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

Guys, let's get started. I think we have a full head of Americas and now EMEA. A bunch of different topics, guys, if you have questions, please throw up your hand.

But I want to start, John, with the LRP and maybe just long term and then we'll sort of funnel and get a little bit more specific. But the LRP hasn't been addressed in a period of time. Your revenue base is what? It's 2x. Competitions come into the market. You guys would talk about being a 20% to 30% grower and OM's 25% to 30%. Maybe just help us out. Is that still Align's intention and thought that that's the right growth profile for the company long term?

Yes, it is. When we think of the market opportunity that we have with the products and services that we have to better go to market, that 20-plus percent -- 20% to 30% revenue growth, 25-plus percent up margin is how we think of our investments, how we think of when we're expanding, when we're adding new products, when we're innovating, that's how we think of that market opportunity. Prior to COVID, that was very consistent and growing in the marketplace. Obviously, you have some impact from COVID, 2021, even stronger than that. But when we think of -- on a more stable market that hopefully we're going to be in soon, that's the long-range plan that we think about.

Okay. And I guess the 20% to 30% top line is pretty clear. It would be innovation, new markets in areas all over the globe. There's a teen market that's widely underpenetrated, we can get into that. But help us out with the OMs. Because I think where I struggle there is you were well in that band, the 25% to 30%. And then this year, you're going to be around the [ 4 bill ] but 20% OMs. Next year -- be scratching 22%. What are the main levels to get back to 25% plus? Where does that come from?

Yes. I think the benefits that we'll see as you make these investments, some of these products come to market. And so as you start to see some of the revenue benefits of the various products, you get some of that benefit. We've been able to add price this year. We see that benefit coming through from a gross margin standpoint down to OP margin. You look at facilities like Poland. Poland, we entered about a year ago, that was about a point impact to us on an OP margin basis. You start anniversary that, and you start to see some of that productivity. But it broadly comes from being able to leverage the investments that we have, whether they're innovations that we have, manufacturing or some of the go-to-market activities, and we should see that improvement. And even if you look at this year, really what we've implied is when you have the first quarter of 18.5% OP margin, we guided to 19.5% in the second quarter. And when we talk to the 20-plus percent for total year, it really talks to some of that acceleration in OP margin as you go out of this year, and we expect that into next year.

Yes, it's a good point. I'm actually cheating and looking at the model right now. I mean I don't have your top line wildly dissimilar. It's higher, but 2H versus 1H, yet I have you exiting at 21.6% versus starting the year at 18%. So maybe there's -- some of those factors will start to more normalize exiting '23 that we can more extrapolate going forward?

That's what we expect, Joe.

Okay. Simon, I'm going to pull you in and maybe just talk to us, do you started running EMEA. You did a lot of great things in EMEA, bifurcating the sales force, you went over to Americas. And now it looks like you're running EMEA again. Maybe talk to us on why the company recently made that change and what it's hoping to accomplish with the leadership?

Sure. So as you said, I run EMEA for 4.5 years, and I've now been 4 years here. And I think there's a lot of synergies. One thing that I suppose has surprised me a little bit is a lot of similarities about how we approach channel, how we approach customer. And so I think there's a great opportunity to kind of double down on where there are those similarities and share best practice and programs that we run across the different regions. I think it's going to be great as well to have -- we're essentially going from, I suppose, 2 regions to 5. That's the way I view it. I don't see it as one big kind of region. And that's just going to enable us to continue to be agile and customer focused, et cetera, and push those kind of decisions and actions down to local leadership.

Is that something that you feel like you're able to make immediately? Or does that take some time to take hold?

Well, some things, I think you can -- we're doing immediately, which is where we're really synergize in around best practice. And then maybe some of the pieces around decision-making take a little bit longer. But I wouldn't see those taking a long time.

