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Align Technology 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-10.3
  3. Ex-10.4
  4. Ex-31.1
  5. Ex-31.2
  6. Ex-32.1
  7. Ex-32.1

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

(Mark One)

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the quarterly period ended June 30, 2007

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the transition period from                        to                           

 

Commission file number: 0-32259


Align Technology, Inc.

(Exact name of registrant as specified in its charter)

Delaware

 

94-3267295

 

(State or other jurisdiction of

 

(I.R.S. Employer

 

incorporation or organization)

 

Identification Number)

 

 

 

 

881 Martin Avenue

 

Santa Clara, California 95050

 

(Address of principal executive offices) (Zip Code)

 

 

 

(408) 470-1000

 

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x                                 Accelerated filer o                                 Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

The number of shares outstanding of the registrant’s Common Stock, $0.0001 par value, as of July 31, 2007 was 67,937,571.

 




Table of Contents

ALIGN TECHNOLOGY, INC.

INDEX

PART I

FINANCIAL INFORMATION

 

3

ITEM 1

 

FINANCIAL STATEMENTS (UNAUDITED):

 

3

 

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

3

 

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

4

 

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

5

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

6

ITEM 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

16

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

25

ITEM 4.

 

CONTROLS AND PROCEDURES

 

25

PART II

OTHER INFORMATION

 

26

ITEM 1.

 

LEGAL PROCEEDINGS

 

26

ITEM 1A.

 

RISK FACTORS

 

30

ITEM 2.

 

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

40

ITEM 3.

 

DEFAULTS UPON SENIOR SECURITIES

 

40

ITEM 4.

 

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

40

ITEM 5.

 

OTHER INFORMATION

 

40

ITEM 6.

 

EXHIBITS

 

41

SIGNATURES

 

42

 

Invisalign, Align, ClinCheck and ClinAdvisor, amongst others, are trademarks belonging to Align Technology, Inc. and are pending or registered in the United States and other countries.




PART I—FINANCIAL INFORMATION

ITEM 1 FINANCIAL STATEMENTS

ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)
(unaudited)

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

76,603

 

$

53,221

 

$

140,364

 

$

102,129

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

20,247

 

16,492

 

37,776

 

30,789

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

56,356

 

36,729

 

102,588

 

71,340

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

24,353

 

20,641

 

47,503

 

40,707

 

General and administrative

 

11,880

 

15,354

 

24,065

 

30,418

 

Research and development

 

6,675

 

4,025

 

12,368

 

8,719

 

Patients First Program

 

 

 

(1,796

)

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

42,908

 

40,020

 

82,140

 

79,844

 

 

 

 

 

 

 

 

 

 

 

Profit (loss) from operations

 

13,448

 

(3,291

)

20,448

 

(8,504

)

 

 

 

 

 

 

 

 

 

 

Interest and other income, net

 

680

 

841

 

1,135

 

1,539

 

 

 

 

 

 

 

 

 

 

 

Profit (loss) before provision for income taxes

 

14,128

 

(2,450

)

21,583

 

(6,965

)

Provision for income taxes

 

(510

)

(160

)

(987

)

(409

)

 

 

 

 

 

 

 

 

 

 

Net profit (loss)

 

$

13,618

 

$

(2,610

)

$

20,596

 

$

(7,374

)

 

 

 

 

 

 

 

 

 

 

Net profit (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.20

 

$

(0.04

)

$

0.31

 

$

(0.12

)

Diluted

 

$

0.19

 

$

(0.04

)

$

0.29

 

$

(0.12

)

 

 

 

 

 

 

 

 

 

 

Shares used in computing net profit (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

66,696

 

62,966

 

66,068

 

62,743

 

Diluted

 

71,207

 

62,966

 

70,346

 

62,743

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3




ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)
(unaudited)

 

 

June 30,
2007

 

December 31,
2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

65,594

 

$

55,113

 

Restricted cash

 

95

 

93

 

Marketable securities, short-term

 

13,551

 

8,931

 

Accounts receivable, net of allowance for doubtful accounts of $685 and $844 at June 30, 2007 and December 31, 2006, respectively

 

47,237

 

33,635

 

Inventories, net

 

3,388

 

3,090

 

Prepaid expenses and other current assets

 

8,560

 

7,227

 

Total current assets

 

138,425

 

108,089

 

 

 

 

 

 

 

Property and equipment, net

 

26,675

 

26,904

 

Goodwill

 

478

 

478

 

Intangible assets, net

 

12,033

 

13,824

 

Marketable securities, long-term

 

2,776

 

 

Other assets

 

1,968

 

2,263

 

Total assets

 

$

182,355

 

$

151,558

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Line of credit

 

$

 

$

11,500

 

Accounts payable

 

5,728

 

5,034

 

Accrued liabilities

 

35,949

 

40,307

 

Deferred revenues

 

12,159

 

10,942

 

Total current liabilities

 

53,836

 

67,783

 

Other long-term liabilities

 

189

 

219

 

Total liabilities

 

54,025

 

68,002

 

 

 

 

 

 

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock: $0.0001 par value; Authorized: 5,000 shares; Issued and outstanding: none at June 30, 2007 and December 31, 2006

 

 

 

Common stock: $0.0001 par value; Authorized: 200,000 shares; Issued: 67,231 and 64,899 shares at June 30, 2007 and December 31, 2006, respectively; Outstanding: 67,199 and 64,859 shares at June 30, 2007 and December 31, 2006, respectively

 

7

 

6

 

Additional paid-in capital

 

432,935

 

408,921

 

Accumulated other comprehensive income

 

166

 

3

 

Accumulated deficit

 

(304,778

)

(325,374

)

Total stockholders’ equity

 

128,330

 

83,556

 

Total liabilities and stockholders’ equity

 

$

182,355

 

$

151,558

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4




ALIGN TECHNOLOGY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
(unaudited)

 

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net profit (loss)

 

$

20,596

 

$

(7,374

)

Adjustments to reconcile net profit (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

5,211

 

4,601

 

Amortization of intangibles

 

1,791

 

191

 

Stock-based compensation expense

 

5,387

 

4,471

 

Loss (gain) on retirement and disposal of fixed assets

 

28

 

(257

)

Income tax benefits from exercise of stock options

 

(409

)

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(13,503

)

(3,485

)

Inventories

 

(300

)

197

 

Prepaid expenses and other current assets

 

(1,301

)

(1,505

)

Accounts payable

 

575

 

2,368

 

Accrued and other long-term liabilities

 

(5,550

)

(2,092

)

Deferred revenues

 

1,182

 

