Align Technology, Inc. ($ALGN)

Good morning, everyone. Welcome to this session of the Leerink Global Healthcare Conference. I'm Mike Cherny, the health care tech distribution analyst. It's my absolute pleasure to have the Align Technology team here. CFO, John Morici; and Madelyn Valente from the IR team in the audience. I'm happy to say that they brought no slides. So we just have a nice fireside chat, we'll dive right into.

But maybe, John, building off last quarter, starting with North America, we saw pockets of strength that saw sequential improvement over the last couple of quarters versus what you'd have. You talked about the dynamics of the market being more stable than what you had. Can you give us a little bit on what that means in terms of practicality, what you're seeing from your customers, from individuals on where that level of stability is starting to dive in?

Yes. It's -- what we've seen as we went through last year, really that stability, meaning that there weren't as much unknowns within the market where people were transacting. And I think people understood that there was still some volatility around tariffs and kind of inflation and other things. But I think people were getting more and more used to that from a consumer standpoint and they were transacting based on that environment. Of course, there's things that happen. We've seen with some of the conflicts and other things that happened that people are aware of. But I think broadly in North America, it's been -- that stability continues, and it's good to see. And from that standpoint, we do everything we can do to be able to help drive the conversion. So we do things to continue to advertise, train more doctors, try to sell to more and more doctors, increase the utilization, do things in this environment from a relatively stable standpoint. DSOs, maybe a little bit more active conversion, and they're able to capitalize on that. Some of the other doctors that we talk about, some of these more retail orthos and GPs that just are a little bit more passive. They kind of get the patients through as they come. But in an overall stable environment, we want that to continue. And then we want to try to drive as much active conversion, be very much around driving local advertising, doing things to be able to help drive that conversion with those doctors.

And what does the strategy look like on the conversion side on a typical DSO versus typical individual practitioner? How does Align go at it to make sure that you're getting for your clients, the customers, the right metrics, the right returns on the push for conversion?

So DSOs, when you think about those enterprises, they're looking for benefits that we can bring to them. And it's usually around some operational scale. So they're looking for a quicker turnaround in terms of the products that are being provided to their patients. They're looking for technology, what's the best technology to be able to help move teeth in a predictable, reliable way and usually something around brand, being able to have a brand that really drives those potential patients to those practices and then ultimately drives that conversion. So when we work to find some of those metrics, it's being able to make sure that those DSOs take that active approach by local advertising, get those potential patients just to their doors, whether you're an ortho or GP. Once they get to the door, doing scans to be able to make sure that they have an iTero scan to be able to help visualize and almost simulate what their teeth are going to look like before and after treatment, get people excited. And the DSOs or even regular retail doctors, those that take that last mile approach help drive conversion. That last mile is usually around -- especially in this environment, is usually around get the right pricing, get decent pricing to those potential patients. And then if that patient is still reluctant to put that money forward initially, if they can have some type of financing to be able to help and put it to a monthly payment that they can afford, that's that active conversion. It's a journey that those patients go through from getting the awareness to seeing what they're going to look like with treatment to understanding kind of the pricing and financing piece of it. And if you take that active approach, those are the doctors that are ultimately powering through a relatively stable environment. Doctors who don't take that approach, they just don't have as high of a conversion. Their utilization is a little bit lower. And it's up to us to be able to work with DSOs because they are leveraging the benefits that we bring, but then also work with those other retail doctors who maybe don't have that approach, but there's things that we can do to help them.

And sticking on the DSO side, there's a logicality in my mind on where you've been able -- because they're professional organizations, because they typically have business offices where the conversion opportunities would tend to work better. But you're also empowering them to be better through, obviously, iTero and Lumina launch, which I'm sure we'll touch on a little more, but also the workflow enhancements that you're making. As you think about your DSO market as a whole, how do you think about the optimal DSO customer? And how many of your DSOs are truly optimized on workflow solutions on the right level of iTero scanners versus where there's incremental opportunity for them to continue to be better organizations, better businesses partner with you?