Okay. Okay. Helpful. And I'll probably circle back in EMEA a little bit. John, we started at a high level, and I want to get a little bit more near term or trends. At the beginning of the year, you mentioned growing cases Q-over-Q throughout the year post 1Q '23 results. And you guided up for cases in 2Q sort of when you do the implied math. I think I land around 3% up sequentially 1Q to 2Q. Where I struggle is, if I go back to your normal historical seasonality, you're usually up closer to high single digits, right, 1Q to 2Q and you've guided again 3%, 4%. For the third quarter, because you sort of said at the beginning of the year, we're going to grow sequentially. The sell sides said, okay, we went ahead and just plugged in the numbers. We all have you growing 2Q to 3Q and your normal historical seasonality is up 1% because it's a very seasonal quarter with EMEA, a lot of them not working too hard over that period of time. So I guess where I'm trying to go with this is help us why -- give us the confidence on why you recapture your historical sequential seasonality 2Q to 3Q when you were below it, 4Q to 1Q? you expect to be below it 1Q to 2Q? How do you get there 2Q to 3Q if some of these indicators around consumer confidence have softened a little bit of late?

Well, I think it starts with making sure that the consumer confidence doesn't get worse. I mean ideally, it's stable to up. So if we see that continue. And I think when you get into the third quarter, it's the biggest quarter for China. And as long as China does COVID and some of the other concerns that have been out there don't materialize, and you see that China is still open, should be a very big quarter. It's teen season for China, and we should see the volume come through there. It does offset the EMEA, where there's holidays and vacations and so on. And it's also a strong season in the U.S. We should see a lot of teen cases in the U.S. and North America as well. So we think when you take all that together of state, keep the stability in the overall economy, nothing gets worse and you see some of the benefits in China and North America from a teen season standpoint, we expect that overall seasonality to hold.

That's helpful. And then you mentioned China, and I want to ask a follow-up question there. And every single company -- dental company at this conference has gotten this question because I think on the 1Q earnings call, as everyone was talking about China. Hey, look, Jan and Feb was really rocky, right? Got better in March, and then we saw an acceleration in April. And then some random day, we get this headline of what's going on in China and peak infection rates not occurring until June. On the ground, what are you seeing?

Well, you see areas where you have improvement. We saw in the fourth quarter, a lot of people -- and things opened up in China, people got sick and had COVID and kind of played itself out into the first quarter. And we talked about it at the last earnings that we saw improvement as we went through the quarter, February better than January, March better than February within China. And we looked at it from an overall quarter standpoint, 1Q was better than 4Q in terms of shipments. So we've seen this within China. We need to have that stability applied to China as well. But we think that it will help us as we go into the second quarter and certainly into third quarter as I discussed.

A couple of clarifications here. 1Q better than 4Q, so sorry for the silly question. So cases in China were up sequentially, 4Q...

Up sequential.

Okay. They were -- and then I'll get you to hopefully just put EMEA and something else there, but China cases were up 4Q to 1Q. And then it seems like the demand slope that you saw exiting the quarter despite some of the headlines, that hasn't changed all too much. Is that a fair conclusion when we think about the headlines that we've seen?

It certainly -- when we talked about earnings, we saw that improvement as we've gone through. I don't want to talk kind of within the quarter, but we certainly saw that as we progressed. But like I said, China is an important market for us, great opportunity for us and especially as it heads into third quarter where it's the biggest quarter for China.

Yes. Okay. Maybe just a couple more around near term, and it will be for John and Simon. I think one of the themes that you were consistently touching on late in '22 into early '23 was this theme of stability, right? Like a lot of this that was going on exiting '21 and in '22 had stabilized. Is that still the thing that we should be latching on to of late across your markets?

Well, that's what we see when we look at the consumer confidence indices. In most countries, they're either stable. Some have improved, and we've seen some improvement in certain countries. U.S. has been largely stable. It comes down to the economics that people feel, inflation, concern about interest rates, concern about a lot of their own personal finances, that impacts their decision. It's -- what we find with -- we hear a lot from doctors is that patients aren't saying no to treatment. They'll say, wait and see. They'll say, I need to see if I -- as I fit this into my budget and so on. That impacts us from an adult standpoint, less so on the teen side. We can get into whatever you want to discuss on the teens, but teens a little bit less discretionary. As they get to certain time of the year, they're on break or holiday or maybe their jaw and the alignment needs to happen at a certain age, less discretionary from teen standpoint.

