Ladies and gentlemen, thank you for standing by and welcome to the Align Technology second 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 Shirley Stacy of Align Technology. Ms. Stacy, you may begin.
Good afternoon and thank you for joining us. I am Shirley Stacy, Senior Director of Investor Relations. Joining me today is Tom Prescott, President and CEO; Ken Arola, Vice President and CFO and Darrell Zoromski, Vice President of Global Marketing.
Before we begin, let me cover some housekeeping items. We issued two press releases today, PR Newswire and First Call; one detailing Align's second quarter fiscal 2008 financial results and the second release announcing the general availability of the Invisalign Teen. 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 PM Eastern Time through 5:30 PM Eastern Time on August 12, 2008. To access the telephone replay, domestic callers should dial 877-660-6853 with account number 292 followed by pound and conference number 289687 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 third quarter and full fiscal year 2008. 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 quarter ended March 31, 2008 and 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.
Please also note now the conference call we will provide listeners with several financial metrics determined on a non-GAAP basis for comparisons to previous quarters. Most of these items together with the corresponding GAAP numbers and a reconciliations to the comparable GAAP financial measures where practical are contained in today's financial results press release, which we have posted on our website at investor.aligntech.com under financial releases, and have furnished to the SEC on Form 8-K. We encourage listeners to review these items.
We have also posted a ten quarter GAAP revenue model and financial results webcast live 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?
Good afternoon, everyone. I am pleased with our solid performance in the second quarter despite an ever more challenging economic environment for our doctors and their patients. In Q2, we continued to execute on our strategic initiatives including today's launch of Invisalign Teen following the successful pilot of the product.
On the call today, I would like to cover the highlights of our Q2 performance and review the three critical levers that are driving our business. Darrell will elaborate on the launch of Invisalign Teen, which we announced in conjunction with today's earnings announcement. Ken will then follow with more detail on our financial results and discuss the cost cutting programs we are implementing to reduce expenses and tighten our belts given the soft economy.
Now for the highlights from the second quarter. Net revenue was a record $79.9 million, an increase of 6.9% sequentially and 4.3% year-over-year. Q2 case shipments were 54,900 compared to 51,800 in Q1 2008 and 55,000 in Q2 2007. Recall that in Q2 last year, we shipped an additional 4,000 cases or 5.2 million from the reduction in backlog in cycle times caused by the allocation of capacity to the Patients First Program. When we subtract the approximately 4,000 cases of backlog shipped in Q2 2007, we get a baseline of approximately 51,000 cases that could be used to provide a more apples-to-apples comparison for our growth this quarter over the same period last year.
Let me now give you a brief update on the three strategic levers that are driving our business: Product innovation, including the launch of Invisalign Teen, adoption growth in the trends and utilization or same practice sales among our core group of Invisalign doctors and consumer demand.
Let's start with product innovation. We continue to make progress in this front, both with recently launched products and with our pilot programs where we test final features and configuration prior to release. We are now through the second quarter of general availability of the Vivera retainers. Our focus is on expanding trial Vivera across our customer base and driving whole practice conversion such that Vivera becomes a meaningful portion of our customer's retainer business overtime.
New trials and utilization are up for both GP and Ortho practices, and we continue to see many practices converting their retainer business to Vivera after initial trial. In fact one of our doctors went from three subscriptions in Q1 to 77 in Q2. While not a big revenue contributor at this point, we are pleased with continued growth from Vivera.
We also remain pleased with the progress and feedback from the pilot of Invisalign ClinAssist, which is intended to help newly certified and low volume Invisalign GP dentists become confident more quickly and speed the adoption of Invisalign into their practice.
We continue to receive positive feedback from the ClinAssist pilot group and are expanding the scope of the pilot to include key opinion leaders and educators in dentistry so we can gain their feedback and early support. ClinAssist is on track and targeted for general availability later this year. The most significant product update we have to share this quarter is the general availability of Invisalign Teen, which was also announced today.
I will turn the call over to Darrell Zoromski, our VP of Global Global Marketing so that he can spend a few minutes discussing what we learned from the Teen pilot and provide more details in the launch of Invisalign Teen. Darrell?
Thanks, Tom. We are excited about the launch of Invisalign Teen and its long-term potential for increasing our share of chair in Orthodontic case starts. Teenagers are a significant part of Orthodontist practices. The American Association of Orthodontists estimates that patients age 12 to 17 represent half of the more than 2 million Ortho case starts in the US each year.
Until now, only a small number of doctors have treated their non-adult patients, ages 12 to 17 with Invisalign. The most often cited barriers to treatment have been patient compliance and the need to accommodate permanent teeth that are still erupting or coming in.
