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

Hi. Good morning, everyone. My name is Erin wright, the health care services analyst at Morgan Stanley. Welcome to the second day of the Morgan Stanley Healthcare Conference. We're happy to have you here, bright and early this morning. So for more important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, we are happy to have Align with us this morning. So thank you so much for joining us. We have CFO, John Morici; as well as Shirley Stacy, who heads up the IR effort at Align. So thank you so much for joining us this morning.

I'll kick it off with some Q&A. Feel free to have question from the audience as well. But I'll talk about I guess, 2025, the guidance that you gave in the most recent quarter and expectations for the remainder of the year. The latest guidance is calling for lowered revenue growth that flat to slightly up in that 2024, I guess that's versus a prior expectation of 3% -- or 3.5% to 5.5% growth. And can you talk about what the cadence looks like from here and your visibility? What are some of those key drivers of that cadence with an implied step up in the fourth quarter?

Yes. Like you said, when we looked at the year and really as we went through the second quarter, typically, we'd see a seasonality, a step up really going from first quarter to second quarter as you start to get into more of the teen season in the Western world and Western Europe as well as North America. And then even as you go through that second quarter, you'd see that step up as you go through that second quarter. What we saw is just teens and even others going to the general practices that just the volume wasn't as much as we would have expected. And you also see some timing differences where somebody goes and wants to get a scan that thinks about treatment and perhaps doesn't go into treatment right away. What we saw that into the second quarter, that's what, let's call some of that slowdown that we saw really into June. And then as we saw that, we really projected what we'd expect for the third quarter based on the closing of June. And shot that into the third quarter in terms of a guidance and then what it would mean for total year. But it really comes down to -- in many parts of the world where you don't have some of that hesitancy to go into treatment, volumes are strong. You have parts of Eastern Europe, Middle East, Southeast Asia, China, Latin America, they've been relatively strong for us. You have certain parts of the world where this plays more of a factor. And unfortunately, it's bigger parts of our market in Western Europe and North America. That's what we use to give us a view of the second half. And now it's executed on the third quarter.

And so third quarter to fourth quarter kind of expectations in terms of what's implied in the guidance, I guess, what gets you to that cadence?

So as you look for the third quarter to the fourth quarter, typically, you have a step up, you have -- it's really due to 2 things. China comes down because China's big quarter is the third quarter. It's mostly a teen season, but it's overall good ortho season for us in the third quarter. As that comes down, Europe comes back up into the fourth quarter, you have the holiday timing and vacations and so on, that goes away in the fourth quarter. And so when we think of that third quarter to fourth quarter step up, with that Europe coming back, coupled with a lot of the new products that we've introduced just came into Europe right into the second quarter and third quarter. These are that palatal expander that we have, mandibular advancement with Occlusal Blocks, even our subscription program that we have there that does touch up cases, that really plays more of an effect in the fourth quarter, and that's great when the volumes come back in the fourth quarter. So we get that benefit there. We also have, and we've talked about that the U.K. VAT. There we had been withholding for VAT. We've changed our -- after that ruling that we had from the lower courts, we changed our pricing. So now we don't have to discount down. It was a 20% discount. And on an annual basis, close to $35 million, just for that U.K. VAT that we had to withhold. So we made that change midway through the third quarter, we'll get a full quarter benefit of it in the fourth quarter. So that's on the clear aligner side between the volume in Europe as well as U.K. VAT. And then as we've introduced aluminum, we've seen a lot of upgrades, and we've really been happy with the trading out from some of the older scanners that we had that can upgrade to the new alumina. Now what we'd expect to see is a lot of full systems being upgraded and especially in the fourth quarter when you have more of a capital market benefit anyway from the scanner. So we should see that a big focus on being able to trade in old scanners that we have or competitive scanners to be able to upgrade and term into new scanners, new systems for alumina in the fourth quarter. So when you couple those together as well as the normal seasonality from third quarter to fourth quarter, that's what we use for our guidance.

