On April 9, 2002, the Company exercised its right to terminate an Exclusive Marketing Agreement dated October 18, 2001 with Discus Dental Impressions, Inc. pursuant to the express terms of the Agreement and the Company issued a press release reporting this termination. On or about May 14, 2002 the Company received a demand for arbitration submitted by Discus Dental with the American Arbitration Association in San Jose, California. In its arbitration demand, Discus Dental seeks damages of approximately $30 million, including commissions and bonus payments it claims it would have received under the Agreement as well as other expenses, attorneys' fees and injunctive relief to prevent us from selling Invisalign to dentists in the U.S. and Canada. However, prior to terminating the Agreement, the Company conducted a thorough review of the Agreement and each party's performance thereunder. Based upon that review of the factual and legal issues, the Company denies all claims made by Discus Dental in its demand and contends that such claims are entirely without merit. In addition, on or about June 13, 2002, the Company submitted a counter- claim against Discus Dental in the arbitration seeking damages of approximately $40 million arising out of our claims for misrepresentation, breach of confidentiality provisions, and unfair competition, among others. As of this date, the arbitrators that will hear the arbitration have not yet been selected and no arbitration date has been set.

The Company was involved in a patent infringement proceeding with a plaintiff asserting infringement of two of its patents. On June 30, 2000, the Company entered into a stipulation of dismissal with the plaintiff whereby the plaintiff agreed not to recommence a suit against the Company for two years with respect to the disputed patents. Pursuant to the agreement, if a patent is subsequently issued to the plaintiff and the plaintiff believes the Company is infringing it, then the plaintiff may commence suit after one year from the effective date of the agreement and include in such action claims involving the two previously disputed patents. If any such action is successful, it could result in a significant monetary damage judgment against the Company.

The Company is subject to claims and assessments from time to time in the ordinary course of business. Management does not believe that any such matters, individually or in the aggregate, will have a material adverse effect on the Company's financial condition, results of operations or cash flows.

Accumulated other comprehensive income (loss) consists entirely of the change in unrealized gains or losses on available-for- sale marketable securities at June 30, 2002 and December 31, 2001.

In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 143, ("SFAS 143"), "Accounting for Asset Retirement Obligations," which is effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to all entities. The Company believes that the adoption of SFAS 143 will not have a material impact on the consolidated financial position or results of operations of the Company.

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," which is effective for fiscal years beginning after May 15, 2002. Under SFAS 145, gains and losses from the extinguishment of debt should be classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion No. 30. SFAS also addresses financial accounting and reporting for capital leases that are modified in such a way as to give rise to a new agreement classified as an operating lease. The Company believes that the adoption of SFAS 145 will not have a material impact on the consolidated financial position or results of the operations of the Company.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities," which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS 146, a liability is required to be recognized for a cost associated with an exit or disposal activity when the liability is incurred. SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a retirement or disposal activity covered by FASB Statements No. 143 and 144. The Company is in the process of determining the impact on the consolidated financial position of the Company.

In July 2002, the Company announced a plan to streamline worldwide operations. The plan includes closing the Company's facilities in Pakistan and the United Arab Emirates. The operations performed at these facilities will be transitioned to the United States and Costa Rica. In addition, the plan includes a global reduction in worldwide staff. One-time charges relating to the plan will range between $7 million and $9 million. It is estimated that the majority of activities relating to the plan will conclude by December 31, 2002. Additionally, due to the closure of the Pakistan facility, land held in Pakistan will be put up for sale.

This quarterly report contains certain forward-looking statements (as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) and information relating to the Company that are based on the beliefs of the management of the Company as well as assumptions made by and information currently available to the management of the Company. For example, statements that are not based on historical facts, which can be identified by the use of such words as "likely," "will," "suggests," "target," "may," "would," "could," "anticipate," "believe," "estimate," "expect," "intend," "plan," "predict," and similar expressions and their variants, are forward-looking. Such statements reflect the judgment of the Company as of the date of this quarterly report and they involve many risks and uncertainties, such as those described below and those contained in "Factors That May Affect Future Operating Results." These factors could cause actual results to differ materially from those predicted in any forward-looking statements. Although we believe that the expectations reflected in the forward- looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these forward- looking statements. The Company undertakes no obligation to update forward- looking statements.

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 in this quarterly report and our audited consolidated financial statements and notes for the year ended December 31, 2001, included in our Annual Report on Form 10-K.

From our inception in April 1997, 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 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.

While our expansion outside of our domestic market (U.S. and Canada) is still in the initial stages, we do incur substantial operating costs outside of our domestic market.