(3,497

)

Net cash provided by (used in) operating activities

 

13,707

 

(6,382

)

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Purchase of property and equipment

 

(3,426

)

(4,768

)

Proceeds from sale of property and equipment

 

 

367

 

Restricted cash

 

 

(9

)

Purchases of marketable securities

 

(17,586

)

(12,282

)

Maturities of marketable securities

 

10,180

 

 

Other assets

 

302

 

147

 

Net cash used in investing activities

 

(10,530

)

(16,545

)

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Proceeds from issuance of common stock

 

18,484

 

6,194

 

Payments on line of credit

 

(11,500

)

 

Income tax benefit from exercise of stock options

 

409

 

 

Employees’ taxes withheld and paid for restricted stock

 

(265

)

 

Net cash provided by financing activities

 

7,128

 

6,194

 

 

 

 

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

176

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

10,481

 

(16,733

)

Cash and cash equivalents at beginning of period

 

55,113

 

74,219

 

Cash and cash equivalents at end of period

 

$

65,594

 

$

57,486

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5




ALIGN TECHNOLOGY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1.  Summary of Significant Accounting Policies

Basis of presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared by Align Technology, Inc. (the “Company” or “Align”) in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and contain all adjustments, including normal recurring adjustments, necessary to present fairly Align’s financial position as of June 30, 2007, its results of operations for the three and six months ended June 30, 2007 and 2006, and its cash flows for the six months ended June 30, 2007 and 2006. The Consolidated Condensed Balance Sheet as of December 31, 2006 is derived from the December 31, 2006 audited financial statements. Certain prior period amounts have been reclassified to conform with current period presentation. These reclassifications had no impact on previously reported net earnings and financial position.

The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007, and the Company makes no representations related thereto. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A and 8, respectively, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in Align’s Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from those estimates.

Foreign Currency

The Company follows Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation” (“FAS 52”) for both the translation and remeasurement of balance sheet and income statement items into U.S. dollars.  The Company analyzes the functional currency for each of its international subsidiaries on an annual basis, or more often if necessary, to determine if a significant change in facts and circumstances indicate that the primary economic currency has changed.  Prior to January 1, 2007, all of Align’s subsidiaries use the U.S. dollar as its functional currency.

During the first quarter of 2007, the Company analyzed the various economic factors of its international subsidiaries in accordance with FAS 52 and determined that there has been a significant change in facts and circumstances to warrant a change in the functional currency for some of its European subsidiaries from U.S. dollars to the local currency. Effective January 1, 2007, the adjustment from translating certain European subsidiaries’ financial statements from the local currency in to U. S. dollars was recorded as a separate component of accumulated other comprehensive income in the shareholders’ equity section of its Condensed Consolidated Balance Sheet.  This foreign currency translation adjustment reflects the translation of its balance sheet at period end exchange rates, and its income statement at an average exchange rate in effect during each period.  As of June 30, 2007, the Company included $173,000 in its accumulated other comprehensive income in stockholders’ equity. See Note 12 “Comprehensive Income (Loss)” of the Notes to Condensed Consolidated Financial Statements for additional disclosures.

Align’s other international entities operate in a U.S. dollar functional environment, and therefore, the foreign currency assets and liabilities are remeasured into U.S. dollars at current exchange rates except for non monetary assets and liabilities which are remeasured at historical exchange rates. Revenues and expenses are generally remeasured at an average exchange rate in effect during each period. Gains or losses from foreign currency remeasurement are included in consolidated net profit (loss).

Accounting for Income Taxes

On January 1, 2007, the Company adopted the provision of  Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertain Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”).

6




FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” (“FAS 109”) and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return.  Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.  An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.  Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The adoption of FIN 48 had no impact on the Company’s consolidated financial position, results of operations or cash flows for the three and six month periods ended June 30, 2007.

Recent Accounting Pronouncements

In February 2007, the FASB issued FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. Under FAS 159, a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees and issued debt. Other eligible items include firm commitments for financial instruments that otherwise would not be recognized at inception and non-cash warranty obligations where a warrantor is permitted to pay a third party to provide the warranty goods or services. If the use of fair value is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred, e.g., debt issue costs. The fair value election is irrevocable and generally made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of FAS 159, changes in fair value are recognized in earnings. FAS 159 is effective for fiscal years beginning after November 15, 2007 and is required to be adopted by the Company in the first quarter of 2008. The Company is currently evaluating the potential impact, if any, of the adoption of FAS 159 on its consolidated financial position, results of operations and cash flows.

In September 2006, the FASB issued FAS Statement No. 157, Fair Value Measurements (“FAS 157”), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Company is currently evaluating the potential impact, if any, of the adoption of FAS 157 on its consolidated financial position, results of operations and cash flows.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force (“EITF”), the American Institute of Certified Public Accountants and the SEC did not or are not believed by management to have a material impact on our present or future consolidated financial statements.

Note 2.  Patients First Program

On October 13, 2006, the Company entered into a formal agreement with OrthoClear, Inc., OrthoClear Holdings, Inc., and OrthoClear Pakistan Pvt. Ltd. (“OrthoClear”), together with certain individuals associated with OrthoClear (the “OrthoClear Agreement”) to end all pending litigation between the parties.  As part of the OrthoClear Agreement, OrthoClear agreed to stop the importation of aligners into the United States and discontinue all aligner business operations worldwide. As a result, most OrthoClear patients were unable to complete their orthodontic treatment with OrthoClear.  In an attempt to help minimize treatment disruptions for the OrthoClear patients and their doctors, the Company committed to make treatment available to these patients at no additional cost under the “Patients First Program”.  Therefore, Align received no revenue for the program, while incurring significant expense.   In the fourth quarter of 2006, the Company recorded a $8.3 million charge for the anticipated costs of completing the Patients First Program in accordance with FASB Statement No. 5, “Accounting for Contingencies” (“FAS 5”). This estimated amount was based on the number of OrthoClear cases registered under the Patients First Program as of December 31, 2006.  In accordance with the Patients First Program terms and conditions, those registered cases were required to submit treatment forms by the deadline of March 30, 2007. In the first quarter of 2007, the Company reduced its Patients First Program accrual by $1.8 million to reflect a reduction of the Company’s initial estimate to the number of cases actually received by the case submission deadline.  During the second quarter of 2007, the Company completed the Patients First Program and shipped virtually all cases that

7




were registered and received. As of June 30, 2007, there were approximately 200 cases remaining to be shipped upon ClinCheck approval by doctors. The accrued Patients First Program balance as of June 30, 2007 was $1.6 million, and principally consists of estimated future warranty and case refinement costs.

