UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] 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 Incorporation or Organization)
(I.R.S. Employer Identification Number)
851 Martin Avenue Santa Clara, California 95050 (Address of Principal Executive Offices including Zip Code)
(408) 470-1000 (Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.0001 par value
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the registrant as of March 18, 2002 was $238,192,119. This calculation does not reflect a determination that persons are affiliates for any other purpose.
On March 18, 2002, 48,119,620 shares of the registrant's common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement relating to its 2001 annual stockholders' meeting to be held on May 16, 2002 are incorporated by reference into Part III of this annual report on Form 10-K.
PART I
In addition to historical information, this report on Form 10-K contains forward-looking statements. 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 the following sections entitled "Factors That May Affect Operating Results" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
ITEM 1. BUSINESS.
Overview
We design, manufacture and market Invisalign®, a proprietary new method for treating malocclusion, or the misalignment of teeth. Invisalign corrects malocclusion using a series of clear, 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 also offers dental professionals a new means of carrying out their diagnosis and treatment planning processes. We believe Invisalign has the potential to transform the traditional practice of orthodontics by appealing to people who would not otherwise seek treatment.
In the U.S. alone, over 200 million individuals have some form of malocclusion. Each year, less than one percent of these individuals, or approximately two million Americans, enter orthodontic treatment, spending approximately $7 billion in the aggregate. We believe Invisalign is a compelling treatment alternative for most of the patients who would seek traditional orthodontic treatment. In addition, given the significant benefits of Invisalign, we have the opportunity to expand the U.S. orthodontic market by addressing the needs of millions of individuals who would not otherwise seek treatment. Further, we believe the international opportunity is larger than the U.S. opportunity.
We received FDA clearance to market Invisalign in 1998 and started commercial sales in July 1999. Our 510(k) clearance from the FDA allows us to market the Invisalign to treat patients with any type of malocclusion. We voluntarily restrict the use of Invisalign to adults and adolescents with mature dentition. Individuals with mature dentition have fully erupted second molars and substantially complete jaw growth. This group represents approximately 130 million people in the U.S. Typically, girls by the age of 13 years and boys by the age of 16 years will have developed mature dentition. Currently, we do not treat children whose teeth and jaws are still developing, as the effectiveness of Invisalign relies on our ability to accurately predict the movement of teeth over the course of treatment. Based on our clinical studies to date, we recommend that dental professionals use Invisalign as a complete treatment for a broad range of malocclusions and as a component of treatment for unusually severe malocclusions.
Historically, we limited our training of dental professionals to orthodontists in the U.S and Canada. In October 2001, we expanded our training in the U.S. and Canada to include dentists. As of February 28, 2002, we had trained over 12,000dental professionals worldwide to use Invisalign. Of those dental professionals trained, approximately80% are dental professionals in the U.S. and Canada, which we consider our domestic market. Within our domestic market, we have trained over 7,300 orthodontists, representing approximately 80% of all practicing orthodontists in the U.S. and Canada, and over 2,300 dentists. As of February 28, 2002, over 4,300 of the worldwide dental professionals we have trained had submitted one or more cases to us, and over 44,000 patients have commenced treatment with Invisalign.
Our objective is to establish Invisalign as the standard method for treating orthodontic malocclusion. Our sales and marketing efforts focus on educating both consumers and dental professionals on the significant benefits of Invisalign. We continue to train dental professionals and work with them to increase the use of Invisalign within their practices. In September 2000, we initiated a national advertising campaign to create awareness of Invisalign as a treatment alternative and to stimulate demand for treatment with Invisalign. In 2001, we continued to advertise nationally using a broader marketing mix to drive consumer and dental professional demand and to reinforce the breadth of applicability of Invisalign.
Industry Background
Malocclusion
Malocclusion is one of the most prevalent clinical conditions, affecting over 200 million individuals, or approximately 75% of the U.S. population. Approximately two million people annually elect orthodontic treatment in the U.S., generating industry revenues of approximately $7 billion. While most individuals seek orthodontic treatment to improve their appearance, malocclusion may also be responsible for dental problems such as tooth decay, tooth loss, gum disease, jaw joint pain and headaches. Because of the compromised aesthetics, discomfort and other drawbacks associated with conventional orthodontic treatments, only a relatively small proportion of people with malocclusion seek treatment.
Traditional Orthodontic Treatment
Dental professionals today apply traditional techniques and principles of orthodontic treatment developed in the early 20th century. In the U.S., dental professionals treat malocclusion primarily with metal archwires and brackets, commonly referred to as braces. Occasionally, in an attempt to improve treatment aesthetics, dental professionals use ceramic, tooth-colored brackets or bond brackets on the inside, or lingual surfaces, of the patient's teeth. Dental professionals also augment braces with elastics, metal bands, headgear and other ancillary devices.
The average treatment takes approximately two years to complete and requires several hours of direct dental professional involvement, or chair time. To initiate treatment, a dental professional will diagnose a patient's condition and create an appropriate treatment plan. In a subsequent visit, the dental professional will bond brackets to the patient's teeth with cement and attach an archwire to the brackets. Thereafter, by tightening or otherwise adjusting the braces approximately every six weeks, the dental professional is able to exert sufficient force on the patient's teeth to achieve desired tooth movement. Because of the length of time between visits, the dental professional must tighten the braces to a degree sufficient to achieve sustained tooth movement during the interval. In a final visit, the dental professional removes each bracket and residual cement from the patient's teeth.
Fees for traditional orthodontic treatment typically range between $3,000 to $5,000 and are generally not reimbursed by insurance. In addition, dental professionals commonly charge a premium for lingual or ceramic alternatives. Fees are based on the difficulty of the particular case and on the dental professional's estimate of chair time and are generally negotiated in advance. A treatment that exceeds the dental professional's estimate of chair time generally results in decreased fees per hour of chair time, or reduced profitability for the dental professional.
Limitations of Traditional Orthodontic Treatment
Although braces are generally effective in correcting a wide range of malocclusions, they are subject to many limitations and disadvantages. Conventional orthodontic treatment is associated with:
Unattractive appearance. Braces call attention to the patient's condition and treatment. In addition, braces trap food, which can further compromise appearance. Braces can also result in permanent discoloration of teeth. Many adults associate braces with adolescence. As a result of these and other limitations, less than one half of one percent of American adults with malocclusion elect orthodontic treatment annually.
Oral discomfort. Braces are sharp and bulky and can abrade and irritate the interior surfaces of the mouth. The tightening or adjustment of braces results in root and gum soreness and discomfort, especially in the days after an orthodontic visit.
Poor oral hygiene. Braces compromise oral hygiene by making it more difficult to brush and floss. These problems can result in tooth decay and periodontal damage. Additionally, the bonding of brackets to teeth can cause permanent markings on the teeth.
Inability to project treatment. Historically, dental professionals have not had a means to model the movement of teeth over a course of treatment. Accordingly, dental professionals must rely on intuition and judgment to plan and project treatment. As a result, they cannot be precise about the direction or distance of expected tooth movement between patient visits. This lack of predictability may result in unwanted tooth movements and can limit the dental professional's ability to estimate the duration of treatment. Because most orthodontic treatment is performed on a fixed price basis, extended treatment duration reduces profitability for the dental professional.
Physical demands on dental professional. The manipulation of wires and brackets requires sustained manual dexterity and visual acuity, and may place other physical burdens on the dental professional.
Root resorption. The sustained high levels of force associated with conventional treatment can result in root resorption, a shortening of tooth roots. This shortening can have substantial adverse periodontal consequences for the patient.
Emergencies. At times, braces need to be repaired or replaced on an emergency basis. Such emergencies cause significant inconvenience to both the patient and the dental professional.
Due to the poor aesthetics, discomfort and other limitations of braces, relatively few people with malocclusion elect traditional orthodontic treatment. Accordingly, we believe there is a large unmet need for an orthodontic system that addresses these patient concerns. We also believe there is an unmet need among dental professionals for a treatment system that increases the predictability and efficiency of treatment and enhances practice profitability.
The Align Solution
Invisalign is a proprietary new system for treating malocclusion. Invisalign consists of two components: ClinCheck™ and Aligners.
ClinCheck. ClinCheck is an interactive Internet application that allows dental professional to diagnose and plan treatment for their patients. We use a dental impression and a treatment prescription submitted by a dental professional to develop a customized, three-dimensional treatment plan that simulates appropriate tooth movement in a series of two-week increments. ClinCheck allows the dental professional to view this three-dimensional simulation with a high degree of magnification and from any angle. Accordingly, ClinCheck enables the dental professional to project tooth movement with a level of accuracy not previously possible.
Upon review of the ClinCheck simulation, the dental professional may immediately approve our projected treatment, or may provide us with feedback for modification. We reflect any requested adjustments in a modified simulation. Upon the dental professional's approval of the ClinCheck simulation, we use the data underlying the simulation to manufacture the patient's Aligners.
Aligners. Aligners are custom-manufactured, clear, removable dental appliances that, when worn in prescribed series, provide orthodontic treatment. Each Aligner covers a patient's teeth and is nearly invisible when worn. Aligners are commonly worn in pairs, over the upper and lower dental arches. Aligners are generally worn for consecutive two-week periods which correspond to the approved ClinCheck treatment simulation. After two weeks of use, the patient discards the Aligners and replaces them with the next pair in the series. This process is repeated until the final Aligners are used and treatment is complete. Upon completion of the treatment, the dental professional may, at his or her discretion, prescribe that the patient wear the final Aligner as a retainer.
Benefits of Invisalign
We believe that Invisalign provides benefits to patients and dental professionals that have the potential to establish Invisalign as the preferred alternative to conventional braces.
Benefits to the Patient
Excellent aesthetics. Aligners are nearly invisible when worn, eliminating the aesthetic concerns associated with conventional braces.
Comfort. By replacing the six-week adjustment cycle of traditional braces with two-week stages, Aligners move teeth more gently. Also, Aligners are thin, smooth and low in profile. As a result, Aligners are substantially more comfortable and less abrasive than conventional braces.
Improved oral hygiene. Patients can remove Aligners for tasks that are difficult with conventional braces, such as eating, brushing and flossing. We believe this feature has the potential to reduce tooth decay and periodontal damage during treatment.
Potentially reduced overall treatment time. Aligners control force by distributing it broadly over the exposed surfaces of the teeth. In addition, the ClinCheck simulation from which Aligners are produced is designed to reduce unintended and unnecessary tooth movements. Together, these factors may significantly reduce overall treatment time relative to conventional braces.
Potentially reduced root resorption. We believe that controlling force and shortening treatment time has the potential to reduce the incidence of root resorption.
Reduced incidence of emergencies. Typically, a lost or broken Aligner is simply replaced with the next Aligner in series, minimizing inconvenience to both patient and dental professional.
We believe that these benefits will prove attractive to people who currently do not seek treatment because of the limitations of conventional braces.
Benefits to the dental professional
Ability to visualize treatment and likely outcomes. We believe that ClinCheck is the only product that enables dental professionals to preview a course of treatment and the likely final outcome of treatment in an interactive three-dimensional computer model. ClinCheck allows dental professionals to analyze multiple treatment alternatives before selecting the alternative they feel is most appropriate for the patient.
Minimal additional training. The biomechanical principles that underlie Invisalign are consistent with those of traditional orthodontics. Dental professionals can complete our initial training and certification program within a day.
Ease of use. When treating patients with Invisalign, dental professionals do not spend their time manipulating wires and brackets. This allows them to spend proportionately more time diagnosing and interacting with their patients.
Significantly expanded patient base. We believe Invisalign has the potential to transform the practice of orthodontics. Currently, less than one percent of the over 200 million people with malocclusion in the U.S. enter treatment each year. We believe that Invisalign will allow dental professionals to attract patients who would not otherwise seek orthodontic treatment.
Higher fees. Dental professionals typically charge between $3,000 and $5,000 for a course of conventional treatment. Due to the substantial patient benefits of Invisalign, we believe dental professionals offering Invisalign have generally been able to command a significant premium. In our experience, the premiums charged by dental professionals for Invisalign have been comparable to other treatment alternatives that attempt to improve the aesthetics of conventional braces, such as ceramic and lingual braces.
Decreased dental professional and staff time. Invisalign reduces both the frequency and length of patient visits. Invisalign eliminates the need for time-intensive processes such as bonding appliances to the patient's teeth, adjusting archwires during the course of treatment and removing the appliances at the conclusion of treatment. As such, use of Invisalign significantly reduces dental professional and staff chair time and can increase practice throughput.