With Invisalign Teen, we have addressed these potential barriers to treatment so that Orthodontists will have confidence that they can treat their teen patients successfully with Invisalign.
Compliance, which we define as teenagers wearing a removable appliances as much as they should is one of the most important issues we have addressed. You have got to wear the aligners as directed, about 22 hours or more per day for optimal results.
Teen aligners include compliance indicator to help doctors, parents and patients monitor Aligner wear. When the Aligner is worn as directed, the indicator, which looks like a small blue dot on the Aligner, will fade from dark blue to light blue or clear over the two week wear period.
Another way we help ensure continuous Align wear is by providing up to six free single-arch replacement Aligners during active treatment to accommodate any Aligner loss or damage.
We have also tackled some of the clinical issues that doctors have previously considered challenges in Teen treatment. Invisalign Teen aligners can accommodate growth of permanent teeth that are still coming in or erupting during treatment, with specially engineered eruption tabs that provide room for second molars to continue growing in.
Invisalign Teen aligners also include a new feature called Power Ridges, which are designed to provide additional force in cases where certain types of root movement are prescribed. Power Ridges are engineered into the Aligner shape and in specific types of cases are used instead of the attachments that are traditionally bonded on to the teeth to help achieve difficult tooth movements.
It will take some time for Orthodontists to see the results of their initial Teen cases and really start to embrace the product, but we are pleased with the positive feedback we have received to date from our customers who participated in the Teen pilot.
In February, we began our initial pilot with about 100 select Orthodontists. In June, we expanded the pilot to include over 300 of our most experienced Orthodontists nationwide. Our goal was to familiarize the participants with Teen's features in advance of the full launch.
The total amount of cases we shipped for the pilot in Q2 was not material, but some of our high volume practices started up to 16 teens in treatment during the pilot period. Our goal over the next six months to 18 months is to gain initial trial among our core Orthodontist customers, approximately 3,000 or so doctors.
Similar to Vivera, we expect Invisalign Teen to ramp gradually overtime as doctors experience outstanding clinical results with the product that we know it can deliver. Orthodontists are conservative by nature and Teen cases make up the vast majority of their business, so we expect them to adopt new Teen Invisalign slowly after they experience multiple successful treatment outcomes.
As a result, our near-term expectations for Teen are very conservative. We recently updated our view of the total available US market for Invisalign based on data from the third national health and nutrition examination survey that was published in an article by Dr. William Proffit.
Proffit is a distinguished professor at the University of North Carolina, Chapel Hill and the author of contemporary Orthodontics. Now the most widely used text in Orthodontics. We use this in the frequency and prevalence of malocclusion in adults and teens to determine the percent of annual US Orthodontist case starts that are applicable to Invisalign treatment.
Previously, we only considered Class I, which is primarily simple crowning cases; however, based on our own data which shows we also treat mild Class 2 for moderately difficult cases we are now including both in determining the total available reserved market for Invisalign.
You can see in the corresponding conference call slides the total available market for Invisalign has increased from about 900,000 annual case starts to approximately $1.2 million. Roughly 26% of the available market is adults and 74% is teens. The bottom line is that we now believe our served market is even larger, and with Invisalign Teen, we will be better equipped to compete for more case starts.
We expect to increase our share of applicable Teen case starts and we are investing the time and effort to do just that. Our other Orthodontic customers are a bit conservative for good reason given how large the mix of teens are in the base business, so we expect our share gains to play out over the number of years.
Over the long-term, we believe adoption will accelerate and there is no reason why Invisalign can not become a substantial part of the Teen market. After all, what Teen would not rather have Invisalign instead of traditional treatment? Over two-thirds in fact, according to our recent survey of 800 teens that showed Invisalign was the top choice for the majority of teens considering teeth straightening treatment. Building and capitalizing on that preference is part of our long term plan to be a bigger part of Orthodontic practices.
Now back to Tom.
Thanks, Darrell. Let's move now to our second strategic lever for growth, utilization and adoption. We continue to focus on adoption of Invisalign through training and certifying new practices as well as increasing utilization or same practice sales of our products.
On a sequential basis, we saw a slight increase from Q1 across the board for US Orthos, US GPs and for international. On a year-over-year basis, utilization declined except for international. However as I said earlier, comparisons last year are not apples-to-apples due to backlog.
Utilization among our core group of high volume Orthos grew sequentially and year-over-year. Nearly 100 Orthos submitted 25 or more cases during Q2, which is the highest ever and one Ortho submitted 123 cases in Q2 alone, the highest quarterly submission from one doctor ever. It is too early to tell whether the Teen pilot was a catalyst for these top submitters but it clearly added excitement and energy to those practices.