Okay. And just to continue down the road of a bit international, so I'm going back to some of the metrics coming out of 1Q. International cases were down 4% Q-over-Q. You mentioned China being up. So it seems like EMEA was down, obviously, more than 4%, just doing sort of the implied math. That seemed like a pretty big reversal. EMEA was a big outperformer in 4Q. It seems like it rolled in 1Q. Simon, can we still use stability in EMEA? I think what spooks me a little bit is the underperformance through my view in 1Q, the leadership changes that took place? Are we still seeing stability in EMEA currently?

Well, leadership changes have nothing to do with the results. Yes, I think stability, I think, across the globe. I think when we across the different regions, different markets, that's what we're seeing. I think we talk about unpredictability in the numbers, that's kind of coming out of COVID. But definitely, I'd say, stability is still the word, yes?

Okay. Fair enough. Again, guys, if you have any questions, let me know. Otherwise, I can keep these guys up here for a couple of hours, so I'll just move forward. One of the things I wanted to talk about was the R&D deleverage. And I think one of the things that I truly value about Align and makes you guys a lot of fun to cover is the R&D and the investment and your -- you're 2x the industry, some of the big players in terms of the R&D investments. The other guys are around 4% of revenue. You're closer to 8%, 9%. That said, I'd love to see you get back to down to 6% or 7% to go ahead and hit those goals of 25% plus OP margins. So a couple of metrics for you. R&D was 6% of revenue in '18, '19 and 2021. In 2018, you were a $2 billion revenue company. This year, you're going to do $4 billion in revs. And in 1Q '23, R&D was 8.5% of sales. So for that LRP to get back on track, John, how do we think about R&D as a percent of sales longer term?

Well, I don't target a percentage when we make our investments. We look at products that sometimes they're more in the R stage versus the D stage. And so when you're in the R stage, you're doing a lot of research, you're developing products and your time line to get them to actually be a product to sell, sometimes takes some time. And so you do see some fluctuations in some of that overall percentage. But I would say, on a long-term basis, it's around 7% is how I would say the net of it all coming together. And therefore, compared to now, you'd see some leverage on that. But it really comes down to the investments that you make. A lot of the technology that we're talking about, whether it's treatment planning, around the software or the innovation that we think will bring to market around the direct fab printing and then the innovation that we also give to our iTero business, that takes a certain amount of investment over time. And then how quickly those investments can turn into actually seeing the revenue, that's the cycle time that you're in. But longer term, I would say 7% is more of the range.

Okay. And so maybe let's talk about the payoff or what's on the common. We discussed this a little bit at the dinner last night. But Joe mentioned on I think it was the fourth quarter call of we're on the cusp of one of the best innovation cycles of the company. What's on the comp? We think palatal expansion is being trialed in Canada, awaiting FDA approval and then rollout. Simon, maybe if you want to talk about it, I think there are some things that might be underappreciated from the Street in terms of workflow tools. And then how do we walk that back to the model and utilization and securing market share if you want to go down that road a little bit?

Yes. Well, I think as John says, we have invested heavily in the last few years, but particularly around software. We know that's the major interface for our doctors. They don't tend to play with the plastic. It's the ClinCheck. That's why they spend a lot their time. And in some cases, too much time. So what we've been trying to do is build a lot of AI into that process. So really taking their treatment preferences, their treatment protocols and automating them in a way that they're still going to get the kind of the treatment plan that they want, but in a more efficient and effective way. So we're now kind of commercializing. There are 2 elements to it. There's what we call IPP, which is the individual -- the Invisalign personalized plan, where the doctor is -- well, we're able to code the doctor's preferences. So instead of it going to a technician to do all the kind of changes, et cetera, the code actually understands what the doctor wants from the scan. And that takes a kind of a -- historically, it was a kind of a 4- to 6-week process of submitting the case and then the backwards and boards with the technician down to literally hours. Because what we also added on the back end was the 3D controls live update where if there are just minor tweaks that the doctor wants to make, they make those and then they push go. So I think there's enormous -- the efficiencies there are for doctors. Doing something in the moment is so much more efficient than having to go back over a number of weeks and remember the patient and remember what they're trying to achieve. So that's IPP. And then we've also introduced templates of some larger groups of general dentists.