We believe the combination of increased patient volume, higher fees per case and reduced chair time has the potential to substantially improve orthodontic practice profitability.
Limitations of Invisalign
In some instances, Invisalign may have certain limitations relative to conventional treatment. Aligners cost more to produce than conventional braces, and we charge dental professionals more than they generally pay for the supplies used in conventional treatment. Depending on the individual pricing policies of each dental professional, the cost of Invisalign to the patient may be greater than for conventional braces. Dental professionals must also incorporate our manufacturing cycle times into their overall treatment plan. Once a dental professional submits a case to us, there is generally a turn- around time of a month or more before the corresponding Aligners are delivered. Aligners may not be appropriate for all cases, such as unusually severe malocclusion, which may require Aligners to be used in combination with conventional braces for optimal results. In addition, because Aligners are removable, treatment using Invisalign depends on patients wearing their Aligners as recommended. Some patients may experience a temporary period of adjustment to wearing Aligners that may mildly affect speech. We believe that these limitations are outweighed by the many benefits of Invisalign to both patients and dental professionals.
Our Target Market
Commercial sales of Invisalign commenced in the U.S. in July 1999. As of February 28, 2002, approximately 44,000 patients have entered treatment using Invisalign.
Our 510(k) clearance from the FDA allows us to market Invisalign to treat patients with any type of malocclusion. We voluntarily restrict the use of Invisalign to adults and adolescents with mature dentition. Individuals with mature dentition have fully erupted second molars and substantially complete jaw growth. This group represents approximately 130 million people in the U.S. Typically, girls by the age of 13 years and boys by the age of 16 years will have developed mature dentition. Currently, we do not treat children whose teeth and jaws are still developing, as the effectiveness of Invisalign relies on our ability to accurately predict the movement of teeth over the course of treatment. Based on our clinical studies to date, we recommend that dental professionals use Invisalign as a complete treatment for a broad range of malocclusions and as a component of treatment for unusually severe malocclusions.
Approximately two million patients enter into traditional orthodontic treatment in the U.S. annually. These patients represent less than one percent of the population of people with malocclusion. Of these, over 50%, or more than one million patients, have mature dentition and are therefore natural candidates for Invisalign.
In addition, we believe that we have an immediate and substantial market expansion opportunity. 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. We believe that by addressing the primary limitations of braces, Invisalign will encourage this group to seek treatment. Adults, who are particularly sensitive to the aesthetic limitations of traditional treatment, represent our most significant market expansion opportunity.
We continue to focus on the domestic market opportunity and have expanded our focus on selected international markets, as we believe a large international market opportunity exists.
Business Strategy
Our objective is to establish Invisalign as the standard method for treating orthodontic malocclusion. Key elements of our strategy include the following:
Educate dental professionals and stimulate demand for Invisalign treatment. 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. By communicating the benefits of Invisalign to both dental professionals and consumers, we intend to significantly increase the number of patients who seek orthodontic treatment annually. We successfully tested consumer advertising in two lead markets and in September 2000 initiated a national advertising campaign in order to create awareness of Invisalign as a treatment alternative and to establish the Invisalign brand name. In 2001, we continued to advertise nationally using a broader marketing mix to drive consumer and dental professional demand and to reinforce the breadth of applicability of Invisalign. In October 2001, we expanded our training of dental professionals in our domestic market to include dentists. As of February 28, 2002, we had trained over 12,000 dental professionals worldwide on the use and benefits of Invisalign.
Communicate practice benefits of Invisalign to dental professionals. Invisalign provides substantial financial incentives to dental professionals by enabling them to increase patient volume, charge a premium price and reduce chair time per treatment. We intend to continue to emphasize these practice benefits to dental professionals through our sales and training efforts.
Expand and enhance manufacturing capability. Our manufacturing operations are designed to produce large numbers of custom Aligners at a high level of quality. To improve cost efficiency, we conduct labor intensive processes in relatively low wage countries. We intend to maintain manufacturing capacity in excess of projected demand to reduce the risk that manufacturing capacity constrains our ability to grow. Our proprietary software underlies our manufacturing process. By continually developing this software and other manufacturing processes, we plan to increase the level of production automation. Increased automation will enhance production capacity and reduce both unit costs and production times.
Extend and defend technology leadership. Invisalign represents a significant technological advancement in orthodontics. We believe that our issued patents, multiple pending patents and other intellectual property provide us with a substantial lead over potential competitors. One of our issued U.S. patents is written to broadly cover any algorithmic method of segmenting orthodontic treatment into a sequence of three or more steps, based on calculated initial and final representations of a patient's dentition. We continue to pursue further intellectual property protection through U.S. and foreign patent applications and non-disclosure agreements. We also seek to protect our software, documentation and other written materials under trade secret and copyright laws.
Expand our target patient base. Invisalign can provide complete treatment for patients with mature dentition and a broad range of malocclusion. In addition, we believe that Invisalign can provide partial treatment of unusually severe malocclusions. In an effort to demonstrate Invisalign's ability to comprehensively treat such cases, we initiated the publication of a series of clinical case studies and articles that highlight the applicability of Invisalign to malocclusion cases of even severe complexity. We are also undertaking post-marketing studies and making additional improvements to the product.
Build an international presence.Initially, we focused our sales and marketing efforts on the U.S. and Canadian market opportunities. While we continue to focus on this domestic market, we have begun to introduce Invisalign in selected international markets. We believe that potential international demand for Invisalign exceeds that of our domestic market.
Manufacturing
We produce highly customized, close tolerance, medical quality products in volume. To do so, we have developed a number of proprietary processes and technologies. These technologies include complex software solutions, destructive and white light scanning techniques, stereolithography and automated Aligner fabrication.
We believe the complexity inherent in producing such highly customized devices in volume is a barrier to potential competitors. Furthermore, we believe the sophisticated software we use to guide a custom manufacturing process on a large scale was not available until we developed it.
Manufacturing is coordinated in Santa Clara, California, where, as of December 31, 2001, we employed a manufacturing staff of approximately 135 people. In addition, we employed a software development team comprising approximately 30 software engineers with backgrounds in computational geometry, animation, computer-aided design and various manufacturing industries. We also employ approximately 500 software operators and other staff in our facilities in Lahore, Pakistan, who are responsible for the creation of treatment simulations. In late 2001, we began developing operations in the United Arab Emerites ("U.A.E.") and Costa Rica, which will also create treatment simulations. In addition, we outsource the fabrication and packaging of Aligners to a contract manufacturer based in Juarez, Mexico.
The Invisalign Treatment Process
Invisalign treatment process comprises the following five stages:
Orthodontic diagnosis and transmission of treatment data to us. In an initial patient visit, the dental professional determines whether Invisalign is an appropriate treatment. The dental professional then prepares treatment data which consists of an impression of the relevant dental arches, x-rays of the patient's dentition, photographs of the patient, a wax bite depicting the relationship between the patient's upper and lower dental arches and an Invisalign treatment planning form, or prescription. The impression is a critical component as it depicts the three-dimensional geometry of the patient's teeth and hence forms the basis for our computer models. An impression requires the patient to bite into a viscous material. This material hardens, capturing the shape of the patient's teeth. The prescription is also a critical component, describing the desired positions and movement of the patient's teeth. The dental professional sends the treatment data to our Santa Clara facility.
Preparation of three-dimensional computer models of the patient's initial malocclusion. Upon receipt, we use the treatment data to construct plaster models of the patient's dentition. We scan the plaster models to develop a digital, three-dimensional computer model of the patient's current dentition. We then transmit this initial computer model together with the dental professional's prescription electronically to our facilities in Lahore, Pakistan
Preparation of computer-simulated treatment and viewing of treatment using ClinCheck. In Pakistan we transform this initial model into a customized, three-dimensional treatment plan that simulates appropriate tooth movement in a series of two-week increments. This simulation is then reviewed for adherence to prescribed clinical, treatment, and quality standards. Upon passing review, the simulation is then delivered to the prescribing dental professional via ClinCheck on our website at www.invisalign.com. The dental professional then reviews the ClinCheck simulation on a computer and, on occasion, asks us to make adjustments. By reviewing and amending the treatment simulation, the dental professional retains control over the treatment plan and, thus, participates in the customized design of the Aligners. At this point, the dental professional may also invite the patient to review ClinCheck, allowing the patient to see the projected course of treatment. The dental professional then approves the proposed treatment and, in doing so, engages us for the manufacture of corresponding Aligners.
Construction of molds corresponding to each step of treatment. We use the approved ClinCheck simulation to construct a series of molds of the patient's teeth. Each mold is a replica of the patient's teeth at each two-week stage of the simulated course of treatment. These molds are fabricated at our Santa Clara facility using custom manufacturing techniques that we have adapted for use in orthodontic applications.
Manufacture of Aligners and shipment to the dental professional. We ship these molds to Juarez, Mexico, where our contract manufacturer fabricates Aligners by pressure forming polymeric sheets over each mold. The Aligners are then trimmed, polished, cleaned, packaged and, following final inspection, shipped directly to the prescribing dental professional. In certain cases, dental professionals may use Invisalign in conjunction with clear attachments bonded to the patient's teeth. These attachments are used to increase the force applied to a tooth or teeth in circumstances where the Aligners alone may have difficulty in effecting the desired movement.
Historically, we have shipped Aligners in batches. The first batch, which typically represented the first several months of treatment, was produced once the prescribing dental professional approved ClinCheck. Thereafter, Aligners were sent at approximately six month intervals until completion of treatment. In mid-February 2001, for cases where ClinCheck was approved, we began shipping all the Aligners in a single batch. In addition, we began accelerating the shipments of Aligners for cases where ClinCheck was approved prior to mid-February 2001.
Throughput Management
Because we manufacture each case on a build-to-order basis, we cannot build inventories. As a result, we must conservatively build manufacturing throughput for anticipated demand. To increase throughput, we must improve the efficiency and increase the scale of our manufacturing processes.
In order to increase the efficiency of our manufacturing processes, we focus our efforts on software development and the improvement of rate-limiting processes, or bottlenecks. In 2001 we upgraded our proprietary, three-dimensional treatment-planning software to enhance computer analysis of treatment data, which reduced time spent on manual and judgmental tasks for each case and thereby increased the efficiency of our technicians in Pakistan. We are also continuing the development of automated systems for the fabrication of Aligners currently conducted in Mexico. In order to scale our manufacturing capacity, we continue to invest in facilities and capital equipment.
Quality Assurance
Our quality assurance system is compliant with FDA Medical Device regulations 21CFR Part 820, and during 2001, we achieved certification to ISO 9001:1994, an internationally recognized quality system. Our system defines processes and procedures to ensure product and service quality, and includes methods to monitor levels of quality, based on internal data and direct customer feedback. We utilize this data to continuously improve our systems and processes, taking corrective action as required.
We custom manufacture Aligners on a build-to-order basis so we do not offer refunds on our products. Because each ClinCheck and each Aligner is unique, we inspect 100% of the product at various points in the manufacturing process, to ensure that the product meets our customer's expectations. However, Aligners are subject to the Invisalign product warranty, which covers defects in materials and workmanship. Defective or broken Aligners must be returned to us for credit evaluation. In the event that returned Aligners fall within the scope of the Invisalign product warranty, we will replace the Aligners at our expense. Our warranty is contingent upon proper use of the Aligners for the purposes for which they are intended. If a patient chooses not to wear the Aligners, and as a result, requests additional Invisalign treatment, the dental professional pays for the additional expense.
The Invisalign product warranty does not provide any assurances regarding the outcome of treatment using Invisalign. However, if actual treatment results deviate significantly from the approved ClinCheck treatment plan, the dental professional may request a mid-course correction under the Invisalign product warranty. These deviations have typically been the result of unpredictable biological factors such as variations in bone density or tooth topography and abnormal jaw growth. A mid-course correction requires that the dental professional submit new molds of the patient's dentition to us. We use the molds to create a new ClinCheck treatment plan for the dental professional to approve, from which a successive series of Aligners will be produced that will allow the patient to finish treatment. Under the Invisalign product warranty, we will provide patients with one mid-course correction at our expense to address significant deviations from the approved ClinCheck treatment plan.
In the event that a dental professional wishes to effect additional adjustments to a patient's treatment when the actual treatment results are in accordance with the approved ClinCheck treatment plan, the dental professional may request a mid-course correction or additional Aligners. However, in these cases, the mid-course correction and additional Aligners are provided at the dental professional's expense. In addition, should a dental professional request a replacement for a lost Aligner, we charge the dental professional for the cost of the replacement Aligner.
