Align Technology 10-Q 2008
Washington, D.C. 20549
Commission file number: 0-32259
Align Technology, Inc.
(Exact name of registrant as specified in its charter)
881 Martin Avenue
Santa Clara, California 95050
(Address of principal executive offices) (Zip Code)
(Registrants 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, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
The number of shares outstanding of the registrants Common Stock, $0.0001 par value, as of July 31, 2008 was 67,615,064.
Invisalign, Align, ClinCheck, Invisalign ClinAssist, Invisalign Teen and Vivera, amongst others, are trademarks belonging to Align Technology, Inc. and are pending or registered in the United States and other countries.
(in thousands, except per share data)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
(in thousands, except per share data)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ALIGN TECHNOLOGY, INC.
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 Aligns financial position as of June 30, 2008, its results of operations for the three and six months ended June 30, 2008 and 2007, and its cash flows for the six months ended June 30, 2008 and 2007. The Condensed Consolidated Balance Sheet as of December 31, 2007 was derived from the December 31, 2007 audited financial statements. Certain prior period amounts have been reclassified to conform with the 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, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008, 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 Managements 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 Companys Annual Report on Form 10-K for the year ended December 31, 2007.
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in Aligns Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from those estimates.
Recent Accounting Pronouncements
In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding 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. The Company adopted FAS 159 effective January 1, 2008, and the adoption of FAS 159 had no material impact to its consolidated financial position, results of operations or cash flows.
In September 2006, the FASB issued FAS No. 157, Fair Value Measurements (FAS 157) which provides guidance for using fair value to measure assets and liabilities. It also responds to investors requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. FAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. FAS 157, as originally issued, was effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), to partially defer FASB Statement No. 157, Fair Value Measurements (FAS 157). FSP 157-2 defers the effective date of FAS 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The Company adopted FAS 157 effective January 1, 2008, and the adoption of FAS 157 had no material impact to its consolidated financial position or results of operations.
In December 2007, the FASB issued FAS No. 141 (revised 2007), Business Combinations (FAS 141R). FAS 141R establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the fair value of identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date. FAS 141R determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141R applies prospectively and is effective for fiscal years beginning on or after December 15, 2008. The Company is currently evaluating the potential impact, if any, of the adoption of FAS 141R on its consolidated financial position, results of operations and cash flows.
In December 2007, the FASB issued FAS No.160, Noncontrolling Interests in Consolidated Financial Statements (FAS 160), an amendment of Accounting Research Bulletin No. 51, Consolidated Financial Statements (ARB 51). FAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions with minority interest holders. FAS 160 is effective for fiscal years beginning after December 15, 2008. The Company plans to adopt FAS 160 beginning in the first quarter of 2009. The Company is evaluating the impact the adoption of FAS 160 will have on its consolidated financial position and results of operations.
In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (FAS 161). FAS 161 requires disclosures of how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for and how derivative instruments and related hedged items affect an entitys financial position, financial performance, and cash flows. FAS 161 is effective for fiscal years beginning after November 15, 2008, with early adoption permitted. The Company is currently evaluating the impact of the pending adoption of FAS 161 on its consolidated financial statements.
In May 2008, the FASB issued FAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (FAS 162). FAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy). FAS 162 will become effective 60 days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not expect the adoption of FAS 162 to have a material effect on its consolidated financial position and results of operations.
In May 2008, the FASB issued FSP Accounting Principles Board (APB) 14-1 Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (FSP APB 14-1). FSP APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuers non-convertible debt borrowing rate. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis and will be adopted by the Company in the first quarter of 2010. The Company is currently evaluating the potential impact, if any, of the adoption of FSP APB 14-1 on its consolidated results of operations and financial condition.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants and the SEC did not or are not believed by management to have a material impact on the Companys present or future consolidated financial statements.
Note 2. Marketable Securities and Fair Value Measurements
The Companys marketable securities as of June 30, 2008 and December 31, 2007 are as follows (in thousands):
For the three and six months ended June 30, 2008 and 2007, no significant losses were realized on the sale of marketable securities.
Fair Value Measurements
The following table summarizes the Companys financial assets measured at fair value on a recurring basis in accordance with FAS 157 as of June 30, 2008 (in thousands):
The Companys financial assets and liabilities are valued using market prices on both active markets (Level 1) and less active markets (Level 2). Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily-available pricing sources for comparable instruments. As of June 30, 2008, the Company did not have any assets or liabilities without observable market values that would require a high level of judgment to determine fair value (Level 3 assets).