Note 3.  Marketable Securities

The Company’s marketable securities as of June 30, 2007 and December 31, 2006 are as follows (in thousands):

June 30, 2007

 

Amortized
Costs

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Loss

 

Fair Value

 

U.S. Government notes and bonds

 

$

5,627

 

$

 

$

(1

)

$

5,626

 

Corporate bonds

 

5,941

 

 

(2

)

5,939

 

Commercial paper and asset-backed securities

 

4,763

 

 

(1

)

4,762

 

Total

 

$

16,331

 

$

 

$

(4

)

$

16,327

 

 

 

 

 

 

 

 

 

 

 

Reported as:

 

 

 

 

 

 

 

 

 

Marketable securities, short-term

 

 

 

 

 

 

 

$

13,551

 

Marketable securities, long-term

 

 

 

 

 

 

 

2,776

 

Total

 

 

 

 

 

 

 

$

16,327

 

 

December 31, 2006

 

Amortized
Costs

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Loss

 

Fair Value

 

U.S. Government notes and bonds

 

$

4,880

 

$

2

 

$

 

$

4,882

 

Corporate bonds

 

2,951

 

 

 

2,951

 

Commercial paper

 

1,098

 

 

 

1,098

 

Total

 

$

8,929

 

$

2

 

$

 

$

8,931

 

 

 

 

 

 

 

 

 

 

 

Reported as:

 

 

 

 

 

 

 

 

 

Marketable securities, short-term

 

 

 

 

 

 

 

$

8,931

 

Marketable securities, long-term

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

$

8,931

 

 

For the three and six months ended June 30, 2007 and 2006, no significant gains were realized on the sale of marketable securities.

Note 4.  Balance Sheet Components

Inventories are comprised of (in thousands):

 

June 30,
2007

 

December 31,
2006

 

Raw materials

 

$

2,367

 

$

2,021

 

Work in process

 

679

 

763

 

Finished goods

 

342

 

306

 

 

 

$

3,388

 

$

3,090

 

 

Work in process includes costs to produce the Invisalign product. Finished goods primarily represent ancillary products that support the Invisalign system.

8




Accrued liabilities consist of the following (in thousands):

 

June 30,
2007

 

December 31,
2006

 

Accrued payroll and benefits

 

$

16,209

 

$

17,768

 

Accrued sales rebate

 

4,290

 

3,895

 

Accrued Patients First Program costs

 

1,649

 

6,800

 

Accrued sales and marketing expense

 

2,670

 

2,235

 

Accrued warranty

 

2,214

 

2,094

 

Other

 

8,917

 

7,515

 

Total accrued liabilities

 

$      35,949

 

$

40,307

 

 

Note 5.  Intangible Assets

The following is a summary of the Company’s purchased intangible assets as of June 30, 2007 and December 31, 2006 (in thousands):

 

 

 

 

June 30, 2007

 

December 31, 2006

 

 

 

Estimated
Useful Life
(in years)

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Net
Carrying
Value

 

Gross
Carrying
Value

 

Accumulated
Amortization

 

Net
Carrying
Value

 

Non-compete agreements

 

5

 

$

14,000

 

$

2,012

 

$

11,988

 

$

14,000

 

$

612

 

$

13,388

 

Consultant relationships

 

3

 

980

 

980

 

 

980

 

626

 

354

 

Patent

 

5

 

180

 

135

 

45

 

180

 

117

 

63

 

Other

 

3

 

55

 

55

 

 

55

 

36

 

19

 

Total

 

 

 

$

15,215

 

$

3,182

 

$

12,033

 

$

15,215

 

$

1,391

 

$

13,824

 

 

Non-compete agreements represent the fair value of intangible assets received in connection with the OrthoClear Agreement. These intangible assets are being amortized on a straight-line basis over the expected useful life of five years beginning in the fourth quarter of 2006.

Consultant relationships and other intangible assets represent the fair value of intangible assets acquired as the result of the acquisition of General Orthodontics, LLC (“GO”) in 2005. Upon the integration of GO, Align included GO’s consulting services in its clinical education and training programs  under the name of Invisalign Consulting Services (“ICS”).  On March 29, 2007, the Company announced the discontinuation of ICS effective June 29, 2007.  During the second quarter of 2007, the net carrying values of the consultant relationships and other intangible assets related to ICS were fully amortized.

The Company performs an impairment test whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Examples of such events or circumstances include significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of acquired assets or the strategy for its business, significant negative industry or economic trends, and/or a significant decline in the Company’s stock price for a sustained period. Impairments are recognized based on the difference between the fair value of the asset and its carrying value, and fair value is generally measured based on discounted cash flow analyses. There were no impairments of intangible assets during the periods presented.

The total estimated annual future amortization expense for these intangible assets as of June 30, 2007 is as follows (in thousands):

Fiscal Year

 

 

 

2007

 

$

1,418

 

2008

 

2,827

 

2009

 

2,800

 

2010

 

2,800

 

2011 and thereafter

 

2,188

 

Total

 

$

12,033

 

 

9




Note 6.  Legal Proceedings

Ormco

On January 6, 2003, Ormco Corporation (“Ormco”) filed suit against the Company in the United States District Court for the Central District, Orange County Division, asserting infringement of certain patents. Ormco is a division of Sybron Dental Specialties. In May 2006, Danaher Corporation acquired Sybron Dental Specialties. The complaint sought unspecified monetary damages and injunctive relief. On February 18, 2003, the Company answered the complaint and asserted counterclaims seeking a declaration by the Court of invalidity and non-infringement of the asserted patents. In addition, the Company counterclaimed for infringement of one of its patents, seeking unspecified monetary damages and injunctive relief. Ormco filed a reply to its counterclaims on March 10, 2003 and asserted counterclaims against the Company seeking a declaration by the Court of invalidity and non-infringement of the patent. The Company amended its counterclaim to add Allesee Orthodontic Appliances, Inc. (“AOA”), a wholly-owned subsidiary of Ormco, as a counterdefendant in regard to its counterclaim of infringement of the patent.

