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

All right. Good morning. We'll go ahead and get started. Welcome to the Jefferies 2023 Global Healthcare Conference. I'm Brandon Couillard, I cover the life science tools, diagnostics and dental sector here at the firm. Very happy to have Align Technology with us back at the conference today and joining us for this conversation, CFO, John Morici; as well as Simon Beard, EVP and Managing Director of Americas and EMEA at this point. Thank you both for being here.

Thank you.

Maybe, John, if we could start off, I mean, if we think back to the first quarter call, I think you probably talked about the word stability maybe 15 times. It's definitely the most frequently said way to describe the current environment, at least at that point in time. Any areas of the business geographically that you feel like are lagging, maybe improving directionally? Just kind of give us, I guess, an update on kind of the state of the union from your point of view and kind of the macro environment.

Okay. Well, welcome, everybody. Well, when we talked about in the first quarter, we talked about that stability. As you said, because really for the last 3 years, we hadn't seen a lot of that stability. And so it was important to at least communicate kind of where things were at. And it really comes down to some of the consumer confidence that we look to some of the indices that we know we're turned upside down for the last few years, first COVID and then a lot of the macro instability. And that's what we had been seeing for the last few quarters. And really, the last quarter, we talked about how the metrics, while not great, at least we're a little bit more stable than we've seen, meaning that not changing negatively like we saw most of last year. So that's what we saw from an overall standpoint. When you look at certain countries, there's some improvement in certain countries that we see as they say -- as we see the macros improved, we saw that certainly from a China standpoint as we went through the first quarter where because of COVID and so on that they had within the country, we saw that February was better than January and March was better than February. And so that was a good trend to see. We saw overall stability within the U.S. being our largest market, which was good. And we're looking for that to continue. There's a lot of uncertainty in the marketplace around the macros and really stemming from the inflation that we saw -- we've seen, and we continue to see, and then the responses to that. But we're doing what we can do to drive the business. I know you'll probably have other questions on that, but from an overall standpoint, it's just why it came up a lot on the call and why we talked about stability is just we haven't seen that as much over the last few years. And it was good to see that point, and we look forward to the future then.

You held back from giving more formal guidance for the year. You did talk about the second quarter. I think a lot of people may be anticipating with a couple of quarters of stability, again, that you might feel more comfortable reestablishing guidance. What are you kind of looking for, I guess, going forward before having that confidence? Is it China? Is it one market in particular? What are the KPIs that you're focused on?

Yes, it's not one market. This year, we started giving more of that quarterly guidance started with 1Q and now we've given 2Q guidance. And look, I'd love to be able to continue that quarterly cadence and then really started out with what the total year is. I think when we look at the back half. Like I said, we've seen some stability, but we want to make sure that some of the economies continue that, and there's not a surprise that you have from whatever you think the economies are going to do from a recession standpoint or inflation and so on. So what we're looking for is could that continued stability, we'll be able to obviously talk about Q2 once we go through that, our call, and we'd be able to talk to Q3 and almost getting to the total year. So -- but the normal guidance that we have prior to COVID was kind of given annual forecast of where we think things are at and then give more specifics around the quarter. That's something that we hope to do. We'll just continue working our way through this a bit of an uncertain environment, but we'd like to be able to get to that overall number.

Traditionally, the business pre-COVID grew in a very linear fashion over a period of time, fairly predictable seasonality. Now that you kind of, I guess, burned through the COVID pull forward, if you will, at least in our view. Do you expect the business to return to more of that normal seasonal cadence? Do you see that in some geographies, actually in terms of the data you have? And if so, I'm curious where.

Right. Our business has a certain amount of seasonality, especially as you go from -- if I use Q2 as an example, where we talked about some of the sequential improvements that we expected from 1Q to 2Q some ASP benefits with pricing and so on. And then you also look at some of the volume benefits that we expect you're heading into teen season in Q2, it continues in Q3. So that seasonality that we expect is kind of built into our forecast, but it's adjusted or there's impacts to it based on how some of the countries are performing and so on. So we look at it as that's a good reference point in terms of what we expect. But in some countries behave a little bit more seasonal, a little bit more at the norm. But then depending on consumer confidence, inflation, some of the other things that go on, it can become muted a bit and doesn't perform the same way. But prior to COVID, we really had that sequential kind of seasonality that you were talking about. We've seen bits and pieces of it as we've come through, and we're looking to see that seasonality continue. And when that does, then I would say we're at a more normal operating environment, but some countries are better and worse than that.

