in product development, systems, and infrastructure projects and marketing programs.

Q1 '08 operating expense also included $3.6 million of stock-based compensation compared to $3.1 million in quarter four, '07 and $2.3 million in the same quarter last year. Q1 EPS of $0.07 compares to $0.08 per share in quarter four and $0.10 per share in the same quarter last year. EPS was well above of our outlook of $0.01 to $0.03 per share as a result of higher than expected revenue and expense management.

Now, taking a look at the balance sheet, cash and cash equivalents, marketable securities, and the restricted cash were $132.4 million compared to $127.9 million at the end of 2007. Cash from operations in quarter one was approximately $3 million, compared to $70 million in quarter four and just under $1 million in the same quarter last year.

Q1 is historically a low cash flow quarter due primarily to the timing of annual incentive compensation programs. Q1 DSOs were 57 days compared to 56 days in quarter four and 54 days in the same quarter last year.

At this point, I would like to take a minute to talk about our press release we issued today announcing that our Board of Directors has authorized a stock repurchase program of up to $50 million. The timing and actual numbers of shares repurchase were depended on a variety of factors including share price, corporate needs regulatory requirements and other market conditions.

We are confident in our ability to generate cash in excess of our needs to grow the business. Returning this excess cash to our shareholders through a repurchase program will contribute to our goal of enhancing shareholder value. It will also have the effect of offsetting dilution from our employee equity plans.

Now, let me turn to our outlook. This is also in our press release so I will only touch on a few highlights. Before I do so, I would like to provide a few general comments about the major factors that are in form our thinking regarding the outlook.

First, we continued to be cautious regarding the economy and the potential effect it may have on our business. Second, as you may recall, we added new sales reps in the fourth quarter of 2007 and it typically takes approximately six months for those new reps to become fully effective in the new territory. Therefore, we expect them to have a greater impact on our revenues over the second half of the year. Third, when you take into account the seasonality in our doctor's practices, particularly in the summer months with vacation and holidays in both North America and Europe, you can typically expect slower case receipts and relatively flat revenue trending from Q2 to Q3. And last, the effects of any stock repurchases are not reflected in this outlook.

With that said, our outlook is as follows. For Q2, we expect revenues to be in a range of $78.5 million to $81.5 million. We expect case shipments to be in a range of 54,000 to 56,000 cases.

We expect worldwide ASPs to decrease slightly sequentially due primarily to increased volume rebate discount associated with the anticipated higher case volumes from doctors qualifying for the advantage rebate program and case refinement deferrals related to the expected sequential increase in Invisalign case volumes.

We expect Q2 gross margin to be in the range of 73% to 73.7% and as expected to include approximately $400,000 in a stock-based compensation expense. In quarter two, we expect operating expense to be in a range of $55.8 million to $57 million. This reflects a full quarter a TV, media spending related to our new advertising campaign launched on February 25th, costs associated with our go to market initiatives and marketing programs in both North America and Europe, and our continued investment in product development, systems, and infrastructure projects.

Also, two of our three annual Invisalign customer's summits are occurring in quarter two the U.S. GP Summit and the European Summit. Q2 offering expense also is expected to include approximately $4.5 million in stock-based compensation expense.

For quarter two, we expect EPS to be in a range of $0.04 to $0.06. We expect diluted shares outstanding in Q2 to be approximately 71.4 million shares.

For fiscal 2008, we remained comfortable with the prior outlook with one exception, deferred revenue. We expect the increase in deferred revenue for fiscal 2008 to be in the range of $6 million to $9 million as the result of introduction of new products including Vivera, Teen and ClinAssist. This compares to our prior range of $9 million to $18 million provided on our last quarter's earnings call. This change reflects the feedback we have received from the ClinAssist pilot. As Tom discussed earlier, more experienced Invisalign GPs want to be able to use ClinAssist to address more difficult cases to improve efficiencies in their busy practices. Based on this feedback, we have modified our assumptions for the initial release to reflect our focus will be on newly certified and low volume doctors.