Currently, two of our key production steps are performed in operations located outside of the U.S. In our facilities in Pakistan, the United Arab Emirates, or the U.A.E., and Costa Rica, technicians use a sophisticated, internally developed computer-modeling program to prepare electronic treatment plans, which are transmitted electronically 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, U.A.E. dirhams, Costa Rican colons 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, difficulties in staffing and managing international operations, controlling quality of manufacture, political, social and economic instability, acts of war or terrorism, 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 in Pakistan, the U.A.E. and Costa Rica are mitigated by the fact that our operations there do not involve the shipping or manufacturing of any physical products, and in Mexico by the fact that our operations there are governed under the provisions of the North American Free Trade Agreement, or NAFTA.

In July 2002, we announced a plan to streamline worldwide operations. The plan includes closing our facilities in Pakistan and the U.A.E. The operations performed at these facilities will be transitioned to the United States and Costa Rica. In addition, the plan includes a global reduction in worldwide staff. One-time charges relating to the plan will range between $7 million and $9 million. It is estimated that the majority of activities relating to the plan will conclude by December 31, 2002.

We have not been profitable for any period since April 3, 1997 (our inception). As of June 30, 2002, we had an accumulated deficit of $243.4 million. We expect to have net operating losses and negative operating cash flows for at least the next 12 months due, in part, to continued spending on our consumer advertising campaign, continued development of our distribution channels, enhancements in our manufacturing process, continued 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. In our domestic market and in other selected international locations, our revenue consists of fees charged for both the ClinCheck and for Aligners. We charge dental professionals a fixed fee for the treatment simulation viewed via ClinCheck on our website, 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. In other international locations, the dental professionals are invoiced for the entire Invisalign case upon the shipment of the Aligners.

Fees from the sale of ClinCheck and Aligners, taken together, are treated as revenues from a single Invisalign case. All of the revenues associated with a given case, including ClinCheck fees, are 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 deferred and recognized as related revenue is earned. In the cases where we expect a net loss, the entire loss is recognized immediately.

Revenues. Revenues for the quarter ended June 30, 2002 increased to $17.3 million, compared with $13.5 million for the quarter ended June 30, 2001. Revenues for the six-month period ended June 30, 2002 increased to $34.4 million, compared with $21.2 million for the same six-month period in 2001. The increase in revenues was primarily due to the increase in Invisalign cases shipped, and for the six-month period ended June 30, 2002, an increase in training revenue of $3.2 million. Substantially all of our training revenue was derived from our agreement with Discus Dental, which was cancelled in April 2002. As a result, training revenue for the quarter ended June 30, 2002 decreased by $1.7 million from the previous quarter. We commenced direct training of general practice dentists in the latter half of the quarter ending June 30, 2002. We expect training revenue to increase in future periods due to the planned increase in offered training courses.

Cost of revenues. Cost of revenues for the quarter ended June 30, 2002 was $10.8 million, compared with $13.8 million for the quarter ended June 30, 2001. Cost of revenues for the six-month period ended June 30, 2002 was $23.3 million, compared with $25.4 million for the same six-month period in 2001. Cost of revenues includes the salaries of staff involved in production, the cost of materials and packaging used in production and shipping, depreciation on the capital equipment used in the production process, unabsorbed manufacturing capacity that resulted from our substantial increase in our manufacturing capacity in fiscal 2001, training costs and an allocation of the cost of facilities. For the quarter ended and six-month period ended June 30, 2002, we achieved positive gross margins mainly due to increases in Invisalign case volume, efficiencies achieved in manufacturing as well as reducing overcapacity in many areas. Our gross margin is affected by changes in manufacturing volume, manufacturing capacity and changes in our pricing policies.

Sales and marketing expenses. Sales and marketing expenses for the quarter ended June 30, 2002 were $11.4 million, compared with $10.9 million for the quarter ended June 30, 2001. Sales and marketing expenses for the six-month period ended June 30, 2002 were $21.3 million, compared with $27.7 million for the same six-month period in 2001. Sales and marketing expenses include sales force compensation together with expenses of professional marketing, conducting training workshops and market surveys, advertising and attending dental professional trade shows. The increase in sales and marketing expenses for the quarter ended June 30, 2002 was primarily due to an increase in international sales and marketing expenses of $3.7 and an increase in expenses related to advanced training of dental professionals of $0.4 million, partially offset by a decrease in our domestic advertising expenses of $4.0 million. The decrease in sales and marketing expenses for the six-month period ended June 30, 2002 resulted primarily from a decrease of approximately $13.6 million in our domestic advertising expenses, partially offset by an in increase in international sales and marketing expenses of approximately $4.1 million.