Note 3. Balance Sheet Components
Inventories, net are comprised of (in thousands):
Work in process includes costs to produce the Invisalign product. Finished goods primarily represent ancillary products that support the Invisalign system.
Accrued liabilities consist of the following (in thousands):
Note 4. Intangible Assets
The following is a summary of the Companys purchased intangible assets as of June 30, 2008 and December 31, 2007 (in thousands):
These intangible assets are being amortized on a straight-line basis over the expected useful life of five years. 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, or a significant decline in the Companys 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, 2008 is as follows (in thousands):
Note 5. Legal Proceedings
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 (a Danaher Corporation subsidiary). 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.
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 arguments took place on April 3, 2006. Following oral arguments, the U.S. Court of Appeals for the Federal Circuit (CAFC) issued a ruling declaring two out of a total of 71 claims in the Companys US Patent No. 6,398,548 and four out of a total of ten claims in US Patent No. 6,554,611 to be invalid as obvious. The CAFCs decision reverses the California District Court summary judgment order of validity.
The second appeal was from the final judgment. Ormco appealed the ruling of the District Court that 92 claims in four of its patents are not infringed by the Company and that the asserted claims are invalid. Align appealed the ruling of the District Court that certain claims of its 6,398,548 patent which were found to be infringed by Ormcos and AOAs Red, White & Blue appliances were invalid. The CAFC issued a ruling on August 24, 2007, affirming the District Courts ruling that 86 out of 92 claims in the four asserted Ormco patents are invalid and not infringed by Align. The CAFC reversed the District Courts non-infringement rulings on six claims in Ormcos 6,616,444 patent, which will be returned to the District Court for a determination of validity and infringement of those claims. The Court has denied Ormcos petition for rehearing with respect to the portion of the Federal Circuits opinion that affirmed the District Courts ruling of non-infringement and non-enablement of the 86 claims. On Aligns cross-appeal, the CAFC affirmed the District Courts finding that six claims in the 6,398,548 patent are invalid.
Ormco filed a petition for review with the U.S. Supreme Court with respect to the portion of the CAFCs opinion that affirmed the District Courts ruling of non-infringement and non-enablement of Ormcos 86 claims. The Supreme Court denied Ormcos petition. In addition, the District Court has set a schedule for the case to proceed on the six claims in Ormcos 444 patent which were returned to the District Court for further proceedings. The parties are currently conducting discovery. Trial dates have been set for February 10, 2009 on liability issues, and for September 2009 on damages issues.
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 Aligns 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.
On July 3, 2007, the Company filed an answer to the complaint and asserted 17 affirmative defenses. On July 20, 2007, the Company filed a motion for summary judgment on the Third Cause of Action (the only cause of action alleged against Align). On August 24, 2007, Weber filed a motion for class certification. On October 1, 2007, the Company filed an opposition to the motion for class certification and it is currently awaiting rulings from the Court. OrthoClear has filed a motion to dismiss. The initial case management conference and all discovery has been stayed pending the Courts decision on the motion for class certification, OrthoClears motion to dismiss and the Companys motion for summary judgment.
Litigating claims of these types, whether or not ultimately determined in the Companys favor or settled by the Company, is costly and diverts the efforts and attention of the Companys management and technical personnel from normal business operations. Any of these results from litigation could adversely affect the Companys results of operations. From time to time, the Company has received, and may again receive, letters from third parties drawing the Companys attention to their patent rights. While the Company does not believe that it infringes any such rights that have been brought to the Companys attention, there may be other more pertinent proprietary rights of which the Company is presently unaware.
Note 6. Credit Facilities
Effective January 1, 2008, the available borrowings under the revolving line of credit is $25 million. This credit facility matures on December 31, 2008. As of June 30, 2008, there were no outstanding borrowings against this credit facility, and the Company is in compliance with the financial covenant of this credit facility.
Note 7. Commitments and Contingencies
As of June 30, 2008, minimum future lease payments for non-cancelable leases are as follow (in thousands):
The Company warrants its products against material defects until the Invisalign case is completed. The Company accrues for warranty costs in cost of revenues 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 replacement costs. The Company regularly reviews the accrued balances and updates these balances based on historical warranty trends. Actual warranty costs incurred have not materially differed from those accrued. However, future actual warranty costs could differ from the estimated amounts.