Any updates as far as your view of China sort of given the COVID case by like the government is trying to encourage people to carry on. But what are you seeing in China given the recent spike?

I think overall, in China, like I said earlier, we saw really at the end of last year to this year, as the country opened up, everybody was kind of out and many people had COVID and that kind of forced that lockdown themselves. But then after they had COVID, they went out and about and did their thing, and that's why we saw some of that improvement as we went through the first quarter. Look, China is one where as long as the -- it's not a lockdown, the government tops down lockdown, and it's an open environment, we can operate in China. It's people going out for treatment. We have providers going and providing care. So we feel like we can operate in that environment as long as it stays open.

Simon, in terms of your leadership roles, you started at the company, I think, as Director of EMEA about 10 years ago, almost moved over to the Americas in 2019, recently appointed EVP of now both regions. Why does that move make logical sense in terms of your focus?

Well, first of all, thanks for aging me. I'm in my 9th year. So it makes sense from a number of angles really is I suppose one of the benefits I've got is, like you say, run EMEA, run Americas for the last 4 years. And I think what I've learned is there are a lot of similarities across the different geographies. So I think there's a real opportunity to leverage some of the marketing programs, some of the education, clinical programs, some of the go-to-market programs as well. So I kind of think of it as not necessarily kind of form in one big region, it's really splitting out into 5 smaller regions where we can more effectively leverage best practice, get the innovation into our customers a lot quicker, make us feel smaller to the customer as well. So the more local decision-making. So that's kind of my role is to kind of enable that to happen across those 5 areas, Canada, U.S., Lat Am, Europe and then a new region we've got, which is EMEA.

Is this strategy different at all between the 2 regions in terms of whether you're looking at a GPs or orthos?

Sorry, say the first part again.

Does that go-to-market commercial model differ at all between the 2 regions, whether you're looking at GPs or orthos. And I'd be curious, any nuances or distinct...

There are some nuances, right? And then a classic one will be around consumer marketing. There are certain markets in Europe where we can't advertise directly to the consumer. There are some markets where doctors can't advertise as well. So yes, we split the kind of teams into kind of ortho-focused and GP-focused when I was in EMEA, and we did that in the U.S. and Canada, and we've done that kind of in Lat Am as well. So I think that's brought a huge amount of benefit, particularly as the -- as we've kind of pushed through all the new innovation, there -- clearly, there are things that work for both customer bases, but there are things that we've developed that are very kind of specific to that channel. And that just enables our sales teams to be a lot more focused in those areas. So yes, that's really going to be the focus. And there are good things. There are a lot of good programs, the EMEA team have run and also stuff that we do in the U.S. and Canada that could be shared a lot more effectively. So yes, we're still committed to that approach. I think the only kind of caveat I'd call out is one of the areas that is different would be particularly how we go after the GP opportunity, which is huge in Europe because it's still other than the U.K. and maybe Nordics is a relatively small part of our business is the way those markets are structured, Spain, Italy, we also -- we have also found this in Brazil, they're multidisciplinary. So how we kind of approach those offices, how we work with the different disciplines within a practice is very different. Whereas when you look at the U.S., U.K., places like France, it's very defined, right? There's an ortho office, there's a GP office. So we have to think about that our go to market in a different way.

What parts of EMEA do you think -- do you expect the strongest performance this year?

I expect strong performance across every country in EMEA. We've got a very -- historically very strong business in Iberia in the U.K. I think there are major opportunities across kind of France and Italy. But even with the U.K. and Iberia, there's still -- we're still relatively underpenetrated in specific channels that we could really drive the business a lot stronger.

You guys have talked about -- you described the R&D pipeline is the strongest right now in the company's history. Is that -- any more color you can kind of share on that, when should we see some, I guess, some of the things in the pipeline coming out? Is it more on the iTero side, software side, aligners?