For US GPs, we have the largest number of total submitters in our history for the third quarter in a row. The number of new submitting GPs remains consistent but we did see a drop off in the number of cases per newly certified doctor, the lowest in some time. It is hard to know for sure, but we believe this may reflect the impact the economy is having on less experienced GPs. International growth in utilization was strong sequentially and year-over-year even with a significant increase in the number of newly certified doctors.
The third strategic lever for growth is consumer demand and on that front, we continue to drive awareness of invisible braces as well as consumer motivation to seek treatment using a mix of media including television, radio, print, and web-based approaches. Our new campaign, which we call "A Smile Changes Everything is doing well by all key measures aided and unaided awareness, reach, frequency as well as total qualified responses.
Qualified responses and lead conversion both increase sequentially from Q1; however we may not see those leads turn into actual cases for up to 12 months. All three of these strategic levers, product innovation, adoption, and utilization, as well as consumer demand, are critical to our long-term growth. As we deliver on our product roadmap and create the opportunity to increase our share of our doctor's procedure mix, we expect to see utilization increase as well.
Continuing to convert consumers into qualified leads for our doctors by building brand awareness and preference for Invisalign treatment also encourages doctors to make Invisalign an even bigger part of their practice. These strategic levers are complimentary and long-term in nature, so while we report (inaudible) almost each quarter we also assess results against our long-term strategic plan.
Given the weak economy we have considered whether we should reduce spending on consumer demand creation. Based on our conversion rates, the net present value for this brand building investment remains positive, despite the current environment, so, we will continue this initiative while we monitor results and evaluate strategic impact on an ongoing basis.
Before I turn the call over to Ken for an overview of our financial performance and outlook, I would like to make several general comments about the economy and how our perspective on consumer spending is driving an increasingly conservative view for the quarters ahead.
When we set expectations for the year, we were cautious about the broader economic environment and a potential for consumer spending slowdown. Despite positive indicators, in a form of quantitative and qualitative data, from customers and consumers regarding their intentions to increase Invisalign in practice or to seek treatment, we adopted a more conservative outlook.
For that conservative outlook in hand, we commend a continued investment in the key strategic initiatives that we have been discussing. As consumer spending has continued to soften, so has our outlook for revenue growth. As a result, we are reducing overall company spending, and slowing headcount growth while preserving the important investments in strategic priorities. Ken will cover the details in just a moment.
Finally, we just completed our annual strategic review of the business and are confident we have the right long-term strategy. We intend to provide a more complete view of this strategy and how our business model will evolve during analyst meeting in November that will be held in conjunction with our Invisalign Summit for Orthos. Please look for a "save-to-date" announcement some time next month.
I am going to close here and turn the call over to Ken. Ken?
Thanks, Tom. Now, let's review our second quarter financial results in more detail beginning with the income statement. Q2 revenues of $79.9 million increased 6.9% sequentially and 4.3% year-over-year. The sequential revenue growth reflects a 6% increase in case volumes with worldwide ASPs being comparable to last quarter.
Q2 gross margin was 74.7% compared to 73.8% in quarter one and 73.6% in the same quarter last year. Q2 gross margin also included $471,000 in stock-based compensation expense compared to $390,000 in quarter one, and $210,000 in the same quarter of last year. The sequential increase in gross margin reflects higher case volumes and improved operating efficiencies.
Q2 operating expense was $55.8 million compared to $50.5 million in quarter one and $42.9 million in the same quarter last year. As a reminder, Q2 2007 operating expense included a one-time, $1.6 million credit for an insurance reimbursement of legal costs associated with OrthoClear.
The sequential increase in Q2 operating expense reflects a full quarter of TV media spending related to our new advertising campaign, costs associated with our go to market initiatives and marketing programs, and our continued investment in product development and process improvement. In Q2, two of our three annual Invisalign customer summits occurred as well as our largest Ortho trade show of the year, the AAO.
Q2 operating expense included $4.3 million of stock-based compensation compared to $3.6 million in quarter one and $2.7 million in the same quarter last year. Q2 EPS was $0.06 compared to $0.07 in quarter one and $0.19 in quarter two, 2007.
Taking a look at the balance sheet, cash, cash equivalents and short-term marketable securities were $110.1 million compared to $127.9 million at the end of 2007.
Cash from operations in quarter two was approximately $10 million compared to $3 million in quarter one and $13 million in the same quarter last year. Q2 DSOs were 57 days, unchanged from quarter one and compared to 55 days in the same quarter of last year. As you may recall, last quarter we announced that our Board of Directors had authorized a stock repurchase program of up to $50 million. As of the end of Q2, we repurchased 2.2 million shares at an average price of $12.65 per share for a total of $27.7 million. We have $22.3 million remaining under the authorization.