Okay. And then now can you help us bridge to the medium-term kind of guidance of 5% to 15% from '26 to '28. I guess the long-term revenue targets, I guess, also of over 15% that you've laid out at your Investor Day, the time frame to get there. Could you comment on that? And then given sort of the 2025 revenue guidance, is it prudent to assume that 2026 is more like low to mid-single-digit growth? Is that the right way to think about it?

Well, the starting point when we think about our long-term guidance is there's just an overall starting point of the market of maybe low single digits just in terms of what the market growth in that orthodontic. It's been challenging of late. But we think of -- when we think of that long-term guide, there's a certain orthodontic market growth. It's just a normal population growth and maybe expanding out and capabilities of the product kind of lends itself to some lower growth within the ortho space. And then on top of that, things that we're doing to be able to grow above that into that 5% to 15%, things like when we have some of the new products like mandibular advancement with Occlusal Blocks, being able to provide capabilities like with palatal expander, which is a new product for us. The subscription program that lends itself to the touch-up cases of minor adjustments that are needed. You add in some of the work that we're doing on direct fabrication to be able to have products that are developed from a directly fabricated aligner starting maybe with retention, but then that will lead itself to a full aligner and movement that we can provide to be able to have those new products. And then also on the iTero side, we have alumina that's come out. There'll be next generation kind of improvements on alumina in the future to be able to help grow into having that upgrade cycle of the scanners and so on. So we've got a product pipeline of various products that will help us on that side. And then further expansion. There's still areas where we've now gone from distributor to direct, but there's still additional investments we can make in many markets that are growing very strong for us in the Middle East and India and Southeast Asia and other places where we have a presence, but we would try to expand that presence based on the demand in those areas. So we feel that from a product standpoint, we've got that pipeline to be able to develop what we're trying to do from a go-to-market standpoint to try to train more doctors and then get those doctors to do more and more cases. We feel like we have a good balance of building off the base market with the things that we can do to be able to drive volume and ultimately, revenue.

Okay. And can you provide us on what you're seeing across the teen market in particular. I think that was a dynamic that was a little bit surprising in the most recent quarter. I guess, can you -- how would you characterize the market penetration? How would you characterize kind of the competitive dynamics with brackets and wires? And you gave some interesting Gaidge data on brackets and wires versus clear aligners. Any changes on that front relative to what you were seeing. I think that was June data that you were referencing?

Well, you're right, teen is very important to our business in the orthodontic area because when you think about the orthodontic case starts that happen every year, over 20 million orthodontic case starts, just regular people going into treatment, 75% to 80% of them are teen. So the vast majority of the market opportunity is within teen. And when you think about how teen cases are performed by mostly orthodontists, those orthodontists predominantly use wires and brackets. So when you think about that 75% of those 20 million patients, our teen maybe 90%, 85% to 90% are done with wires and brackets and clear aligners is the majority -- where the majority of that of the clear aligner market. But the opportunity is great. It comes down to having great products to be able to give those doctors confidence to move teeth in a predictable, reliable way. So that's the products that we've talked about with mandibular advancement, products that are like Invisalign First to be able to expand the arch, palatal expander, which actually breaks the suture. But a lot of these cases that we're really focused on with these orthodontists are -- they're preteens. These are 6, 7, 8-year olds who are going into treatment and being able to, through our doctors be able to provide that type of early care. And so that's really important. That market for us is typically teen grows faster because of the dynamics. It's an underpenetrated market. It's a huge opportunity. It's been growing faster prior to COVID, during COVID and after COVID. It's just a matter how fast can we get that to be able to grow.

Yes. One of the interesting things, just to add to what John said with respect to teens and some of these new products, IP is a great product across the board because it also helps us get after kind of expansion into the teen segment with kids on both ortho and the GP side. So the pediatric dentists, we just came from our GP Summit in Las Vegas, the [indiscernible] expander resonates really well with pediatric dentists.