These are efforts to really scale up that initiative more broadly.

Yes. Who tend to follow the kind of the philosophy of some of the preeminent general dentists out there. And then -- so they follow the template works in exactly the same way. So they're getting the treatment plan back in a couple of hours.

And then walk me back to the model, I see sort of like 3 different impacts coming out of that. One is maybe it is utilization because now I'm a doc, it's much more streamlined. I'm not going to spend 6 hours on a Saturday doing my ClinCheck. So I've got a greater likelihood to do more cases. I would think it's stickier in terms of potentially losing some on a competition, right? Like if I go and I get an aligner and source it for $100 or $150 less, what am I getting back in terms of inefficiencies and then around treatment planning. Fair, all 3 of those variables. John, is there any way to quantify 1, 2, 3 in this journey?

No, I think it's difficult to quantify. But I think all 3 of those things are potentials. But there are other elements as well on the software. So we've talked about IPP, we've talked about templates. We've bolted on Smile Architect, which is kind of a multidisciplinary ClinCheck. Now where you can plan pre-restorative before you do ortho. We've got CBCT integration. We've got the ClinCheck now that we do in face visualization where you can take the ClinCheck and show a before and after in the patient's face. And as you know, you've seen we've got the video come in as well. So that will not be a 2D...

Conversion tool.

So it's not just about IPP and templates. I know we talked about -- a lot about that last night, but there's a -- the 8.5% has been going on, just the full suite of software, creating efficiencies, visualization and making the whole process more impactful.

And fair to say, we're just seeing a much -- we will see a much greater return from those initiatives '24 versus...

Well, and that's the key, Jon, because not only -- once those products come to market, and some of them are to market, you don't have the OpEx spend there. And then on many of these, we're also seeing productivity benefits as well. When we don't have to go back and forth with our technicians, I can either have -- we can have technicians working on other things to drive volume and help with the kind of the treatment planning and so on or I can just have less technicians and that will drive productivity for us.

Okay. Let me try to go a little further down on some of these roads. So palatal expansion, I mentioned is out in Canada. If you get FDA approval tomorrow, can you go? I mean can you -- can you move from a manufacturing standpoint?

It's a ramp up. I mean, it's a -- but it will be our first commercial direct printed product that we'll have. And it's -- but it's a ramp-up that you have. But as soon as we get approval in the U.S, we will go.

I was thinking back on the bus tour in December. I believe you had submitted at that time. How long has it been sitting with the FDA in terms of palatal? Has there been an active dialogue with the agency?

Yes, there's a process to go through. But ideally, we've seen it released now on a trial basis within Canada, great results. We're getting the movement. It's doing what doctors have expected to be able to move those young child's upper pallet in the right way to create space for those permanent teeth to come in. And in the U.S., we need the FDA approval.

So largely incremental market opportunity for you guys expanding the palate. I went back and I looked at one of the other markets that you went into that I thought was largely incremental being Invisalign First, right? And I pulled some stats that you guys gave to the Street. You started 32,000 Invisalign First cases in the first 18 months. Is that a good analog? Is that a good benchmark? I know the ASP is different. I'm thinking for your rapid palate expander, it might be around $500. But is that 32,000 in the first 18 months where we should look toward? Can you run faster than that?

Look, I would like to run faster than that because I think when you start to think of the opportunity, if you think that there's 21 million orthodontic case starts worldwide, 16 million of them are teen. And we hear that 10-plus percent of those teenagers -- in this case, preteens, need some type of palate expansion. Some of its handled in Invisalign First. It does do some of that. But really, if you need that palate expansion, that's a huge opportunity. You're talking about 1.5 million kids who need something like this. And the product that we have, which is for 30 days, the mom pops in that aligner, that's -- palate expander at the top, it's in for a day, popped the next one in another day, it goes 30 days, creates that space. It's a much less torturous device than the metal palate expander that we have now. So you think about from a compassion standpoint, you think about from kids actually wearing and creating that space and so on, when you have over 1.5 million potential customers kind of within their patients within this, I look at that as a huge opportunity for us. And that's incremental revenue that we don't have. And that's a development coming from the research that it took to now we're kind of in the development phase, that's a benefit for us.