Now, let me turn to our outlook. Before I do so, I would like to provide a few general comments. As mentioned, we believe that the continuing challenges in the US economy and weak consumer spending will continue.
Given this environment, we are more cautious about our ability to accelerate growth in our base business over the back half of the year. The drivers that we described on our Q1 call that would contribute to increased growth, sales force expansion, consumer demand creation, and excitement around new products are in place, but we are not anticipating a lift in the second half as we expected. Additionally, we are now taking a more conservative view of the adoption and initial ramp of new products into doctor's practices.
We are expecting gross margins in the second half of 2008 to be impacted approximately 50 basis points from increases in fuel surcharges and aligner raw material costs. Operating expense guidance reflects the cost savings measure s we are implementing across the company, including a reduction of 38 full-time headcount, a significant slowing of headcount growth over the remainder of the year and discretionary spending cuts. These initial actions will have the effect of reducing expenses by $5 million to $6 million over the second half of the year in selected areas while allowing the company to continue critical investments in our new products and strategic initiatives.
Additionally, we are implementing a phased consolidation of our order acquisition operations from Santa Clara to Juarez, Mexico. We anticipate completing this consolidation by the end of 2008 at which time an additional 29 physicians in Santa Clara will be eliminated. Annualized cost savings of approximately $1 million to $1.5 million from this action will be realized in 2009.
These combined actions will result in a restructuring charge estimated to be approximately $2.6 million in the second half of fiscal 2008 of which roughly $2.2 million will be recognized in quarter three. Last, the effects of any additional stock repurchases are not reflected in this outlook.
With that said, our outlook is as follows. For Q3, we expect revenues to be in a range of $74 million $76 million on case volume of 51,000 to 53,000 thousand cases. We expect Q3 worldwide ASPs to remain consistent with the first half of 2008. We expect Q3 gross margin to be in a range of 73.6% to 74.4% and is expected to include $400,000 in stock based compensation expense.
In Q3, we expect GAAP operating expense to be in a range of $53.7 million-$55.2 million. This reflects the cost savings I just described as well as approximately $2.2 million of the estimated $2.6 million restructuring charge. Excluding the restructuring charge, we expect non-GAAP operating expense to be in a range of $51.5 to $53 million.
Q3 operating expense is also expected to include $4.3 million in stock based compensation expense. For Q3, we expect GAAP EPS to be between $.01 and $.03. We expect non-GAAP EPS to be between $.04 and $.06. We expect diluted shares outstanding in quarter three to be approximately 70 million shares.
For fiscal year 2008, we expect revenue to be in the range of approximately $309 to $314 million on case volumes of 213,000 to 216,500 cases. We expect deferred revenue to increase in a range of $5 million to $8 million, primarily relating to the introduction of new products.
As a result, total deferred revenue on the balance sheet is expected to be in a range of approximately $17 million to $20 million by the end of 2008. We expect GAAP gross margin for fiscal 2008 to be in a range of 73.7% to 74.2% and is expected to include $1.7 million in stock based compensation expense.
We expect fiscal 2008 GAAP operating expense to be in a range of approximately $210.8 million to $213.8 million. This reflects cost savings of $5 million to $6 million over the second half of the year and an estimated $2.6 million restructuring charge.
Excluding the restructuring charge, we expect non-GAAP operating expense to be in a range of $208.2 million to $211.2 million. Fiscal 2008 operating expense is also expected to include $17.9 million in stock-based compensation expense.
We expect fiscal 2008 GAAP EPS to be between $0.26 and $0.30. We expect non-GAAP EPS to be between $0.29 and $0.33. We expect diluted shares outstanding for the full year 2008 to be approximately 70 million shares. From a balance sheet standpoint, we expect to continue to generate positive cash flows and expect to end 2008 with $130 million to $135 million in the bank.
In summary, we had a good quarter and I am pleased with our results. Our outlook for growth is not as robust as we had planned, but in this economic environment we believe it is reasonable. We are committed to delivering shareholder value and are positioning the company for increased growth and profitability as the market improves.
The cost saving actions we announced today are only the first steps inactively reducing our cost structure and moving towards a financial model with greater operating leverage. Beyond this year, as we deliver on product innovation and gain efficiencies from productivity and process improvements, we have a great opportunity to flatten our expense growth and take structural costs out of the business.
Now, let's go back to the operator for Q&A.
(Operator Instructions). Our first question is coming from Taylor Harris with JPMorgan. Please state your question.