Sales and Marketing
We market Invisalign by communicating Invisalign's benefits directly to consumers and dental professionals with a nationwide advertising campaign. Based on our experience with advertising and commercial sales in our test markets, we believe that making consumers aware of Invisalign as a new treatment alternative generates significant demand for Invisalign. In order to serve anticipated worldwide demand, we are training a broad base of dental professionals.
Consumer Marketing
Our national consumer marketing efforts primarily focus on television advertising and are supported by print, event marketing, public relations and direct mail campaigns. We tested our consumer marketing strategy in two markets, Austin, Texas and San Diego, California. Based on the positive results of these initial marketing efforts, in September 2000, we launched a nationwide consumer marketing campaign to create awareness and stimulate demand for Invisalign. In 2001 we continued to advertise nationally using a broader marketing mix to drive consumer and dental professional demand and to reinforce the breadth of applicability of Invisalign.
Our experience indicates that prospective patients exposed to our advertising seek information from four primary sources:
a general practice dentist;
an orthodontist;
our toll-free support line (1-800-INVISIBLE); and
our website (www.invisalign.com).
Our marketing efforts have generated substantial consumer interest directed toward our telephone support line and our website.Our telephone support line and our website not only provide consumers with information on Invisalign, but, importantly, also allow us to channel consumer interest to dental professionals of our choice. Traditionally we have outsourced the telephone support function to a large national call center operator. During 2001, we transitioned this function in-house. We maintain the outsourced function for back-up and peak periods.
Professional Marketing
Professional marketing consists of training dental professionals and assisting them in building their practices. As of December 31, 2001, our sales team consisted of 32 salespeople experienced in orthodontic product sales. Approximately 31 technical support staff, together with the marketing department and our in-house orthodontic staff, support the sales team. Our sales and support staff has been engaged in marketing Invisalign to orthodontists since July 1999. In October 2001, through our partner Discus Dental, we began marketing Invisalign to general dentists in our domestic market. Under a five year marketing agreement, Discus Dental will act as our exclusive Invisalign marketing and sales representative providing training, certification, marketing and clinical support to general dentists in the U.S. and Canada.
As of February 28, 2002, we had trained over 12,000dental professionals worldwide to use Invisalign. Of those dental professionals trained, approximately80% are dental professionals in the U.S. and Canada, which we consider our domestic market. Within our domestic market, we have trained over 7,300 orthodontists, representing approximately 80% of all practicing orthodontists in the U.S. and Canada, and over 2,300 dentists. As of February 28, 2002, over 4,300 of the worldwide dental professionals we have trained had submitted one or more cases to us, and over 44,000 patients have commenced treatment with Invisalign. Our sales and orthodontic teams conduct training primarily in a workshop format. The key topics covered in training include Invisalign applicability, instructions on filling out the Invisalign prescription form, guidance on pricing and instructions on interacting with our ClinCheck software and the many other features of our website.
Invisalign relies on the same orthodontic principles that apply to traditional treatment, and we present our training material in a manner consistent with dental professionals' training and experience. As a result, we are able to complete these training workshops within one day. Our success in training a large number of dental professionals confirms our belief that training represents a minimal barrier to adoption for most dental professionals.
After training, sales representatives follow up with the dental professional to ensure that their staff is prepared to handle Invisalign cases. Such follow up may include assisting the dental professional in taking dental impressions, establishing an Internet connection and familiarizing them with our website. Sales representatives may also provide practice-building assistance, including helping the dental professional market to local general practice dentists and to prospective patients through direct mail or other media. Indeed, many practices have commenced promotional activity in their local region with our assistance.
We have developed a system of tiering dental professionals that encourages our sales force to devote more time to those dental professionals most proficient in the use of Invisalign.
We use objective criteria, primarily the number of cases initiated with Invisalign, to tier dental professionals. Inquiries from prospective patients through our customer call center and our website are directed to higher tier dental professionals. We believe the tiering process will rapidly increase the penetration of our product within selected dental professionals' offices.
General dentists play an important role in informing their patients about orthodontics and are a key source of both referrals to orthodontists and Invisalign case submissions. There are over 120,000 active general practice dentists in the U.S. and Canada. Through our agreement with Discus Dental, we educate these general dentists and staff to encourage them to recommend Invisalign to their patients.
Research and Development
As of December 31, 2001, our research and development team consisted of 21 individuals with medical device development, orthodontic and other relevant backgrounds. Prior to commercial launch in July 1999, our research and development strategy had three primary objectives: developing Invisalign, establishing the ability of Invisalign to treat malocclusion and developing software and processes to enable the manufacture of Aligners in volume. Since our commercial launch, our research and development effort has focused on extending the range of dental applicability of Invisalign, enhancing the software used in the manufacturing process and enhancing our line of products.
In an effort to demonstrate Invisalign's broad treatment capabilities, we initiated the publication of a series of clinical case studies and articles that highlight the applicability of Invisalign to malocclusion cases of even severe complexity. We are also undertaking post-marketing studies and making additional improvements to the product. In 2001, we upgraded our proprietary, three-dimensional treatment-planning software primarily to increase our manufacturing capacity and efficiency. Our product development team is testing enhanced materials and a number of complementary products that we expect will provide additional revenue opportunities.
Intellectual Property
We believe our intellectual property position represents a substantial business advantage. As of February 28, 2002, we have nine issued U.S. patents, 11 issued foreign patents, 52 pending U.S. patent applications, and 121 pending foreign patent applications.
We continue to pursue further intellectual property protection through U.S. and foreign patent applications and non-disclosure agreements. We also seek to protect our software, documentation and other written materials under trade secret and copyright laws. We cannot be certain that patents will be issued as a result of any patent application or that patents that have been issued to us or may issue in the future will be found to be valid and enforceable and sufficient to protect our technology or products.
Competition
We are not aware of any company that has developed or is marketing a system comparable to Invisalign. However, we compete for the attention of dental professionals with manufacturers of other orthodontic products. These suppliers include manufacturers of traditional orthodontic appliances such as 3M Company, Sybron Dental Specialities, Ormco and Dentsply International, Inc.
We believe that, in addition to price, the principal competitive factors in the market for orthodontic appliances include the following factors:
aesthetic appeal of the treatment method;
comfort associated with the treatment method;
effectiveness of treatment;
ease of use; and
dental professionals' chair time.
We believe that Invisalign compares favorably with respect to each of these factors.
Government Regulation
FDA Regulation of Medical Devices. Invisalign is regulated as a medical device. Accordingly, our product development, labeling, manufacturing processes and promotional activities are subject to extensive review and rigorous regulation by government agencies in countries in which we sell our products.
In the U.S., the FDA regulates the design, manufacture, distribution, preclinical and clinical study, clearance and approval of medical devices. Medical devices are classified in one of three classes on the basis of the controls necessary to reasonably assure their safety and effectiveness. Class I or II devices require the manufacturer to submit a pre-market notification requesting permission for commercial distribution, which is known as 510(k) clearance. Class III devices, which are deemed by the FDA to pose greater risk than Class I and II devices, require FDA approval of a pre-market approval application which includes, among other things, extensive preclinical and clinical trial data and information about the device's and its components' design, manufacturing and labeling.
Invisalign is a Class I device, the least stringent class, which only requires general controls, including labeling, pre-market notification and adherence to the FDA's Quality System regulations. In addition, because Invisalign is a Class I device, we are required to register contract manufacturers located outside the U.S. with the FDA. Accordingly, we have registered our Mexico-based contract manufacturer, Elamex. Elamex is certified under ISO, an internationally recognized quality standard, and also performs subcontractor manufacturing for other U.S.-based medical device companies. Our quality system and procedures are set up to comply with all FDA regulations. Elamex has dedicated an area in its facilities and personnel for our exclusive use. We have supplied Elamex with procedures for how to manufacture and ship our products and have trained Elamex's personnel, thus assuring compliance with FDA regulations as long as the procedures are followed. We conduct frequent visits to the Mexico facility to monitor Elamex's performance and its compliance with our procedures.
In November 1998, Invisalign received 510(k) Pre-Market Notification by the FDA, allowing us to market Invisalign in the U.S. The manufacture and distribution of Invisalign are subject to continuing regulation by the FDA. We are subject to routine inspections by the FDA to determine compliance with facility registration, product listing requirements, medical device reporting regulations and Quality System requirements. The Quality System regulation is similar to good manufacturing practices and relates to product testing and quality assurance, as well as the maintenance of records and documentation.
If the FDA finds that we have failed to comply, it can institute a wide variety of enforcement actions against us, ranging from a public Warning Letter to more severe sanctions, including but not limited to financial penalties, withdrawal of 510(k) pre-market notification clearances already granted, and criminal prosecution.
In Europe, Invisalign is regulated as a custom device. As such, we will not be subject to regulations promulgated by the European Community, although we have the option to CE mark our product. We achieved certification to ISO 9001:1994 in fiscal 2001, which facilitates the commercialization of Invisalign outside the U.S.
Other Federal and State Laws. As a participant in the health care industry we are subject to extensive and frequently changing regulation under many other laws administered by governmental entities at the federal, state and local levels, some of which are, and others of which may be, applicable to our business. Furthermore, our health care service provider customers are also subject to a wide variety of laws and regulations that could affect the nature and scope of their relationships with us.
Laws regulating medical device manufacturers and health care providers cover a broad array of subjects. For example, the confidentiality of patient medical information and the circumstances under which such information may be released for inclusion in our databases, or released by us to third parties, are subject to substantial regulation by state governments. These state laws and regulations govern both the disclosure and the use of confidential patient medical information and are evolving rapidly. In addition, provisions of the Social Security Act prohibit, among other things, paying or offering to pay any remuneration in exchange for the referral of patients to a person participating in, or for the order, purchase or recommendation of items or services that are subject to reimbursement by Medicare, Medicaid and similar other federal or state health care programs. Most states have also enacted illegal remuneration laws that are similar to the federal laws. These laws are applicable to our financial relationships with, and any marketing or other promotional activities involving, our dental professional customers. Finally, various states regulate the operations of an advertising and referral service for dentists, and may require registration of such services with a state agency as well as compliance with various requirements and restrictions on how they conduct business and structure their relationships with participating dentists. Violations of any of these laws or regulations could subject us to a variety of civil and criminal sanctions.
Employees
As of December 31, 2001, we had approximately 1,093 employees, of whom approximately 358 were employed in the U.S., with 637 employed in Pakistan, 42 in Europe and 56 in Latin America. Of our U.S. employees, approximately 135 are employed in manufacturing, 30 are software engineers, 32 are sales representatives, 31 are customer support staff, 21 are employed in research and development and 109 are employed in various management, administrative and support positions.
Risk Factors
The statements contained below and elsewhere in this report on Form 10-K that are not purely historical are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, including, without limitations, statements regarding our expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future. Actual results could differ from those projected in any forward-looking statements for the reasons, among others, detailed below. The fact that some of the risk factors may be the same or similar to our past filings means only that the risks are present in multiple periods. We believe that many of the risks detailed here are part of doing business in the industry in which we compete and will likely be present in all periods reported. The fact that certain risks are characteristic to the industry does not lessen the significance of the risk. The forward-looking statements are made as of the date of this report on Form 10-K and we assume no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements.
Factors That May Affect Operating Results
Since we have a history of losses and negative operating cash flows, and we expect our operating expenses to continue to increase, we may not achieve or maintain profitability in the future.
We have incurred significant operating losses, negative operating cash flows and have not achieved profitability. From inception through July 2000, we spent significant funds in organizational and start-up activities, recruiting key managers and employees, developing Invisalign and developing our manufacturing and customer support resources. We also spent significant funds on clinical trials and training programs to train dental professionals in the use of Invisalign. We expect to have net losses and negative operating cash flows for at least the next 12 months.
We intend to increase our operating expenses as we continue to:
scale our manufacturing operations;
develop new software and increase the automation of our manufacturing processes;
execute our national direct to consumer marketing campaign;
increase the size of our sales force and dental professional training staff;
expand our manufacturing operations from Pakistan to additional relatively lower wage countries, including the U.A.E. and Costa Rica;
increase our international sales and marketing efforts;
undertake quality assurance and improvement initiatives; and
increase our general and administrative functions to support our growing operations.
As a result, we will need to increase our revenue significantly, while controlling our expenses, to achieve profitability. It is possible that we will not achieve profitability, and even if we do achieve profitability, we may not sustain or increase profitability in the future.