The following table reflects the change in the Companys warranty accrual during the six months ended June 30, 2008 and 2007, respectively (in thousands):
Note 8. Stock-based Compensation
Summary of stock-based compensation expense
Stock-based compensation expense recognized in the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007 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 table summarizes stock-based compensation expense related to all of the Companys stock-based awards and employee stock purchases under FAS 123R for the three and six months ended June 30, 2008 and 2007:
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:
(1) The Employee Stock Purchase Plan has purchase dates on February 1 and August 1 of each year. There were no Employee Stock Purchase Plan activities during the second quarters of 2008 and 2007.
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 discretion. 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.
Stock option activity for the six months ended June 30, 2008 under the stock incentive plans is set forth below:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between Aligns closing stock price on the last trading day of the second quarter of 2008 of $10.49 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, 2008. This amount changes based on the fair market value of Aligns stock.
The total intrinsic value of stock options exercised for the three and six months ended June 30, 2008 was $0.8 million and $4.5 million, respectively. The total intrinsic value of stock options exercised for the three and six months ended June 30, 2007 was $17.9 million and $24.2 million, respectively. As of June 30, 2008, Align expects to recognize $24.5 million of total unamortized compensation cost related to stock options over a weighted average period of 2.8 years. The Company has recognized tax benefits from exercised options for the six months ended June 30, 2008 of approximately $86,000. 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 (RSUs) that generally vest over 4 years. Prior to October 2007, 25% of the grant vested on the one year anniversary of the date of grant and 6.25% vested quarterly thereafter. In October 2007, the Compensation Committee of the Board of Directors approved to change the vesting for prospective grants of RSUs to 25% annually. The fair value of each award is based on the Companys closing stock price on the date of grant. A summary of the nonvested shares for the six months ended June 30, 2008 is as follows:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (calculated by using Aligns closing stock price on the last trading day of the second quarter of 2008 of $10.49 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, 2008. This amount changes based on the fair market value of Aligns stock.
The total intrinsic value of restricted stock units vested and released for the three and six months ended June 30, 2008 was $0.7 million and $1.9 million, respectively. The total intrinsic value of restricted stock units vested and released for the three and six months ended June 30, 2007 was $0.6 million and $2.0 million, respectively. As of June 30, 2008, the total unamortized compensation cost related to restricted stock units was $13.4 million, which Align expects to recognize over a weighted average period of 3.0 years.
Employee Stock Purchase Plan
Aligns 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, 2008, Align expects to recognize $2.8 million of total unamortized compensation cost related to employee stock purchases over a weighted average period of 0.7 years.
Note 9. 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 TaxesAn Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entitys 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.
The Company has unrecognized tax benefits of approximately $2.8 million as of December 31, 2007. Included in the unrecognized tax benefits are $0.3 million of uncertain tax positions that would impact the Companys effective tax rate if recognized. The application of FIN 48 would have resulted in an increase of the accumulated deficit by $2.9 million, except that the increase 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 Companys unrecognized tax benefits for the six month period ended June 30, 2008 nor does the Company expect a material change for the twelve month period ending December 31, 2008.
The Company is subject to taxation in the U.S. and various states and foreign jurisdictions. All the Companys tax years will be open to examination by the U.S. federal and most state tax authorities due to the Companys 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 2003.
Note 10. Net Profit Per Share
Basic net profit per share is computed using the weighted average number of shares of common stock during the period. Diluted net profit 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, restricted stock units, and the dilutive component of Purchase Plan shares.
The following table sets forth the computation of basic and diluted net profit per share attributable to common stock (in thousands, except per share amounts):
For the three and six months ended June 30, 2008, stock options and restricted stock units totaling 5.5 million and 4.7 million, respectively, were excluded from diluted net profit per share because of their anti-dilutive effect. For the three and six months ended June 30, 2007, stock options and restricted stock units totaling 1.0 million and 1.9 million, respectively, were excluded from diluted net profit per share because of their anti-dilutive effect.
Note 11. Comprehensive Income
Comprehensive income includes net profit, foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. The components of comprehensive income are as follows (in thousands):
Note 12. Segments and Geographical Information
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 Companys reportable operating segments. During all periods presented, the Company operated as a single business segment.
Net revenues and long-lived assets are presented below by geographic area (in thousands):
Note 13. Common Stock Repurchase Program
In April 2008, the Companys Board of Directors approved a common stock repurchase program authorizing management to repurchase up to $50 million of the Companys outstanding common stock. Purchases under the program were made, from time to time, in the open market. During the three months ended June 30, 2008, the Company repurchased 2.2 million shares of common stock at an average price of $12.65 per share for an aggregate purchase price of $27.7 million, including commissions. The common stock repurchases reduced additional paid-in capital by $19.6 million and increased accumulated deficit by $8.1 million. The remaining authorized amount of stock repurchases under this program is $22.3 million. All repurchased shares will be retired.