Finally, I want to review the comments I made last quarter about the tax planning strategy and future year's effective tax rate. During 2008, we will continue to evaluate our tax position and may determine that we will be able to utilize the future tax benefits from our deferred tax asset. At that time, we would release the valuation allowance and the worldwide tax strategy is in place and the valuation allowance has been released, we would expect to have a GAAP effective tax rate of 32% to 37%.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Taylor Harris with JPMorgan Chase. Please proceed with your question.

Taylor Harris - JPMorgan Chase

Thanks a lot. Tom and Ken, just wondering if you could talk to us a bit about what you saw as you progressed through the quarter. You have obviously had a tough consumer backdrop that a lot of people are worried about. May be just update us on your thinking there, and specifically with your case volume guidance? You are guiding to the second quarter being higher case volume number than the first quarter. So, what are you seeing in the months of March and April that help you get there? And then as you progressed through the year, the second half of the year certainly needs a pick up. So, just help us with that pick up, is that primarily, what do we count, what needs to happen there, does the economy need to improve? Or do you think you can get there just with your plans around sales force expansion and new marketing slogans? I know that's a lot of question, so I'll cut it off there.

Tom Prescott

I think you just answered the question with your last kind of rejoinder there. I'll start there, Taylor. We think as there Ken outlined, the area that informed our viewer of our outlook, we are being thoughtful and cautious about the economy. We think it has two effects there; one dampening effect on consumer behavior. We think that is play a lesser effort in our business given the huge number of patients. There are a lot of people still that are not enormously impacted by this difficult economy.

We think the greater effect is actually in channel with doctors that are perhaps less likely especially low volume doctors, less likely to offer up a high-valued procedure like Invisalign, full and cosmetic restorative procedures and so. But going back to the beginning, we are working really hard. The business is responding. The sales people are starting to come online. We think we got another quarter to really get them fully operational and with all the disruptions that we created for customer relationships and all that.

Again with, dropping in 25 to 30 people, it really interrupted more likely 60 plus territory, so half roughly of our customer base. That is coming along. The team is really focused. They're working their tails off. Again, we see some good things going on. As we continue to evolve our clinical education and we get better initial results, it makes us more comfortable that we're on the right track with new products like ClinAssist. We do not look to really impact this year so much, if we're nowhere on the right track.

On top of that, in other word, there is quickly, the new advertising campaign has created excitement energy out in the offices and among patients coming in that have seen ads. So collectively, with these improvements in hand, we do not think it's going to be an easy year, but we are comfortable that we're going to see reasonable expansion as the year evolves.

Taylor Harris - JPMorgan Chase

Okay.

Ken Arola

Taylor, I would add a couple of things to that. First of all is, in the international front, we continue to see volumes growing on international, especially quarter two and quarter four are typically the bigger quarters for the international guys. And then in addition to that, the training that Tom mentioned and the doctors are coming up to speak quicker after coming at a certifications and submitting cases.

Taylor Harris - JPMorgan Chase

Okay. But Tom I guess, maybe just to make clear, let us assume the economy stays status quo. Do you feel comfortable with the guidance? And what should we be looking for with respect to utilization rate as we go through the year, does guidance assume that there is pick up?

Tom Prescott

So, those are maybe two really different questions. I'll answer them in pieces Taylor. We don't think the economy is going to get better anytime soon. We think we can definitely see a bottoming out in some areas. And maybe, I'll use an example of what we call ground zero. We're pretty close to it here in the Central Valley and those communities like Stockton and areas like that where we are watching very closely what's going out with consumers and doctors.

I think Stockton has the unfavorable opportunity to be, they have the highest foreclosure rate in the country roughly six times the national average and yet we saw our doctors being successful there. Although, in general, through the Central Valley, we believe we have seen compression around 25% to 30%. I think we are stirring through that with our team and learning a lot from it.

So, we think that represents ground zero. And virtually everywhere we look in the country, other than the State of Michigan which has had been under some distress for a quite a while. Everywhere else in the country has some pockets to distress, but in general we have this huge population of potential patients and a pretty sizeable base of doctors that are still very motivated with Invisalign.

So, all that said, we do not expect or not counting on a balance of the economy, we think we have to drive the business through it. However, the good news is we have ton of patients that are still financially more or less unaffected by the economy.