So DSOs are at various levels. Some are -- you could think of it as DSO where just a few practices together, and they're still relatively small and trying to grow. And you're right, those DSOs are really trying to optimize their profitability just to try to drive that return on investment. Most DSOs, let's face it, in the U.S. for sure, are private equity owned or investors, and they're looking for that return on investment. So some DSOs are more equipped. They have infrastructure. They do all the things I just said about trying to drive that active conversion and they take it even further. They have treatment planning services. They monitor refinements. They use products that don't have a lot of refinements upfront and then really manage refinements and time for treatment and profitability that they have. Those DSOs have evolved. We've invested in them. That's like a Heartland or Smile Doctors and so on. But there's other DSOs that are middle level and lower level where they're trying to grow too. But they're all on that journey to be able to help digitize, help drive efficiency to ultimately drive that conversion. But we have special teams that work with those DSOs no matter what level they're at, and we want to continue to help them train their doctors that they have in their practices and ultimately drive a higher, higher utilization. But it's certainly the way things are going. It's DSO revenue for us is in North America is about 1/3 of our revenue. And it's consolidating that you see. We think we're properly positioned there because, again, they're looking for scale. They're looking for technology and they're looking for a brand. And we bring all 3 of those together and really help them be more efficient and grow in their space.

And along those lines for DSOs, one of the things I think I hear you saying and something I believe in is the idea of standardization and the fact that they want one system, one solution. The more that they can do with you, the better it is for them. How do DSOs play into the competitive environment relative to the Invisalign brand in the U.S.? And how important is that role of not only the brand, but also the entirety of the workflow and ensuring that you're driving better same-store sales with your DSO?

They're equally important because those DSOs are looking for that efficiency. They're looking -- if you're a general dentist, a majority of what you do is not orthodontics. The majority of what you do is restorative. So we fit into that workflow where they're scanning every patient, but they're doing whatever restorative or hygiene that they need and then they start to visualize and we fit right into that. And then while that person is in the chair, they can look at the treatment plan and be able to say, yes, that looks good. I like to see that. or we have smile video where you can have a patient talking. And it would be -- on one side, it's a normal video of them. And then one other side, it's with orthodontic or orthodontic and restorative. So there's a part of that workflow that we want to be a part of. And I think that really helps standardize across. There's a model that they can follow that it's working for these DSOs. It's driving a higher conversion. And it really goes to show that even in a tougher environment, you can still see this volume benefit. And that applies to U.S. and North America, but that's also what we're seeing, even though DSOs are a little bit more -- they're just not as big in some of the other markets in Europe and APAC, but that same play that we're talking about in North America applies to other regions as well.

And maybe turning to product launches. You recently launched zero refinement cases rolling out in various different forms. Maybe talk to us what's been the early feedback from not only your customers but also patients relative to the new offering?

So early feedback is -- I mean, what we started with our DSOs, and they have been using this for a number of quarters now. And what I think those doctors like and maybe ultimately the patients like is flexibility. When you buy something, you don't always have to buy a product that has essentially a service plan because that's what those refinements are. You're providing additional refinements to be able to have that patient get the completed care that they want. And with no refinements, it just offers flexibility. And it's really an evolution of our portfolio. When we introduced -- if I rewound the tape 10 years ago, our main product was the Comprehensive Unlimited, which was 5 years of treatment with unlimited refinements. And that was at a time where we're trying to drive utilization, especially on our comprehensive products, but we had technology that maybe wasn't as good as it is now. So we had to offer 5 years. We had to offer refinements. We've evolved in terms of putting more technology into the product such that you can have a comprehensive case, maybe you don't need a refinement or maybe need one refinement. But let's let the doctor decide that they want to do a refinement because they didn't get the exactly right and then the doctor pays for it. And what it does is it reduces the upfront cost to those doctors. They still might do a refinement or 2 or 3 later. We just -- they kind of pay as you go, and it gives a doctor much more flexibility. And I think with the product evolution that we have with the doctor capability, remember, 10 years ago, majority of cases they didn't even use it in iTero. They were using PBS impression in it and it was kind of an old kind of digital, but it wasn't -- really wasn't as elegant as it is now. Now 90-plus percent of the cases go through a digital scan through iTero. So the quality is better, the products are better, and we really improved things so that you don't need to have that. And I would say as a side note to that, when we had the Comprehensive Unlimited, it used to be our #1 product. 3 years ago, we introduced the 3 and 3, which is this comprehensive over 3 years with 3 refinements. That's our #1 selling product. And now as you give more options to doctors, I think you're going to see a portfolio. Some still might take the comprehensive unlimited because they like that security. Some might do 3 years or 3 refinements, some might do zero. But we just want to give that flexibility in the marketplace. And I think doctors appreciate that. And I think patients appreciate that, too, because they know that they're getting quality of care in whatever level of treatment that they need, but ultimately let the doctor decide.