Note 14. Subsequent Events
In July 2008, the Company announced a restructuring plan to reduce its overall company spending and slow headcount growth while allowing the Company to continue critical investments in its new products and strategic initiatives. The Company announced a reduction in full time headcount and the implementation of discretionary spending cuts, which will have the effect of reducing expenses by $5 to $6 million over the second half of the year in selected areas. Additionally, the Company will implement a phased-consolidation of order acquisition operations from corporate headquarters in Santa Clara, California to Juarez, Mexico. The Company anticipates completing the consolidation by the end of 2008, at which time, the headcount in the United States will be transitioned out. Annualized cost savings of $1.0 to $1.5 million from this action will be realized in 2009. These actions will result in a restructuring charge of approximately $2.6 million in the second half of 2008, of which approximately $2.2 million will be recognized in the third quarter of 2008.
On July 31, 2008, the Company entered into an agreement in favor and for the benefit of Elamex de Juarez, S.A. DE C.V., landlord to International Manufacturing Solutions Operaciones, S.R.L. (IMS), Aligns third party shelter services provider, to guarantee IMS lease payments for its facility located in Juarez, Mexico. The current lease for this facility expires in July 2013. Pursuant to the guarantee, the Company is obligated to pay Elamex de Juarez, S.A. DE C.V. for any rents in default by IMS.
In connection with the above guarantee issued by the Company and as of August 1, 2008, the Company is contingently liable for future rental payments of approximately $1.8 million, which will decrease monthly as IMS pays the monthly rent of approximately $30,000.
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 release of Invisalign ClinAssist, Invisalign Teen and Vivera including the expected impact these new products and product enhancements will have on doctor utilization and our market share, and with respect to Invisalign ClinAssist the anticipated product release date and product features, our expectations regarding product mix, our expectations regarding the existence and impact of seasonality, the anticipated amount of cost-savings due to the restructuring, the expected amount and timing of the charges to be incurred in connection with these measures, our expectation that our utilization rate will improve over time, our expectations regarding our average selling prices and gross profits in 2008, 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 in 2008 regarding case shipment volume, the anticipated level of our operating expenses, and the number of doctors trained, statements regarding our stock repurchase program which could be delayed indefinitely by conditions in the stock or debt markets, our need to conserve capital resources for use in our operations and other factors beyond our control, 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 7 Managements Discussion and Analysis of Financial Condition and Results of Operations, and in particular, the risks discussed below in Part II, Item 1A Risk Factors. 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.
Align Technology, Inc., founded in April 1997, designs, manufactures and markets the Invisalign system, 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. We received the United States Food and Drug Administration (FDA) clearance to market Invisalign in 1998. The Invisalign system is regulated by the FDA as a Class II medical device.
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 sets of 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, for minor crowding and spacing, or as a pre-cursor to restorative or cosmetic treatments such as veneers. Invisalign Teen, which was launched in July 2008, is designed to meet the specific needs of the non-adult comprehensive or teen treatment market. Upon completion of an Invisalign or non-Invisalign treatment, the patient may be prescribed our Vivera retainers, a clear aligner set designed for ongoing retention.
A number of factors, the most important of which are set forth below, may affect our results during the remainder of 2008 and beyond.
· Product innovationNew products and enhancements to existing products. We believe that product performance and innovation is a cornerstone to our future long-term growth by driving and sustaining product adoption and enhancing the user experience and thereby increasing utilization growth. Currently, the Invisalign system is a single system used by both GPs and orthodontists. We are committed to delivering new products and introducing new product features to better meet the needs of our two customersorthodontists and GPseach with distinct and separate needs. Orthodontists want a more robust set of tools for greater predictability, wider applicability and more flexibility in the use of the Invisalign system. On the other hand, typical GPs want greater ease of use, more efficient and simplified diagnostic tools, guidance through the case set-up process, minimal treatment intervention and self-help tools designed to simplify treatment of cases of mild to moderate malocclusion. Based on this knowledge, in July 2008 we announced the release of Invisalign Teen and the anticipated release of Invisalign ClinAssist later this year.
