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

Good morning. Why don't we get started? My name is Jeff Johnson. I'm the senior medical technology analyst at Baird. Our next presentation this morning is from Align Technology, a leading manufacturer in the $6.5 billion global orthodontics market with its Invisalign system of clear aligners. With us today from Align, we're happy to have Chief Financial Officer, John Morici; and VP of Finance, IR and Global Communications, Shirley Stacy. This is just going to be a full Q&A fireside chat. So John, I think we'll just get into it.

Sounds good. All right.

Any opening remarks? Anything you want to say or you want to go first question?

You could jump into first questions.

All right. Well, I told you what it was going to be because it's what all the -- at least the hedge funds are telling me to ask, which is -- and I'm not a mouthpiece for hedge funds, but how are you feeling? How are things?

I think as we've talked about in the last quarter, it's about executing on our strategy. So we're happy with our -- some of our new products. I'm sure we'll get into a little bit on Invisalign Palatal Expander and expansion of that, working to try to drive and increase our submitters that we have globally, trying to work to increase utilization, to try to get those doctors to do more and more cases. So it's about the products that we have, whether it's Invisalign Palatal Expander or our new scanner that came out recently with Lumina, being able to drive more and more of the usage of our products and really executing on our strategy has been our focus. We can get into whatever market discussion you want to have, but we're focused on what we can do as a company.

Yes. Well, if I do try to dig into that just a little bit, I mean, I think, Joe, for multiple quarters now has really described the end markets as stable. And stable is the word that he's used over and over and over. I think there's some data out there that would suggest that -- whether it's our survey data, some of the gauge data that July was actually a decent month, our survey took a little step back in August. But is stable still the right word for kind of the global markets? And maybe if you can talk about global markets and then just U.S. perspective. Is stable still the right...

I think it is. When you think of -- and I think the way we phrase it is just on an overall basis. Obviously, certain markets are better or worse than others based on how they're navigating through inflation and interest rates and other things that they've faced. But when we think of stability, we've got markets where they're doing better. Southeast Asia, Latin America, Middle East and others. You have other places that are still kind of waiting for maybe interest rates to come down, which will help overall demand. But when we think of a stable environment, we're looking at that on a global basis to be able to say, look, this is the operating environment that we're in, and that stability is there. When you do surveys, we see the surveys and other things that come up on what July was versus August and so on, I think that's -- you're going to have all those fluctuations on a month-to-month basis. But broadly, when you look at things, as long as interest rates ideally start to come down, inflation seems like it's coming down in many places, and that's a good thing for our business.

Okay. I thought you were going to say those month-to-month surveys aren't helpful or valuable. Watch what you say, I do them every month...

It just depends where you take them. I think the surveys are a bit biased of just kind of a U.S. view. I think that's the backyard the people are in. But we're a global business. And you have your volume and operations in a lot of different areas. And U.S. is still a big part of our business, but there's other places that we're operating in.

Yes. I think what's interesting, we've started to have these conversations just probably in the last quarter or two with some of the customers we talked to out there and some of the bigger customers. I don't think it happens in the adult population. I think they're -- if they decide they don't have the money to spend on clear aligner case right now, then maybe they'll do it down the road some time. But it's kind of just an off-the-cuff kind of decision sometimes they make. But in teens, there truly is that kind of limited time period, right, that 3-, 4-year window where your kids are getting old enough. Before they leave the house, you've got kind of that window. I've talked to some providers, including some large DSOs where it does sound like there's an inordinate number of times, kids have come in or adults have come in even, gotten scanned, gone through the whole work up and haven't yet pulled the trigger. Is there a backlog in any way you can measure or judge of teen cases especially that if we get the right macro environment, no matter what your LRP is or whatever your long-term true growth rate is going to be, we can shoot above that for a couple of few quarters as we clear some of that backlog?