So it's a good growth opportunity for us. That's how we grow. What you do see -- the last part of your question, you do see, especially orthos who maybe don't have as much traffic coming to their offices. So you think about they've got a certain amount of -- they've got their fixed space. They've got their staff. They've got their own time that they've committed to that office. So if you play back to June and what we saw in some cases where if that patient traffic was less, maybe there was uncertainty with either parents or the patients coming in, where they didn't come as much to those ortho offices in April and May and when others come in, in June, that ortho makes a decision. Do I put that patient into wires and brackets or do I use Invisalign. And they look at their short-term economics that they haven't digitized fully, sometimes those orthos make decisions and they'll put that patient into wires and bracket because that upfront cost could be upwards of $1,000 difference. Our -- we know our system that when a doctor uses it takes up a lot of labor and overhead, don't need as many chairs and all the benefits that we talk about, a lot of productivity that we could bring to those offices. But in that short term, a lot of those costs are fixed and they make those trade-offs. And we saw, in some cases, with Gaidge data in the U.S., which is a subset of orthos, you would see, in some cases, wires and brackets up double digit and clear aligners and us not up as high as that. So you see those trade-offs that happen, but it's really up to us to work with doctors, get doctors that we do sell to, to use more and more products that we have to really have Invisalign be part of their -- what they're using to go to market and be able to provide those products. And as they digitize more and more, there's less of that shifting back and forth between analog and digital.

Is there anything else you can do? Is it more just about the doctor training, getting them comfortable and also does seeing the volume to justify it, too. But to ease that upfront burden, what else can you do? Is there more promotions? Is there more incentive opportunities programs that you can do for the docs?

Some of it is in programs. You can do the right type of advertising being able to explain the differences between Invisalign versus wires and brackets. Faster treatment time, less office visits, less painful. Just there's a lot of benefit that we can bring so that both the child that comes in can ask for it and that parent is educated to know those differences. So that's a plus. We also look at our product portfolio. Typically, if you went back in the past, we really had a comprehensive unlimited product, which is a 5-year unlimited refinement and it was really set up to get those doctors to start using our products and get comfortable that -- okay, it might take several years to finish this treatment, but we're going to be with you along the way to provide us many refinements as needed. And we've started introducing products that have less years, shorter treatment time and fewer refinements. So a product like the 3 and 3 that we had, which was 3 refinements over 3 years. That came out 2.5 years ago. It's now our #1 selling product. Why? Because that upfront cost for those doctors is less. And from our standpoint, that's a great trade-off because you have a product that the cost to serve is less. It's less for the doctor upfront. And then as the doctor needs additional refinements they are able to use that product and use refinements as they go. And so what that does, when you think of that type of product, if you have fewer refinements over a time period, their upfront cost for those doctors will be less. They'll be able to still use refinements and that additional revenue that we get over that time, but it's not upfront. And giving those doctors that flexibility to choose the way they want to practice mainly just the initial product and refinements come later or they want to buy the product with refinements upfront.

Okay. I'll shift gears here, and I want to get back to innovation and some of the initiatives around the teen market, but you did announce a series of actions to streamline operations more recently and reallocate resources. How are these efforts progressing now relative to your expectations? What is embedded in some of these actions? And are we on track to improve kind of operating margins by at least 100 bps in 2026?

So part of what we -- as we think about our changing product portfolio, we want to be able to have our cost structure that meets those needs because as you have -- could have a great high gross margin rate product, but if it's less gross margin dollars, you want to be able to have your overall margin work from that standpoint. So when we think about some of the restructuring and things that we've made, it's really designed around getting closer to our customers. So in many cases -- we have 3 manufacturing sites, but we want to be able to use those manufactured sites that get closer to our customers. So for example, in Poland, where as we continue to ramp up that facility. There's still some manufacturer and other parts of the world that we want to make sure is manufactured in Poland because it significantly reduces our freight costs. In many cases, our freight cost is 1 of our highest input cost that we have. when you're air shipping things from 1 geography to another, this can help us save on that. Also using the most -- the latest equipment. So having that equipment that you put in that's closer to your customers, but do it in a way that is as productive as possible. So some of this is changing out some of the older equipment that we have to be the next-generation equipment to save on material costs and labor costs and so on. So that's a big benefit for us, and that will help us from a COGS standpoint and therefore, gross margin. The other part of it is just looking at our overall structure, the layers that we have in the organization, the span of control that we have can we increase our span and control. So we have -- we're more productive from an OpEx standpoint and therefore, get some of that leverage. So we're really looking at it as to get closer to our customers, be as productive as possible. Hopefully reduce our cost to serve so that we can be flexible as an organization and be able to not only deliver that productivity that we need. But in some cases, that productivity that we generate, perhaps there's other areas that we need to really work with our doctors to be able to grow. But it's -- our changes that we're making is all designed around trying to drive additional growth. We want to be able to grow the market. We're really the only company that actually grows the clear aligner market. We're focusing on that, working with new doctors, being able to get that right messaging to those potential patients, being able to message parents so that they can understand those differences. And then we also talked about through all that and being able to drive a 100 basis point improvement from this year to next year. So some productivity drops to the bottom line, but the rest of it is all about driving growth.