We may be unable to raise additional capital if it should be necessary, which could harm our ability to compete.
We have incurred significant operating losses and negative operating cash flows since inception and have not achieved profitability. As of December 31, 2001, we had an accumulated deficit of approximately $206.1 million.
We expect to expend significant capital to establish a national brand, build manufacturing infrastructure and develop both product and process technology. We believe that the existing cash balances, the proceeds from our initial public offering in January 2001 and other potential financing alternatives will be sufficient to meet our capital and operating requirements for at least the next 12 months.
We are currently working towards our objective of realizing profitability by achieving the key goal of successfully marketing our product throughout our domestic market and internationally, while controlling our expenses. The failure to win increased acceptance by orthodontists and dentists of Invisalign could have a material adverse effect on our business, results of operations and financial conditions.
If we are unable to generate adequate operating cash flows, we may need to seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we could be required to delay establishing a national brand, building manufacturing infrastructure and developing our product and process technology, or to reduce our expenditures in general. Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.
We have a limited operating history and expect our future financial results to fluctuate significantly, which may cause our stock price to decline.
We were incorporated in April 1997 and began sales of Invisalign in July 1999. Thus, we have a limited operating history, which makes an evaluation of our future prospects and your investment in our stock difficult. In addition, we expect our future quarterly and annual operating results to fluctuate as we increase our commercial sales. These fluctuations could cause our stock price to decline. Some of the factors that could cause our operating results to fluctuate include:
changes in the timing of product orders;
unanticipated delays in production caused by insufficient capacity, any disruptions in the manufacturing process or in the introduction of new production processes;
inaccurate forecasting of revenue, production and other operating costs; and
the development and marketing of directly competitive products by potential competitors.
To respond to these and other factors, we may need to make business decisions that could adversely affect our operating results. Most of our expenses, such as employee compensation and lease payment obligations, are relatively fixed in the short term. Moreover, our expense levels are based, in part, on our expectations regarding future revenue levels. As a result, if our revenue for a particular period falls below our expectations, we may be unable to adjust spending quickly enough to offset any unexpected shortfall in revenue growth or any decrease in revenue levels.
Due to these and other factors, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. You should not rely on our results for any one quarter as an indication of our future performance.
We have limited product offerings, and if demand for Invisalign declines or fails to develop as we expect, our revenue will decline.
We expect that revenue from the sale of Invisalign will continue to account for a substantial portion of our total revenue. Continued and widespread market acceptance of Invisalign is critical to our future success. Invisalign may not achieve market acceptance at the rate at which we expect, or at all, which could reduce our revenue.
If dental professionals do not adopt Invisalign in sufficient numbers or as rapidly as we anticipate, our operating results will be harmed.
As of December 31, 2001, approximately 3,700 orthodontists have submitted one or more cases to us. Our success depends upon increasing acceptance by orthodontists and dentists of Invisalign. Invisalign requires dental professionals and their staff to undergo special training and learn to interact with patients in new ways and to interact with us as a supplier. In addition, because Invisalign has only been in clinical testing since July 1997 and commercially available since July 1999, dental professionals may be reluctant to adopt it until more historical clinical results are available. Also, increasing adoption by dental professionals will depend on factors such as the capability, safety, efficacy, ease of use, price, quality and reliability of our products and our provision of effective sales support, training and service. In the future, unanticipated poor clinical performance of Invisalign could result in significant adverse publicity and consequently in reduced acceptance by dental professionals. If Invisalign does not achieve growing acceptance in the orthodontic and dental communities, our operating results will be harmed.
If consumers do not adopt Invisalign in sufficient numbers or as rapidly as we anticipate, our operating results will be harmed.
Invisalign represents a significant change from traditional orthodontic treatment, and patients may be reluctant to accept it or may not find it preferable to conventional treatment. In addition, patients may not comply with recommended treatment guidelines which could compromise the effectiveness of their treatment. While we have generally received positive feedback from both dental professionals and patients regarding Invisalign as both an alternative to braces and as a clinical method for treatment of malocclusion, our success will depend upon the rapid acceptance of Invisalign by the substantially larger number of potential patients to which we are now actively marketing. We have had a limited number of complaints from patients and prospective patients generally related to shipping delays and minor manufacturing irregularities. Market acceptance will depend in part upon the recommendations of dentists and orthodontists, as well as other factors including effectiveness, safety, reliability, improved treatment aesthetics and greater comfort and hygiene compared to conventional orthodontic products. Furthermore, consumers may not respond to our direct marketing campaigns or we may be unsuccessful in reaching our target audience. Adoption by consumers may also be impacted by general macroeconomic conditions and levels of consumer confidence and consumer spending. If consumers prove unwilling to adopt Invisalign as rapidly or in the numbers that we anticipate, our operating results will be harmed.
We are dependent on our international manufacturing operations, which exposes us to foreign operational and political risks that may harm our business.
Two of our key production steps are performed in manufacturing operations located outside the U.S. We currently rely on our facilities in Pakistan to create electronic treatment plans with the assistance of sophisticated software. In late 2001, we also began developing facilities in the U.A.E. and Costa Rica, which will perform these functions. We employ approximately 500 people in Lahore, Pakistan, most of who are Pakistani, in this effort. In addition, we rely on third party manufacturers in Mexico to fabricate Aligners and to ship the completed product to customers. Our reliance on international operations exposes us to risks and uncertainties, including:
political, social and economic instability;
acts of war and acts of terrorism, particularly in light of the terrorist attacks of September 11, 2001;
difficulties in staffing and managing international operations;
controlling quality of manufacture;
interruptions and limitations in telecommunication services;
product or material transportation delays or disruption;
burdens of complying with a wide variety of local country and regional laws;
trade restrictions and changes in tariffs;
import and export license requirements and restrictions;
fluctuations in currency exchange rates; and
potential adverse tax consequences.
If any of these risks materialize, our operating results may be harmed.
Our success depends in part on our proprietary technology and if we are unable to successfully enforce our intellectual property rights, our competitive position may be harmed.
Our success will depend in part on our ability to maintain existing intellectual property and to obtain and maintain further intellectual property protection for our products, both in the U.S. and in other countries. Our inability to do so could harm our competitive position. As of February 28, 2002, we have nine issued U.S. patents and 52 pending U.S. patent applications. We have 11 foreign-issued patents and 121 pending foreign patent applications. We intend to rely on our portfolio of issued and pending patent applications in the U.S. and in other countries to protect a large part of our intellectual property and our competitive position. However, our currently pending or future patent filings may not issue as patents. Additionally, any patents issued to us may be challenged, invalidated, held unenforceable, circumvented, or may not be sufficiently broad to prevent third parties from producing competing products similar in design to our products. In addition, protection afforded by foreign patents may be more limited than that provided under U.S. patents and intellectual property laws.
We also rely on protection of copyrights, trade secrets, know-how and proprietary information. We generally enter into confidentiality agreements with our employees, consultants and our collaborative partners upon commencement of a relationship with us. However, these agreements may not provide meaningful protection against the unauthorized use or disclosure of our trade secrets or other confidential information and adequate remedies may not exist if unauthorized use or disclosure were to occur. Our inability to maintain the proprietary nature of our technology through patents, copyrights or trade secrets would impair our competitive advantages and could have a material adverse effect on our operating results, financial condition and future growth prospects. In particular, a failure of our proprietary rights might allow competitors to copy our technology, which could adversely affect pricing and market share.
If we infringe the patents or proprietary rights of other parties, our ability to grow our business will be severely limited.
Extensive litigation over patents and other intellectual property rights is common in the medical device industry. We have been sued for infringement of another party's patent in the past and, while that action has been dismissed, we may be the subject of patent or other litigation in the future.
In January 2000, Ormco Corporation filed suit against us asserting an infringement of U.S. Patent Nos. 5,447,432 and 5,683,243. The complaint sought unspecified monetary damages and equitable relief. The complaint alleged that Invisalign infringed certain claims of the two patents relating to computer modeling of an ideal dentition and the production of orthodontic appliances based upon the ideal dentition. The suit has been dismissed but can be recommenced under certain circumstances. See "Item 3--Legal Proceedings." If the Ormco suit were recommenced and if Ormco were to prevail, we would have to seek a license from Ormco, which license might not be available on commercially reasonable terms or at all. In that event, we could be subject to damages or an injunction, which could materially adversely affect our business.
From time to time, we have received and may again receive letters from third parties drawing our attention to their patent rights. While we do not believe that we infringe any valid and enforceable rights which have been brought to our attention, there may be other more pertinent rights of which we are presently unaware. The defense and prosecution of intellectual property suits, interference proceedings and related legal and administrative proceedings could result in substantial expense to us and significant diversion of effort by our technical and management personnel. An adverse determination in a patent suit by Ormco or in any other litigation or interference proceeding to which we may become a party could subject us to significant liabilities. An adverse determination of this nature could also put our patents at risk of being invalidated or interpreted narrowly or require us to seek licenses from third parties. Licenses may not be available on commercially reasonable terms or at all, in which event, our business would be materially adversely affected.
We currently rely on third parties to provide key inputs to our manufacturing process, and if our access to these inputs is diminished, our business may be harmed.
We currently outsource key portions of our manufacturing process. We rely on a third party manufacturer in Mexico to fabricate Aligners and to ship the completed product to customers. In addition, third party rapid prototyping bureaus fabricate some molds from which the Aligners are formed. As a result, if any of our third party manufacturers fail to deliver their components or if we lose their services, we may be unable to deliver our products in a timely manner and our business may be harmed. Finding substitute manufacturers may be expensive, time-consuming or impossible. Although we are in the process of developing the capability to fabricate all molds and Aligners internally, we may not be successful and may continue to rely on outsourcing in the future.
In addition, we are highly dependent on manufacturers of specialized scanning equipment, rapid prototyping machines, resin and other advanced materials. We maintain single supply relationships for many of these machines and materials technologies. Our rapid growth may exceed the capacity of these manufacturers to produce the needed equipment and materials in sufficient quantities to support our growth. In the event of delivery delays or shortages of these items, our business and growth prospects may be harmed.
We are growing rapidly, and our failure to manage this growth could harm our business. We have experienced significant growth in recent periods.
Our headcount increased from approximately 50 employees as of June 30, 1999 to approximately 1,100 employees as of December 31, 2001. We expect that our growth will place significant demands on our management and other resources and will require us to continue to develop and improve our operational, financial and other internal controls both in the U.S. and internationally. In particular, continued growth increases the challenges involved in a number of areas, including: recruiting and retaining sufficient skilled personnel, providing adequate training and supervision to maintain our high quality standards, and preserving our culture and values. Our inability to manage this growth effectively would harm our business.
If we lose our key personnel or are unable to attract and retain key personnel, we may be unable to pursue business opportunities or develop our products.
We are highly dependent on the key employees in our clinical engineering and management teams. The loss of the services of those individuals may significantly delay or prevent the achievement of our product development and other business objectives and could harm our business. Our future success will also depend on our ability to identify, recruit, train and retain additional qualified personnel. There is currently a shortage of skilled clinical, engineering and management personnel and intense competition for these personnel, especially in Silicon Valley where our headquarters is located. In addition, few orthodontists are accustomed to working in a manufacturing environment since they are generally trained to work in private practices, universities and other research institutions. Thus, we may be unable to attract and retain personnel with the advanced qualifications necessary for the further development of our business. Furthermore, we may not be successful in retaining our key personnel or their services.
We experience competition from manufacturers of traditional braces and expect aggressive competition in the future.
We are not aware of any company that is marketing or developing a system directly comparable to Invisalign. However, manufacturers of traditional braces, such as 3M Company, Sybron Dental Specialities and Dentsply International, Inc. have substantially greater financial resources and manufacturing and marketing experience than we do and may, in the future, attempt to develop an orthodontic system similar to ours. Large consumer products companies may also enter the orthodontic supply market. Furthermore, we may face competition in the future from new companies that may introduce new technologies. We may be unable to compete with these competitors and one or more of these competitors may render our technology obsolete or economically unattractive. If we are unable to compete effectively with existing products or respond effectively to any products developed by our competitors, our business will be harmed.
Complying with the Food and Drug Administration (FDA) and other regulations is an expensive and time-consuming process, and any failure to comply could result in substantial penalties.
Our products are medical devices and subject to extensive regulation in the U.S. and internationally. FDA regulations are wide ranging and govern, among other things:
product design, development, manufacture and testing;
product labeling;
product storage;
pre-market clearance or approval;
advertising and promotion; and
product sales and distribution.