On February 1, 2006, the Company entered into a settlement agreement (the “Settlement Agreement”) with Ormco and AOA.  In accordance with the terms of the Settlement Agreement, Ormco and AOA  paid into escrow, pending the completion of the appellate process, $884,000 to resolve the issues of past damages, willfulness and attorneys’ fees for the adjudged infringement of two of the Company’s patents  (the “Align Patents”) through the manufacture and sale of Ormco’s and AOA’s Red, White & Blue appliances.  The Company’s receipt of the payments out of escrow is contingent upon the Court, in a final, non-appealable judgment, finding that Ormco or AOA infringes at least one of the claims in the Align Patents.  If, however, the Court issues a final, non-appealable judgment of non-infringement, invalidity or unenforceability with respect to each asserted claim of the Align Patents, all funds in the escrow account will be returned to Ormco and AOA.  The Settlement Agreement does not affect (a) Ormco’s appeal of the decisions and orders of the District Court relating to Ormco’s patents; or (2) our pending cross-appeal of the orders of the District Court relating to our patents.

 There have been two appeals.  After the permanent injunction was entered, Ormco and AOA appealed that injunction and the orders of the District Court on summary judgment on which the injunction was based.  Oral argument took place on April 3, 2006.   Following oral argument, the U.S. Court of Appeals for the Federal Circuit (“CAFC”) issued a ruling declaring two out of a total of seventy-one claims in our US Patent No. 6,398,548 and four out of a total of ten claims in US Patent No. 6,544,611 to be invalid as “obvious.” The CAFC’s decision reverses the California District Court summary judgment order of validity.

The second appeal is from the final judgment. Once final judgment was entered, Ormco filed a Notice of Appeal from the final judgment and the Company filed a notice of cross-appeal.  Ormco has appealed the ruling of the District Court that its patents are not infringed by the Company and that the asserted claims are invalid.  The Company appealed the ruling of the District Court that certain claims of its 6,398,548 patent which were found to be infringed by Ormco’s and AOA’s Red, White & Blue appliances were invalid.  Briefing on this appeal and cross-appeal is complete, and oral argument occurred on February 6, 2007.  The Federal Circuit has not yet issued a ruling.

Class Action

On May 18, 2007, Debra A. Weber filed a consumer class action lawsuit against Align, OrthoClear, Inc. and OrthoClear Holdings, Inc. (d/b/a OrthoClear, Inc.) in Syracuse, New York, U.S. District Court.  The complaint alleges two causes of action against the OrthoClear defendants and one cause of action against Align for breach of contract.  The cause of action against the Company, titled “Breach of Third Party Benefit Contract” references Align’s agreement to make Invisalign  treatment available to OrthoClear patients, alleging that the Company failed “to provide the promised treatment to Plaintiff or any of the class members”.   The Company intends to vigorously defend itself against this lawsuit.

Litigating claims of these types, whether or not ultimately determined in the Company’s favor or settled by the Company, is costly and diverts the efforts and attention of the Company’s management and technical personnel from normal business operations.  Any of these results from litigation could adversely affect the Company’s results of operations.  From time to time, the Company has received, and may again receive, letters from third parties drawing the Company’s attention to their patent rights. While the Company does not believe that it infringes any such rights that have been brought to the Company’s attention, there may be other more pertinent proprietary rights of which the Company is presently unaware.

Note 7.  Credit Facilities

On March 7, 2007, the Company renegotiated and amended its existing credit facility with Comerica Bank. The amendment, among other things, reduced financial covenants to require only a quick ratio covenant. Effective January 1, 2008, the amendment will also increase the available borrowings under the existing revolving line of credit from $20 million

10




to $25 million. The amended credit facility matures on December 31, 2008 at which point all outstanding borrowings under this credit facility must be repaid. During the first half of 2007, the Company repaid  $11.5 million of its outstanding borrowing on this credit facility.  As of June 30, 2007, there were no outstanding borrowings against this credit facility. The Company is in compliance with the financial covenant of this credit facility.

Note 8.  Commitments and Contingencies

Operating leases

On August 3, 2007, the Company entered into an amendment to the lease agreement of its European Headquarters located in Amsterdam, The Netherlands.  Commencing June 1, 2007, the original lease agreement was amended to expand the Amsterdam facility to approximately 16,000 square feet of office space and will expire June 2012, with an option to renew for an additional five year term.

As of June 30, 2007, minimum future lease payments for non-cancelable leases are as follow (in thousands):

Years Ending December 31,

 

 

 

 

 

 

 

2007

 

$

1,806

 

2008

 

2,597

 

2009

 

1,530

 

2010

 

955

 

2011

 

494

 

Thereafter

 

306

 

Total

 

$

7,688

 

 

Product Warranty

The Company warrants its products against material defects until the Invisalign case is completed. The Company accrues for estimated warranty in costs of goods sold upon shipment of products. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on repair costs. Actual warranty costs could differ from the estimated amounts. The Company regularly reviews the accrued balances and updates these balances based on historical warranty cost trends. Actual warranty costs incurred have not materially differed from those accrued.

The following table reflects the change in the Company’s warranty accrual during the six months ended June 30, 2007 and 2006, respectively (in thousands):

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

Balance at beginning of period

 

$

2,094

 

$

1,998

 

Charged to cost of sales

 

1,090

 

1,287

 

Actual warranty expenses

 

(970

)

(1,443

)

Balance at end of period

 

$

2,214

 

$

1,842

 

 

Note 9.  Stock-based Compensation

Summary of stock-based compensation expense

The Company accounts for stock–based compensation in accordance with Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-based Payment” (“FAS 123R”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors and employee stock purchases related to the Employee Stock Purchase Plan (“the Purchase Plan”) based on estimated fair values over the requisite service period.

Stock-based compensation expense recognized in the Consolidated Statements of Operations for the three and six months ended June 30, 2007 and 2006 is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. FAS123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience.  The following

11




table summarizes stock-based compensation expense related to all of the Company’s stock-based awards and employee stock purchases under FAS 123R for the three and six months ended June 30, 2007 and 2006:

 

Three Months Ended
June 30,

 

Six Months Ended
 June 30,

 

(In thousands)

 

2007

 

2006

 

2007

 

2006

 

Cost of revenues

 

$

210

 

$

181

 

$

444

 

$

329

 

Sales and marketing

 

898

 

732

 

1,755

 

1,411

 

General and administrative

 

1,429

 

1,029

 

2,532

 

2,117

 

Research and development

 

328

 

324

 

656

 

614

 

Total stock-based compensation

 

$

2,865

 

$

2,266

 

$

5,387

 

$

4,471

 

 

The fair value of stock options granted and the option component of the Purchase Plan shares were estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Stock Options:

 

 

 

 

 

 

 

 

 

Expected term (in years)

 

4.4

 

5.0

 

4.6

 

5.0

 

Expected volatility

 

58.8

%

75.0

%

71.5

%

77.0

%

Risk-free interest rate

 

4.8

%

4.9

%

4.7

%

4.6

%

Expected dividend

 

 

 

 

 

Weighted average fair value at grant date

 

$

11.61

 

$

5.28

 

$

10.89

 

$

5.45

 

 

 

 

 

 

 

 

 

 

 

Employee Stock Purchase Plan: (1)

 

 

 

 

 

 

 

 

 

Expected term (in years)

 

 

 

 

 

1.3

 

1.3

 

Expected volatility

 

 

 

 

 

59.5

%

54.9

%

Risk-free interest rate

 

 

 

 

 

5.1

%

4.7

%

Expected dividend

 

 

 

 

 

 

 

Weighted average fair value at grant date

 

 

 

 

 

$

6.84

 

$

3.18

 

 


(1)  The Employee Stock Purchase Plan has purchase dates on the last trading days of January and July of each year. There were no Employee Stock Purchase Plan activities during the second quarters of 2007 and 2006.