The second question is concerning utilization. We think there is some softness in the economy in that number. We're having a hard time quantifying it. So, I am going to call that a qualitative factor. The quantitative effect is due to the large surge in GP certifications we did especially in the second half of 2007, growing the denominator that rapidly and dropping that many relatively low producing, low volume GPs into the base, groups up the math's from a comparative level.

So there was some compression and we saw that most specifically in the Central Valley, but we still have practices that are growing. The bigger part of it is just the denominator grew very rapidly and comparisons is driving that down.

Taylor Harris - JPMorgan Chase

Okay. So, if you strip out the increasing denominator with the low volume docs, would utilization be increasing in the rest of the base?

Tom Prescott

I want to promise, you can take a group of cohorts and start looking at when they will train it, and we still have solid adoption going on all through the base. The promise, the base is growing very fast. So, kind of large numbers are against us on utilization rate.

The best way to think about the utilization rate is probably on an annual basis in the near term given the large number of docs we're training, what I would say is, in general GP broadly is flattish to down, if you look at same practice equivalent, we think that's the reflection of the economy. When you add in a huge number of new lower producing doctors, it really pulls it way down.

Taylor Harris - JPMorgan Chase

Okay. Great. And then last question, just a push back on March and April, did things move in the right direction for you in these last couple of months? Is that part of what's giving you confidence on the remainder of the year?

Ken Arola

Taylor, when we went through the last quarter here, things were on track as we were anticipating going into the quarter for March timeframe. And our guidance for this quarter, that we given takes into account what we're seeing going into the quarter.

Shirley Stacy

Thanks, Taylor. Next question, please? And please do try to limit your questions to one, so we can get everybody through.

Operator

Thank you. Our next question comes from Mark Mullikin with Piper Jaffray. Please proceed with your question.

Mark Mullikin - Piper Jaffray

Good afternoon.

Tom Prescott

Hi, Mark.

Mark Mullikin - Piper Jaffray

I am going to ask one question in two parts, but I thought it is pretty much the same question. The expense management in the quarter, part A, where were the positive variances as far as expense management in the first quarter?

And then, B, as I look to your second quarter guidance, I really need to load up the expenses to get to $0.04 to $0.06 of EPS based on your revenue guidance. So, are you expecting to spend more money in the second quarter across the board, what's in the plan?

Tom Prescott

Mark, it is a great question. Let me start from a spending and activity perspective which is not linear in anyway. We have quarters like Q2 every year, which are loaded up with trade shows, which are loaded up with summits, in this case two, and this year, we have increased spending in expended pilots and commercialization activities for some new products, et cetera.

On top of that, we're really pushing very hard to get a lot of reach and frequency with this new ad campaign before ad rates start to tick-up as we approach the elections and the Olympics in the middle of the year. So, we planned on a significant expansion on spending versus kind of natural organic growth through headcount expansion and talking spending, I want to kind of remind you about that first and then I would ask Ken. Most people model us linearly because frankly, we do not give you better information on that. But maybe that's a starting point for Ken to dive and provide some more detail.

Ken Arola

Yes, Mark, let me just give you a little more detail here. First of all, with the question on quarter one, our expense management for the quarter, that was generally across the board, across all areas as we were looking at how we can keep expenses on the low end of our range here and manage it as we go into quarter two.

What Tom said is, the business is not exactly linear as you model expenses given our significant customer wins that we have. So you get a full quarter of TV media spend but you also get an increased amount of media spend because of the focus this year being early in the year versus stressed out over the entire year.

The addition to that, we have the product launches that Tom was talking about. So, our product development and launch costs, which we did not have in previous years as we transition from quarter one to quarter two. And the last thing I would mention on, if you were to go back and look at last year, you may ask the question, why do not you see expenses increases much last year. In fact, they did have a pretty significant increase last year.

There were two things that brought that expense down a little bit in quarter two in 2007. First of all, we got an insurance reimbursement related to the OrthoClear settlement agreement that we had, which was the pretty significant amount. And then we also had media spend go down pretty significantly from quarter one to quarter two. In prior years, we had heavier media spend in quarter one and three and little bit lower in quarter two and in quarter four. So you take all that into account, quarter two is typically a higher spending quarter for us, more so than most of the others during the year.

Tom Prescott

And I will add one more thing, as we're flowing a bit more resource to our international team, they are demonstrating continued solid, solid growth and we're giving them some more resources to build the business. We want more of that.