Taylor Harris - JPMorgan
Thank you. Tom, why don't you just walk us through what you saw as the quarter progressed that specifically has given you a reduced outlook for the back half of the year. I think as we add up what you did in the first half of the year, it's probably a little above your plan from when you started the year, so did things just slow down as you moved through the quarter? Can you help us out with that?
Sure, Taylor. Well I guess the last time we were really out speaking was in May where we had a lot of interaction with our owners, and at the time in May we were just coming off a series of large tradeshows and several summits both in Europe and in the US. And our doctors were still very, very bullish about the economy, even as we were doing some survey work and with all of the underlying economic data that seemed to point to that direction.
What we find still is our doctors remain optimistic on Invisalign. We don't think they're always the keenest observers of the broader economic environment and they tend to be more reactive when patients come in the door.
What I'd say is in general, the biggest quantitative impact has been on the lower volume doctors and a less experienced G Ps that are, as we dig into it, are less likely to want to lead with an expensive procedure hike Invisalign or any other major restorative procedure and there are likely less fewer consumers in the normal flow through of the offices that are initiating those discussions for those more expensive procedures like Invisalign, and there for we really see that more passive GP, low volume Invisalign GP, really not leading with Invisalign.
The higher volume orthos, higher volume GPs seem to in general have schedules that are fuller, but almost across the board, we hear reports of procedure volumes down and patients deferring more expensive procedure, so we think it's despite the steps we took to build volume in the second half, to build out the sales force and our planning and expectations initially expected to get a lift from productivity in the second half, the consumer demand and the other elements along with some excitement from new products, we think we're being appropriately cautious to pullback a bit on those expectations and reflect the less growth in the second half.
Taylor Harris - JPMorgan
Okay. I guess is it possible to know for sure that it is the economy that's creating a headwind. This is sort of where the business has reached a steady state and it's hard for the investments that you're making to change that. As I think about longer term, that the question is, is this a business that once you get through a tough economic spell, can grow, and I'm just wondering have you been able to assess that? How thoroughly have you been able to assess that? Where do you think you are in that process?
Sure. Well I guess the first thing, there's a great book out called the Black Swan and what it really goes through is you can't know what you don't know, and where events occur that any forecasting models don't provide for. This economy evolution is clearly discontinuous. We thought we were being conservative and cautious as we put our annual guidance together and we didn't get it right and our views unfolded through the year. If I step back from that reality, and how we're going to manage the business, given a more constrained economic environment, if we do better than that, wonderful. But we're expecting a little more headwind.
All of the underlying factors that point to this huge market , enormous demand for Invisalign, we quarterly do a tracking survey against a very detailed baseline we created to look at doctors interest and expectation to expand Invisalign, orthos and GPs, high, medium and low volume, as well as consumers, and as well as patients that are in treatment. Nothing has changed, no inflection points have occurred, and in fact they rate that even more highly than many of their expensive procedures, whether it be plastic surgery, or whether it's other aesthetic opportunities for patients; so none of the underlying factors that point to very small penetration into a very big space have changed.
We believe this is just a very significant challenging economic time. We're having consumers take a pause here. That said, we're still continuing to deliver significant volume to the business and patients love their treatment as well as doctors actually using this. The higher volume practices tend to push through tougher times. Anecdotally, we do hear that there are some procedures across the board in dentistry that are down. It's hard to quantify that. It will be better to see that with some more rear view mirror data here in the next couple quarters.
Taylor Harris - JPMorgan
Okay, last question if I can. How many cases are you expecting from Teen in the second half of the year and then Ken, maybe explain why deferred revenue is increasing despite the fact that you're expecting less from new products.
I'll maybe start, and I'll ask Darrell to add-on to what I'm suggesting about Teen. As these elements of these new products become more material, we will expect to start reporting on them in total. Maybe I'll ask Darrell to build on that a little bit and project how we think this plays out over the next three to six quarters and why we think it's a gradual ramp.
Yeah. Teen, we are very excited about and where it can take the business over the next six months to 18 months based on the pilot results we've seen over the past three or four. One key insight that we have gotten is there is a fairly slow adoption of new product, new technology in the orthodontic industry in general, and as we sort of dug into it to understand specifically why would that be, in the case of Teen, it was largely because this is where the majority of the business is done and for the orthodontist to really trust the product, they need to see the successful outcomes we know they will see with our Teen product, but it will take six months to 18 months for them to actually see that occur, and then we believe we'll see increased repeat rates based on its success.
So we're being conservative in our forecast and believe in the product, we believe the orthodontists will believe in it as well, but they're going to have to see the actual treatment completed to be able to have confidence in repeating.
And then Taylor I think you directed a question to Ken at the end.