Stock Incentive Plans

In May 2005, stockholder approval was obtained for the 2005 Incentive Plan (the “2005 Plan”), which replaced the 2001 Stock Incentive Plan (the “2001 Plan”). The 2005 Plan, which expires December 31, 2010, provides for the granting of incentive stock options, non-statutory stock options, restricted stock units, stock appreciation rights, performance units and performance shares.  Employees, non-employee directors and consultants are eligible to receive grants under the 2005 Plan.  The options are granted for periods not exceeding ten years and generally vest over 4 years with 25% vesting one year from the date of grant and 1/48th each month thereafter.  The Plan Administrator may, however, grant options with different vesting schedules at its option. Options are to be granted at an exercise price not less than the fair market value of the underlying shares at the date of grant.

12




Options

Stock option activity for the six months ended June 30, 2007 under the stock incentive plans is set forth below:

 

 

Total Shares

 

In-the-money Shares

 

 

 

Number of
Shares
(in thousands)

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual Term
(in years)

 

Number of Shares
(in thousands)

 

Weighted
Average
Exercise
Price

 

Aggregate
Intrinsic
Value
(in thousands)

 

Outstanding as of December 31, 2006

 

9,178

 

$

8.86

 

 

 

 

 

 

 

 

 

Granted

 

1,084

 

18.05

 

 

 

 

 

 

 

 

 

Cancelled or expired

 

(101

)

11.94

 

 

 

 

 

 

 

 

 

Exercised

 

(1,960

)

8.62

 

 

 

 

 

 

 

 

 

Outstanding as of June 30, 2007

 

8,201

 

$

10.09

 

7.5

 

8,201

 

$

10.09

 

$

115,360

 

Ending vested and expected to vest at June 30, 2007

 

7,859

 

$

10.04

 

7.4

 

7,859

 

$

10.04

 

$

110,956

 

Exercisable at June 30, 2007

 

5,165

 

$

9.12

 

6.6

 

5,165

 

$

9.12

 

$

77,690

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between Align’s closing stock price on the last trading day of  second quarter of 2007 of $24.16 and the number of in-the-money options multiplied by the respective exercise price) that would have been received by the option holders had all option holders exercised their options on June 30, 2007. This amount changes based on the fair market value of Align’s stock.

The total intrinsic value of stock options exercised for three and six months ended June 30, 2007 was $17.9 million and $24.2 million, respectively.  Total intrinsic value of stock options exercised for the three and six months ended June 30, 2006, was $0.2 million and $0.8 million, respectively.  As of June 30, 2007, Align expects to recognize $17.4 million of total unamortized compensation cost related to stock options over a weighted average period of 2.6 years. The Company has recognized tax benefits from exercised options of approximately $0.4 million in the three and six months ended June 30, 2007.  The tax benefits associated with these option exercises reduced income taxes payable with the offset credited to additional paid-in capital.

Restricted Stock Units

The Company grants restricted stock units that generally vest over 4 years with 25% vesting on the one year anniversary of the date of grant and 6.25% vesting quarterly thereafter. The fair value of each award is based on the Company’s closing stock price on the date of grant. During the six months ended June 30, 2007, the total fair value of vested restricted stock unit awards was $0.9 million. A summary of the nonvested shares for the three and six months ended June 30, 2007 is as follows:

 

Number of 
Shares
(in thousands)

 

Weighted
Average Grant
Date Fair Value

 

Weighted
Average
Remaining
Contractual
Term (in years)

 

Aggregate
Intrinsic Value
(in thousands)

 

Nonvested as of December 31, 2006

 

419

 

$

8.71

 

 

 

 

 

Granted

 

325

 

18.08

 

 

 

 

 

Vested and released

 

(110

)

8.41

 

 

 

 

 

Forfeited

 

(14

)

10.40

 

 

 

 

 

Nonvested as of June 30, 2007

 

620

 

$

13.63

 

1.6

 

$

14,977

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between Align’s closing stock price on the last trading day of second quarter of 2007 of $24.16 multiplied by the number of nonvested restricted stock units) that would have been received by the award holders had all restricted stock units been vested and released on June 30, 2007. This amount changes based on the fair market value of Align’s stock.

The total intrinsic value of restricted stock awards vested and released for three and six months ended June 30, 2007 was $0.6 million and $2.0 million, respectively.  There were no restricted stock awards vested during the three and six month

13




periods ended June 30, 2006. As of June 30, 2007, the total unamortized compensation cost related to restricted stock units was $7.0 million, which Align expects to recognize over a weighted average period of 3.1 years.

Employee Stock Purchase Plan

Align’s Employee Stock Purchase Plan (the “Purchase Plan”) consists of overlapping  twenty-four month offering periods with four six-month purchase periods in each offering period.  Employees purchase shares at 85% of the fair market value of the common stock at either the beginning of the purchase period or the end of the purchase period, whichever price is lower. The Company accounts for the Purchase Plan as a compensatory plan and has valued the shares in accordance with FAS 123R. The fair value of the option component of the Purchase Plan shares was estimated at the date of grant using the Black-Scholes option pricing model.

As of June 30, 2007, Align expects to recognize $0.6 million of total unamortized compensation cost related to employee stock purchases over a weighted average period of 0.4 years.

Note 10.  Accounting for Income Taxes

The Company has unrecognized tax benefits of approximately $3.3 million as of January 1, 2007. Included in the unrecognized tax benefits are $0.4 million of uncertain tax positions that would impact the Company’s effective tax rate if recognized. The application of FIN 48 would have resulted in a decrease in retained earnings of $2.9 million, except that the decrease was fully offset by the application of a valuation allowance.  In accordance with FIN 48, the Company recognizes interest and penalties related to unrecognized tax benefits as a component of income taxes.   Interest and penalties are immaterial at the date of adoption and are included in the unrecognized tax benefits.  There was no change to the Company’s unrecognized tax benefits for the three and six month periods ended June 30, 2007.