Well, teen definitely is a part of our business that is maybe less discretionary. I mean overall, when you're aligning teeth, people will say, well, do I need to go into this treatment or not? And you're right, adults might say, I'll wait another 6 months when I go back to my general dentist, and they said, "I want to wait, and I'll maybe try something different." And they might be also interest rate sensitive to say, okay, do I want to spend $5,000, $6,000, $7,000 on something when they have to finance it. So some people will delay that. You're right, from a teen standpoint, it's less of that. Maybe parents have saved up for it or maybe they're just at a time in their lives where their teeth have -- need to be straightened and they decide to do this. But I think there's also some that, under any circumstances, say, well, we're not ready to do this. Financially, it's not right. But when you look at our teen growth that we've had prior to COVID, post COVID, still grows faster than adults. Because when you look at the general population that we serve, 75% of orthodontic cases are teens, when it's almost a reverse of that from our business, 70% of our cases are adult and only 30% are teen. So we have a huge opportunity to grow within that teen market, and our market share is low. And we have a lot of great products, Invisalign Palatal Expander and Invisalign First and mandibular advancement, a lot of products that could help serve those -- that teen market. So like I said, things get discretionary at some point, less so with teens. And we think we have both the market opportunity to go after and serve the teen business and the products to be able to do so.

Yes. And I think a lot of those products are starting to get some traction on DSP, obviously, in IP, and that -- we'll come back to those in a second. You've mentioned them a couple of times. What else are you doing out there to maybe help facilitate -- we've been in a, what, 2-year process here or 2-year period now of higher inflation, less spending on higher cost, the $5,000, $6,000, $7,000 procedures, as you said. You guys have such a strong balance sheet. Is there anything you're doing in the dental office? There's been talk about, would you go out there and help support some of these payment plans or put money up on the payment plans? What can you do just purely from a financing and helping doctors get more of those patients to pull that trigger in the chair?

Well, we don't actually want to do financing direct to the patients. I mean, it's just a difference in our model where we don't want to finance the entire case. But if we can do things to help our doctors with their payments, that's something that we've looked at and do in many cases where if a doctor normally has 60-day payment terms with us and they're in good standing, we might go to something higher. And therefore, that doctor has longer to pay us, maybe they can provide some financing to those end patients. Because if you think about -- broadly speaking, it's usually -- from a patient that wants to go into treatment, there's 3 ways that ultimately they're going to pay. Some pay in advance. Great, they pay that doctor in advance, and maybe that's 1/3 of the cases. It varies slightly, but let's say, 1/3 of the cases. There's about 1/3 of the cases that a doctor will provide some type of kind of internal payment plan. They pay some money upfront. And then every time they see the doctor, that patient or the parents pay kind of as you go. And then there's the third category, which is -- and many times, it's adults, where they'll do some external financing. And where we try to really give the doctor some benefit is that middle category of saying, can we do something from a working capital standpoint. And you're right, we're fortunate to be in a great situation from a company standpoint with a good business model, no debt, generate cash if we can use that to help. That applies both for the Invisalign side as well as iTero. There's a lot of iTero business that we do nowadays where there's rental models, there's leasing models and so on. So that helps the doctor not have to put so much money upfront. They can use that money for whatever else they want to use for, and they get access to the newest scanner and helps them run the practice with really just a low monthly charge for that. So we'll do a lot of things to be able to help try to convert those doctors to want to utilize our cases. And sometimes the conversion process is about cash flow for the patients.

And are those efforts somewhat consistent over the past year or 1.5 years? Or are they anything that you can increase in the near term to help grease those kids a little more? Any change there?

I would say we're increasing the number of -- our days sales outstanding has increased a little bit to that. You can see that in our numbers. When we think of iTero, there's a lot more that we lease than we had in the past. And again, that's just a reflection of doctors want to buy a certain way. Patients want to buy in a certain way. We're fortunate to have a model that gives us flexibility to do that. And in any way that we can do that to leverage the cash benefit that we have to be able to help our customers grow their practices, we'll do that. And that's been a good model for us, and it's something that, especially in this day and age where inflation and interest rates are high, there's things that we can continue to do.

