Align Technology, Inc. (ALGN) Earnings Call Transcript & Summary

Good morning, everyone. Thanks again for joining on our Virtual Central Day. We're on our second -- another very exciting presentation that we're having today, or fireside chat, rather, with Align Technology. This is a company that William Blair has a long history with, and excited to have them here given that there's -- this is, if I was looking across my coverage list, I'd say, one of the best, most durable growth opportunities within our coverage list and also an impressive P&L, with good profitability and opportunities for kind of expansion going forward. So I'm excited to have John Morici, CFO and EVP of Global Finance; and Raj Pudipeddi, Chief Product & Marketing Officer, EVP and Managing Director, Asia Pacific.

So let's just kind of dive into it and maybe we'll start at a high level. For those that are newer to the story, it's interesting because you guys have been in the market for, I think, over 20 years now, but yet there's a lot of opportunity still for you in markets that are underpenetrated. So maybe just lay the groundwork for us in this chat what are your kind of opportunities and what levels of penetration are we at today so we can kind of understand the growth trajectory from here.

Yes, it's a good question, Brandon. I'll start and then Raj add in any color to it. When you think of the opportunity that we have, like you said, we've been around now just over 25 years. And as a company, we've developed products and innovations over that time period that helped us and helped our doctors be able to work on more and more complicated cases. We started out really as maybe going towards more adults in the simpler cases when we first started the company, and through innovation and investments, we've invested probably over $1.5 billion over our 25 years. We'll spend $300 million this year in development, in research to make sure that we can continue to have the best products available for our customers, our doctors. And over that time, we've given them the ability with doctors who have some experience with us and can treat these more complicated cases. We have some doctors that can treat 100% of their caseload with our products. But we feel that an experienced doctor should be able to do 85%, 90% of all the cases that he/she sees from a product standpoint to be able to treat those more and more complicated cases. And when we look at the opportunity that we have, we think of it in terms of there's 21 million, approximately 21 million orthodontic case starts every year. 75% of those are teen. And when we look at those 21 million orthodontic case starts, say, 20% of those or so are done with clear aligners, and we make up the majority share of those clear aligners. But even with that, we've got the most technical, highly advanced products that move teeth in a predictable and reliable way through digital orthodontics. And yet less than 20% is being done with clear aligners and even less than that from -- with Invisalign. So we think we have a huge opportunity. Just in the orthodontic case starts with our technology to be able to help dentists and orthodontists move teeth digitally and provide that digital orthodontics with the products that we have. And then if you look at just the general dentistry that goes on, where you and I might be in that office share a couple of times a year, where you might have minor movement or you just have put off having your teeth aligned over those periods, we've been able to provide more of a seamless workflow for those general dentists to be able to make this a part of what they do. The majority of what those dentists might do, say, 95% of what they might do would not be orthodontics. And we can help provide them the digital dentistry, the digital orthodontics that they need because much of what those general dentists are doing is restorative, and we can help them move teeth in a way to help preserve healthy teeth and be able to find a way so that you provide the orthodontic movement and then you can also finish -- and those doctors can finish from a restorative standpoint. So been around for 25-plus years, but it feels like we're just getting started in terms of the opportunity, but it fundamentally comes down to the products and the innovation that we've had over this time period to be able to give doctors confidence to move teeth.

Got it. That's great. And then the next one maybe to set the ground for us of like where we are today, right? That's higher level, let's go a little granular. Talk to us a little bit about the Q1 results you guys reported a little bit a couple of weeks ago, and maybe I'll lump in another question there. Subsequent to the Q1 results, we've got another macro updates like consumer confidence, things like that. Talk to us about, maybe put it in context of how those subsequent updates maybe impact your thoughts coming out of Q1, how we can think about that on a go-forward basis.