It's really all of that. I mean like I said, we've we made the strategic decision that we want to continue to invest in our R&D even during some of these COVID and now macro uncertainties. Our R&D and our investment into products we know -- continues to pay off for us now and will pay off for us in the future. When we think about the investments we make, think about it in 3 parts, some on the software side. So that's just about being more productive for our customers so that as they are treatment planning and the 15 million-plus cases that we've done, if we can provide them kind of that machine learning, AI intelligence so they can do cases faster. They could have personal protocols and so on to be able to make sure that they get their treatment plan as to -- after they've done a scan, how they want it. And because it's done that way, with some automation that we can provide, they may make adjustments in terms of that final positioning through some of the technology that we've released called Live update and some of the other technology we've been able to give them a treatment plan that's much faster than what they've seen in the past. We used to go back and forth days and sometimes weeks with our technicians and them. And now they get something in hours or minutes. That's a treatment plan that they're ready to go with. It's a huge productivity savings on the doctor side, and it's a productivity savings on our side. So there's a lot of innovation going into software. We announced something called Virtual Care this year, and that's really been able to, as a patients in treatment, they could take a picture of their teeth. And through AI and understanding, we can then take are the teeth tracking to what that ClinCheck would say? And are they tracking to what was expected? And so that's a productivity benefit for the doctors. It's easier for the patients to not have to come in the office at certain times, and it certainly helps us. So there's a lot of technology that's coming on the software side. We also have it on the appliance itself. There's a lot of investments that we're making -- continue with the direct fab printing being able to print aligners. And a large part of that has been the research that we've put in to be able to make these aligners or in a product that we have that it's in trials now in Canada and going through the FDA process in the U.S. is the rapid palate expansion. So that's our first commercial 3D printed product that is a direct fab product where you have a child that has crowding that needs upper palate space. This is a device that traditionally has been done where you put a metal device on top, and that slowly opens up that upper palate. Here we have a 3D printed -- direct 3D printed product that will snap on to the top of that child's mouth. It's replaced every day, and it slowly moves that upper palate and create space for those permanent teeth to come in. It's a new market for us. We're not in that space, and this helps us continue to help doctors do upwards of 100% of what they see, all the patients that they come through now they'll be able to treat more and more of these patients. So there's investments that we make on the direct fab printing side and then also on the scanner side, faster processing, better field of view, changes to the wand and so on. But doing things to ultimately make our customer lives easier so that they can properly and effectively treat patients. When we see those investments, obviously, it helps us from a revenue standpoint as those come to market. but it also helps us from a productivity standpoint. We will then be more efficient on some of the tools that we're providing to our doctors because there's a lot of back-and-forth interface that we see now, and that will help us with not only the revenue side but also from a leverage standpoint in our operating model.

In terms of operating margins, I think the guide implies, correct me if I'm wrong, about a 21.5% operating margin -- excuse me, 21% for the back half of the year. Is that the right way to think about that as a jumping off point maybe for '24?

It's a good proxy, I think, for that. What we've talked about this year is even though we didn't give total revenue guidance, we talk about the levers that we can pull or not pull within our business. And we talked about being slightly above 20% for the year. We printed 18.5% for the first quarter. We've kind of guided to 19.5% in the second quarter. So your point of the second half kind of acceleration, that's what we expect as we go into this year. And it's really a way to be able to look at the leverage that we get in our business, to be able to look at some of the investments. I just talked about some of the R&D that we're spending. And now as it becomes further into development, and you can actually release the products, you get leverage on that. So it's a good way to think about the progression that we see within our business.

I think one of the things that did cause maybe some investor confusion coming off the last quarter is the DSP program. Can you describe exactly what that is for people that may be less familiar and what impact that has as far as how you recognize volume and pricing and what the puts and takes are exactly?