All right. Fair enough. Let's move on to ASPs. I want to come back to the new products in a second. But on ASPs, obviously, there was a big focus on the second quarter call. I think your blended ASP helped me out globally, was down 5 points, is that right, just over 5%?

On a year-over-year basis, yes, yes, just over $40. Yes.

So down just over 5%. About 200 basis points of that probably was currency, so that's kind of -- nobody can call that or get blamed for that. On the other 250 basis points or so, maybe a little more than 250, how much of that was like good ASP pressure as I think about it? I mean, going to DSP, going to IPE, some of these things are like where the model is going, and that's good. You're getting more cases from that, and we'll come back and kind of define what DSP is and talk through that in a minute. But how much of that was kind of good ASP pressure? And how much of that was -- I don't want to call it defensive, but happened to change ASPs, give more discounts away because of competitive pressures or whatnot? How to bucket kind of that last 250, 300...

Yes. I'll take it into -- in terms of just overall dollars. If you just looked at it on a year-over-year basis in the second quarter, I know that ASP got a lot of visibility. But if you take it this way, down $40 year-over-year, like you said, currency of that $40 change was $22. So take that piece a bit out of it. The other $8, an additional $8 was -- and we put it in our disclosure, talked a little bit about our earnings, but the U.K. changed their -- the VAT that is now -- needs to be withheld for selling clear aligners within the U.K. And to comply with that, what we decided to do is discount our product down 20% in U.K. and then add the VAT, which is 20% on top of that. So from an ASP standpoint, it shows up as a 20% drop in ASP when we're selling in the U.K. We don't think that's good for our doctors to have a higher VAT on there when we're trying to get further adoption and certainly not good for -- if they pass it on to their patients. So we made that decision. That shows up on a global basis as $8. So on a year-over-year basis, $8 is purely due to that U.K. VAT. And like I said, $22 was due to FX. So I say the remaining $10 to the focus of your question is, look, there's going to be -- as we're selling to more and more doctors, our submitters that we had, just over 86,000 last quarter, it was the highest that we've ever had. When you have new submitters coming in, chances are they might not be buying your most expensive product. They're using some type of cases there, maybe more lower stages that have a lower ASP. And I think -- so you have that. You also have doctors that are growing. They're doing more and more cases, volume utilization was up and so on. You saw that in the second quarter. And that's doctors working their way to more and more cases and come into some of these higher tiers that also give them some pricing benefits. I think when you look at the cases that we did, and that's why you see our gross margin up and so on, the cases that we did, a lot of those cases, they might be lower stage cases, they might be lower ASP cases. And you mentioned DSP, which is our doctor subscription program. In all those cases, there's either no additional alignments, no additional refinements that are needed or very small amount. When they're very small amount, the cost to serve is very low, and therefore, the gross margin is better. So I think when you look at that remaining $10 or others, you have -- some of that is a -- you have more submitters who are doing cases that are a lower ASP, but good gross margin, gross margin rate. And you have also doctors that are working their way through and doing more cases, and you end up -- they get a volume benefit from that. So when we look at that and we say, as we think of ASP going forward, I'm not saying it's not important, but I think the focus needs to be, if we're going to be the standard of care and really drive this further and further, you have to sell to more doctors. There's over 2 million doctors in the world, and we're selling -- we had a great quarter, we sold to 86,000 of them. So as you get to more and more doctors, you're going to have that where you just have to meet that doctor where they're at. And it might be just a lower-stage product, lower-ASP product but it still drives good gross margin. So that's the perspective there. It's not a competitive play to say, look, let's go and share shift and so on. I know some of our competition might take that approach to discount things down to try to share shift. We're about growing the category. We're about trying to get to sell to more than 86,000 doctors. We're about trying to get doctors to use this on a more regular basis. Because ultimately, the competition that we're driving against and all of you know our story, is about wires and brackets. How do we get more and more cases to shift from wires and brackets to Invisalign? And that's the effort that we're making.