Okay. And then ASPs, how should we think about that going forward just given the mix dynamics as well as competitive dynamics and I guess FX flows through there to [indiscernible].

Well, if FX -- just assuming FX stays constant from here, what we see in our mix is a continued shift to lower list price products. You have it in 2 ways. One of it is the product dynamic that I was talking about. We've moved from kind of the comprehensive unlimited, which is kind of the ultimate product we have, 2 products that have less and less refinements. And if they have less refinements, it's a lower list price. So you're going to see that as you look at our product portfolio. You see that also on the noncomprehensive side. In some cases, just need 5 sets of aligners, 7 sets of aligners to do the minor crowding that a patient might have and the price is less. And it's just the reality of what it is. Gross margin rate on those types of products is higher. And the rate is good, but you've got to be able to manage the fact that for those products that come through, it's just at a lower list price. So you see this mix shift that continues to happen. You also see it from a geographical standpoint. You see some of the growth areas that we have in Middle East and Turkey and India and Southeast Asia and LatAm. Those are very good growth regions that we have, but in some cases, there's lower list prices. So it's managing the list price and also being able to be aware of the product portfolio. Through all that, we would expect ASPs to be down slightly on a year-over-year basis through that. Gross margin rate still those cost to serve products that we have are very favorable for us. We just have to manage what it means from a gross profit standpoint. But the design that we have and how we're going to market is to expand the market. We want to be able to grow this market in this underpenetrated.

One thing to note, though, as John talked about this shift to lower list prices, it's a reflection of a couple of things. It doesn't mean that the products are not necessarily as sophisticated and not clinically effective. So if you think about ITE, it's half the price, right? It's not a clear aligner. It's a different device. So it just naturally carries a lower list price. Similarly, if you think about the transition that John talked about from 5 and 5 to 3 and 3 and less aligners, that's a reflection of the product capabilities, right? So 5 and 5 served us really well because of its innovation, but the ability to complete cases with a product like Invisalign is a reflection of the materials and the science behind it that allows us to do that.

Okay. Let me switch gears a little bit. So -- and I'm going to ask you about a competitor, but there was -- you did file a patent infringement lawsuit against Angel Align. I guess, can you talk -- anything you can speak to that in terms of how you're thinking about defending your positioning from an IP perspective? And any color or further thoughts you can share on the development?

Well, first off, we spend millions of dollars a year like any technology company spends on the R&D and that R&D turns into the intellectual property that we've established over time. It's in many jurisdictions. So the 1 that we filed with Angel is actually multiple jurisdictions in China and Europe and as well as the U.S. to be able to show that in many cases. I think when you spend as much as we have and develop as much intellectual property, you can expect maybe some companies to trip on some of that intellectual properties. It's a shared space and you have some of that. But when we look at what that competitor is doing, it's more than just tripping on things. It is a clear, we think, a very clear case of a company, not only using the software, which a large amount of our technology goes into the treatment planning and how teeth move and sequencing and all the features related to that. But also the material itself and in terms of how they've established the material and so on. And so look, it will be 1 where we want to make sure that the investments that we're making we want to be able to grow this market, but we want a fair marketplace to be able to operate in. And when a company is blatantly, we think blatantly violating that space, we came with this to try to establish that and make sure there's a level of playing field.

Can you speak a little bit more about the competitive landscape or competitors even moving the needle at this point in terms of in certain markets and Angel Align coming in at a pretty low price point. Is that even sustainable in your view?