Mark Mullikin - Piper Jaffray

Great, thank you.

Shirley Stacy

Thanks Mark. Next question, please?

Operator

Our next question is from Derek Leckow with Barrington Investment. Please proceed with your question.

Derek Leckow - Barrington Investment

Thank you. Good afternoon.

Tom Prescott

Thanks Derek. How are you doing?

Ken Arola

Hi, Derek.

Derek Leckow - Barrington Investment

Hi. Just looking at the doctor utilization rates, they look like they have stabilized here. And as you mentioned, as you grow the denominator, it is more difficult to get the numbers to go up. What is sort of a same-store comp? Is there a way to look doctors who are certified over 12 months ago and compare those to, what are you seeing out of that group compared to some of the newer ones?

Tom Prescott

Well, that is exactly how we look at it internally Derek, because the two things we consistently say is, a utilization on a quarter-to-quarter basis, there is a lot of moving parts. First you have to sort out what's meaningful. Internally, we look at different cohorts of doctors trained at different times and then characterize what their adoption growth looks like and what the utilization growth looks like.

You asked the specific question about what about docs trained 12 months ago versus say, let us just go back one more quarter, say five quarters ago versus one quarter ago. What we can say is from a roughly a year ago, with the certification and support model that was in place versus doctors training last quarter, we are seeing a faster ramp, less time from completion of the cert course to first case and a faster ramp to multiple cases than we have seen in the past.

We think that is a reflection of better coverage of improving clinical education and improving clinical support and that is actually in advance of getting the product evolution in place which is going to further to accelerate that. When we get that the new ClinAssist product out which has really targeted that specific group, that newly certified Doc or the real low volume Doc that hasn't quite go over the learning curve yet. We think that ClinAssist is just going to really further lubricate that that adoption cycle. So we are seeing again, in other word, same-store growth, we call same practice growth, significant change year-over-year and we think it's the product of coverage, clinical education effectiveness. And we think in a year or so, we'll see the impact from product.

Derek Leckow - Barrington Investment

And how many of your doctors are now operating with the new ClinAssist software in their practice?

Tom Prescott

We have not sized the pilot yet, it is substantial. But before we go to release, it we will be large, large hundreds. We are out in a significant way with multiple versions of the software and the tools.

Derek Leckow - Barrington Investment

Okay. If I may ask one an additional question. On the tax rate, you guys were talking about making that termination sometime in 2008. So are you kind of telling us that we should be looking for rate in the range you provided for starting in '09, or is that too early should move that to 2010?

Ken Arola

No Derek, I think that's a fair assumption on your part.

Derek Leckow - Barrington Investment

Okay. All right. Thanks. But for 2009, then you will probably see that range, right?

Tom Prescott

Like I said, I think that will be a fair assumption on your part. We will be evaluating as we go through this year for the end of the year.

Derek Leckow - Barrington Investment

Okay. Thank you very much. Good luck.

Shirley Stacy

Thank you, Derek. Next question?

Operator

Our next question is from Matt Dolan with Roth Capital Partners. Please proceed with the question.

Matt Dolan - Roth Capital Partners

Hi, everyone. Good afternoon.

Tom Prescott

Hi, Matt. How are you?

Matt Dolan - Roth Capital Partners

Good. A follow on to your comments on the Q2 outlook relative to whole year, it looks like EPS will have to really kick in, in the back half of the year to maintain your guidance. Can you give us a feel for another operating expense line that we haven't talked about yet, the sales and marketing relative to the sales force? How many hit their quota in Q1 into that play in, and how should we look at that going forward for the year?

Tom Prescott

I guess, I really not get into detail break down of the distribution of comp payout for the reps, but what I was seeing in general is, if you are starting with Ken's description a moment ago on Q2 spend, the increase, there is a pretty significant chunk of that that is non-recurring, that was very much event based, where we expect to see some increasing spend in the Q3 and Q4 based on a normal planned headcount and program spending around key initiatives.

Some of that are marketing and dialing back a little bit on the marketing spend as the year progresses. We do not see any big surge on the sales side. We have made big investment. We incrementally had a few hedge here and there, as we trained doctors and evolved through the year.