Yes. I would look at our Q1 results and say, look, we met our commitments and what we talked about from a guidance standpoint. We talked about that there would be some sequential decrease that we saw, in particular what we thought was going to happen in China. And we saw China actually performing better than what we had expected. They've opened up the economy much more, allowed people to go about. It tossed a lot of COVID and other impacts that we saw at the end of the fourth quarter into the first quarter. But then after you got past that, China has become much more of a stable environment than we've seen. And that's what's happened in other places as well. We talked a lot about Q1 being more stable and just an easier, a better environment to operate in. We've got a couple years, 3 years or so, with this instability with COVID and some of the macro impacts that we've had around inflation and interest rates. And as you mentioned, consumer sentiment. That is, I would say, better than the lows that we saw, especially during COVID, but it's still not where we'd like it to be. We'd like it to see improve. But I think what we -- the takeaway from Q1, Brandon, is it was a more stable environment. And with that stability, we were able to execute. We were able to do things in a way that we introduced a price increase that reflected some of the investments that I talked about earlier, but it's just a reflection of some of the inflation that we've had. We were able to operate in a way that provided more profitability. We talked about how that's very important for us when we talk to the total year. We talked about that 20% non-GAAP operating margin, and that was key. So we delivered on that in Q1. And with all that, it provided us continued ability to be able to look at Q2 and say, okay, this is the guidance that we expected in Q2, given the environment that we're in. And so like I said, it's not great having higher inflation. It's not great having some of that consumer sentiment that we have, but it doesn't feel like it's getting worse. And from that standpoint, we say it's more stable. And look, what I said at the outset about our opportunity, we're in a vastly underpenetrated market. We know that down the line, we will -- digital dentistry, digital orthodontics will prevail. It's a matter of time as we work through that. It's just that short term, you have some of these macro things that are on people's minds. But we felt good about Q1 and delivering what we did. We put that into our guide for Q2, and we'll evaluate and update as we go forward.

Great. Yes. And we had an expert call from China this morning who actually described the situation there pretty similar, where things are better but still well below pre-COVID levels, kind of hard to see. I think, for what it's worth, he had described it as there's a lot of vacationing going on, a lot of pent-up demand to go on vacation. And so it's kind of taking a little bit of wind out of the sales in the near term for kind of a dental recovery, but the overlying trends are pretty strong for the long term, right? So that makes sense. A follow-up question to that topic. When you're talking about you previously gave this Q2 guide, can you talk about what was kind of baked in for China in that Q2 guide? Did you kind of leave some room for some noise in China? Or any kind of commentary you can give around what you're expecting there?

Yes. I think from China, well, as we do with all of our forecasts that we have, China is a piece of it, obviously, all the other pieces are, and that's what forms our opinion to come up with what we expect from a guidance standpoint. China, we've noted was improving as it went through the quarter just because you had so much of it locked down from people being sick from end of last year into this year, and then we started to see some of that recover. We look at that as an overall basis. We expect some sequential improvement as you get from Q1 to Q2, given those conditions that we have. And as you get into China, you start to get into more of the teen season at the end of the second quarter and certainly into the third quarter, where there's a lot of teenagers that will go into treatment. And so that's factored into our overall guidance in terms of what we expect from China. And I'll let Raj to add any color of what you see in China.

Sure. So Brandon, I think you said you had an expert call who said things are starting to get better, but kind of folks are still kind of vacationing, trying to kind of come back to normal life. Look, I'll take us back to January when -- December or January when the opening was pretty chaotic. None of us knew kind of where we would net out. So since then, to John's point, we've seen some stabilization, some improvement as it has come through. But I think the reason why we are optimistic about China and the long-term plan, as you've said, is it's a really big market. We've got -- if you just think about our footprint there, we've got a manufacturing facility, we've got a treatment planning facility. And on top of all of that, we've launched a whole portfolio of products recently just for the China market, including the Invisalign Adult, Invisalign Standard that gives doctors so many more options to treat patients. The last thing I'd add is, what's unique to China and many countries in Asia is you got lots of crowding of teeth because kind of the jaws are small. So our recently launched CBCT, which is Cone Beam Computed Tomography, significantly helps treatment planning because it's integrated and doctors can see roots before they could do the planning. So all in all, I'd say the long-term story for us continues to be very optimistic and China is a strategic market for us.

Okay. Great. And I think I'll ask you, Raj, a follow-up on that in a second, but I just want to remind everyone because this is the second session now, I forgot, if you have questions, you can throw them in the Q&A. I'm kind of getting them in live, and so I'll incorporate them as we go through as well. But feel free to throw questions in there, anyone listening in. But so Raj, I'll stick on China for just a second. There's so much else to talk about. But it's interesting because we spoke to an expert this morning, like I was saying, one of his kind of pushbacks on clear aligners in general, not just Align, was that they're just more expensive than wires and brackets. My sense maybe, and tell me if I'm wrong, is it's an earlier market, and so that's kind of a friction point that they're still working through clearly in other developed markets. We've worked through that. How do you guys tackle that in a market like China, where it's more expensive to the dentist to do a clear aligner? And how do you get them to kind of grow their volume over time?