And maybe just to round out R&D because I want to go after gross margins. We talked palatal expander. We talked a lot of initiatives around software and workflow to go over to the scanner and services division. It seems like there's initiatives there, a faster scanner, better workflow and usually what a company that is hardware in order to make those changes. Is that fair?

It's fair. So when you think about the cycle that we're on in terms of some of these devices, you're in the 3- to 5-year range in...

A 5D was...

5D is like 3 years ago or so. So you start to think, you want to have a scanner that meets these requirements that you can build off of and then supplement it with software and so on. So that's the mindset that we have there.

I want to go to gross margin because I feel like to get back to the 25% plus, we need to see a different trajectory in gross margin. I feel like the building blocks are there. And so I'm going to start in the less obvious place. We did some work in one of our most recent reports sort of bifurcating systems and services, because there's 2 very different businesses in there. There's the capital and the services, and you've given enough pieces to the puzzle where services is right around 50%. And that's a services business. And I think, John, 80% gross margin-ish fair?

On the equipment side? Yes, I mean you...

On the services part within their...

Yes. On the service part.

So you've had this massive positive mix shift to services, yet overall systems and services GM has been flat to modestly down. And so the implied math on the actual scanner is down pretty hard. I don't -- look, scanners went through the roof coming out of COVID and then they've come back down. But talk to us -- and now it seems like the number of scanners going out, it's starting to stabilize. So can you get stability on the equipment side of things, so the mix shift comes back more to your favor and we get overall margin expansion within the...

I think you have 2 things that have impacted kind of on the scanner side. So you have the volume that you need. You need volume leverage there, that helps. That helps your absorption, helps you generate some of the margin improvement. And I think it's also been some of the raw material input into the product, where we've seen some of the inflationary where not long ago, we were talking about chip shortages and some of these other things that were impacting where you incur the price for that, some of the freight and other costs that have kind of gone into that. I think as we see some stabilization there and not as much inflation on some of those inputs as well as some of the volume that we have, you start to get some of that gross margin leverage there.

Okay. So that might be, call it, a driver for Systems and Services going forward. The other one, it's funny, sometimes, I think I just get lazy at times with the analysts being -- you're looking at the gross margin percentages. And then one of the things I was like, hey, I want ASPs going up, but the gross margin is going down. So I turned around into COGS dollars. And when you actually turned around in the COGS dollars, you see a pretty big move higher over the past 3 to 4 quarters. Is it as simple as saying, let's tie that to pole and that should normalize over the next handful of...

Well, that's a part of it. I mean you think about when you have facility -- I mean, we're putting out 1 million aligners in a day. And when you're trying to get that right mix of those facilities, and in Poland's case, that's a new facility for us. So you put in the equipment, you've got labor, you've got overhead to support that plant and then you're adding production to that. And as a production and you utilize that plant more and more, you start to see that productivity and that shows up in reducing our costs and so on. So we're aware of that. We know how to scale things there. It's just a matter of putting that in and then seeing the benefit. To a smaller -- to maybe a more hidden extent, you saw this -- I mean it was kind of forgotten during COVID, but we put China as a greenfield in June of 2020. But it was lost and everything else going on in the world. It experienced kind of the similar things but it was lost during the fact that you -- COVID and the volumes and everything else. We know how to scale this. It's a matter of doing that within Poland, and we'll see that cost improvement.

Simon, quick question for you, and I'm going to see what I can get through in 5 minutes. If the consumer weakens, how do you alter your approach? Let's just pick a market like EMEA and consumer confidence starts to roll over. What are sort of the marching orders that you give to the organization or your sales force in terms of what they can do or what's within your control to try to maximize the opportunity?

Well, I think the good news about the business is there's a lot of levers we can pull, whether that's from a channel perspective. So how do we approach an orthodontist, for example, in Europe? How do we approach a general dentist, right? So in that scenario is -- I always view a general dentist is about converting the patients that are already coming in to your practice maybe for other things into clear aligners. And then on the ortho side, teen is the big play, right? As John said, that's the -- tends to be the less discretion purchase that happens. So I think we've got a lot we can do from a channel perspective. And then we've also got geographic, the geographic side so...