Noncompliance with applicable regulatory requirements can result in enforcement action which may include recalling products, ceasing product marketing, and paying significant fines and penalties, which could limit product sales, delay product shipment and adversely affect our profitability.
In the U.S., we must comply with facility registration and product listing requirements of the FDA and adhere to applicable Quality System regulations. The FDA enforces its Quality System regulations through periodic unannounced inspections, which we have yet to undergo. If we or any third party manufacturer of our products do not conform to applicable Quality System regulations, we may be required to find alternative manufacturers, which could be a long and costly process.
Before we can sell a new medical device in the U.S., we must obtain FDA clearance or approval, which can be a lengthy and time-consuming process. Even though the devices we market have obtained the necessary clearances from the FDA through the pre-market notification provisions of Section 510(k) of the federal Food, Drug, and Cosmetic Act, we may be unable to maintain the necessary clearances in the future. Furthermore, we may be unable to obtain the necessary clearances for new devices that we market in the future.
Extensive and changing government regulation of the healthcare industry may be expensive to comply with and exposes us to the risk of substantial government penalties.
In addition to medical device laws and regulations, numerous state and federal healthcare-related laws regulate our business, covering areas such as:
storage, transmission and disclosure of medical information and healthcare records;
prohibitions against the offer, payment or receipt of remuneration to induce referrals to entities providing healthcare services or goods; and
the marketing and advertising of our products.
Complying with these laws and regulations could be expensive and time- consuming, and could increase our costs or reduce or eliminate certain of our activities or our revenues.
We face risks related to our international operations, including the need to obtain necessary foreign regulatory clearance or approvals.
Sales of our products outside the U.S. are subject to foreign regulatory requirements that vary widely from country to country. The time required to obtain clearances or approvals required by other countries may be longer than that required for FDA clearance or approval, and requirements for such approvals may differ from FDA requirements. We may be unable to obtain regulatory approvals in other countries. We may also incur significant costs in attempting to obtain and in maintaining foreign regulatory approvals. If we experience delays in receipt of approvals to market our products outside of the U.S., or if we fail to receive these approvals, we may be unable to market our products or enhancements in international markets in a timely manner, if at all. We have recently launched sales of our product in Germany, France and the U.K. and intend to further expand our international operations. We do not know whether orthodontists, dentists and consumers will adopt Invisalign in sufficient numbers or as rapidly as we anticipate.
Our business exposes us to risks of product liability claims, and we may incur substantial expenses if we are sued for product liability.
Medical devices involve an inherent risk of product liability claims and associated adverse publicity. We may be held liable if any product we develop or any product that uses or incorporates any of our technologies causes injury or is otherwise found unsuitable. Although we intend to continue to maintain product liability insurance, adequate insurance may not be available on acceptable terms and may not provide adequate coverage against potential liabilities. A product liability claim, regardless of its merit or eventual outcome, could result in significant legal defense costs. These costs would have the effect of increasing our expenses and could harm our business.
The market price for our common stock may be highly volatile.
The trading price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:
quarterly variations in our results of operations;
changes in recommendations by the investment community or in their estimates of our revenues or operating results;
speculation in the press or investment community;
strategic actions by our competitors, such as product announcements or acquisitions; and
general market conditions.
In addition, the stock market in general, and the market for technology and medical device companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated to or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company's securities, class action litigation has often been brought against the company. If a securities class action suit is filed against us, we would incur substantial legal fees and our management's attention and resources would be diverted from operating our business in order to respond to the litigation.
Concentrations of ownership and agreements among our existing executive officers, directors and principal stockholders may prevent other stockholders from influencing significant corporate transactions.
The interest of management could conflict with the interest of our other stockholders. As of December 31, 2001, our executive officers, directors and principal stockholders beneficially owned, in total, approximately 47.7% of our outstanding common stock. These stockholders, if acting together, would be able to influence significantly all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This could have the effect of delaying or preventing a change of control of the Company, which in turn could reduce the market price of our stock.
ITEM 2. PROPERTIES.
Our headquarters are located in Santa Clara, California. We lease approximately 90,000 square feet of space where we house our manufacturing, customer support, software engineering and administrative personnel. The leases for our facilities expire between 2002 and 2005. The combined monthly rent for the Santa Clara facilities is approximately $270,000.
We operate two facilities in Pakistan, both in the city of Lahore. The main facility comprises over 5,000 square feet of office space. The lease for this facility expires at the end of 2002. The second facility comprises over 10,000 square feet of office space. The lease for this facility expires in August 2010.
As of December 31, 2001 we have committed $1.2 million in funds to purchase approximately 215 acres of land in Pakistan.
ITEM 3. LEGAL PROCEEDINGS.
In February 2001 Align Technology was named in a class action lawsuit filed on behalf of all licensed dentists (excluding orthodontists) in the U.S. The complaint alleged that Align Technology's policy of selling Invisalign exclusively to orthodontists violated the U.S. antitrust laws. Without admitting any wrongdoing, the company entered into a Stipulation and Agreement of Settlement with the plaintiffs to settle the lawsuit. The total legal and other settlement costs that Align has agreed to pay are approximately $400,000. Pursuant to the settlement, Align will undertake to train and certify 5,000 general practice dentists each year over the next four years. In November 2001, the Court approved the Stipulation and Agreement of Settlement.
In January 2000, Ormco Corporation filed suit against us asserting infringement of U.S. Patent Nos. 5,447,432 and 5,683,243. The complaint sought unspecified and monetary damages and injunctive relief. In March 2000, we answered the complaint and asserted counterclaims seeking a declaration by the Court of invalidity and non-infringement of the asserted patents.
In June 2000, we entered into a Stipulation of Dismissal with Ormco. Ormco agreed for a period of at least two years not to pursue litigation with respect to these patents, except as set forth below. Further, Ormco agreed that it would not bring any patent action against us for at least a period of one year with respect to any as yet unissued patents. If Ormco were to bring such an action concerning as yet unissued patents after one year, the Stipulation of Dismissal would allow Ormco to include in such an action claims involving U.S. Patent Nos. 5,447,432 and 5,683,243. In August 2001, Ormco notified us of the issuance of U.S. Patent No. 6,244,861 and offered a license for this patent. No assurance can be given that Ormco will not bring another action against us or, that if brought, it will not be successful. Should the suit be recommenced and should our technology be found to infringe, we would have to seek a license from Ormco, which license might not be available on commercially reasonable terms or at all. In that event, we could be subject to damages or an injunction which could materially adversely affect our business. It is possible that, depending on the scope of any new patents that are issued to Ormco, Ormco will bring another patent action after a period of one year has passed.
The claims at issue in the Ormco suit relate to methods and systems for forming and manufacturing custom orthodontic appliances. The relevant claims are limited to the calculation of the final positioning of a patient's teeth based upon a derived or ideal dental archform of the patient. The treatment plan simulation developed in our Pakistan facilities determines the final positioning of a patient's teeth but is not based on a derived or ideal dental archform of the patient.
From time to time, we have received, and may again receive, letters from third parties drawing our attention to their patent rights. While we do not believe that we infringe any such rights which have been brought to our attention, there may be other more pertinent rights of which we are presently unaware.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of securityholders during the fourth quarter of our 2001 fiscal year.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Price Range of Common Stock
Our common stock is listed on the Nasdaq National Market under the symbol "ALGN." Public trading of our common stock commenced on January 26, 2001. Prior to that date, there was no public market for our common stock. The following table shows, for the periods indicated, the high and low per share closing prices of common stock, as reported by the Nasdaq National Market:
Year Ended December 31, 2001
High Low
--------------------
Fourth Quarter.........................$ 5.59 $ 2.87
Third Quarter......................... $ 8.00 $ 2.18
Second Quarter........................ $ 12.07 $ 5.45
First Quarter (since January 30, 2001) $ 16.88 $ 6.69
On March 18, 2002, the last reported sale price of our common stock on the Nasdaq National Market was $4.95 per share. As of March 18, 2002 there were approximately 549 holders of record of our common stock. We currently intend to retain any future earnings to fund the development and growth of our business and do not anticipate paying any cash dividends in the foreseeable future.
We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to fund the development and growth of our business and do not anticipate paying any cash dividends in the foreseeable future.
(b) Sales of Unregistered Securities
We did not issue any unregistered securities during the year ended December 31, 2001.
(c) Use of Proceeds from Sales of Registered Securities
On January 25, 2001 the Securities and Exchange Commission declared effective our Registration Statement on Form S-1 (File No. 333-49932) relating to our initial public offering of our common stock. The 10,000,000 shares offered by us under the Registration Statement were sold at a price of $13.00 per share on January 31, 2001. The managing underwriters for the offering were Deutsche Banc Alex. Brown, Bear, Stearns & Co. Inc., JP Morgan and Robertson Stephens. The underwriters also exercised an overallotment option on March 15, 2001 for 628,706 shares. The overallotment shares were sold at a price of $13.00 per share. The aggregate proceeds to the Company from the offering were $128.5 million after deducting the underwriting discounts and commissions of $9.7 million, and exclude expenses incurred in connection with the offering of approximately $2.3 million. Of the net proceeds, as of December 31, 2001, we have used net offering proceeds to purchase plant machinery and equipment, leasehold improvements and working capital in the amounts of approximately $17.0 million, $1.6 million and $53.2 million, respectively. No direct or indirect payments were made to directors, officers, general partners of the issuer or their associates, or to persons owning 10% or more of any class of equity securities of the issuer, or to any affiliates ofthe issuer in connection with the offering.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Annual Report on Form 10-K.
SELECTED CONSOLIDATED FINANCIAL DATA (in thousands, except per share data)
Period
from
Inception
(April 3,
Year Ended December 31, 1997) to
------------------------------------------ December
2001 2000 1999 1998 31, 1997
--------- --------- --------- --------- ---------
Consolidated Statement of
Operations Data:
Net Revenue............................ $ 46,384 $ 6,741 $ 411 $ -- $ --
Loss from operations................... (98,845) (81,115) (14,705) (3,951) (688)
Other income (expense), net............ 1,381 (7,633) (710) 176 24
--------- --------- --------- --------- ---------
Net loss before provision for
income taxes.......................... (97,464) (88,748) (15,415) (3,775) (664)
Provision for income taxes........... 10 -- -- -- --
--------- --------- --------- --------- ---------
Net loss............................... (97,474) (88,748) (15,415) (3,775) (664)
Dividend related to beneficial
conversion feature of preferred stock. (11,191) (53,516) -- -- --
--------- --------- --------- --------- ---------
Net loss available to common
stockholders.......................... $(108,665) $(142,264) $ (15,415) $ (3,775) $ (664)
========= ========= ========= ========= =========
Net loss per share available to
common stockholders, basic and
diluted............................... $ (2.57) $ (25.64) $ (3.65) $ (1.33) $ (0.43)
========= ========= ========= ========= =========
Shares used in computing net
loss per share available to
common stockholders, basic and
diluted............................... 42,247 5,548 4,218 2,842 1,542
========= ========= ========= ========= =========
December 31,
-----------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
Consolidated Balance Sheet Data:
Working capital........................ $ 63,747 $ 18,273 $ 10,027 $ 6,815 $ 1,370
Total assets........................... 118,218 70,561 17,091 8,117 1,642
Total long-term liabilities............ 980 1,455 3 10 4
Convertible preferred stock and
preferred stock warrants.............. -- 130,691 32,755 12,147 2,164
Stockholders' equity (deficit)......... 99,402 (84,674) (19,414) (4,433) (661)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis of our financial condition and results of operations should be read together with "Selected Consolidated Financial Data" and our consolidated financial statements and related notes included elsewhere in this report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under "Factors That May Affect Operating Results" and elsewhere in this report on Form 10-K.
Overview
From our inception in April 1997 to July 2000, we were engaged in the design, manufacture and marketing of Invisalign, a proprietary new system for treating malocclusion, or the misalignment of teeth. In July 1999, we commenced commercial sales of Invisalign. Prior to July 1999, we devoted nearly all our resources to developing our software and manufacturing processes, clinical trials of Invisalign and to building our sales force, customer support and management teams. We exited the development stage in July 2000.
Invisalign has two components: ClinCheck and Aligners. ClinCheck is an Internet-based application that allows dental professionals to simulate treatment, in three dimensions, by modeling two-week stages of tooth movement. Aligners are thin, clear plastic, removable dental appliances that are manufactured in a series to correspond to each two-week stage of the ClinCheck simulation. Aligners are customized to perform the treatment prescribed for an individual patient by a dental professional using ClinCheck.