It's a great question. I would say that, first, look, aligner awareness in China in Tier 1 and Tier 2 cities is pretty high. So consumers and potential patients know about aligners. Second thing, even though wires and brackets are cheaper in China, parents, especially moms know that Invisalign is the best product brand. So for Chinese parents, they actually want to provide the best they can for their children. So if you think about the long term, we think the potential for aligners and growing aligners is actually very significant. But you said it well. It's in a slightly earlier stage than when you compare it to, let's say, the United States, especially as you go to Tier 3 and Tier 4 cities. So we continue to kind of market to consumers, potential patients, but also to doctors. To consumers and patients, we talk about how aligners are really predictable and can be done without changes to lifestyle. To doctors, we talk about how applicable we are, like 90% of the cases can be treated with Invisalign, how predictable we are. And frankly, we are faster in many cases than braces, without the pain of emergency visits. So the message is resonating well. The way I look at it is, once we get out of this current difficult macroeconomic situation globally and they come out of COVID, in the long term I think China continues to be an important and strategic market. And I think it's no different than, for example, the United States, where we develop the market with marketing, both to doctors and potential patients, and also launch relevant innovation to drive the product.

Okay. Great. Yes, it makes sense. And we'll kind of look forward for some more China updates. Two kind of quick ones that we're getting in the Q&A here. I'm trying to think how to -- in an appropriate setting here, what you can say. But we have heard this morning, we have heard that there could be another COVID wave within China. I guess maybe the way that we could discuss that is, was there anything kind of contemplated like that within the Q2 guide?

We are not -- we don't look at that specifically on COVID, and that was part of what we've had at least for the last 3 years around COVID. We find it a challenge to predict or understand kind of what the implications could be, but we're not at that level of detail from a forecast standpoint. And I guess, COVID can -- is still out there. You hear less and less about it, and it disrupts less and less than it has. But I haven't contemplated that in the guide.

Okay. And then there's kind of like 2 others here, just in general, on consumer confidence, how things are trending. To what degree -- remind us what kind of like indicators you guys are looking at internally as you look at the rest of the year. This primarily, of course, probably impacts your adult business. But how do we think -- how should we kind of contextualize some of the macro updates we've gotten since the Q1 call and how they might impact your business?

Well, I think consumer confidence is a good indicator of -- because that factors in a lot of things that are going on in people's minds. Consumer confidence factors in concerns they might have in inflation. It might factor in concerns that they might have on their own job that they have, their finances as a family and how they're spending money, what they're spending money on and so on. So I like it from that standpoint, not to compare across like what the U.S. has versus U.K. versus China and so on. You look at those indices and say, okay, what's the trending within that environment that they're looking at? So in the U.S., as an example. So we'll use Michigan consumer confidence index to understand kind of what's happening from a trend standpoint. And I would say, broadly, look, there's changes that happen at different rates within other countries. But broadly, what you see is it's not getting worse. It's trending either to neutral to slightly better, at least as we look at some of these indices now. So there's uncertainty in the marketplace. I mean, in the U.S., you hear a lot now is with kind of the comp down to the debt -- raising the debt and so on, and that rattles some people in terms of their own personal finances and what it might mean for the stock market and so on. You see the same thing happening with banks. People don't like to hear this uncertainty about is this bank going to fail? What does it mean for my money? What does it mean for -- how I want to live and operate? So that all factors in to what people want. And I think, Brandon, what you will take it back to is, look, every product that somebody sells is discretionary at some point. And so orthodontics, at some point, is discretionary. Maybe less so from a teen standpoint, but still discretionary, but less so because at that standpoint is you're a 6-year-old, 7-year-old, and your permanent teeth are coming in or you're losing teeth and you want to be able to create space with Invisalign first and some of the products that we have. There's a certain window that you have to be able to provide that product to be able to create that space. Same thing for a product that we have called mandibular advancement, which is -- provides your orthodontic care but also aligns your jaw so that your jaw is properly positioned. And it's at a certain point in time that, that's really useful for a child or, in that case, an early teen to be able to have that procedure done. So in many cases, during the summer, when people are out of school, that's just the right time for them to go into treatment as a teenager. Your parents have saved up for it, and they want to go into treatment. So what I'm getting at is that's less discretionary. But what we see is there's -- people look at their own kind of their finances, how stable they are in terms of what's going on with the macro economy, and they make decisions based on that. But I would say, overall, and kind of what we talked about in Q1, it varies country by country, but it seemed more stable. It seemed like it wasn't getting worse. Where we saw -- if you went back to those indices a year ago, it was just -- we just didn't know how far things are going to -- how bad things might get. And I think it came up in what consumers were spending on. They pulled back on all spending. A lot of the money that they were spending on other things, now were going to food and fuel and everything else. And I think that stability has improved. Not great yet. It's not a great environment, and there's still uncertainty in by all means. But the further we go along in getting some of these unknowns understood, like the debt that we -- negotiations that we have, some of the other factors that having more bank stability, maybe not raising interest rates as much or maybe be more stable on that, I think that will put the confidence back into people and then they'll spend as they want to. But I think the point on as we head into teen season, mainly a little bit less discretionary. We see our doctors certainly are busy with teenage cases. And I think we want to be that orthodontic appliance of choice. We want to be the ones to be able to provide those doctors with a product to be able to take on those cases.