And I appreciate you brought up the 3x3 dynamic because I think we're all looking for corollaries on what something like a zero refinement rollout looks like and penetration looks like. How do you measure the success of the new product rollout? Or maybe do you set targets for yourself of where you want zero refinements to be as a percent of your overall share?

It's not so much of a target. What we're looking on that one is we -- especially on the ortho side because I think that's where this plays the most, where an ortho now is making a decision, do I put this patient into wires and brackets or do I use Invisalign? And I think when you have the comprehensive unlimited pricing compared to wires and brackets, a big gap. Comprehensive Unlimited, doctor could be paying $1,500 for and wires and brackets, they might pay $300 for the material, big gap. Now when you look at the comprehensive with no refinements, that might be $800 to that doctor, still more because there's the digital aspect and the workflow and the time savings it has, but it's now closer and it closes that gap. So I'm really looking at this as certain doctors, how do you see their utilization play out? Do they -- can we get a higher share of chair for the comprehensive with no refinements? Can we increase that utilization, get it into doctors who maybe were making the switch or hesitating to make the switch because they saw the pricing. So we'll see that evolution, but it's not so much of a target. But if I went back again 3 years ago, before -- just when we launched the comprehensive with the 3-year through that was zero because we were just launching it and 70% of the cases were done with the comprehensive unlimited. Now 1/3 of our cases are done with the comprehensive, the 3 and 3. So I would expect it's going to increase. I don't know if it will be our #1 selling product, but it will certainly take away from some of that. But we're really looking at this as an evolution of the portfolio because of the technology is there to be able to make sure we get this done in the right way and also drive incrementality. We should be able to see higher utilization, especially amongst those orthos who would have normally used wires and brackets versus Invisalign.

And along those lines, I would love to just dive in for a second on price. I think you've been very helpful in talking about the mix dynamics and the fact that you're selling a zero refinement case, the math on the ASP is going to obviously bring it down. But how do you feel on a product-by-product basis, your pricing power currently sits right now? It's not about comparing the price on zero refinements versus Comprehensive Unlimited because obviously, they're 2 different products. But how do you feel within your -- especially your key product categories, where your price sits currently in the market?

I think when you look at our pricing, it's really -- when you think about ASP, the 2 dynamics that hit ASP the most is, one, where do we sell the product. So if you're selling a product in Turkey or Latin America or India, it's a lower ASP. It's just that list price is lower there compared to our overall average. And it happens to be that we grow the fastest in some of those areas. So you have this mix effect that hits ASP. The other part to our ASP mix effect is around the products, as you said. So if you're selling into markets like that, that maybe they just -- they want to moderate or they just want the touch-up cases that we have, that's only 5 or 6 or 7 sets of aligners, that ASP is lower. And the reality is it's lower just because that's what it costs for a product like that. Now when we see that mix effect, especially on the product side, what we're seeing is most of those products that doctors are picking do not have refinements. And for us, refinements impact our gross margin in an unfavorable way. When we sell a product like that doesn't have refinements, that ASP might be low. It might be a $500 ASP product, but that will also be an 80% gross margin product for us. So we look at it as, look, we want to sell to as many doctors as we can, increase the number of doctors and then also increase the utilization. To get to that, you have to meet the doctor where they're at. In some cases, they're going to want to have a product that just to suit their needs, doesn't have as much refinements. That's fine. We still get a higher gross margin rate on that. And we have to be able to manage the gross profit dollars in terms of what's that cost to serve to be able to get to that. But I would say our product portfolio has just evolved. It's evolved based on technology and based on the fact that we're reaching more and more doctors. And those doctors have different behaviors, and we want to be able to sell to them the way they want to buy, and we're doing more and more of that.

There's been some moving pieces in the U.S. about potential for consumer-oriented relief. Obviously, we have last year's tax reform and the One Big Beautiful Bill that could unlock some personal consumer spending. It looked like we may have had tariff dividends. Now it looks like we won't. Supreme Court decision. But within your guidance, what are you baking in relative to the, call it, financial health of the consumer?

We're really not forecasting that in. So our guidance is a reflection of kind of what we've seen and not taking that future. Now to be clear on that guidance, though, it's -- I want stability, I want overall stability. If there's -- we know that if there's stimulus, if you call that stimulus, if people get more of a tax refund, look, in the end, a large part of what a potential patient pays for is out of pocket. There's not as much reimbursement, some reimbursement. And so that discretionary piece, especially on the adult side, it certainly can help from a tax refund. We're not factoring that in. But if people get more of a refund, they'll spend it on many things, but we think they'll also spend it on some type of treatment. And if that helps us down the line, that would be great.