Yeah, Taylor the other question on why is deferred revenue increasing over the year. We pointed out earlier in the year in various conference calls that we will have deferred revenue components related to the Teen product as well as ClinAssist and Vivera, so as Vivera has started to ramp a little bit during the year, although slower than we thought, we had some build up of deferred revenue there with Teen being launched here, a portion of that revenue will be deferred as we go forward, as well as ClinAssist like I mentioned in previous calls, going into the year, our annual guidance was $9 million to $18 million, I believe, in revenue before associated with new products plus just standard case refinement.
Last quarter, we brought it down to $6 million to $9 million and this quarter we just moderated it a little bit and brought it down to $5 million to $8 million.
So it's reflecting a new product, that volume is in products but not yet recognized, Taylor.
Taylor Harris - JPMorgan
Right. Okay. I thought you had lifted your deferred revenue, okay, so it's a lower contribution, it's a lower…
Lower contribution than our original guidance was at the beginning of the year and a little bit lower than we actually guided to last quarter.
And consistent with lowering the second half in general.
Taylor Harris - JPMorgan
Okay, that makes sense and so Teen, it sounds like a few thousand cases, is that fair?
We aren't going to put a framework around that Taylor. When it becomes meaningful enough and we're going to have multiple new products rolling out at different stages of adoption, we will start laying out an appropriate level of detail, both so you can understand what that adoption cycle looks like and then secondarily as they start to become material as individual products.
Taylor Harris - JPMorgan
Okay, thank you.
Thanks Taylor, next question, please?
Our next question is from Tao Levy with Deutsche Bank. Please state your question
Tao Levy - Deutsche Bank
Hi, good afternoon.
Tao Levy - Deutsche Bank
Have you guys disclosed what the ASP is of Teen?
Yes, we have.
So, Teen is roughly $100 premium to our current full product at $1,599, excluding any discounts or special programs.
Tao Levy - Deutsche Bank
Okay, and as the year goes on, and obviously you've brought your numbers down a little bit, how does it affect sales force compensation? Are they still going to be held to their prior targets, and if so, how do you get them motivated to go out and sell?
Well, Tao, we adjust targets quarterly as we unfold, and if we aren't making our numbers consistent with our expectations, they probably aren't making there's. Let me tell you. What gets them excited is new products and the opportunity to change an industry and they're out there working their tails off doing a really, really good job. Pioneering new products in this space, so, I think they're very jazzed about what's going on. They love Teen. They like Vivera as a nice compliment to the existing practices. They have their eye on ClinAssist coming out later this year for the GP practices, especially low volume or newly certified practices.
So, I think we're just getting to the point where it's going to be fun for them, but let's face it, in a difficult time, they just got to scratch and claw for that share, but they're incentivized to beat their numbers, not just make them.
Tao Levy - Deutsche Bank
Okay. And obviously we're about six months out since the first Teen patient. What are you seeing specifically that's giving you sort of the confidence that six months is enough, and that some of the doctors that already have these patients are using Teen more or less. Any thoughts around that would be helpful.
Yeah. We've been in pretty consistent contact with the pilot, doctors asking them about how the feature set, the new feature set is delivering on their expectations, if there's any feedback from their patients and all of the feedback we've gotten both from the doctor and patients who are in this pilot has been positive.
So all our expectations of the Teen product, we're delivering to the plan that we had for it across the board, so we haven't seen anything that would lead us to believe it's not going to be able to deliver what we're estimating.
And specifically, the features that we design based on explicit feedback from these ortho groups that dealt with those issues versus our existing core product are working as advertised and they're seeing good results in terms of managing through these cases.
Tao Levy - Deutsche Bank
Great, And just lastly, you did mention in Japan on this call, what's the latest thoughts on launching fully in Japan?
Sure. The team on a very small base there continues to make some progress on a very small volume, we continue to work, while the changes that have gone on in the regulatory environment, we continue to work in point towards clearance. We hope the remainder of this year, and what I would say is, well, in conjunction with our Analyst Day, which we're going to hold in November, we're going to take a deeper dive into a long-term view about how we believe growth outside the US will unfold.
Japan will be part of that, we think that will be a longer-term journey for Japan, but Europe continues to outpace the US by some significant margin. On a small base, some of these other countries are outgrowing the US on their volume, and so we're looking forward to laying out more information about this when we get all of you in room November for that Analyst day.
Tao Levy - Deutsche Bank
Thanks a lot.
Next question, please?
Our next question is from Matt Dolan with Roth Capital. Please State your question.
Matt Dolan - Roth Capital
Hi, guys, good afternoon.
Following up on what's going on here in terms of your reduced outlook. It seems that relative to the metrics when we look at that everything, utilization, training, those types of indicators were all at the highest level they've been sequentially here in a while Tom, so from your comments were you indicating that new users or low volume docs are taking longer to start up and that's kind of the tail we've talked about in the past that's really not moving up, the utilization curve, so is that the case?