Okay. Great. All right. I think a lot of those been said already on kind of like near term and attempting to forecast the unimpossible right now of the macro economy. So let's maybe focus a little bit. There's a lot of other topics to kind of try to get to here. The first -- because I don't want to forget this, and it's very topical today. Can we just spend a couple of minutes talking about how you guys today are utilizing artificial intelligence within your platform? I believe you already have a couple of commercial products using AI. What are they? Maybe talk about like how difficult it is to build those things and what kind of a competitive moat it offers you guys as well?

Good. Let me take that. Look, we have a platform that we call Align Digital Platform that engages a potential patient, a consumer, a potential patient, all the way from getting to know about Invisalign to maintaining their beautiful smile even after Invisalign. The starting point really is connect. And our learning is that when a consumer gets interested in Invisalign, he or she wants to see how the smile could look if they use Invisalign. And so we have an AI-driven tool called SmileView, which we've integrated in our app, where the consumer can just take a photograph. The consumer can see his or her transformed smile in front of her, right? This is just the first application of AI. And I think Brandon, you said this well, we have AI and ML integrated end-to-end. So let's say, this potential consumer gets interested, comes to the office to get a scan. On the scanner, our iTero scanner, we show the Invisalign Outcome Simulator, which is essentially a simulation of the transformation of the person's smile, but which is clinically valid. So the doc can then and there show to the consumer, "Hey, look, here is how your smile can look after transformation." We are building on top of that very soon. Later this year, we are launching a product where it's not just a still visual, you can actually see a video of the potential patient, right? Now let's say the potential patient decides to become a patient and then the doctor has to plan. We've now developed templates that once a doctor sends a scan, gets the treatment plan, which is very, very close to what he or she wants to do, right, from a preference standpoint. So the multiple weeks of going back and forth to the technician, those days are gone. Now the doctor gets a plan, which is much more closer to what he or she wants. And then they can actually change the plan in front of them and see the changes in 2 minutes. We call it the live update. Brandon, you asked how difficult it is. It takes almost a billion computations to get the live update done and the treatment plan in front of the doctor. So after the plan stage, then it goes to treat where we have literally world-class manufacturing with multiple AI-led systems, visual scanners built in to enable us to manufacture almost 1 million aligners a day. Followed by -- now the patient is starting to use Invisalign and wants to stay on top of it, wants to track progress, takes photographs, sends back to the doctor. AI lets us identify only photographs that are actually off track, right? So just an example to say end-to-end, we have AI and ML completely integrated. And they've been added for well over a decade, right? So if you just look at some of the key components of planning and manufacturing, we've built a competitive moat, I'd say, for well over a decade with many of the innovations. And the important part is it's only accelerating that part, right? So 60,000 doctors use our Invisalign practice app actively every month. 350,000 patients actually use our app every month. So all the digital nurturing and all that you hear companies talk about happens automatically in our ecosystem and our digital platform. So in essence, I would tell you that every part of the consumer and the patient journey and the doctor journey we've mapped out and leverage AI to reduce the friction and increase conversion.

And that, Brandon, it's just -- what Raj talked about is those are investments that we've been making for a number of years. And really when we -- even when we talk about the COVID era that we're in a few years ago, we were still making investments in what Raj is talking about, live updates and CBCT and some of these other breakthroughs because we're so close to getting this, and we knew the benefits it would be able to provide to our doctors and ultimately their patients. And so we continue to make these investments and continue to improve our products and processes so that we put it in the hands of our doctors. So -- and that's continued all through COVID. And we knew that we had to do this because this is the way to be able to scale. This is the way able to use the intelligence that's there, that's available there on the 15 million-plus patients and be able to provide that technology to the doctors, and now is a way that Raj described, being able to almost personalize some of that treatment plan for those doctors so that they can move teeth in a predictable way that is used -- is how they're used to moving teeth. It's very customized to how they want to move things. And that's so powerful. It's so powerful nowadays to be able to help provide that and get doctors to be able to move teeth in a predictable way and saving time on their side, plus also now seen some of the productivity benefits on our side where it doesn't have to -- what Raj was talking about with live update. It just -- it used to take sometimes weeks back and forth between making adjustments and so on that the doctor wanted and we'd have to put it in and the technicians would have to make the changes and so on. Now what they're talking about can happen in minutes. And in many cases, what used to take days or weeks is down to hours or minutes. And that's much more productive for doctors to be able to help them integrate this into their workflow, and it's certainly a productivity benefit for us.