Well, we don't think it is. I mean I think when you look at how the marketplace has evolved, we used to be talking about the direct-to-consumers. The DTC, they've come and gone, the model wasn't right. You see the challenges that you see with some of these other companies that come in where there's a certain amount of technology that they might invest in, but for this, their go-to-market strategy is to come in with a lower price. And we think that that's not sustainable. And in many cases, they've had to come in with a lower price to get doctors to be able to try their products. And that might be a way to get in. But what you're finding and many doctors are finding is the technology isn't giving them the results that they want. And then you couple that with many of the competitors are realizing they have to raise price because they're not able to make the margins work. And you can pretty much go across all the different competitors. They -- 1 way or another, having to change their product offering because it's a low price, but it's not sustainable from an overall margin standpoint. So from our view is we want the best products in our doctor's hands. There's a certain amount of investment in that. We're always mindful of price and what it means in promotions and other things that we're doing. But we're focusing on driving this market. In the end, it's an underpenetrated market, vast majority of cases are done with wires and brackets. And we're going to keep doing everything we can to grow the overall marketplace of clear aligners and competition comes and goes in varying level of technology and pricing and then so on, but we're just focused on what we can control.

I want to talk a little bit about direct fab. Can you talk a little bit about the timing and magnitude, how this should drive efficiency and cost savings. Can you just quantify, at least for now, what can you quantify at this point?

So the direct fabrication that Erin references to is the typical manufacturing that we have is we print the negative and then you vacuum form the plastic on top, the SmartTrack material plastic on top, and then you laser trim it and you create the aligner. And so you make the negative and then you vacuum form on top, and that's a traditional manufacturing that we make over 1 million parts a day, unique parts a day in our operation. The direct fabrication is you don't need to make the negative. You actually just make the aligner. You make the aligner itself. So what does that give you? That gives you ultimate design flexibility because you think about when you're taking a sheet of plastic and vacuum format, the thickness is relatively the same. You can't necessarily change thickness on that or if you want certain parts of the aligner cut open and maybe and a mixed dentition and so on, you don't have that design flexibility. When you direct fabricate something, you design what you want. You might have buttons to make attachments for elastics. You might have things that are open because there's mixed dentition. You could have maybe thicker parts of the aligner on molars. We have to move those in a more predictable way. So there's a lot of design flexibility when you have an aligner like that being manufactured. There's 2 parts to making that aligner. One is being able to have resin that is used in this production and then can you actually produce this? And on the resin side, we couldn't find a polymer that met the needs that we have that would be similar types of movements like a SmartTrack. So we need to have a polymer that could provide predictable, reliable results to the actual aligner itself so that they could provide the treatment. We invented that polymer. It's a certain type of polymer that matches up with the actual printer that we now manufacture, and that's a company that we bought a couple of years ago called Cubicure. So Cubicure, we have that manufacturing company that actually makes the printers we match that up with the actual resin that we've invented. Put those 2 together, it makes a aligner retainer that has performance capabilities. It can be able to take and move teeth in a predictable, reliable way. It gives outcomes as good or better than SmartTrack material, the traditional manufacturing that we have. But it also brings to market the ability to have complete design flexibility. So you have a performance aligner that you can manufacture through the printers that we have with Cubicure. And as you scale that up, what you're going to find is you get that design capability, flexibility to be able to go to market with. But you also now will have a production as that scales up, where you need significantly less materials because you think about that first manufacturing I was talking about, majority of the plastics that you're using makes the mold that ultimately gets discarded. It's not used in the final product. And in our new manufacturing, you just print the aligner. You don't need the negative. You don't need anything else around it. So as you scale this up, there's a significant material savings, 80-plus percent of the plastic in your manufacturing goes away, you've got that design flexibility, which helps us at least have a price premium on those products, and you also get the cost benefit from less input cost that we have. So it's a scale up. We're doing a lot of testing now. We'll see retainers first, certain types of retainers for -- especially on the teen side, to be able to hold teeth as they're going through treatment. Some of these early products that we have with IPE and Invisalign First, you need a retainer to help hold that child dentition. And as we start to scale that in retention, we'll see it also start to cross over into aligners. And as we scale that up, we'll have 2 types of products. You'll have the traditional manufacturing that we have that will be useful for several years to come, but you'll also start to see us scaling up the direct fabrication for those doctors who want to have that flexible type of manufacturing to be able to give them the products that they're looking for. And we know and we feel that we're the only company who can provide this. There's a lot of intellectual property on this, a lot of development that's gone in to be able to get these products to what we get our cost.