Yes. Fair enough. And just to complete that thought just on ASPs, as we think out over the next year or two, that U.K. VAT issue should anniversary through by Q1 of next year, I believe. And we've seen maybe a little bit of U.S. dollar weakness here over the last few months, so hopefully, currency isn't a big drag. We'll see if it's going to be a positive contributor year-over-year over the next few quarters or not. But theoretically then, as we get beyond Q1 of '25, we should be down to just those, as you bucketed it, kind of $10 of pressure. None of those are probably going to go away or change in a big way. Is that the way to think about your ASPs over the next few years, maybe a point of decline, which would be pretty consistent with what you've seen over the last 5 years or so, if I put that on a trend line? About 1 point a year. Is there any reason to think it should be outside of that negative 1%, plus or minus a little bit range...

That's in the range. I mean, I would -- if I would project out, you'd say flat to slightly down for the reasons that I said, as you're expanding out to new doctors, you're giving them different ways to buy. But again, it's up to us to make sure that the products and the services that they want give us the right gross margin rate, and that's the focus. But from an ASP standpoint, flat to slightly down is how to think about it.

Okay. And your palate expansion products, as we go into the new products now, your palate expansion product has been on the market about 6 months now. I think -- we've seen a little bit of pushback on some of your advertising from an ADA perspective. And that -- any issues there that we need to flag or be concerned about?

No. I mean we advertise. It's part of our portfolio of products. We're showing -- we're trying to be reasonable in terms of here's the current technology with the 3D printed product that slowly expands the upper palate for that child and compares that to the current technology. And I think some doctors maybe don't want that comparison. But in the end, we're advertising to patients and, in this case, parents to let them know that there's alternatives.

Yes. Fair enough. And so on that product itself, I think 20% of young kid cases, orthodontic cases need palate expansion, over time. How has the initial demand been? Do you think you start taking a meaningful share of those 20% of orthodontic cases over time with IP? How long does it take to scale and really start impacting the model?

When you look at -- and so far, it's really just been North America, ANZ, just select countries. It will get further released as it gets approved in different countries. But like you said, if you're looking at 15% to maybe 20% of the teen cases, you think about -- if there's 22 million orthodontic case starts every year, let's just say, 16 million or so of those are teen. You're talking about products, a product that can help service a significant amount of cases that are out there. So you look at a couple of million cases that are out there where we weren't servicing really at all. Maybe Invisalign First was doing some arch expansion, but this is actual skeletal expansion to be able to help a child that has a palate that needs to be expanded. So we look at it as it's incremental to our business where we weren't selling before. We see doctors that try it. They like to see that it can see the results. And fortunately, it's 30, 40 days. They can actually see that it's working to what they thought. So doctors have tried it. They're learning more and more. And then as they see the success, they end up utilizing it more and more. And we think this is a good way in to be able to help patients understand kind of this technology, parents understand that there's a removal of device that is 3D printed like this compared to the metal apparatus that they currently have. And we think it lends itself to the fact that we would call this Phase I and you expand the upper palate. And then when that child has permanent teeth coming in at 12, 13, 14, we think that lends itself to being able to use Invisalign for that upper -- for straightening their teeth. So it's a good way into a market that we really weren't in, and we think it has further benefits down the line.

Yes, two questions to follow up there. One, how is the $500 price point going over on IP? Is that a reasonable price point...

I think it's reasonable. It's more than what a doctor -- the traditional metal device, but it gives them so much flexibility in terms of how they move the teeth and the ease of taking it on and off and some of the other problems that it solves compared to that. So I think doctors understand that there's more technology that's gone into it, and a price point isn't that much more than...

Fair enough. And we've looked at -- kind of we build out the TAM, we think it's maybe a $1.5 billion TAM, something like that if we do the math on your $16 million, 20% of that, $500 per case, things like that, you get to about $1.5 billion, I think, if I remember the math. Is it crazy to think you could take 10%, 20% of the palate expansion market over the next couple of years? Is that too high of an expectation to have over a couple of year period?