And secondly, how did that track throughout the year? It seems that the performance itself in the quarter was fairly strong, so did we see a slowdown here as we got into the early stages of the summer and is that really the reason for the lowered outlook?
The answer is yes to both of those assertions. To be a little more precise, we track a whole range of segments of these doctors for same practice growth and track how long it takes them after they went to the certification to start their first cases and then what the ramp looks like from there.
Over the first half of the year, we've had a lot of variability. It's been a pretty linear process for us and we've seen with improving clinical education programs, steady solid progress meaning reducing the cycle time from certification to first case is started, and increasing the ramp.
We guided in the first part of this year and it's been very choppy through the year. On total, the numbers were still showing progress, when I say choppy meaning week-to-week, different certifications going on.
The second thing is, as we got into the second quarter, while overall utilization numbers are solid, we saw compression at the lower end, the newer certified doctors taking longer to get cases started and being slow to ramp and in general on lower volume GP specifically as we dug into that with follow-up and some specific survey and gathering anecdotal and qualitative data around it.
It's very clear that those doctors regarding their Invisalign practice and other higher value restorative procedures, A, they are not initiating as many of those discussions in their existing kind of what we call in practice marketing, and B, they aren't as aggressively seeking patients recruiting to practice.
So they're more passive in general, and we believe that's what's at the core of this little bit of compression at the low end, so a significant number of doctors, we're working on longer-term plans to move the needle there, but that's part of what drives our taking a more thoughtful approach in the second half.
Matt Dolan - Roth Capital
Okay. And then specifically to Q4, looking at your guidance implies about a 10% year-over-year volume increase to about a high single-digit sequential increase. So when we look at last year, you were slightly up sequentially Q4 over Q3. What gives you the confidence here that we've got everything kind of taken into account from the economy and the uncertainty around that relative to the Q4 implication?
It's a great question. This is the best product, if you will, a critical thinking of data, of a lot of survey work we do, the best thinking we've got around the table, talking to lots of doctors and then looking at the broader factors.
And we believe when we started the year we had a pretty conservative outlook and we've got the year off of to a pretty solid start. We don't believe, we're not assuming we're going to get the uplift in sales force productivity from that coverage, and we're not assuming we're going to get as much impact in this year from a consumer demand programs, and we're taking a slightly more conservative posture on the initial adoption cycle of new products, collectively those things go together , we believe we can go do what we've said we're going to do, but at the same time, it has taken us to a slightly more conservative posture.
Matt Dolan - Roth Capital
Okay and of the 38 person reduction in headcount, can you help us break down what areas those are from, sales versus R&D, etcetera?
And Matt, this is Ken. So the 38 people, they're predominantly all in Santa Clara through the headquarters here, so it's roughly about 10% or so of the headcount here locally. As far as breaking them out across the organization, we had, we were very focused in looking at where we make choices to be able to basically preserve our strategic investments going forward on product development and some of our go to market initiatives as well as advertising promotion activities.
So we took a more focused effort on the G&A areas. I would say probably a good portion of the reduction came out of the G&A areas of the company and a little bit scattered throughout the other areas.
Matt Dolan - Roth Capital
Thanks very much.
Next question, please?
(Operator Instructions). Our next question is coming from Isaac Ro with Leerink Swann.
Isaac Ro - Leerink Swann
Hi, guys. Thanks for taking the question.
Isaac Ro - Leerink Swann
Just looking at the slide 16, where you talked about that revised opportunity for the overall market, I'm wondering, is that from the US Market only first of all, because and just coming on for a second, if we take a look at the 900,000 Class I cases, and I think you said 26% of those would be adults. That's about 234,000 cases annually, and you guys are doing about 180 in the US, call it, so, I'm just wondering, where you think you are on the adoption curve for Class I?
Sure. Well there's a couple new sizes we're looking at this, Isaac. The first piece is A, this is just US to your original question and B, this is strictly ortho. So, if you look at our penetration, I think the number was around 74,000 case shipments to orthos in 2007 which is where we're anchoring this data.
What we're really saying is our penetration was 6% and change, in total, not all of that was adults, some of those were what we call mature teens, but in general, we've been going after the older teen and the adult. This expansion and we've done this on our own data and looking at our own results, our orthodontists especially are comfortably using in Invisalign on moderate Class II cases.
And so, as we reapply kind of a clinical or reality check on clinical applicability in North America and then we look at the served market opportunity, that's what's driven the size of the served market to up to about $1.2 million from 900.