But the biggest growth plan is to support product development, technology development and commercialization of those new products and that is a more linear effect. And there are opportunities to accelerate or slow that spend based on our relative broader priorities, how the business is doing, how our products and pilots are doing in market, and all sort of things like.

So, I think we have a reasonably good handle on discretionary spend. And again, there is this big chuck of spending in Q2 that does have an impact on Q2 EPS is very event-driven by a large number of very market focused activities.

Matt Dolan - Roth Capital Partners

Okay. That helps. Secondly on revenue line, first, can you give us a reminder of what happened in Q2 of '07 relative to the Patients First program? How should we be thinking of underlying growth relative to that?

And secondly, your deferred revenue guidance, just maybe a feel for why that came in relative to the initial uptick of your new product and I'll jump off. Thanks.

Ken Arola

Okay. Hi, Matt, this is Ken. Yeah, going back to your first question for quarter two of '07, if you recall we had about 4,000 cases in backlog that we shipped in quarter two in relation to the patient's first backlog that was traded. And that generated about $5 million or so of additional revenue in quarter two.

So, if you were to back off that and kind of normalize the quarter, the year-over-year growth for quarter two would more -- given the guidance we have out there would be in that 10% to 14% range year-over-year excluding that impact from Patients First.

Matt Dolan - Roth Capital Partners

Okay.

Ken Arola

Okay? And then….

Tom Prescott

And your second question, again, was--?

Matt Dolan - Roth Capital Partners

The deferred revenue, with the rational behind that what have you seen initially over Teen and ClinAssist to drop that a little bit?

Tom Prescott

Yeah. I think, when we frame that total annual guidance, we had some -- we have the pretty wide range because we had some uncertainty about whether or not we hit the mark with some of these new products that had been tested in concept and had a couple of different targets there.

The biggest piece, the deferred revenue component was ClinAssist. As we described, I think in our year end call while giving the guidance in January, much smaller components of deferred revenue respectively in Teen and Vivera.

And so, not much has changed in our view for those two and we have more market experience. Certainly, we're in market with Vivera, we're in substantial pilot with Teen. We continue to tune our view of how those are doing or what's excess or not excess. But as we really now have separated the two very different target groups of doctors and the usage environment for ClinAssist, we've tested it in concept more as one and what we found in pilot is it -- its too got a pretty different products based on the same base.

We decide that the most important priority was our starting point, which was to make sure doctor's work through the adoption cycle became confident effective quickly with using a complicated new product. So, we've put with the great learning and is a very positive outcome from our prospective. Because it's really confirmed, the impact and the leverage, those practices they've done it in pilot have gotten off to a very fast start and have gotten a lot of cases going quickly compared to the base line.

And so, that's our whole goal. If we can move them to five or 10 or more cases quickly, simply easy cases with ClinAssist shortly after certification, they're pretty much ready to go with Invisalign full, with some normal support and clinical support and help from the rep. The challenge is getting them over that hump and sometime that takes literally years.

So, we're focusing our efforts on getting ClinAssist offering out first and are evaluated. And because of that, it will be applied initially to a smaller group those newly certified docs and then in the segment of way going back to those lower volumes docs that haven't gotten over that hump. Rather than blowing it out broadly to the whole base we'll come back and we're evaluating now, how much resource, effort, et cetera, to put into that relative to other roadmap priorities, whether we should bring out a full ClinAssist all the way through moderately difficult cases through our whole base, and how that impact fits in relative to some of our other important priorities like Teen and elsewhere.

So that's the issue. Yeah, it's a little bit down in deferred revenue but we think it's a very good news story relative to our primary goal, which is getting an adoption growth.

Matt Dolan - Roth Capital Partners

Thanks, Tom. Okay. Thanks guys. Nice results.

Shirley Stacy

Okay. Thanks, Matt. Next question, please?

Operator

Our next question is from Spencer Nam with Summer Street Research Partners. Please proceed with your question.

Spencer Nam - Summer Street Research Partners

Hi. Thanks for taking my questions. Just a couple of good questions Invisalign Teen, when are you going to fully launch this in the U.S.?