Well, I think it comes down to orthodontists in many cases, general dentists too, but it comes down to, is the doctor willing to give alternatives? So that's part of why we advertise to let parents and patients know about this. But look, I think in these cases, you're going to see with the right product to be able to solve these needs, you're going to see higher and higher adoption. And we're also seeing that doctors are talking about -- or coming to us to say, well, is there a combo that we can have? Can I have Invisalign Palatal Expander plus Invisalign First or plus something else? So they're almost coming to us saying, can I have a Phase I and Phase II type of product that can do the skeletal expansion as well as straightening teeth? And that's a good sign. We want to be able to have doctors thinking that way, holistic, so that it will grow due to the indication of being able to expand the upper palate, but then also straighten teeth. And if doctors think that way more and more, we think that's good for the patients as well.

Yes, no, we've talked to docs, and I think what I hear is it's also kind of a good patient capture tool. If you can get IPE going on the uppers and you do start first on the lowers, you're kind of now starting in the clear liners, the patient is now captive to going forward with the treatment beyond just palate expansion, things like that. You've kind of got them locked into a full case there, so good. Maybe move on to DSP. I guess question on DSP. First off is it's been about -- it started out at about 1% of your case volume a couple of years ago. It's up to about 4% of your case volume today, I think, been going up maybe 30 to 50 basis points per quarter as a percentage of those total cases. I think a lot of that, though, has been as you've moved it, you've started moving it into other countries and all that. I mean, does DSP grow to be 10% of your case volume, 20% of your case volumes over the next couple few years? Or do we kind of level out somewhere below that?

I think DSP is -- and for those that don't know, it's a doctor subscription program. And it really was designed mostly going after orthos who, they were doing a lot of cases with us on the comprehensive side, but they weren't doing a lot of cases with us on the noncomprehensive side, kind of the touch-up cases or retention. And so what this was designed to be able to do is say to those doctors, "Hey, keep giving us the comprehensive cases but we also have a solution for you for the touch-up cases and retention and so on." So where we have this with doctors, they see the benefit. They were making things themselves or going to other labs. Now they've given us the business and essentially, they're saying -- the idea is that, that additional volume comes to us, and we are able to provide. Because I think the reality is doctors -- we've got to meet doctors where they're at. They're looking at their practice, they're looking at the volumes that they have, they're looking at how they want to run things. In many cases, we're the most -- from a material standpoint, we're the highest cost for their lab bill, and they want to be able to have flexibility there. And this provides them that flexibility. That's why you see the incremental cases go up and up. In most cases, when doctors start the program, they start at a lower and then they end up going higher. They end up getting -- committing to more and more cases as they go forward. So there's a utilization benefit that we're seeing that's grown the number of cases. There's also a number of doctors that have started, and now there's a lot more doctors. And you're right, we've put it into different countries. We've gone into Europe this year and other places. So I think it's just a further reflection of being able to meet doctors where they're at. We've got the capability from an operation standpoint to be able to turn these cases very fast, get them the products that they need, and that's been a big selling point for them.

Okay. And to be clear, if a doctor uses a DSP set of aligners for Vivera, that goes into other...

Yes. It's not a case, it's not a case.

It's not a case. And you have the technical ability to see, are they using these aligners for a case versus...

Yes.

They order it as a case.

They order it as a case...

So they order it as a case, they say, okay, as part of the allotment of aligners they have, this is a case for that. And then the others just come through as...

And even in those cases, not just in Vivera, it is gross margin accretive?

It's gross margin accretive. So you're going to -- look, these will be lower ASP. I mean you might be $500, $600, $700 touch-up case. Those are cases that we wouldn't have had. Those are cases where there's no additional refinements or anything else. It's here's the case that they needed for that child, their parent or adult whatever, to be able to put them into treatment to do the minor movement that they needed. And from a gross margin rate standpoint, that's -- so when you -- your earlier question about the other mix, some of it is this...