The Company is subject to taxation in the U.S. and various states and foreign jurisdictions.  All the Company’s tax years will be open to examination by the U.S. federal and most state tax authorities due to the Company’s Net Operating Loss and overall credit carryforward position.  With few exceptions, the Company is no longer subject to examination by foreign tax authorities for years before 2002.

Note 11.  Net Profit (Loss) Per Share

Basic net profit (loss) per share is computed using the weighted average number of shares of common stock during the period.  Diluted net profit (loss) per share is computed using the weighted average number of shares of common stock, adjusted for the dilutive effect of potential common stock.  Potential common stock, computed using the treasury stock method, includes options and restricted stock units.

The following table sets forth the computation of basic and diluted net profit (loss) per share attributable to common stock (in thousands, except per share amounts):

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net profit (loss)

 

$

13,618

 

$

(2,610

)

$

20,596

 

$

(7,374

)

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding, basic

 

66,696

 

62,966

 

66,068

 

62,743

 

 

 

 

 

 

 

 

 

 

 

Effect of potential dilutive common shares

 

4,511

 

 

4,278

 

 

Total shares, diluted

 

71,207

 

62,966

 

70,346

 

62,743

 

 

 

 

 

 

 

 

 

 

 

Basic net profit (loss) per share

 

$

0.20

 

$

(0.04

)

$

0.31

 

$

(0.12

)

Diluted net profit (loss) per share

 

$

0.19

 

$

(0.04

)

$

0.29

 

$

(0.12

)

 

For the three and six months ended June 30, 2007, stock options and restricted stock units totaling 1.0 million and 1.9

14




million were excluded from diluted net loss per share because of their anti-dilutive effect. For the three and six months ended June 30, 2006, stock options and restricted stock units totaling 6.8 million and  6.6 million, respectively,  were excluded from diluted net loss per share because of their anti-dilutive effect.

Note 12.  Comprehensive Income (Loss)

Comprehensive income (loss) includes net income, foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. The components of comprehensive income (loss) are as follows (in thousands):

 

 

Three Months  Ended 
June 30,

 

Six Months  Ended 
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Net profit (loss)

 

$

13,618

 

$

(2,610

)

$

20,596

 

$

(7,374

)

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

75

 

 

173

 

 

Unrealized loss on available-for-sale securities

 

(8

)

(12

)

(10

)

(14

)

Comprehensive income (loss)

 

$

13,685

 

$

(2,622

)

$

20,759

 

$

(7,388

)

 

Note 13.  Segments and Geographical Information

Segment

The Company reports segment data based on the management approach which designates the internal reporting that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable operating segments.  During all periods presented, the Company operated as a single business segment.

Geographical Information

Revenues and long-lived assets are presented below by geographic area (in thousands):

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

Revenues:

 

 

 

 

 

 

 

 

 

Domestic

 

$

64,721

 

$

44,691

 

$

119,064

 

$

86,487

 

Europe

 

11,329

 

7,085

 

19,806

 

13,156

 

Other International

 

553

 

1,445

 

1,494

 

2,486

 

Total revenues

 

$

76,603

 

$

53,221

 

$

140,364

 

$

102,129

 

 

 

As of June 30,
2007

 

As of December 31,
2006

 

Long-lived assets:

 

 

 

 

 

Domestic

 

$

38,416

 

$

40,745

 

Europe

 

827

 

745

 

Other International

 

1,911

 

1,979

 

Total long-lived assets

 

$

41,154

 

$

43,469

 

 

15




ITEM 2.       MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS.

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, statements concerning our expectations regarding the benefits of new products, product features, and software enhancements, including ClinAdvisor, and the expected impact these new products and product enhancements will have on doctor utilization and our market share, our expectations regarding product mix and Invisalign Express, our expectations regarding the existence and impact of seasonality, our expectation that our utilization rate will improve over time, our expectations regarding our average selling prices and gross margins in 2007,  our expectations regarding the anticipated benefit of increased collaboration between orthodontists and general practitioner dentists (“GPs”) and the impact this collaboration will have on sales of Invisalign and on our revenue, our expectation that the percentage of revenue generated by general practitioner dentists will represent an increasingly larger percentage of our revenue, our intention to continue the integration of Invisalign into the curriculums of additional universities, our expectations regarding the benefit of increased consumer marketing programs, our expectations regarding increased case shipment volume in 2007, our expectation regarding the anticipated level of our operating expenses in 2007, as well as other statements regarding our future operations, financial condition and prospects and business strategies. These statements may contain words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” or other words indicating future results. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and in particular, the risks discussed below in Part II, Item 1A “Risk Factors” and in other documents we file with the Securities and Exchange Commission (“SEC”) . We undertake no obligation to revise or update these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

The following discussion and analysis of our financial condition and results of operations should be read together with our Condensed Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form  10-Q.

Overview

Align Technology, founded in April 1997, designs, manufactures and markets Invisalign, a proprietary method for treating malocclusion, or the misalignment of teeth. Invisalign corrects malocclusion using a series of clear, nearly invisible, removable appliances that gently move teeth to a desired final position. Because it does not rely on the use of metal or ceramic brackets and wires, Invisalign significantly reduces the aesthetic and other limitations associated with braces. Invisalign is appropriate for treating adults and teens with mature dentition. We received the United States Food and Drug Administration (“FDA”) clearance to market Invisalign in 1998, and we began commercial operations and sales of full Invisalign treatment in July 1999.

Each Invisalign treatment plan is unique to the individual patient. Our full Invisalign treatment consists of as many Aligners as indicated by ClinCheck in order to achieve the doctors’ treatment goals.  Our Invisalign Express is a dual arch orthodontic treatment for cases that meet certain predetermined clinical criteria and consist of up to ten Aligners. Invisalign Express treatment is intended to assist dental professionals to treat a broader range of patients by providing a lower cost option for adult relapse cases, minor crowding and spacing or as a pre-cursor to restorative or cosmetic treatment such as veneers.

A number of factors, the most important of which are set forth below, may affect our results during the remainder of 2007 and beyond.