Maybe shifting a bit geographically. I think North America stood out because of the improved stabilization, but it was still a fair call, the slowest growing geography for you in 4Q, which means that the other segments are clearly doing better. Starting with Europe, like there's a lot of seemingly macro uncertainty across various different parts of the continent, yet you're outgrowing in Europe. So maybe talk about some of the characteristics that have underpinned that level of growth.

So Europe has been great for us. I mean we've seen good growth across Mainland Europe, U.K. and Nordics. Spain, Italy and so on have been very good growth for us. And then if I broaden out EMEA and get into Turkey and Middle East and so it's been very strong growth for us. I think that's just a reflection of the underpenetrated market. It's digitizing with iTero. We've got a direct sales force training more and more doctors, getting them to understand what treatment options they could bring and then ultimately driving utilization. We've seen good growth there because there's been new products that have really hit there, especially last year, Invisalign Palate Expander, some of the DSPs, some of those doctor subscription program, which have those touch-up cases, and that's been good adoption there. So I think it starts with Europe. It's has been an underpenetrated market where we have opportunity. And then you have some of the new products that have come there. We've seen good double-digit growth across Europe.

And as you think about I hate to use the baseball analogy but I'm going to use it. How would you compare what inning we're in for North American penetration versus EMEA penetration?

Look, I think we've been in North America the longest. Really, we started out more as a U.S. focus and then expanded out from there. So I would say when you think of U.S. and North America, I mean, you're in the middle kind of third or fourth inning. I think in Europe, I mean, it's early. It's earlier than that because you have so many -- just the utilization difference that you have between doctors and orthos and GPs. And I think also the DSO is a little bit younger in Europe, and it gives us a lot of opportunity to continue to grow there. So I think in both regions, it's -- we're not the standard of care yet, wires and bracket is. So I would always say we're not even like to the -- we're certainly not to the seventh inning stretch type. We're in the earlier stages in both markets. Europe a little bit earlier because of the underpenetrated market. And I would say the DSO is just younger compared to North America.

And just to make sure we're touching on the current news environment, you have a manufacturing facility in Israel. I hope everyone is okay there. Any dynamics we should be thinking about relative to shipment availability anything tied to the current Middle East?

Yes, it's a good question. And everybody is safe and able to manage in a difficult environment, and it's a testament to that team and what they continue to have to go through. But we've got a global supply chain where some of the manufacturing is there, some of the technology comes out of there. But we're very good. They're very good about shipping it to the regions that need the product. So we have hubs in all different regions that are outside of Israel, and the teams have done a really good job of getting the products to where they need to be to those hubs. And then as that customer needs an iTero, they pull from those hubs. So our supply chain is pretty well established. Sadly, they've had to establish it in this way because of these unforeseen events, but they've been able to manage, and I don't see any issue from an iTero standpoint in terms of supply chain for the quarter.

That's helpful. And then maybe shifting wrap up the world to Asia. Obviously, a tale of, I would say, 2 areas, China versus non-China. How are trends progressing between the 2 areas? And maybe I'm just bad at tracking this, but have we heard anything more about how the VBP process is going to roll out at this point in time?

Well, APAC has been double-digit growth for us. So we've been -- we feel really good about that. And that includes China as well as the rest of APAC. So when you roll it all together, it's been very strong for us. Again, underpenetrated market, some of the new products of kind of the Europe play, very underrepresented from a DSO standpoint. So there's opportunities to continue to grow just like Europe would be. So if you were talking innings, I would say the innings, it's even a little bit earlier than EMEA in terms of what APAC can bring. VBP, it's been talked about several times. It was supposed to start last year. Maybe it hits this year. Typically, it goes into the public kind of sector first. 85% of what we sell to in China is private. So it's a little bit different there. Not to say it won't go to private. It usually does. We have a product portfolio that can help manage through this and sales team, and we're very local within -- I think if you -- if we were kind of an outside company coming in, you'd have more of a challenge. And I think companies have had that challenge. I think for us, we've got a sales team that's local. We've got treatment planning local. We've got manufacturing that's local, and we'll be able to manage as we go through. But I think our product portfolio will put us in the right spot there and keep us in that right spot. And we'll see what comes out of the government actions as we go forward.