And the variable thickness that John is talking about, because we're not limited to the -- just a piece of plastic, if you will, on a sheet. It allows for, we believe, delivering a more effective treatment, faster treatment times and a product offering that gives doctors a lot more flexibility.

And so do you -- should we think about it being like 2 different tiers of clear aligner offerings? And at different price points, what would those price points look like? And then also, I think you have to give 510(k) approval, all that kind of stuff, given that this is a totally new product.

Yes, that's right. So yes, you have to get 510(k) approval and make sure that the biocompatibility and the effectiveness is all there. So you have to follow that path. Think of it as 2 types of products. You have a premium, which will be the direct fab and then you have the traditional that we have. And it might help us either get price on that on the direct fab or at the very least hold price. And then you'd have a pricing differential and ultimately giving those doctors that flexibility. And then as that scales up, it actually becomes a lower cost product than even the traditional manufacturing for us.

I want to make sure I get the capital deployment. Are you buying back a boatload of shares today? Or what is the priority from a share repurchase standpoint relative to M&A or otherwise?

Yes. When we look at our model, we're fortunate to have a model that generates a lot of cash. So that cash generation that we have as a company with no debt and being able to deploy that cash. Some of it is reinvesting back in the business, how do we grow the business through the R&D and go-to market and so on. So some of that is there. Others is, okay, what's the amount of CapEx that we need. We're not -- there's some CapEx that we're spending on the direct fab, but it's minimal, and we have our facilities. We have some of the big purchases that we've already made, so we don't need that. We've invested with certain partners that we have to be able to help grow their business, that share our same digital orthodontic mindset. So that's been important for us. And then we look at where we can put capital back to our shareholders. So we've been doing buybacks. And the buybacks go to buying back our shares to be able to be reflective of the cash generation that we have and the overall needs. But from a free cash flow standpoint, we generate a lot of cash through our model and we want to be able to use it to be able to give back to the shareholders to that way.

One thing you talked about at the Investor Day and delve into a little bit more, was leveraging clear aligners for more restorative pieces, a potential $10 billion revenue opportunity for you. I guess when do we hit the inflection point? What do we need to see, whether it's reimbursement, training, otherwise, to see an inflection point there?

It's an important part of our business because you think about -- there's many doctors, many dentists on the restorative side. Most of what they do is restorative. They're doing fillings and caps in crowns and veneers and so on. Our push to them is look, you should also do the ortho piece first, move the teeth in a healthy way to then do restorative. And if you do that, you're going to save a lot more healthy dentition. Keep the healthy dentition, don't remove it, move the teeth first and then do the restorative. To be able to get at a lot of these general dentists that we don't sell to we're working through the labs. The labs, the commonality for a lab is they reach all different dentists. Every dentist has lab, sometimes multiple labs that they use to provide their caps and crowns and veneers and so on. We want to work with the labs to be able to make sure those labs can talk to the dentists and say, "Wait a second, before you do this implant, you could actually move the teeth in a way so that you don't have to shave as much down and we moved that to healthy dentition." So it's educating the labs, working with the labs to be able to help provide that information back to those general dentists who might not have used ortho first. And they might not know how. So we have various pilots in play where we're working with those labs to be able to help their general dentists provide alternatives and in this case, move the teeth first before you provide the restorative. And we're seeing really good results with this. This is -- it's just a force multiplier that we have. Those labs see those general dentists and the more that we can work with those labs to try to find that right combination, it'll get those general dentists to be able to move teeth and make it part of their workflow but it also helps for the patient standpoint to be reactive.

It's an acquisition and you refer to the Invisalign and Exocad are the products that are in pilot.

Okay. Great. Thank you so much. I appreciate the time today.

Great. Thank you.

Thanks, Erin.