These are ortho starts not including GPs, so if you take the 74,000 ortho starts that we shipped cases too in 2007, applied to the 1.2 we're about 6% penetration into that existing market.
The GP isn't really fishing out of the same pool. A lot of patients they start, aren't even getting referred to orthodontists in the first place. And so, those two opportunities and therefore those two penetration dynamics have to be looked at separately.
Isaac Ro - Leerink Swann
Okay, thanks. And then just secondly, could you maybe break down how your cost of goods components, work on a percentage basis between raw materials, freight, labor?
Yes, Isaac. The biggest component of our product cost is labor and overhead related to our factories in Costa Rica and Juarez. Our material cost is overall a small percentage of the cost and as far as freight charges are concerned, are generally maybe a few percentage points overall.
We've had a little bit of uptick in relation to surcharges which I refer to, roughly about 50 basis points but of that 50 basis points, the majority of that was really around the freight surcharges and a little bit in relation to aligner material cost.
Isaac Ro - Leerink Swann
Okay. And then just lastly on sales and marketing, I think it's a little bit over 35% of revenue. Can you break down much of that is, in your advertising campaign?
We haven't broken out the great detail there. What we do provide is a general outline on total consumer [spend]. In our total consumer spend, the significant bulk of that is on media in total, but we haven't really laid out in detail what that is, Isaac.
Isaac Ro - Leerink Swann
Okay. Thanks much.
Thanks. Okay, Operator, we'll take one last question, please?
Thank you. Our last question is coming from Ben Forest with Summer Street Research. Please State your question.
Spencer Nam - Summer Street Research
Good afternoon, this is Spencer Nam here. I just have a quick question on the guidance. The new guidance, is that, how in terms of thinking about the third quarter and fourth quarter, how much of your visibility into third quarter affected the final guidance, the one that we have now versus the previous one? Are you seeing that the Q3 momentum will actually carry into Q4 or is that just sort of separate analysis based on the macro-economic situation?
This is Ken. I would say more of the latter. We have a comparable visibility to what we historically had into the business going into any particular quarter, it was just typically about 30 days. We have efforts inside the company trying to get after that and trying to get more visibility as we go into the quarters.
But we don't have any significant anecdotal information to point to, at this point in time. So from a historical point of view, like I said, nothing has really changed. As far as going into the transitioning from the third quarter to the fourth quarter, we'll point to things Tom mentioned a moment ago on the call.
And then in addition to that, we will see some incremental revenues coming out of the European region, we typically do in the fourth quarter, we see an uptick and we're anticipating this year to see the same thing.
Spencer Nam - Summer Street Research
Appreciate that. I guess just as a follow-up to that, to that question and that answer, as late as last quarter, the management felt that the outlook was fairly stable at the previous guidance of 3.20 to 3.30, and so I guess when you look into Q4 and the rest of the year, in my assessment, is there somewhat of a step down, if you will, or fairly distinct revaluation of the outlook.
And I'm just trying to get a handle of based on the answer that you just provided, how confident are you of this sort of new outlook in terms of that is going to be the possibility, the most life outcome or there could be a surprise around this.
If somehow things turnaround or as the comments in the earlier, and you have indicated that physicians, the orthodontists and general dentists seem to be very positive about the outlook. Is there a possibility that they could actually kick things into another gear and in late Q3, Q4 to have a very successful Q4 and how does that all play into this?
Well, I guess the simple answer I'd give you is that these are the best numbers we can come up with. We didn't bring this guidance down lightly. It's informed by the same building blocks and understanding of the business that we built our original guidance on, and at the core of it, given the headwind in the economy, kind of the unprecedented impact on consumers, we don't believe we're going to get the up-lift. The biggest factors as we provided our original guidance, the biggest single factor we said was going to be sales force productivity in North America.
We don't expect to get the same level of productivity that we originally planned for and expected, and we believe the biggest factor there is probably the economy. The team is out there doing a good job, having an impact, and all that, [but] we don't see that uplift coming on the same track.
The second thing is consumer demand. Our conversion rates continue to grow, but again those conversion rates, those qualified leads flow into case starts over a period of time, so we aren't expecting to get as much impact as we may have originally planned in Q3, Q4.
And then the third was more excitement rather than pure volume with some of these new products, and we think we're taking a slightly more conservative posture there, so we believe, we've reflected appropriately the view of the business going forward, and we're just calling it as we see it.
Spencer Nam - Summer Street Research
Great, appreciate it very much. Thanks.
Thanks, Spencer, and thank you, everyone. That concludes our conference call this afternoon. If you have further questions, please contact Align investor relations. Thank you.
Ladies and Gentlemen, this does conclude Align Technology's teleconference. You may disconnect at this time. Thank you for your participation.
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