Tom Prescott

We haven't put a date around, Spencer. We indicated that in Q2, we were substantially going to expand the pilot out to make sure we had a lot of our most experienced orthos using the product, making sure we had a very full and complete view of the product usage in environment. Again, our goals to become mainstream with this into the middle of orthodontists practice we want to make sure it must flow into that. So we haven't really described the full launch yet. We did defined as it would be a stage release following all the normal things we want to put in place with this expanded pilot in Q2 and that will be later in the year.

Spencer Nam - Summer Street Research Partners

We'll see that. And then deferred revenue, I know you've already commented a couple of times on this but should we expect some of that amount -- some of that deferred revenue to transfer over to the full revenue line this year?

Tom Prescott

That might be something that you could think about. But the way I think we need to think about it now is with the different way we are looking at ClinAssist and the fact that we are going after newly certified doctors and low volume doctors and the product is not going to be rolled out to more experienced doctors. Right now, our anticipation is that the more experienced doctors utilization related rates will not uptick significantly from where they are today, until we have additional product features incorporate into ClinAssist in the future and they have availability for that product.

Ken Arola

We are going to be a bit thoughtful and conservative and make the assumption that won't be a base business uptick this year.

Spencer Nam - Summer Street Research Partners

I see. And then one final quick question, pricing increase, can you guys give some guidance on what the range we should be thinking about or the percentage growth from where it is today for the rest of the year. How should we think about that?

Tom Prescott

Let me answer a high level question. I will ask Ken to come back to provide the outlook information. As far as price increase per say, we aren't planning any. In this constrained economic environment, we are trying to work with our doctors to make sure they can improve profitability using this product. I ask Ken to speak on how we see ASP evolving specifically through the year.

Ken Arola

Yeah, so Spencer, there are number of things that impact our ASPs as we go quarter over quarter, time to time. Certainly, there is a volume impact related to full cases and express case mixes that we shift every quarter. There is also the volume rebate program where doctors have to qualify percent levels of rebate and then as typically impacts related to case refinements in relation to full cases. So, as we see increases in full case shipments that have case refinements associated with them, we defer more revenue in that subsequent quarter where we see the increase in volumes.

If doctors as we saw in quarter one do not reach the tiers, so they can qualify for more significant rebate. In our rebate program, we actually in the quarter issued less rebates to fewer doctors in quarter one. Our anticipation as we go into quarter two as we will issue actually more rebate as we have increased volume, and the anticipation is that the doctors will be working to reach those higher tiers and get a larger volume rebate from us.

So those are fluctuations that you will see quarter-over-quarter and we also potentially have, depending on what's going on with international exchange rates, you have going into the overall ASPs. I would look at it at this point going forward for quarter two as it indicates slightly decreasing ASPs as we see, are anticipating more doctors participating in the rebate program plus shipping more full cases and we will see how it goes in the year but I would say to be probably somewhat comparable.

Spencer Nam - Summer Street Research Partners

Thanks very much.

Ken Arola

Thank you.

Shirley Stacy

Thank you, Spencer. Next question?

Operator

Our next question is from Tao Levy with Deutsche Bank. Please proceed with your question.

Seth Waugh - Deutsche Bank

Hi guys, this is Seth for Tao. Thanks for taking my question.

Tom Prescott

Hey Seth.

Ken Arola

Hey Seth.

Seth Waugh - Deutsche Bank

First couple of financial questions, I guess, the DSO was up a little bit, I think, you said the 57 days, could you help explain that? And also it looks like the international channel, pricing was down sequentially. And I know you said you had FX helping out there. So wanted to maybe get a little more color, what's causing the pressure on price there?

Ken Arola

So, let me take your second question first on international pricing. What you saw from quarter four to quarter one in the trend there was in quarter four, we actually do a lot of true up of our case facts that, we had doctor signed up for an Europe. So there is an impact to the overall ASP when you look it from a quarter-to-quarter basis and you saw that trend down to either favorable uptick in quarter four related to that true up. The overall ASPs in Europe in general over the quarter have increased a little bit into the quarter and then came out of the quarter, so we had a little bit of uptick in revenue associated with that exchange rate.