·                  Driving Utilization Growth.  One of our key  objectives is to continue to increase utilization, or the adoption of and frequency of use, of the Invisalign system (which includes full Invisalign treatment and Invisalign Express) by new and existing customers.  We believe that a key lever for increasing utilization in the future is product performance.  As a result, we are committed to investing in delivering new products, enhancing the user experience and introducing new product features to our existing products.  Specifically, much of our research and development effort is aimed at developing and deploying GP-specific and Ortho-specific product platforms described more fully under “Continued Product Leadership below.  Although we expect that over the long term

16




our utilization rates will improve, we expect that period over period comparisons of our utilization rates will fluctuate.  Factors that may cause these fluctuations include an increase in the number of newly certified/trained doctors in one period compared to another period and the impact of seasonality, specifically, during summer vacation/holiday periods in the United States and Europe.  For the quarters ended June 30, 2007 and June 30, 2006 our utilization rates are as follows:

 

Three Months Ended June 30,

 

Doctor Utilization Rates*

 

2007

 

2006

 

U.S. Orthodontists

 

5.3

 

5.0

 

U.S. GPs

 

2.7

 

2.6

 

International

 

3.1

 

2.9

 

Total Utilization Rate

 

3.4

 

3.2

 

 


*Utilization = # of cases shipped / # of doctors cases were shipped to

 

·              Continued Product Leadership.  As stated above, in an effort to improve the user experience for our customers and increase utilization over time, we are currently in the process of developing and deploying GP-specific and Ortho-specific product platforms to improve the overall user experience for our doctors.  In the second half of 2006, we announced a phased rollout of ClinAdvisor, a new suite of software tools designed to make Invisalign case selection and submission processes more efficient for doctors. ClinAdvisor is designed to help newly certified and less experienced doctors learn how to assess and select appropriate cases given their experience and skill level.  The phased rollout of ClinAdvisor is now complete and it has been launched to our U.S. customers. We expect to integrate ClinAdvisor into our Certification Level 1 training program by the end of the third quarter of 2007. We also expect to extend the product features and functionality of the GP platform and release it to an increasing number of practices.  In addition, we plan to introduce further software enhancements directed at our orthodontists that will provide these doctors with a robust set of tools for greater predictability, wider applicability and more control.  We are also continuing to focus our research and development efforts on a next generation Aligner material as well as a compliance indicator which will help doctors and patients understand if the patients have worn their Aligners for enough time to effectively move their teeth. We expect these efforts to extend at least through 2008. By investing in developing these new products and continually enhancing our existing products, we expect to increase adoption and utilization by our doctors.

·              Expansion of our Customer Base. We generate the vast majority of our revenues from the sales of the Invisalign system to orthodontists and GPs in the United States and Canada, our domestic market.  For the six months ended June 30, 2007 and 2006, our Invisalign revenues as a percentage of total net revenue are as follows:

 

Six Months Ended June 30,

 

Revenues By Channel

 

2007

 

2006

 

Domestic Invisalign:

 

 

 

 

 

Ortho revenues

 

33.1

%

34.2

%

GP revenues

 

47.2

%

45.7

%

Total domestic Invisalign revenues

 

80.3

%

79.9

%

 

 

 

 

 

 

International Invisalign revenues

 

14.8

%

14.9

%

Other revenues

 

4.9

%

5.2

%

 Total revenues

 

100.0

%

100.0

%

 

As specialists, orthodontists are a critical part of our business, and we expect that orthodontists will continue to treat the majority of complex cases and continue to drive research for expanding Invisalign applications.  However, there exists a significantly greater number of GPs in North America than orthodontists. As the primary provider of dental care, GPs have access to a greater number of patients than orthodontists, and possess a unique opportunity to educate these patients on the benefits of oral care and introduce them to Invisalign. GPs also have the ability to refer appropriate cases to orthodontists and may choose to treat less complex cases themselves. Largely due to the

17




fact that there are significantly more GPs than orthodontists, we expect that an increasingly larger percentage of our revenues will be generated by GPs. By increasing adoption and utilization rates among our existing GP customers, the overall market for Invisalign will increase, as patients who would not have otherwise sought orthodontic treatment are introduced to Invisalign by their GPs.

In addition, by educating dental students and orthodontic residents on the benefits of the Invisalign technique, we believe they will be more likely to use this technology in their future practices and offer Invisalign as a treatment option. We have also integrated the Invisalign technique into the curriculums of 38 university programs, including Harvard University, Columbia University, Temple University and the University of Texas at San Antonio. We expect additional dental schools to integrate the Invisalign technique into their curriculums in the future.

·                  Seasonal Fluctuations.  Seasonal fluctuations in the number of doctors in their offices and available to take appointments have affected, and are likely to continue to affect, our business. Specifically, our customers often take vacation or are on holiday during the summer months and therefore tend to start fewer cases. This seasonal trend has caused and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.

·                  Product Mix.   During the first half of 2007, we experienced a decline in the number of Invisalign Express cases compared to the same period of 2006.  We expect that for the remainder of 2007 Invisalign Express cases as a percentage of our revenues will remain consistent with the first six months of 2007.  We believe that this shift in product mix began in the fourth quarter of 2006 after we removed the cancellation fees on full Invisalign cases prior to ClinCheck approval and clarified clinical protocols surrounding what is an appropriate Invisalign Express case. For the six months ended June 30, 2007 and 2006, our Invisalign revenues as a percentage of total net revenue are as follows:

 

Six Months Ended June 30,

 

Revenues By Product

 

2007

 

2006

 

Domestic Invisalign:

 

 

 

 

 

Full revenues

 

72.5

%

65.1

%

Express revenues

 

7.8

%

14.8

%

Total domestic Invisalign revenues

 

80.3

%

79.9

%

 

 

 

 

 

 

International Invisalign revenues

 

14.8

%

14.9

%

Other revenues

 

4.9

%

5.2

%

Total revenues

 

100.0

%

100.0

%

 

·                        Increase Demand at the Consumer Level.  In 2007, we expect to increase the overall marketing spend in the United States with a focus on programs designed to raise the profile of Invisalign and drive more consumers to our most experienced doctors.  We anticipate that this increased consumer awareness of Invisalign will increase the market for our product.

·                  Growth of International Markets.   We will focus our efforts towards increasing adoption of Invisalign by dental professionals in our key international markets, Europe and Japan.  We continually evaluate cost effective ways to support our customers in smaller and less strategic markets. During the first quarter of 2007, we transitioned the sales of our product in part of the Asia-Pacific region to a distributor model. We will consider selling through distributors in other smaller or less strategic markets as well as consider expanding directly into additional countries on a case by case basis.   In the first six months of 2007, our international channel represented approximately 15% of our total net revenue primarily as a result of growth in Europe.  In 2007, we increased our consumer marketing efforts in key European markets.  We expect our international revenue to continue to increase in absolute dollars, and we expect international revenue as a percentage of total net revenue will be comparable in the foreseeable future.