I'll describe the program and then John can talk about how we recognize it. So DSP is Doctor Subscription Program. And it's primarily focused around what we would call kind of lower stage. So that's 10 stages or less, so more mild treatment relapse, touch-up as we call the product. Doctors finish wires and brackets cases often with aligners. So it's a flexible program for them and then also retainers retention, which we think is a huge opportunity for us as a business. So we principally focus this on ortho in our higher volume doctors who historically had either bought an in office printer or outsourced to a local lab. And what it allows doctors to do is they buy kind of a package, like 100 aligners a month or 200 aligners, in some cases, many thousands of aligners a month. And they use it to put all of their patients in retention or like I say, to treat kind of these mild cases. We've had huge, huge positive feedback from customers? Because essentially, they buy the package, they pay a set kind of monthly fee, and they can use those aligners on whatever they want to. There's kind of is that almost their playing field, they decide how they use it and they like that kind of freedom on control. The great thing is, it is really leverages our platform and our scale. So we can deliver these products pretty quickly to them. We know they get that quality. They don't have to work often the software system or another platform. They just do it straight off of IDS, which is our Invisalign Doctor Site. So it's just very, very convenient. And like I say, it's been hugely well received by doctors. And at the moment, it's just in U.S. and Canada, which is rolling it out into Europe now. That's probably another good advantage of the change in structure. We get things like DSP into other markets.

And in terms of revenue recognition, how we -- I mean there's a commitment by the doctors, as Simon said, to be able to use these aligners for the cases that they have. But we actually recognize revenue based on how we ship. And like Simon had said, most of the subscription program that the doctors are using it for retention. So it's just how they're running their practices. So we look at this as we said, it's really for high-volume doctors who really weren't giving us a lot of retention or doing some of these more -- moderate or mild cases. Now we're getting those cases through this program, which is great. It's incremental for us. It's at margin neutral to accretive, depending on what they're purchasing. So it's really a good combination of being flexible to the doctors in terms of how they want to practice leverages our infrastructure that we have. We can provide retention and other refinements in a timely manner. So we can provide to the doctors and kind of meet the needs of scheduling and so on with their practices. So it's a benefit for us and for our doctors and ultimately for the patients. But what you also have within, and I think where it came up on the call and just to provide clarity on, there are some cases, not on the retention side, but on the mild movement cases that doctors would have previously bought a case from us and maybe wanted a set of -- 5 sets of aligners. Well, now that gets captured under DSP in terms of that revenue related to that, but we don't capture the unit. So we'll go through and think through what that means almost thinking of like equivalent units from a shipment standpoint so that people can understand kind of how things have changed over the last quarters, or the last year and make those adjustments so that we can get to that. But ultimately, it's -- obviously, it shows up in revenue. It's a great way to be able to go to market with our customers, sell to them the way they want to buy. And we look at this as incremental, and we're a company that can really provide the needs of our customers because many times, they want a fast turnaround. They want kind of extra service related to this and where it would provide it.

In terms of Alliance historical LRP, I think you historically talked about kind of 20% to 30%. Is that still relevant? Do you still feel comfortable with that range, even despite maybe the limited visibility and emergence of [ new ] -- competition.

When we look at our long-range plan, I mean that's how we think of our business. And it really comes from 2 things. One is when we think of that 20-plus percent from a revenue standpoint, it's a reflection of the underpenetrated market that we're in 80-plus percent of the cases that we talk about from our orthodontic starts and so on are done with wires and brackets. Small percent is Clear Aligner. We're a big part of that Clear Aligner, but majority of cases are done with wires and brackets. And some of the aspects that you see of our business where we have investments in products and R&D to better provide as I spoke about, some of the greatest products to our customers to be able to treat -- help them treat their patients in upwards of 100% of what they'll see in terms of the malocclusion that they can correct or some higher percentage. We feel that doctors have the capability to treat these more complicated cases. It's an underpenetrated market from an overall standpoint where majority is done with wires and brackets, investments we're making are helping us get to being able to continue to grow our business. And we've seen this prior to COVID. We've seen the adjustments and some of the changes since COVID. But when we look at our investments and what we can do to grow the business, we feel that, that long-range model is appropriate, and we look forward to getting to a more normalized environment and be able to show that.

Super. Unfortunately, we're out of time. So I have to leave it there. John, and Simon, thank you so much for being here. You all have a great day.

Thanks.

Thanks.