Those are greenfield from...

Yes, yes, yes. As we were talking about last night, the kind of the Eastern Europe, into Middle East and into Africa, a lot of that is kind of virgin territory for us. So whilst we've -- their investments, we -- that's a new business for us. So like I say, there's options for us. But the -- marching orders are drive the adoption of technology. We can share insights with customers that shows when you adopt the platform, when you use the technology, when you use these tools that we've introduced around in-face visualization, the simulation...

Helps with conversion.

Yes, helps with conversion, yes. So we see some great results from that across multiple markets where we do that.

And one of the things that I wanted to hit on with the platform that we have this morning is DSP. And I'll try to be quick here, but what should be a positive -- I don't want to say it was a negative in the quarter. I just think there was some confusion. So John, we have your DSP run rating at around $80 million or $85 million. It's within non-case revenue. Most of that is retention. But if I try to throw a case volume number in there embedded in the 1Q results, I land 8,000, 9,000. And am I on the right ZIP code within some of those numbers? Maybe you could talk to that.

Well, okay. On DSP, which is doctor subscription program, it's really a program that the commercial team thought through of saying, look, you've got a typically a lot of high-volume orthodontists who do comprehensive cases. But what we found with those orthodontists, they weren't really giving us any retention or some of these minor touch-up cases that we have. So the DSP program allows those doctors to buy aligners over a period of time, typically a year. And they commit to a certain amount of aligners that they're going to use for cases like touch-up or retention. And that doctor gets a meta at a price over a period of time. As you rightly said, if they do a touch-up case, they do a case where they need some minor adjustments, maybe the person that wear the retainers or maybe they had some movements and so on, those cases that they do, they just put it under their subscription. It doesn't fall as a case. Typically, it might have been a 5-set aligner case, and we would have counted that as volume. Your 8% to 10% is probably -- it's in the right, but it's north of that in terms of the volume...

The cases that are being pulled out...

The cases that are being pulled -- yes, out of the first quarter, it would be north of that. And it just -- it's a way that doctors want to buy. So what has helped us is it keeps that high-volume doctor able to support those. They still want to do those comprehensive cases, they buy them from us. But now they're not making aligners themselves, they're not doing other lab work for retention or so on. They're using us. So we're getting that volume that they were either using themselves or going somewhere else, we're getting that volume to us. Might not show up as case volume, but it shows up as revenue.

Got it. Very helpful. And maybe just to conclude, and I know we're sort of at time. But DSP, in my eyes has been wildly successful. And Simon, I think last time, you talked about maybe rolling that out to additional markets going forward. Teen case pack was another initiative around the same time that we had done a lot of diligence on and I think the feedback was a little bit more muted. And I think Joe has always talked about you run some plays, some initiatives, you see what the outcome is and then you might make some modification. So is that something where we could see some sort of like a TCP reboot? Or what didn't resonate maybe in the field the way that you initially expected in and around TCP?

Well, first and foremost, we launched teen packs in a number of markets. I think -- and I agree, DSP has probably been more successful, but we've had some success in other countries. I think in the U.S. I think when we launched it, it was right when the kind of macro situation shifted. So that commitment to a volume and...

Hit the doc a little bit...

Yes, kind of a timing. But we've learned a lot from that. And so we're doing a lot of work looking at slight tweaks around business model and how we can make it because there's still an appetite out there for almost like this concept of digital inventory and trading kind of commitment for certainty around price, et cetera. So it's not -- I wouldn't say it's dead. We've learned a lot. We've still got doctors out there using those packs. I think the other thing as well is the kind of the 2 refinements, maybe that was too little, particularly around teen. So we -- as I kind of Joe said before, we'll try things out. They're not always successful, but we learn and then we can tweak and implement and keep going because we definitely believe that kind of subscription pack type of approach for certain doctors is really appealing.

Get them on TCP and then get on DSP as well.

Yes, yes, yes absolutely.

Fair enough. Okay. We're going to have to stop there. I appreciate the time, guys, Simon and John. Thank you very much.

Thank you.

Thank you.