As far as volume is concerned over on the international front, rep volume in relation to Europe was relatively flat, actually slightly down a few 100 cases may be quarter-over-quarter. We saw an uptick in our distributors that we transition to so for Asia-Pac and Latin America. In 2007, we transition to a distributor model where we had internal managing directors to take over the business as a third-party. They actually had an uptick in volumes, but we are selling to those customers at a distributor price instead of a full list price, so you see a little impact there on ASPs. Okay. Lastly, there is a pricing challenge in the UK.

Seth Waugh - Deutsche Bank

And then DSOs?

Tom Prescott

Yeah, DSOs really that is an impact of, more shipments coming in the later two-thirds of the quarter than the first of the quarter. Our aging is actually in excellent shape. So, I am concerned about, that I think we'll be bumping around in that 55 to 57 range here going forward.

Seth Waugh - Deutsche Bank

Okay. And then back to the Teen product, I assume the rollout is into the -- when it happens it will into the worker channel not into the GPs or do you plan on releasing it to the heavier volume GPs as well?

Tom Prescott

I said that's correct, the former. This is an Ortho product. And that said, there are GPs that have an Ortho practice. This is a real orthodontic product at the mainstream of their practice, which is teens and kids. And so as we launch this and you could see by our description in our call we are going out to a large group of our most experienced orthodontic customers.

So our goal is to earn the opportunity to gain a much bigger share, their chair, their practice and to increase our potential served market. We are going to have opportunities, it's not going to be a quick overnight things, we are going to have earn our way and these are practices they have lowest average behaviors. But with the feedback we gotten so far, we think this product really appeals to the practices that are using Invisalign and which certainly appeals to the Teens. And so we are going to roll it out at orthodontic practices.

Seth Waugh - Deutsche Bank

Okay. One last housekeeping question, the Vivera product, is it recorded in other and are you going to break that out eventually?

Ken Arola

You know it is recorded in our other category right now. As we move forward and the volumes become more significant, that is something we will consider doing.

Tom Prescott

I would love that, if that becomes big enough to have a stand out in France.

Seth Waugh - Deutsche Bank

Sure. Thank you for taking the questions.

Tom Prescott

Thanks, Jeff.

Shirley Stacy

Next question, please?

Operator

Our next question is from Anthony Ostrea with GMP Securities. Please proceed with your question.

Anthony Ostrea - GMP Securities

I just wanted to ask about your comment on TV and web-based advertising, I think you said more TV in the front half of the year versus the back half of the year. Can you maybe just comment on the mix between that advertising mix this year versus last year? And also, maybe what the relative productivity of each of those media are in terms of case volumes?

Tom Prescott

Sure. Let's start with leads -- qualified leads, which flow into case volumes and we've had a number of years to be able to test and kind of verify our payback, our productivity inward. Starting with TV, because the balloon campaign was getting a bit faded, a bit tired, we were metering our investment in that campaign was 2.5 years old and we're using it. It was having impact, but it was showing some signs of fatigue. So, we are already metering down our relative spend last year on that, and productivity was flattening.

The small makes a difference is showing a wonderful productivity improvement over that. When we look at all the metrics we compare to test, once we test it and released it, we're only month or two into it and we're already having a very significant impact. All the normal measures we look in terms of doctors searches, qualified lead responses and an initially case starts from some of those already are showing to be better than even back when we first rolled out balloon.

And now comparisons are difficult because we are in a competitive situation and we certainly didn't capture all that demand. So, as we look forward and we certainly haven't described things like internal things we track like conversion rates, but we are very pleased with what we see so far from this new campaign. And Q2 and into some part of Q3, we're investing pretty significantly to get the right kind of math, what we call, reaching frequency out there.

We believe we know the math very well about what that turns into, what qualifies leads turn into where case starts, but we are going to attract that to make sure we are getting that productivity or better. When we start looking at the other things they go along with that between point of sale materials, print in magazines, some media, radial media. They are effective but in a different way. Collectively, we have targeted this mix so we test this mix for certain impact.

Then, we look to see, how may leads, how many responses, how many qualified leads, and then what the case flow is out of that? We actually go back and test this with the people that they start it or did not start a case. So, our process haven't changed, our mix of tools have changed, and we are using some more cost-effective approaches in some new forms of print and especially in, digital approaches with some very new ways, which are now we're going to get into detail, we're still testing the total productivity of those, but they are dramatically less expensive to use.