With the introduction of Invisalign Teen in July, our Invisalign product family now includes a product designed to meet the specific needs of the non-adult comprehensive, or teen market. Invisalign Teen includes features such as an aligner wear indicator to help gauge patient compliance and specially engineered aligner features to address the natural eruption of key teeth and root control issues common in teen patients. Predominantly marketed to orthodontists who treat the vast majority of malocclusion in teen patients, these features make it easier and more efficient for orthodontists to treat those younger patients. The launch of a teen-specific product will make the Invisalign system more applicable to an orthodontists patient base, which we believe will increase our penetration into and our share of the teen treatment market.
Invisalign ClinAssist is the first phase of our GP-specific product platform and is intended to help newly-certified and low volume Invisalign GPs accelerate the adoption and frequency of use of Invisalign into their practice. ClinAssist is being designed with built-in monitoring tools and progress tracking.
We believe continuing to introduce new products and product features as well as enhancing the user experience will keep us at the forefront of the market and increase demand for Invisalign. The recent launch of Invisalign Teen and the planned roll out of Invisalign ClinAssist and other future products will rely on new features, tools and delivery options to meet specific clinical demands while providing a family of end-to-end solutions for our customers. We believe enhanced product performance and innovation will continue to drive the adoption and frequency of use (what we call utilization). See Part II, Item 1ARisk Factors for risks related to our ability to develop and successfully introduce new products.
· Increase customer adoption and utilization. By increasing adoption through the expansion of our customer base and then increasing utilization by offering new products and feature enhancements to meet the needs of orthodontists and GPs, we believe the overall market for Invisalign and our share of that market will increase. Although we expect that over the long-term our utilization rates will gradually improve, we expect that period over period comparisons of our utilization rates will fluctuate. Our quarterly utilization rates from the first quarter of 2006 through the second quarter of 2008 are as follows:
* Utilization rates = # of cases shipped / # of doctors cases were shipped to
· Training new orthodontists and general practitioners. Expanding our customer base through training is a key part of our strategy. Through June 30, 2008, we have trained 30,260 GPs and 8,510 orthodontists in the United States and 13,340 doctors internationally. We expect to train approximately 6,600 GPs and orthodontists worldwide in 2008. 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. Currently, we have incorporated the Invisalign technique into the curriculum of 38 university programs. We expect additional dental schools to integrate the Invisalign technique into their curricula in the future.
· Focus on education and customer support. In order to build long-term relationships with our customers and increase utilization, we focus on providing ongoing training, support and services. In early 2008, we announced the introduction of the Aligntech Institute program brand (www.aligntechinstitute.com ), which is a new interactive website that will provide clinical education and practice development training. These clinical education and practice development training opportunities will include instructor-led certification classes, seminars and workshops, conference calls, web-based videos, case studies, and other clinical resources. Many of these courses and resources are eligible for continuing education (CE) credits. By participating in these events, we believe that our customers will emerge with a better understanding of the product and its applicability, and with a greater aptitude for starting and finishing Invisalign cases successfully. Our VIP portal (Virtual Invisalign Practice) provides our trained doctors and their staff access to thousands of Invisalign cases and best practices as well as up-to-date support information, programs and marketing materials for continuous support and information access.
· Stimulate demand for Invisalign treatmentIncreasing our patient base. Marketing to the consumer and creating demand is one of our key strategic objectives to driving long-term growth. Our market research indicates that the vast majority of people with malocclusion who desire treatment do not elect traditional treatment because of its many limitations, such as compromised aesthetics and oral discomfort. By communicating the benefits of Invisalign to both dental professionals and consumers, we intend to increase the number of patients who seek Invisalign treatment annually. In 2008, we expect to increase our overall marketing spending in the United States with expenses related to the launch of our new TV advertising campaign which occurred in the first quarter of 2008 and an increased focus on other programs, such as digital online media, designed to raise the profile of Invisalign and drive more consumers to our most experienced doctors. We will incur additional costs in the United States related to bringing new products to market, such as Invisalign Teen and Invisalign ClinAssist. We also intend to initiate similar consumer marketing efforts, but on a smaller scale, in key European countries. Despite the continuing challenges in the U.S. economy and weak consumer spending, we believe that consumer demand creation is critical to our long-term growth. As a result, we will continue to invest in efforts to increase consumer awareness of Invisalign.