And along those lines, I mean, I appreciate the commentary on the local presence. There's obviously China bread manufacturers [indiscernible] both your direct and indirect comments over the last, who knows how long, you seem to be taking share in China. So how much of that is the balance of local versus local in terms of the way your business is aligned no pun intended, versus the idea of having that product quality, product availability, breadth of product portfolio.

And that's the key within China because, look, there's not much reimbursement, really no reimbursement in China. So there's a lot of potential patients and people willing to pay, and they pay for quality. They pay for better cases that from us where there's product capability to be able to move teeth in a predictable, reliable way. Doctors want that. They want that premium brand. They advertise and co-market and other things. So there's that premium piece of it that we bring as well as that local manufacturing and treatment planning that we bring. So look, we feel we're properly positioned within China. We've been able to grow within China. We think in the end, we're kind of taking share back. But in the end, it's going after the wires and brackets. If you look at China broadly, 85-plus percent of the cases are done with wires and brackets. And on the teen, it's even worse. 90-plus percent of the cases are done with wires and brackets. So there's some share shifting that goes on. It's less about that for us. It's more about how do we grow the overall market. And China is a huge opportunity. A lot of people and a lot of people who want to ultimately pay for good quality products like ours.

We've basically spent most of this discussion on the revenue line, but there's a lot going on to the positive below the revenue line as you drive towards margin expansion. In your guidance, you have 100 basis points of expected margin expansion this year. Can you walk us through some of the puts and takes on what gets you to that number? And how much of it is offensive opportunities you can control versus just the general nature of the market, general nature of mix?

So we took a lot of actions in the second half of last year, some of the restructuring that we've talked about, and that was really focused on the cost line, the COGS line where we wanted to improve our productivity, some of the equipment that we needed to upgrade and go to more productive equipment. Some of it is around getting closer to our customers, so we could minimize freight and some of the logistics that we have. We've taken those actions, and we feel good about how we exited from a cost standpoint. There's a lot of initiatives that we have to be able to reduce our resin cost and reduce our labor costs and other things that across our business, when you're making over 1 million unique aligners a day, vastly larger than anything else in the market. If you can take $0.01 out of a product, it goes a long way. And so we're seeing more and more of that productivity show up on the cost side from the actions we take and the actions that we continue to take for productivity. And then we've done some things on the OpEx side to -- around layers and span of control and other things to be more efficient there. So we feel like we're in a good place from a structure standpoint to be able to drive this 100 basis point improvement. And that overall improvement is despite scaling up the direct fab manufacturing. So we want to make sure people understand that there is some inefficiency when you scale up some of that direct fab manufacturing. You've got to get some more scale there, both on the resin side as well as on the processing and manufacturing side. But as you scale that, that becomes more productive. But initially, you need all these other cost improvements to be able to help offset that. But we feel like we've taken the actions in place. Once you drive more volume through all the sites that we have, that drives a lot of productivity, like I said, getting more throughput out of those sites lends itself to a lot of productivity.

And you laid out a lot of the time line of the direct fab opportunity at the Investor Day last year. How are you tracking on those metrics? And how is it progressing relative to where you hoped it would be at this point in time?

Yes. It's -- we talked about having products this year, kind of middle part of the year where you start to have some retention. And these retainer type products are going to be, especially for children that need their upper palate expanded, and we have products to be able to help with that. But then after that product is used, they need some type of retainer to be able to hold that upper palate in the space that they've created. And so we'll have products that will actually go to that. So some of the retainers, some of the more challenging products that we make like mandibular advancement with occlusal blocks where the -- right now, it's a very manual process that we have to do to actually like ultrasonically weld the blocks on or we'll have other products that have buttons where you actually have to stick those buttons on and so it's very manual. That will come -- start to come through some of the direct fab. So we'll start to see that in the middle part of this year. We'll work to try to scale that, and we want to get to more and more scale. And then into next year, we'll have more and more commercial products that, again, initially, it's unproductive. Then you get to kind of neutral when you get a certain amount of volume through. And then ultimately, it's more productive on the direct fab because now you're just making the product. Our traditional manufacturing, the majority of the material that we use is essentially thrown away. It's the negative. You make the negative, you make the mold and then you vacuum performance plastic on top of it. So going forward, we won't need that as much material and resin costs, which will help us going forward.

We're out of time. John, thank you so much for being here, give us update.

Of course, Thanks, everyone.