General and administrative expenses. General and administrative expenses for the quarter ended June 30, 2002 were $10.6 million, compared with $8.1 million for the quarter ended June 30, 2001. General and administrative expenses for the six-month period ended June 30, 2002 were $21.1 million, compared with $15.0 million for the same six-month period in 2001. General and administrative expenses include costs for the compensation of administrative personnel, outside consulting services, facilities, legal expenses and general corporate expenses. The increases for both periods were primarily attributable to increased headcount and administrative costs relating to being a public company and due to the growth of our international operations.

Research and development expenses. Research and development expenses for the quarter ended June 30, 2002 were $3.0 million, compared with $3.8 million for the quarter ended June 30, 2001. Research and development expenses for the six-month period ended June 30, 2002 were $6.1 million, compared with $7.8 million for the same six-month period in 2001. 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. We expense our research and development costs as they are incurred. For the quarter ended June 30, 2002, research and development expenses decreased primarily due to the continued reduction in outside services by approximately $0.6 million. For the six-month period ended June 30, 2002, research and development expenses decreased primarily due to the continued reduction in outside services by approximately $1.3 million.

Litigation settlement expenses. Litigation settlement expenses resulted from the settlement of a class action lawsuit. In February 2001, a class action lawsuit was filed against us on behalf of all licensed dentists (excluding orthodontists) in the U.S. The complaint alleged that our policy of selling the Invisalign System exclusively to orthodontists violated the U.S. antitrust laws. Without admitting any wrongdoing, we reached an agreement in principle with the plaintiffs to settle the lawsuit. The total legal and other settlement costs that we agreed to pay were approximately $0.4 million. Pursuant to the settlement, we will undertake to train and certify 5,000 general practice dentists each year over the four-year period following the settlement.

Interest and other income (expense), net. Interest and other expense was $0.3 million for the quarter ended June 30, 2002 compared to interest and other income of $1.3 million for the quarter ended June 30, 2001. Interest and other income for the six-month period ended June 30, 2002 was $0.03 million, compared with $0.7 million for the same six-month period in 2001. Other expense for the first six months of 2002 consisted of bank management fees and bank service charges. Partially offsetting these charges was interest income, which has been decreasing primarily due to the decrease in our cash and cash equivalents balances and marketable securities balances. Interest income for the six-months ended June 30, 2001 was primarily generated from the our cash and cash equivalents balances and investments in short-term marketable securities. Offsetting this income in 2001 was non-cash interest expense of $1.8 million, recorded in January 2001, 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 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 the 419,700 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 three months ended March 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.

Stock-based 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. 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 $3.8 million and $6.1 million for the quarters ended June 30, 2002 and 2001, respectively. For the six-month periods ended June 30, 2002 and 2001, we recorded amortization of deferred compensation of $8.7 million and $11.8 million, respectively. Additionally, we recorded expenses of $0.8 million for the quarter ended June 30, 2002 and $1.5 million for the six-month period ended June 30, 2002, related to options granted to non-employees during the current fiscal year.

During the quarter ended June 30, 2002, the Company accelerated the vesting of options to several employees in connection with severance packages. The accelerations were accounted for as a charge to the statement of operations. The charge was $1.2 million for the quarter ended June 30, 2002 and $1.3 million for the six month period ended June 30, 2002. The charge is equal to the intrinsic value difference between the exercise price of the accelerated options and the fair value of the common stock on the date of acceleration. There were no acceleration charges for the quarter or six-month periods ended June 30, 2001.

Historically, we have funded our operations with the proceeds from the sale of our common and preferred stock, equipment leases and bridge loans. As of June 30, 2002, we had $35.4 million in cash and cash equivalents and marketable securities and an accumulated deficit of $243.4 million. Additionally, we had $0.3 million of restricted cash.

Net cash used in operating activities totaled $26.4 million for the six-month period ended June 30, 2002, and $52.2 million for the six-month period ended June 30, 2001. In each of these periods, net cash used by operating activities consisted primarily of net operating losses and increases in accounts receivable balances, partially offset by increases in depreciation and amortization and amortization of deferred stock-based compensation.

Net cash provided by investing activities totaled $2.5 million for the six month period ended June 30, 2002 and net cash used by investing activities totaled $38.3 million for the six-month period June 30, 2001. For the six-month period ended June 30, 2002, net cash provided by investing activities consisted primarily of sales and maturities of marketable securities, partially offset by purchases of property and equipment. For the six-month period ended June 30, 2001, net cash used in investing activities consisted primarily of purchase of property and equipment and marketable securities, partially offset by proceeds from the sales and maturities of marketable securities and a decrease in restricted cash.

Net cash provided by financing activities was $0.5 million for the six-month period ended June 30, 2002, and $127.2 million for the six-month period ended June 30, 2001. For the six-month period ended June 30, 2001, net cash provided by financing activities consisted primarily of proceeds from the issuance of common stock. In January 2001, we completed our initial public offering of 10 million shares of common stock. In March 2001, the underwriters exercised an overallotment option for 628,706 shares. Net proceeds to us were approximately $126.2 million.