Yes, and that's why I say, I mean there's actually -- if there's a point of pressure from DSP on your ASPs, that's actually a good thing. You wouldn't have gotten those cases like you said, and it's gross margin accretive...

We're going to expand the category. These are ways to be able to go at it. In this case, it's a product in solution for doctors to give us those incremental.

All right. Let me just move on to the last couple of questions here. If I look back at the adult business, we're still kind of off those peak 2021 levels, which were obviously a fantastic year that we'll probably never see that kind of strength again coming out of COVID with stimulus dollars, all that stuff. But what do you think the growth rate for the adult market is in clear aligners going forward? Even though you haven't grown that business in the last couple of years, relative to pre-COVID, I think you're still up like 60% or 70% or something relative to 2019. So I mean, you're still doing a ton of adult cases today relative to pre-COVID. It's just it's off that 2021, very, very tough comp, hard to get growth. Is that -- is the adult clear aligner market a 5%, 10%, 15% growing market over the next 5 years? How to think about that?

Adults -- like I said, adults will grow slower than teens. Teens, just that huge opportunity that we have to displace wires and brackets to use Invisalign, so teen is a bigger growth opportunity. But adults, when we think of doing ortho before restorative, many general dentists have really taken the approach that, look, they can save a lot of healthy dentition by moving teeth first, then doing restorative veneers or crowns or implants or so on. Move the teeth first, then do the restorative, and you see more and more doctors doing that as well as you see patients coming in and their chipped or grinding and so on. They need to move the teeth to be able to help save and have that healthy dentition. So look, I think once the economy improves a bit, you'll see that more from an adult standpoint, especially around financing. Those potential patients, I think, are there. They were there before COVID. They're coming out of COVID. Like you said, you had a lot of other factors that contributed to the growth. But coming out, I would say that this will grow into the -- as a market standpoint, it should grow faster than kind of the overall industry because I think there's a lot of demand from potential patients out there who need to get something done. And we look at those patients, there's 500 or 600 million potential patients out there who have a malocclusion that need to get it fixed, and it's just a matter of time when they will come in.

Okay. Three quick questions in one minute. So one, teen market then can still grow you think mid-teens, 20% when we get back into a normal macro? Is that -- as an overall market, is that crazy?

Teen market will grow faster than adults. But I think when you look at the opportunity, it will be -- it should be in that double-digit range...

Okay. Lumina. Did you guys get FDA approval for resto in early August. We saw something come through that kind of look like that. And I know we're waiting for the...

Not resto yet, it's for the NIRI. So the near-infrared technology, so that's been approved. So we have that scanner now, can provide -- is approved for kind of that NIRI technology. We're still working through, and we have the restorative release that we talked about in our last earnings call, kind of limited release in the fourth quarter, general release in the fourth...

Yes. But to be clear, you don't need FDA approval for Lumina Pro...

That was the NIRI we saw that came through in the -- okay. And then last question in 10 seconds. Just are we still in the early innings of Lumina kind of supporting that scanner in CAD/CAM? Do we have to think as we get into 2025 about big comps from just is scanner and CAD/CAM still going to be a good growth market over the next few years?

And when we look at the under penetration that we have in iTero and kind of the iOS opportunities, still majority of doctors are not using the digital technology. We think we have the best scanner on the marketplace. Having Lumina out now on the ortho side, soon to be the restorative and general dentist side, we think that we have a huge opportunity for continued growth. Not just on the new product, so the flagship being Lumina. But as you work your way through that portfolio, there's others -- you get trade-ins, there's others, certified, preowned, other different products that we could put into the market so that you can meet those doctors at the price point that they're at and then some of the leasing and rental options that I talked about. So we feel very good about the systems and services business with the new products that we have as well as the rest of the portfolio products.

All right. Great. With that, we're over time, so we will end there. Please join me in thanking John and Shirley for a great presentation here.