In the third quarter of 1999, we recognized revenue for the first time from the sale of Invisalign and related dental impression machines manufactured by ESPE America, Inc. We expect to sell dental impression machines to an orthodontist only once, if at all. Accordingly, sales of such machines are expected to represent a lower proportion of our revenue in the future. Substantially all our revenue is generated in the U.S. and Canada, which, taken together, we regard as our domestic market.
While our expansion outside of our domestic market is still in the initial stages, we do incur substantial operating costs outside of our domestic market. Two of our key production steps are performed in operations located outside of the U.S. In our facilities in Pakistan, technicians use a sophisticated, internally developed computer-modeling program to prepare electronic treatment plans, which are transmitted via the Internet back to the U.S. These files form the basis of our ClinCheck product and are used for the manufacture of Aligner molds. In addition, a third party manufacturer in Mexico fabricates and performs finishing work on completed Aligners and ships the completed products to our customers. Our costs associated with these operations are denominated in Pakistani rupees and Mexican pesos. Our reliance on international operations exposes us to risks and uncertainties that may affect our business or results of operations including, among others, political, social and economic instability, acts of war or terrorism, difficulties in staffing and managing international operations, controlling quality of manufacture, interruptions and limitations in telecommunication services, product or material transportation delays or disruption, and trade restrictions and changes in tariffs. However, we believe these risks are mitigated in Pakistan by the fact that our operations there do not involve the shipping or manufacturing of any physical products, and in late 2001, we began developing facilities in the U.A.E. and Costa Rica which will also perform this function. We believe the risks in Mexico are mitigated by the fact that our operations there are governed under the provisions of the North American Free Trade Agreement, or NAFTA.
In October 2001, we entered into an exclusive marketing agreement with Discus Dental Impressions, Inc. Under the terms of the agreement, Discus will act as our exclusive Invisalign marketing and sales representative providing training, certification, marketing and clinical support to general dentists in the U.S. and Canada. Discus is required to maintain minimum sales quotas and will earn a commission on all products shipped under the terms of the agreement. We are required, under the terms of the agreement, to provide minimum consumer advertising commensurate with Discus meeting minimum sales quotas. The initial term of the agreement expires December 31, 2006, but is renewable for five years if not terminated earlier. The agreement includes termination rights for convenience and for failure to meet agreed upon minimums.
We have not been profitable for any quarter since April 3, 1997 (inception). As of December 31, 2001, we had an accumulated deficit of $206.1 million. We expect to have net losses and negative operating cash flows for at least the next 12 months due, in part, to our national consumer advertising campaign, the expansion of manufacturing capacity, our launching of our international sales and marketing efforts and continued research and development efforts. We will need to generate significant revenue growth to achieve profitability and positive operating cash flow. Even if we do achieve profitability and positive cash flow, we may not be able to sustain or increase profitability or positive operating cash flow on a quarterly or annual basis.
We earn revenue primarily from the sale of Invisalign. Our revenue consists of the ClinCheck fee and the charge for each Aligner. We charge dental professionals a fixed fee for the treatment simulation viewed via ClinCheck on our website, www.Invisalign.com. This fee is invoiced when the dental professional orders ClinCheck prior to the production of Aligners. In addition, we charge dental professionals a fee for Aligners upon shipment.
Historically, we have shipped Aligners in batches. The first batch, which typically represented the first several months of treatment, was produced once the prescribing dental professional approved ClinCheck. Thereafter, Aligners were sent at approximately six month intervals until completion of treatment. In mid-February 2001, for cases where ClinCheck was approved, we began shipping all the Aligners in a single batch.
Fees from the sale of ClinCheck and Aligners, taken together, are treated as revenues from a single Invisalign case. For cases where ClinCheck was approved prior to mid-February 2001, revenues associated with a given case are recognized ratably as batches of Aligners are shipped to the dental professional. For orders placed subsequent to notification of our change to single batch shipments, all of the revenues associated with a given case, including ClinCheck fees, will be recognized at the time the Aligners are shipped. The costs of producing the ClinCheck treatment plan, which are incurred prior to the production of Aligners, are capitalized and recognized as related revenue is earned. In the cases wherewe expect a net loss, the entire loss is recognized immediately.
Results of Operations
Comparison of Years Ended December 31, 2001 and 2000:
Revenues. Revenues for the year ended December 31, 2001 increased to $46.4 million compared to $6.7 million for the year ended December 31, 2000. For the year ended December 31, 2001, revenues of $45.0 million were derived from the sale of Invisalign compared to revenues of $5.4 million for the year ended December 31, 2000. The balance of our revenues for year ended December 31, 2001 and 2000 represented sales of dental impression machines, other products and training.
Cost of revenues. Cost of revenues includes the compensation of staff involved in production, the cost of materials and packaging used in production and shipping, together with an allocation of the cost of facilities and depreciation on the capital equipment used in the production process. Cost of revenues for the year ended December 31, 2001 increased to $46.8 million compared to $20.3 million for the year ended December 31, 2000. Cost of revenues for the year ended December 31, 2001 and 2000 includes $10.6 and $11.2 million, respectively, of unabsorbed manufacturing costs due to an increase in our manufacturing capacity in 2001 and 2000. For the third and fourth quarters of fiscal 2001, we achieved positive gross margins mainly due to efficiencies achieved in manufacturing as well as reducing over capacity in many areas. Our gross loss is affected by changes in manufacturing volume, manufacturing capacity and changes in our pricing policies.
Sales and marketing. Sales and marketing expenses include sales force compensation together with the expense of professional marketing - principally, conducting training workshops and market surveys, advertising and attending orthodontic trade shows. Sales and marketing expenses for the year ended December 31, 2001 increased to $50.6 million compared to $40.4 million for the year ended December 31, 2000. This increase resulted primarily from: increases in headcount and related expenses of approximately $4.6 million; expenses relating to increased direct mailings of $1.4 million; and expenses related to the expansion of our international sales and marketing offices of $5.7 million. Partially offsetting the increase was a $2.4 million decrease in advertising expenses.
General and administrative. General and administrative expenses include costs for the compensation of administrative personnel, outside consulting services, facilities, legal expenses and general corporate expenses. General and administrative expenses for the year ended December 31, 2001 increased to $32.7 million compared to $18.0 million for the year ended December 31, 2000, primarily due to increased headcount and related expenses. We expect administrative expenses to continue to increase in the future to support expanding business activities and the additional administrative costs related to being a public company.
Research and development. Research and development expenses include the cost for the compensation of staff, the costs associated with software engineering, the costs of designing, developing and testing our products and the conduct of both clinical and post-marketing trials. Research and development is expensed as incurred. Research and development expenses for the year ended December 31, 2001 increased to $14.7 million compared to $9.2 million for the year ended December 31, 2000. This increase resulted primarily from increases in headcount and related expenses of approximately $3.3 million.
Litigation settlement. In February 2001 Align Technology was named in a class action lawsuit filed on behalf of all licensed dentists (excluding orthodontists) in the U.S. The complaint alleged that Align Technology's policy of selling Invisalign exclusively to orthodontists violated the U.S. antitrust laws. Without admitting any wrongdoing, the company entered into a Stipulation and Agreement of Settlement with the plaintiffs to settle the lawsuit. The total legal and other settlement costs that Align has agreed to pay are approximately $400,000. Pursuant to the settlement, Align will undertake to train and certify 5,000 general practice dentists each year over the next four years. In November 2001, the Court approved the Stipulation and Agreement of Settlement.
Other income (expense), net. Other income was $1.4 million for the year ended December 31, 2001 compared to expense of $7.6 million for the year ended December 31, 2000. The interest income in fiscal 2001 was generated from higher average cash and cash equivalents balance and investments in short-term and long-term securities in fiscal 2001, which included the proceeds from our initial public offering completed in January 2001. Partially offsetting the interest income was a non-cash interest expense of $1.8 million, recorded in January 2001, related to the beneficial conversion feature embedded in convertible subordinated notes. The other expense balance of $7.6 million as of December 31, 2000 was primarily the result of non-cash interest expense related to the beneficial conversion feature of a bridge loan financing.
Dividend related to beneficial conversion feature of preferred stock. In 2000 we issued 9,535,052 shares of Series D preferred stock which were subject to an antidilution conversion price adjustment feature which we triggered when we granted options to purchase our common stock beyond the number of options that were authorized under our 1997 Plan at the time we commenced our Series D preferred stock offering in May 2000. The conversion feature provided that if, during the period between May 12, 2000 (the commitment date for our Series D preferred stock offering) and the earlier of the closing of an initial public offering or January 31, 2001, we had granted more than an aggregate of 3,331,978 options to purchase our common stock, then the conversion price of our Series D preferred stock would be adjusted downward from its original conversion price of $10.625 per share. As of the end of January 2001, we had granted an aggregate of 3,591,458 options to purchase shares of our common stock in excess of the 3,331,978 options permitted, and we were therefore required to issue an additional 790,342 shares of common stock upon the conversion of the Series D preferred stock. These shares were in addition to the419,700 additional shares of common stock that we were required to issue upon conversion of the Series D preferred stock as of December 31, 2000. As a result, we recorded a deemed dividend for the year ended December 31, 2001 based on the fair value of the common stock at the commitment date of the Series D preferred stock offering of $11.2 million related to the preferred stock sold and a charge to interest expense of $1.8 million for the beneficial conversion feature embedded in convertible subordinated notes that were previously converted.
Deferred Compensation. In connection with the grant of stock options to employees and non-employees, we recorded deferred stock-based compensation as a component of stockholders' equity (deficit). Deferred stock- based compensation for options granted to employees is the difference between the fair value of our common stock on the date such options were granted and their exercise price. For stock options granted to non-employees, the fair value of the options, estimated using the Black-Scholes valuation model, is initially recorded on the date of grant. As the non-employee options become exercisable, we revalue the remaining unvested options, with the change in fair value from period to period represented as a change in the deferred compensation charge. This stock-based compensation is amortized as charges to operations over the vesting periods of the options. We recorded amortization of deferred compensation of $22.2 million for the year ended December 31, 2001 and $13.4 million, for the year ended December 31, 2000.
Comparison of Years Ended December 31, 2000 and 1999:
Revenues. Revenues for the year ended December 31, 2000 increased to $6.7 million compared to $411,000 for the year ended December 31, 1999. We recorded revenues for the first time in the third quarter of 1999. For the year ended December 31, 2000, revenues of $5.4 million were derived from the sale of Invisalign compared to revenues of $98,000 for the year ended December 31, 1999. The balance of our revenues for year ended December 31, 2000 and 1999 represented sales of dental impression machines. We expect to sell a dental impression machine to an orthodontist only once, if at all. Accordingly, sales of these machines are expected to represent a substantially lower proportion of our revenue in the future.
Cost of revenues. Cost of revenues includes the salaries of staff involved in production, the cost of materials and packaging used in production and shipping together with an allocation of the cost of facilities and depreciation on the capital equipment used in the production process. Cost of revenues for the year ended December 31, 2000 increased to $20.3 million compared to $1.8 million for the year ended December 31, 1999. Cost of revenues for the year ended December 31, 2000 includes $11.2 million of unabsorbed manufacturing costs due to a substantial increase in our manufacturing capacity in 2000.
Sales and marketing. Sales and marketing expenses include sales force compensation together with the expense of professional marketing- principally, conducting training workshops and market surveys, advertising and attending orthodontic trade shows. Sales and marketing expenses for the year ended December 31, 2000 increased to $40.4 million compared to $5.7 million for the year ended December 31, 1999. This increase resulted primarily from: increases in advertising expenses of $19.1 million; increases in headcount and related expenses of $6.2 million; expenses relating to participation in the annual convention of the American Association of Orthodontists of $1.9 million; expenses relating to orthodontist training of $1.3 million; and expenses related to the outsourced call center function to support our national advertising campaign of $1.0 million.
General and administrative. General and administrative expenses include costs for the compensation of administrative personnel, outside consulting services, facilities, legal expenses and general corporate expenses. General and administrative expenses for the year ended December 31, 2000 increased to $18.0 million compared to $3.5 million for the year ended December 31, 1999, primarily due to increased headcount and related expenses. We expect administrative expenses to continue to increase in the future to support expanding business activities and the additional administrative costs related to being a public company.