We expect our operating expenses to decrease in conjunction with our plan to streamline worldwide operations, announced in July 2002. While we believe that our existing working capital will be sufficient to fund our operations and our capital investments through the next twelve months, we are in the process of obtaining additional financing in the form of an accounts receivable line of credit and an equipment line of credit. However, there can be no assurance that such additional financing will be available on a timely basis on terms acceptable to us, or at all, or that such financing will not be dilutive to stockholders. If adequate funds are not available, we could be required to further reduce operating expenses by, including but not limited to, reducing planned capital expenditures relating to enhancing the Company's manufacturing process and reducing worldwide staff.

In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 143, ("SFAS 143"), "Accounting for Asset Retirement Obligations," which is effective for fiscal years beginning after June 15, 2002. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to all entities. The Company believes that the adoption of SFAS 143 will not have a material impact on the consolidated financial position or results of operations of the Company.

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," which is effective for fiscal years beginning after May 15, 2002. Under SFAS 145, gains and losses from the extinguishment of debt should be classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion No. 30. SFAS also addresses financial accounting and reporting for capital leases that are modified in such a way as to give rise to a new agreement classified as an operating lease. The Company believes that the adoption of SFAS 145 will not have a material impact on the consolidated financial position or results of the operations of the Company.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities," which is effective for exit or disposal activities initiated after December 31, 2002. SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Under SFAS 146, a liability is required to be recognized for a cost associated with an exit or disposal activity when the liability is incurred. SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a retirement or disposal activity covered by FASB Statements No. 143 and 144. The Company is in the process of determining the impact on the consolidated financial position of the Company.

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 continue to incur significant operating expenses to:

• develop new software and increase the automation of our manufacturing processes;
• execute our consumer advertising campaign;
• increase the size of our sales force and dental professional training staff;
• continue our international sales and marketing efforts; and
• undertake quality assurance and improvement initiatives.

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 have incurred significant operating losses and negative operating cash flows since inception and have not achieved profitability. As of June 30, 2002, we had an accumulated deficit of approximately $243.4 million.

We expect to expend significant capital to continue to build our national brand, expand our dental professional channel, automate our manufacturing processes and develop both product and process technology. While we believe that our existing working capital will be sufficient to fund our operations and its capital investments through the next twelve months, the Company is in the process of obtaining additional financing in the form of an accounts receivable line of credit and an equipment line of credit. However, there can be no assurance that such additional financing will be available on a timely basis on terms acceptable to us, or at all, or that such financing will not be dilutive to stockholders. If adequate funds are not available, we could be required to further reduce operating expenses by, including but not limited to, reducing planned capital expenditures relating to enhancing the Company's manufacturing process and reducing worldwide staff.

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 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.

As of June 30, 2002, approximately 6,000 dental professionals have submitted one or more cases to us. Our success depends upon increasing acceptance of Invisalign by dental professionals. Invisalign requires dental professionals and their staff to undergo special training and learn to interact with patients in new ways. 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.

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 dental professionals, 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, 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.

Two of our key production steps are performed in manufacturing operations located outside the U.S. We currently rely on our facilities in Pakistan, the U.A.E. and Costa Rica to create electronic treatment plans with the assistance of sophisticated software. In addition, we rely on third party manufacturers in Mexico to fabricate Aligners and to ship the completed product to customers. In July 2002, we announced a plan to streamline worldwide operations. The plan includes closing our facilities in Pakistan and the U.A.E. The operations performed at these facilities will be transitioned to the United States and Costa Rica. In addition, the plan includes a global reduction in worldwide staff. It is estimated that the majority of activities relating to the plan will conclude by December 31, 2002.

Our reliance on international operations exposes us to risks and uncertainties, including:

• political, social and economic instability;
• acts of terrorism and acts of war, particularly in light of the terrorist attacks of September 11, 2001 and the war in Afghanistan;
• 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 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 July 31, 2002, we have 19 issued U.S. patents and 63 pending U.S. patent applications. We have 15 foreign-issued patents and 119 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.

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 "Part II-Item 1--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 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.

                                                                   Authority
                                                          For      Withheld
                                                      -----------  ---------
H. Kent Bowen                                         30,846,473    113,772
Zia Chishti                                           30,826,146    134,099
Brian Dovey                                           30,844,273    115,972
Joe Lacob                                             30,788,907    171,338
Thomas M. Prescott                                    30,399,164    561,081
Kelsey Wirth                                          30,815,773    144,472

                                                          For       Against   Abstained
                                                      -----------  ---------  ---------
                                                      30,852,977    102,690      4,578