·                  Reliance on International Manufacturing Operations.   Our manufacturing efficiency has been and will be an important factor in our future profitability. Currently, two of our key production steps are performed in

18




operations located outside of the U.S. At our facility in Costa Rica, dental technicians use a sophisticated, internally developed computer-modeling program to prepare electronic treatment plans, which are transmitted electronically back to the U.S. These electronic files form the basis of ClinCheck and are used to manufacture Aligner molds. In addition, we use International Manufacturing Solutions Operaciones, S.R.L. (“IMS”), a third party based in Juarez, Mexico, for the fabrication and packaging of Aligners. Our success will depend in part on the efforts and abilities of management to effectively manage these international operations, including our relationship with IMS. In addition, we currently are and will continue to be dependant on IMS’s and our ability to hire and retain employees generally, as well as hire and retain employees with the necessary skills to perform the more technical aspects of our operations. If our management and/or IMS fail in any of these respects, we could experience production delays and lost or delayed revenue. In addition, even if we have case submissions in the manufacturing backlog, if for these or other reasons we do not have sufficient number of trained dental technicians in Costa Rica to create the ClinCheck treatment forms or if IMS is unable to ship our product to our customers on a timely basis, our revenue will be delayed or lost which will cause our operating results to fluctuate. See Part II, Item 1A—Risk Factors for risks related to our international operations.

·                  “Patients First Program”.    In the fourth quarter of 2006, we entered into a formal agreement with OrthoClear, Inc., OrthoClear Holdings, Inc., and OrthoClear Pakistan Pvt. Ltd. (“OrthoClear”), together with certain individuals associated with OrthoClear (the “OrthoClear Agreement”) to end all pending litigation between the parties.  As part of the OrthoClear Agreement, OrthoClear agreed to stop the importation of aligners into the United States and discontinue all aligner business operations worldwide. As a result, most OrthoClear patients were unable to complete their orthodontic treatment with OrthoClear.  In an attempt to help minimize treatment disruptions for these patients and their doctors, we committed to make Invisalign treatment available to OrthoClear patients at no additional charge from Align. Therefore, we received no revenue for any additional cases we started under this program while incurring significant expenses.  In the fourth quarter of 2006, we recorded an expense of $8.3 million for the anticipated cost of completing this program. This estimated amount was based on the number of OrthoClear cases registered under the Patients First Program as of December 31, 2006.  In accordance with the Patients First Program terms and conditions, those registered cases were required to submit treatment forms by the deadline of March 30, 2007. In the first quarter of 2007, we reduced our Patients First Program accrual by $1.8 million to reflect a reduction of our initial estimate to the number of cases actually received by the case submission deadline.

Additionally, this program generated increased demands on our sales and customer service representatives and on our manufacturing processes, including increased headcount.  In the fourth quarter of 2006, we hired approximately 100 additional dental technicians at our facility in Costa Rica. Training these technicians to use the sophisticated computer modeling program necessary to create ClinCheck treatment forms, takes approximately 90 to 120 days.  Therefore, although we hired these additional technicians in the fourth quarter of 2006, these individuals were not able to provide meaningful contribution to our manufacturing process until the beginning of 2007.  As a result of this manufacturing constraint, although we initially sought to implement the Patients First Program without impacting our existing customers, or new, paid Invisalign cases, the influx of Patients First Program cases, as well as a higher than expected number of paid Invisalign case submissions in the fourth quarter of 2006, caused a delay in product delivery time for some new cases by approximately 10 days and consequently created a backlog of cases in the fourth quarter of 2006 and the first quarter of 2007.  As we returned to normal cycle times by the end of the second quarter of 2007, second quarter revenues benefited from a conversion of this backlog and not solely from organic growth. During the second quarter of 2007, the Patients First Program was completed and we shipped virtually all of the cases that were registered and received. As of June 30, 2007, there were approximately 200 cases to be shipped upon ClinCheck approval by doctors.

19




Results of Operation

Revenues:

Invisalign product revenues by channel and other revenues, which represented training and sales of ancillary products, for the three and six months ended June 30, 2007 and 2006 are as follows (in millions):

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

Net Revenues

 

2007

 

2006

 

Net
Change

 

%
Change

 

2007

 

2006

 

Net
Change

 

%
Change

 

Domestic Invisalign:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ortho full

 

$

22.4

 

$

14.9

 

$

7.5

 

50.8

%

$

41.8

 

$

29.3

 

$

12.5

 

42.8

%

Ortho Express

 

2.5

 

2.8

 

(0.3

)

-11.1

%

4.6

 

5.7

 

(1.1

)

-18.8

%

Total Ortho revenues

 

24.9

 

17.7

 

7.2

 

40.9

%

46.4

 

35.0

 

11.4

 

32.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GP full

 

32.9

 

19.2

 

13.7

 

71.2

%

59.9

 

37.1

 

22.8

 

61.2

%

GP Express

 

3.5

 

4.9

 

(1.4

)

-28.4

%

6.3

 

9.5

 

(3.2

)

-33.8

%

Total GP revenues

 

36.4

 

24.1

 

12.3

 

50.9

%

66.2

 

46.6

 

19.6

 

41.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

International Invisalign

 

11.6

 

8.3

 

3.3

 

40.1

%

20.8

 

15.3

 

5.5

 

36.3

%

Total Invisalign revenues

 

72.9

 

50.1

 

22.8

 

45.6

%

133.4

 

96.9

 

36.5

 

37.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other revenues

 

3.7

 

3.1

 

0.6

 

17.5

%

7.0

 

5.2

 

1.8

 

32.2

%

Total revenues

 

$

76.6

 

$

53.2

 

$

23.4

 

43.9

%

$

140.4

 

$

102.1

 

$

38.3

 

37.4

%

 

Case volume data which represents Invisalign case shipment by channel, for the three and six months ended June 30, 2007 and 2006 are as follows (in thousands):

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

Case Volume

 

2007

 

2006

 

Net
Change

 

%
Change

 

2007

 

2006

 

Net
Change

 

%
Change

 

Domestic Invisalign:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ortho full

 

16.8

 

10.4

 

6.4

 

61.3

%

31.0

 

20.6

 

10.4

 

50.5

%

Ortho Express

 

3.4

 

3.7

 

(0.3

)

-9.7

%

6.2

 

7.5

 

(1.3

)

-17.9

%

Total Ortho volume

 

20.2

 

14.1

 

6.1

 

42.6

%

37.2

 

28.1

 

9.1

 

32.2

%