Research and development. Research and development expenses include the costs associated with software engineering, the costs of designing, developing and testing our products and the conduct of both clinical and post-marketing trials. Research and development is expensed as incurred. Research and development expenses for the year ended December 31, 2000 increased to $9.2 million compared to $4.2 million for the year ended December 31, 1999. Expenses through the third quarter of 1999, until we recognized revenue for the first time from the sale of Invisalign, include the costs of researching processes to manufacture our product.
Other income (expense), net. Other expense increased to $7.6 million for the year ended December 31, 2000 compared to other expense of $710,000 for the year ended December 31, 1999. This increase, partially offset by interest income on marketable securities, resulted primarily from non- cash interest expense related to the beneficial conversion feature embedded in convertible subordinated notes.
Dividend related to beneficial conversion feature of preferred stock. In 2000 we issued 9,535,052 shares of Series D preferred stock. The difference between the conversion price and the fair value per share of the common stock on the commitment date for that offering resulted in a beneficial conversion feature of $53.5 million which has been reflected as a preferred stock dividend in the December 31, 2000 consolidated financial statements.
Deferred Compensation. In connection with the grant of stock options to employees and non-employees, we recorded deferred stock-based compensation as a component of stockholders' deficit. Deferred stock-based compensation for options granted to employees is the difference between the fair value of our common stock on the date such options were granted and their exercise price. For stock options granted to non-employees, the fair value of the options, estimated using the Black-Scholes valuation model, is initially recorded on the date of grant. As the non-employee options become exercisable, we revalue the remaining unvested options, with the change in fair value from period to period represented as a change in the deferred compensation charge. This stock-based compensation is amortized as charges to operations over the vesting periods of the options. We recorded amortization of deferred compensation of $13.4 million for the year ended December 31, 2000 and $394,000 for the year ended December 31, 1999.
Income Taxes
We have incurred immaterial amounts of income tax expense to date since we have not been profitable. As of December 31, 2001, we have aggregate federal and state net operating loss carryforwards of $312.5 million. As of December 31, 2001 we have recorded a full valuation allowance for our existing net deferred tax assets due to uncertainties regarding their realization. We also have aggregate federal and state research tax credit carryforwards of $3.1 million as of December 31, 2001. The federal and state net operating loss and research credit carryforwards expire beginning in the year 2017 for federal and 2005 for state purpose if not utilized. Utilization of the federal net operating losses and credit carryforwards may be limited by the change of ownership provisions contained in Section 382 of the Internal Revenue Code.
Liquidity and Capital Resources
Prior to our initial public offering, we financed our operations primarily through private sales of approximately $128.9 million of convertible preferred stock. We have also financed our operations through equipment leases and bank loans. In January 2001, we received proceeds, net of underwriting discounts and commissions and other expenses incurred, as a result of our initial public offering of approximately $126.0 million. As of December 31, 2001, we had $65.7 million in cash, cash equivalents and short-term and long-term marketable securities and an accumulated deficit of $206.1 million. Additionally, we have $723,000 of restricted cash as of December 31, 2001.
Net cash used in operating activities totaled $77.9 million in 2001, $58.8 million in 2000 and $11.6 million in 1999. The increase was primarily due to the increase in our net loss to $97.5 million in fiscal 2001, which is up from $88.7 million in fiscal 2000 and $15.4 million in fiscal 1999, and to a lesser extent, increases in accounts receivable. This was offset significantly by increased non-cash charges related to amortization of deferred stock compensation and depreciation and amortization.
Net cash used in investing activities totaled $2.0 million in 2001, $41.6 million in 2000 and $3.6 million in 1999. For fiscal 2001, cash used in investing activities was primarily the result of the investment of the initial public offering proceeds in marketable securities. Offsetting the cash used was cash provided by the maturities and sales of the marketable securities, as well as the decrease in our restricted cash balance. For fiscal 2000 cash used in investing activities was primarily used for the investment of the proceeds from the sale of preferred stock in marketable securities. Additionally, for the year ended December 31, 2000, there was a substantial increase in restricted cash of $15.6 million which primarily consisted of cash related to the transfer of funds to our media buying agent to fund our national advertising campaign. Offsetting the cash used was cash provided by the maturities and sales of the marketable securities. For fiscal 1999 cash used in investing activities was primarily the result of the investment of the proceeds from the sale of preferred stock in marketable securities. Additionally, in each of these years, there was a use of cash for the purchase of clinical and manufacturing equipment, computers and facilities to support the expansion of our operations.
Net cash from financing activities was $127.5 million in 2001, $96.4 million in 2000 and $19.6 million in 1999. For fiscal 2001, cash provided by financing activities was attributable primarily to net proceeds from the issuance of common stock principally through our initial public offering. For fiscal 2000 and 1999, cash provided by financing activities was attributable to the proceeds from the issuance of preferred stock and convertible promissory notes that were converted to preferred stock.
We finance capital purchases through cash and capital leases. We had capitalized lease obligations outstanding of $1.5 million at December 31, 2001 and $1.9 million at December 31, 2000.
Our capital requirements depend on market acceptance of our products and our ability to market sell and support our products on a worldwide basis. We believe that our current cash and cash equivalents, short-term and long-term investment balances will be sufficient to fund our operations for at least the next 12 months. If we are unable to generate adequate operating cash flows, we may need to seek additional sources of capital through equity or debt financing, collaborative or other arrangements with other companies, bank financing and other sources in order to realize our objectives and to continue our operations. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, or at all. If adequate funds are not available, we could be required to delay establishing a national brand, building manufacturing infrastructure and developing our product and process technology, or to reduce our expenditures in general. Accordingly, the failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.
Quarterly Results of Operations
The following table sets forth certain quarterly financial information for the periods indicated. This information has been derived from unaudited financial statements that, in the opinion of management, have been prepared on the same basis as the audited information, and includes all normal recurring adjustments necessary for a fair presentation of such information. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future periods.
Three Months Ended
---------------------------------------------------------------------------------------------------
2001 2000
-------------------------------------------------- -----------------------------------------------
December 31 September 30 June 30 March 31 December 31 September 30 June 30 March 31
------------ ------------ ---------- ---------- ------------ ----------- --------- ---------
(in thousands, except per share data)
Revenues.................. $ 12,300 $ 12,912 $ 13,483 $ 7,689 $ 3,276 $ 1,439 $ 1,397 $ 629
Gross profit (loss)....... 2,118 1,647 (347) (3,865) (5,433) (3,870) (2,810) (1,397)
Operating loss............ (20,827) (23,026) (23,567) (31,425) (35,121) (22,127) (15,819) (8,048)
Net loss.................. (20,719) (22,503) (22,294) (31,958) (35,437) (21,839) (23,392) (8,080)
Net loss available to
common stockholders...... $ (20,719) $ (22,503) $ (22,294) $ (43,149) $ (44,803) $ (21,839) $ (67,542) $ (8,080)
Net loss per share
available to common
stockholders, basic and
diluted.................. $ (0.45) $ (0.50) $ (0.50) $ (1.29) $ (7.39) $ (3.84) $ (12.31) $ (1.55)
Shares used in computing
per share amounts,
basic and diluted........ 45,660 45,035 44,518 33,574 6,066 5,682 5,489 5,225
Historical quarterly operating results do not necessarily reflect our expectations of future quarterly operating results. We believe that future operating results will fluctuate on a quarterly basis due to a variety of factors, including: the rate of adoption of Invisalign for the treatment of orthodontic malocclusion, the rate which manufacturing operations is scaled, the timing of automation of manufacturing processes and the extent of national direct to consumer marketing campaigns.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and judgements that affect the reported amounts of assets and liabilities, revenue and expenses and disclosures at the date of the financial statements. On an on-going basis, we evaluate our estimates, including those related to accounts receivable, warranty accrual and income taxes. We use authoritative pronouncements, historical experience and other assumptions as the basis for making estimates. Actual results could differ from those estimates.
We believe the following critical accounting policies affect our more significant judgements and estimates used in the preparation of our consolidated financial statements. We recognize revenues from product sales when there is pervasive evidence that an arrangement exits, delivery has occurred, the price is fixed and determinable, and collection is reasonably assured. Provisions for discounts and rebates to customers and other adjustments are provided for in the same period that the related product sales are recorded based upon analyses of historical discounts and rebates. We accrue for estimated warranty costs upon shipment of products. Our warranty policy is effective for shipped products which are considered defective or fail to meet the product specifications. We maintain an accounts receivable allowance for an estimated amount of losses that may result from customer's inability to pay for product purchased. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We have established a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We account for income taxes under the provisions of Statement of Financial Accounting Standards, or SFAS, No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which thee differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"),"Business Combinations," which establishes financial accounting and reporting for business combinations and supersedes APB Opinion No. 16,Business Combinations, and FASB Statement No. 38,Accounting for Preacquisition Contingencies of Purchased Enterprises. It requires that all business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement apply to all business combinations initiated after September 30, 2001, and also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. To date, the Company has not engaged in a business combination.
In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"),"Goodwill and Other Intangible Assets," which establishes financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17,Intangible Assets.It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition, and after they have been initially recognized in the financial statements. The provisions of this Statement are effective for fiscal years beginning after December 15, 2001. The Company will adopt SFAS 142 during fiscal year 2002. To date, the Company has not recorded goodwill or other intangible assets.
In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long- Lived Assets," which is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal periods. This Statement supersedes FASB Statement No. 121 and APB 30, however, this Statement retains the requirement of Opinion 30 to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of (by sale, by abandonment, or in a distribution to owners) or is classified as held for sale. This Statement addresses financial accounting and reporting for the impairment of certain long-lived assets and for long-lived assets to be disposed of. Management does not expect the adoption of SFAS 144 to have a material impact on the Company's financial position and results of operations.
In May 2000, the Emerging Issues Task Force (EITF) issued EITF Issue No. 00- 14, "Accounting for Certain Sales Incentives." EITF Issue No. 00-14 addresses the recognition, measurement, and income statement classification for sales incentives that a vendor voluntarily offers to customers (without charge), which the customer can use in, or exercise as a result of, a single exchange transaction. Sales incentives that fall within the scope of EITF Issue No. 00-14 include offers that a customer can use to receive a reduction in the price of a product or service at the point of sale. The EITF agreed to change the transition date for Issue 00-14, dictating that a company should apply this consensus no later than the Company's annual or interim financial statements for the periods beginning after December 15, 2001. In June 2001, the EITF issued EITF Issue No. 00-25, "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products," effective for periods beginning after December 15, 2001. EITF Issue No. 00-25 addresses whether consideration from a vendor to a reseller is an adjustment of the selling prices of the vendor's products and, therefore, should be deducted from revenue when recognized in the vendor's statement of operations or a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be included as a cost or expense when recognized in the vendor's statement of operations. Upon application of these EITFs, financial statements for prior periods presented for comparative purposes should be reclassified to comply with the income statement display requirements under these Issues. In September of 2001, the EITF issued EITF Issue No. 01- 09, "Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor's Products", which is a codification of EITF Issues No. 00-14, No. 00-25 and No. 00-22 "Accounting for `Points' and Certain Other Time- or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the Future." The Company is currently assessing the impact of the adoption of these issues on our financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Quantitative Disclosures
We are exposed to market risks inherent in our operations, primarily related to interest rate risk and currency risk. These risks arise from transactions and operations entered into in the normal course of business. We do not use derivatives to alter the interest characteristics of our marketable securities or our debt instruments. We have no holdings of derivative or commodity instruments.
Interest Rate Risk. We are subject to interest rate risks on cash and cash equivalents, available-for-sale marketable securities, existing long-term debts and any future financing requirements. Interest rate risks related to marketable securities are managed by managing maturities in our marketable securities portfolio. The long-term debt at December 31, 2001 consists only of outstanding balances on lease obligations.
The fair value of our investment portfolio or related income would not be significantly impacted by changes in interest rates since the marketable securities maturities do not exceed fiscal year 2002 and the interest rates are primarily fixed. Our capital lease obligations of $1.5 million at December 31, 2001 carry a fixed interest rate of 6.53% and 11.15% per annum with principle payments due in 60 and 48 monthly installments, respectively, beginning in 2000.
The following table presents the future principal cash flows or amounts and related weighted average interest rates expected by year for our existing cash and cash equivalents, marketable securities and long-term debt instruments:
The available-for-sale securities will fall in value if market interest rates increase.
Our ability to pay long-term debts at maturity.
The impact of interest rate movements on our ability to obtain adequate financing to fund future operations.
We have the ability to hold at least a portion of the fixed income investments until maturity and therefore would not expect the operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates on our short- and long-term marketable securities portfolio.