· Product mix. For the six months ended June 30, 2008 and 2007, our Invisalign revenues as a percentage of total net revenues are as follows:
We launched Vivera retainers in November 2007 and Invisalign Teen in July 2008, and we anticipate the launch of Invisalign ClinAssist in the latter half of 2008. As a result of and depending upon customer adoption of these new products, as well as the timing of the Invisalign ClinAssist launch, we expect our mix of products to begin shifting gradually in the latter part of 2008 and into 2009. Key features of these new products include staged delivery of retainers with Vivera, staged delivery of aligners with Invisalign ClinAssist, and up to six free replacement aligners with Invisalign Teen. As a result of these features, these new products will have a significantly higher amount of deferred revenue as a percentage of their average selling price compared to our current products. Included in the price of full Invisalign treatment, we offer case refinement, which is a finishing tool used to adjust a patients teeth to the desired final position. Both Invisalign Teen and Invisalign ClinAssist include a deferral for case refinement. In addition, revenue for the six replacement aligners included in Invisalign Teen will be deferred based on their fair market value until the earlier of replacement aligners being used or until the case is completed. Invisalign ClinAssist will be invoiced upon the first staged shipment and revenue will be deferred to the balance sheet and recognized upon shipment of the final staged shipment. The Vivera retainer subscription includes four shipments per year, and revenue is deferred upon the first shipment and then recognized ratably over the one year subscription period. As these new products increase as a percentage of our total case volume in the latter part of 2008, deferred revenue on our balance sheet will increase.
· Growth of international markets. We will continue to focus our efforts towards increasing adoption of Invisalign by dental professionals in our key international markets, Europe and Japan. We expect our international revenues to continue to increase in absolute dollars and as a percentage of total net revenues in the foreseeable future. We continually evaluate cost effective ways to support our customers in smaller and less strategic markets. During 2007, we transitioned the sales of our product in part of the Asia-Pacific and Latin American regions 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.
· Reliance on international manufacturing operations. Our manufacturing efficiency has been and will continue to be an important factor in our future profitability. Currently, two of our key production steps are performed in 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. These electronic treatment plans 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 dependent on IMSs and our ability to hire and retain employees, as well as hire and retain employees with the necessary skills to perform the more technical aspects of our operations. If our management 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, we may not have a 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 1ARisk Factors for risks related to our international operations.
· Stock Repurchase Program. On April 29, 2008, we announced that our Board of Directors had approved a stock repurchase program of up to $50 million. During the three months ended June 30, 2008, we repurchased 2.2 million shares of our common stock at an average price of $12.65 per share for an aggregate purchase price of $27.7 million.
· 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. These seasonal trends have caused and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.
· Foreign Exchange Rates. Although the U.S. dollar is our reporting currency, a portion of our revenues and profits are generated in foreign currencies. Revenues and profits generated by subsidiaries operating outside of the United States are translated into U.S. dollars using exchange rates effective during the respective period and as a result are affected by changes in exchange rates. We have generally accepted the exposure to exchange rate movements without using derivative financial instruments to manage this risk. Therefore, both positive and negative movements in currency exchanges rates against the U.S. dollar will continue to affect the reported amount of revenues and profits in our consolidated financial statements.
· Restructuring. In July 2008, we announced a restructuring plan to reduce our overall company spending and slow headcount growth while allowing us to continue critical investments in our new products and strategic initiatives. We announced a reduction in full time headcount and the implementation of discretionary spending cuts, which will have the effect of reducing expenses by $5 to $6 million over the second half of the year in selected areas. Additionally, we will implement a phased-consolidation of order acquisition operations from our corporate headquarters in Santa Clara, California to Juarez, Mexico. We anticipate completing the consolidation by the end of 2008, at which time, the headcount in the United States will be transitioned out. Annualized cost savings of $1.0 to $1.5 million from this action will be realized in 2009. These actions will result in a restructuring charge of approximately $2.6 million in the second half of 2008, of which approximately $2.2 million will be recognized in the third quarter of 2008.
· Stock-based compensation. We implemented Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-based Payment (FAS 123R) in 2006, and we expect stock-based compensation to increase until at least 2010, which corresponds to our standard 4 year vesting term. Thereafter, new grants will be expensed over the vesting period, however, this expense may be offset by fully vested grants that are no longer expensed. For the three and six months ended June 30, 2008 and 2007, stock-based compensation expense recognized in accordance with FAS 123R is as follows (in thousands):
Results of Operations
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, 2008 and 2007 are as follows (in millions):
Case volume data which represents Invisalign case shipment by channel, for the three and six months ended June 30, 2008 and 2007 are as follows (in thousands):