So our goal is to create the demand and awareness and then be able to really harvest some of that with more digital techniques later in the year, in the heat of the election campaign and all that. So we can more cost-effectively stand in front of our customers and their patients. But, again, we're going to continue to track productivity. So far it looks really very good in the new campaign.

Anthony Ostrea - GMP Securities

Great. Thanks a lot.

Shirley Stacy

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

Operator

Our final question is from Isaac Ro with Leerink Swann & Company. Please proceed with your question.

Isaac Ro - Leerink Swann & Company

Hey, guys. Thanks for squeezing me in.

Shirley Stacy

Of course.

Tom Prescott

Yeah. Hi, Issac.

Isaac Ro - Leerink Swann & company

Hi. So I will ask you two part question. First would be, just trying to get comfortable with your guidance as it relates to the back half of the year and you know, just back of the envelope, when I look at past few years, typical kind of jump up in the back half has been maybe like 50 to 100 basis points in your total revenue kind of weighted to the back-half.

Given the reiteration of guidance, it looks like you are looking for, perhaps, a 200 basis point swing to the back half that causes 52% change. Is there a new element to your seasonality that you are seeing, that gives you confidence that those volumes can kind of ramp accordingly in the back half?

Ken Arola

Sorry. I would not necessarily say new thinking, what I would say is that as we think about going through the summer months, typically, you'll see slower cast receipts coming in quarter three over quarter two. We had some learning experiences last year that I would point to also in the summer months where doctors where the office or patients where the office and we had the case receipts did not pick up after the Labor Day weekend as we originally anticipated. We are going to be more mindful of that this year as we go through the summer months and we're looking at making sure the sales folks are coordinating with their doctors on their travel plans, their vacations, and when they're going to have their offices open and close in relation to the summer. We will see how that goes. This should be a first time that we're really taking a more serious look at that.

The other things that we are looking is getting a lot of benefit from in the second half of the year, are the 20 somewhat headcount we added at the end of the fiscal 2007. We disrupted a number of territories as we talked about and with those reps now coming at the speed as we move to the first half of the year, which should see a lot more productivity as those guys has moved into quarter four. And a lot of that go to market initiatives that we have going on in the sales organization with business reviews, with the doctor's that we think and drive the most volumes and has sales force effectiveness. Making sure the sale guys are tapping into the doctors coming at the training classes that they think that can be the most productive and targeting them and going after them to help them increase their volumes and their practices sooner than later.

So, those are some of the key initiatives and also the TV media advertisement that Tom talked about a little while ago, that's picked up pretty significantly here and we should start seeing some impact to that over the second half of the year as well.

Ken Arola

And if we add to that, typically Q4 for the increasingly significant international businesses, they're typically the strongest quarter of the year.

Isaac Ro - Leerink Swann & company

Okay. So this is a follow-up on the TV media ad spend, just given the Olympics and the fact that it's an election year, how does this affect the rates that you guys are paying for that ad space and to what extent have you guys locked up that ad inventory over the balances of the year?

Tom Prescott

We have already bought that space as dedicated space, and I am trying to buy remnants, we are and we've already planned our mix to evolve away from being on as much TV as we approach the election and working a bit around the Olympics.

Again, buying significant blocks that matter and doing it in a way that organizes that through the year is more efficient in terms of media buy. That said, we're not a big media buyer like Procter & Gamble like billions of dollars a year, but is meaningful enough that we can lock in reasonable rates, further things we want to do.

Again, we said, we're migrating away, relying less on TV as the year evolves, relying more on print, some radio and certainly some new web-based approaches that appeared to paying up but we have a more work to do before we're ready to say they are as productive as traditional media.

Isaac Ro - Leerink Swann & company

Okay. Thanks very much.

Tom Prescott

Take care.

Isaac Ro - Leerink Swann & company

All right.

Operator

Thanks, Issac. And thank you everyone for joining us today. This concludes our conference call. We look forward to speaking to you again at upcoming events including the Deutsche Bank Healthcare Conference on May 6th. As always, our conference presentation and breakouts are available on our webcast at www.investoraligntech.com. If you have any further questions, please contact Investor Relations. Have a great day.

Operator

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Align Technology Inc. Q1 2008 Earnings Call Transcript
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