We manage interest rate risk on our outstanding long-term debts through the use of fixed rate debt. Management evaluates our financial position on an ongoing basis.
Our decentralized or outsourced operations, whereby approximately $14.3 million of our expenses are related to operations outside the United States, denominated in currencies other than the U.S. dollar.
We do not hedge any balance sheet exposures and intercompany balances against future movements in foreign exchange rates. The exposure related to currency rate movements would not have a material impact on future net income or cash flows.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of Align Technology, Inc. and subsidiaries
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Align Technology, Inc. and subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
San Jose, California, February 7, 2002
ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (in thousands, except per share data)
December 31,
--------------------
2001 2000
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 50,550 $ 2,828
Restricted cash............................................ 723 15,986
Marketable securities, short-term.......................... 12,494 9,633
Accounts receivable, net of allowance for doubtful
accounts of $1,882 and $494 at December 31, 2001 and
2000, respectively........................................ 11,556 4,465
Inventories, net........................................... 1,549 2,024
Deferred costs............................................. 714 2,431
Other current assets....................................... 3,997 3,995
--------- ---------
Total current assets...................................... 81,583 41,362
Property and equipment, net................................ 32,021 21,100
Marketable securities, long-term........................... 2,627 6,251
Other assets............................................... 1,987 1,848
--------- ---------
Total assets.............................................. $ 118,218 $ 70,561
========= =========
LIABILITIES, CONVERTIBLE PREFERRED STOCK,
WARRANTS AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................... $ 4,376 $ 5,541
Accrued liabilities........................................ 11,426 14,753
Deferred revenue........................................... 1,551 2,350
Current portion of capital lease obligations............... 483 445
--------- ---------
Total current liabilities................................. 17,836 23,089
Capital lease obligations, net of current portion.......... 980 1,455
--------- ---------
Total liabilities......................................... 18,816 24,544
--------- ---------
Commitments and contingencies (Note 5)
Convertible preferred stock:
$0.0001 par value; Authorized: none and 27,211 shares at
December 31, 2001 and 2000, respectively.
Issued and outstanding: none and 25,788 shares at
December 31, 2001 and 2000, respectively, (aggregate
liquidation preference: $0 and $134,306 at
December 31, 2001 and 2000, respectively)................. -- 128,873
Preferred stock warrants................................... -- 1,818
--------- ---------
-- 130,691
--------- ---------
Stockholders' equity (deficit):
Preferred stock: $0.0001 par value; Authorized: 5,000
shares; no shares issued and outstanding
at December 31, 2001 and 2000, respectively............... -- --
Common stock: $0.0001 par value; Authorized: 200,000 and
120,000 shares at December 31, 2001 and 2000,
respectively; Issued and outstanding: 47,771 and
9,622 shares at December 31, 2001 and 2000, respectively.. 5 1
Additional paid-in capital................................. 355,055 105,828
Deferred stock-based compensation.......................... (48,324) (80,160)
Notes receivable from stockholders......................... (1,484) (1,814)
Accumulated other comprehensive income..................... 226 73
Accumulated deficit........................................ (206,076) (108,602)
--------- ---------
Total stockholders' equity (deficit)...................... 99,402 (84,674)
--------- ---------
Total liabilities, convertible preferred stock,
warrants, and stockholders' equity (deficit)............. $ 118,218 $ 70,561
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
Year Ended December 31,
----------------------------------
2001 2000 1999
---------- ---------- ----------
Revenues:
Revenue--Invisalign....................................... $ 44,955 $ 5,436 $ 98
Revenue--Ancillary products and other services............ 1,429 1,305 313
---------- ---------- ----------
Total revenues.......................................... 46,384 6,741 411
---------- ---------- ----------
Cost of revenues:
Cost of revenue and manufacturing costs--
Invisalign............................................... 45,040 19,031 1,508
Cost of revenue--Ancillary products and other services.... 1,791 1,220 246
---------- ---------- ----------
Total cost of revenues.................................. 46,831 20,251 1,754
---------- ---------- ----------
Gross loss.................................................. (447) (13,510) (1,343)
Operating expenses:
Sales and marketing....................................... 50,581 40,445 5,688
General and administrative................................ 32,734 17,991 3,474
Research and development.................................. 14,683 9,169 4,200
Litigation settlement..................................... 400 -- --
---------- ---------- ----------
Total operating expenses................................ 98,398 67,605 13,362
---------- ---------- ----------
Loss from operations........................................ (98,845) (81,115) (14,705)
Interest income........................................... 4,261 2,306 362
Interest expense.......................................... (1,999) (9,807) (986)
Other expense............................................. (881) (132) (86)
---------- ---------- ----------
Net loss before provision for income taxes.................. (97,464) (88,748) (15,415)
Provision for income taxes................................ 10 -- --
---------- ---------- ----------
Net loss.................................................... (97,474) (88,748) (15,415)
Dividend related to beneficial
conversion feature of preferred stock...................... (11,191) (53,516) --
---------- ---------- ----------
Net loss available to common stockholders................... $ (108,665) $ (142,264) $ (15,415)
========== ========== ==========
Net loss per share available to common
stockholders, basic and diluted............................ $ (2.57) $ (25.64) $ (3.65)
========== ========== ==========
Shares used in computing net loss per share
available to common stockholders, basic and
diluted.................................................... 42,247 5,548 4,218
========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) For the years ended December 31, 2001, 2000 and 1999 (in thousands)
Notes Accumulated
Common Stock Additional Deferred Receivable Other
------------------ Paid-In Stock-based from Comprehensive Accumulated
Shares Amount Capital Compensation Stockholders Income Deficit Total
-------- -------- --------- ----------- ----------- ------------ ---------- ---------
Balance at December 31, 1998............. 5,355 $ 1 $ 5 $ -- $ -- $ -- $ (4,439) $ (4,433)
Net loss................................. -- -- -- -- -- -- (15,415) (15,415)
Stock options exercised.................. 331 -- 42 -- -- -- -- 42
Repurchase of common stock............... (42) -- (2) -- -- -- -- (2)
Deferred stock
compensation, net of
cancellations........................... -- -- 2,174 (2,174) -- -- -- --
Amortization of deferred
stock compensation...................... -- -- -- 394 -- -- -- 394
-------- -------- --------- ----------- ----------- ------------ ---------- ---------
Balance at December 31, 1999............. 5,644 1 2,219 (1,780) -- -- (19,854) (19,414)
---------
Net loss................................. -- -- -- -- -- -- (88,748) (88,748)
Net change in unrealized
gain from available-
for-sale securities..................... -- -- -- -- -- 73 -- 73
---------
Comprehensive loss....................... (88,675)
---------
Stock options exercised.................. 4,121 -- 2,828 -- (1,814) -- -- 1,014
Repurchase of common stock............... (143) -- (48) -- -- -- -- (48)
Deferred stock
compensation, net of
cancellations........................... -- -- 91,752 (91,752) -- -- -- --
Amortization of deferred
stock compensation...................... -- -- -- 13,372 -- -- -- 13,372
Charge for accelerated
vesting of employee
stock options........................... -- -- 429 -- -- -- -- 429
Beneficial conversion
feature embedded in
convertible
subordinated notes...................... -- -- 8,648 -- -- -- -- 8,648
Beneficial conversion
feature embedded in
preferred stock sold.................... -- -- 53,516 -- -- -- -- 53,516
Deemed dividend on
preferred stock......................... -- -- (53,516) -- -- -- -- (53,516)
-------- -------- --------- ----------- ----------- ------------ ---------- ---------
Balance at December 31, 2000............. 9,622 1 105,828 (80,160) (1,814) 73 (108,602) (84,674)
---------
Net loss................................. -- -- -- -- -- -- (97,474) (97,474)
Net change in unrealized
gain from available-
for-sale securities..................... -- -- -- -- -- 153 -- 153
---------
Comprehensive loss....................... (97,321)
---------
Issuance of common stock to
preferred stockholders upon
conversion............................... 26,998 3 128,870 -- -- -- -- 128,873
Sale of common stock upon the
completion of initial public
offering, net of issuance
costs of $12,200......................... 10,629 1 125,976 -- -- -- -- 125,977
Issuance of common stock upon
exercise of stock options................ 260 -- 184 -- -- -- -- 184
Issuance of common stock relating
to employee stock purchase plan.......... 39 -- 245 -- -- -- -- 245
Issuance of common stock upon
the conversion and the
exercise of warrants..................... 529 -- 1,818 -- -- -- -- 1,818
Repurchase of common stock............... (306) -- (266) -- 213 -- -- (53)
Deferred stock
compensation, net of
cancellations........................... -- -- (9,627) 9,627 -- -- -- --
Charge for accelerated
vesting of employee
stock options........................... -- -- 224 -- -- -- -- 224
Payments received on stockholders
notes receivable....................... -- -- -- -- 287 -- -- 287
Interest accrued on stockholders
notes receivable....................... -- -- -- -- (170) -- -- (170)
Amortization of deferred
stock compensation...................... -- -- -- 22,209 -- -- -- 22,209
Beneficial conversion
feature embedded in
convertible
subordinated notes...................... -- -- 1,803 -- -- -- -- 1,803
Beneficial conversion
feature embedded in
preferred stock sold.................... -- -- 11,191 -- -- -- -- 11,191
Deemed dividend on
preferred stock......................... -- -- (11,191) -- -- -- -- (11,191)
-------- -------- --------- ----------- ----------- ------------ ---------- ---------
Balance at December 31, 2001............. 47,771 $ 5 $ 355,055 $ (48,324) $ (1,484) $ 226 $ (206,076) $ 99,402
======== ======== ========= =========== =========== ============ ========== =========
The accompanying notes are an integral part of these consolidated financial statements.
ALIGN TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year Ended December 31,
-------------------------------
2001 2000 1999
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................... $ (97,474) $ (88,748) $ (15,415)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.................... 7,592 2,513 559
Amortization of deferred stock-based
compensation.................................... 22,209 13,372 394
Amortization of accelerated vesting of stock
options......................................... 224 429 --
Loss on retirement of fixed assets............... 35 98 --
Realized loss on marketable securities .......... -- 10 --
Allowance for doubtful accounts.................. 1,388 461 33
Amortization of capitalized financing costs
and debt discount............................... -- 834 984
Non-cash interest income on notes receivable
from stockholders............................... (170) (23) --
Non-cash interest expense on convertible
subordinated note............................... 1,803 8,648 --
Non-cash accretion on marketable
securities...................................... (1,174) -- --
Provision for excess and obsolete inventory...... 555 -- --
Changes in operating assets and liabilities:
Accounts receivable.............................. (8,479) (4,612) (347)
Deferred costs................................... 1,717 (2,431) --
Inventories...................................... (80) (1,658) (366)
Other current assets............................. (1,886) (1,425) (187)
Accounts payable................................. (450) 4,401 672
Accrued liabilities.............................. (2,866) 7,100 1,921
Deferred revenue................................. (799) 2,231 119
--------- --------- ---------
Net cash used in operating activities.......... (77,855) (58,800) (11,633)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment................. (19,175) (13,571) (2,463)
Decrease (increase) in restricted cash............. 15,263 (15,646) (340)
Purchase of marketable securities.................. (72,219) (19,645) (5,906)
Maturities of marketable securities................ 54,412 1,250 3,365
Proceeds from sale of marketable securities........ 19,898 7,827 1,740
Change in other assets............................. (139) (1,848) --
--------- --------- ---------
Net cash used in investing activities.......... (1,960) (41,633) (3,604)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock............. 138,606 1,037 42
Proceeds from issuance of convertible preferred
stock, net of issuance costs...................... -- 83,085 18,740
Proceeds from note receivable for preferred
stock............................................. -- -- 76
Proceeds from payment on stockholders' notes
receivable........................................ 287 -- --
Repurchase of common stock......................... (53) (48) (2)
Proceeds from convertible subordinated notes....... -- 14,000 750
Payments for incurred IPO costs.................... (10,853) (1,327) --
Proceeds from draw down of line of credit.......... -- 5,000 --
Repayment of line of credit........................ -- (5,000) --
Payments on capital lease obligations.............. (450) (318) (8)
--------- --------- ---------
Net cash provided by financing activities...... 127,537 96,429 19,598
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents......................................... 47,722 (4,004) 4,361
Cash and cash equivalents, beginning of year......... 2,828 6,832 2,471
--------- --------- ---------
Cash and cash equivalents, end of year............... $ 50,550 $ 2,828 $ 6,832
========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
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