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

All right. Good afternoon. Why don't we get started? My name is Jeff Johnson. I'm one of the senior medical technology analyst at Baird and our next presentation this afternoon is from Align Technology, a leading manufacturer in the 6.5 billion global orthodontics market with Invisalign. It's system of clear aligners designed and manufactured by the company, and he's a long explanation there. I'm just going to cut that. With us today from Align, we're happy to have Chief Financial Officer, John Morici. John, thanks for joining us. I don't know if you have seconds of prepared remarks or anything you want to say to open the afternoon, but we can go straight into Q&A whenever you're ready.

Happy to go into Q&A.

Yes. All right. Well, let's start topic came up at dinner last night, and it definitely is something I get from investors is just around kind of the U.S. growth rate. And I think a point of conversation last night was -- if I look at pre-COVID to today, your U.S. case volumes or Americas case volumes, however, we want to look at them, have grown at a compound annual growth rate, probably 5%, 6%, 7% globally, I think, a little higher than that, but the Americas, somewhere in that 6%, 7% range. But if I look off '22, which was kind of that really '21 and '22 were those heightened years post COVID, everybody sitting at home on Zoom deciding to get their teeth fixed, case volume hasn't grown since then. So is the U.S. in America is still a growth market? Are there still growth opportunities? Have we hit just some ceiling of you can only do $1.3 billion, 1.25, whatever million cases a year, just how to think about the the next few years and growth opportunities in the U.S. from a clear aligner perspective?

Well, when you look at the U.S., the opportunities that we have you start with the backdrop of the overall market, and it has been challenged from an overall economy standpoint. You've got higher inflation. You've got maybe a reluctant patient to maybe want to go into treatment and that trickles into what the doctors, how the doctors view things and what they invest in and how they want to grow their practice. But what you have in the last couple of years here, 18 months or so, you've had a challenged economy, but it's been relatively stable, meaning this is what we've -- the environment that we've been in. And this is something that -- we as a company are trying to push against. And to do that, you've got to be able to recognize that the predominance in the market is still wires and brackets. So we have a huge opportunity to grow in U.S., just like the rest of the world, to get clear liners for tab Invisalign. -- to be able to have that Invisalign and be able to make a difference in a market like the U.S., you've got to give your doctor options. That options could come from different types of products in our portfolio. So we push against that in terms of the economy to say let's offer varying types of products that don't have as many refinements and therefore, leave the upfront cost to be a little bit lower. And so that doctor then can look at I'm going to use wires and brackets or I'm going to use Invisalign, the upfront price is closer and you don't have to have that make some of these tougher decisions from an economic standpoint. Same way, offering flexibility to the potential patients. I think in the past, patients would come. Maybe they had financing alternatives, maybe they did. What we've been able to do and really help with the overall market is to have more financing options to those potential patients, give them an ability to -- they see what their teeth will look like with treatment, whether you're on the ortho side or GP side. And then as it eventually gets to the end idea of whether they're going to go into treatment or not. They want to see that the financing is affordable for them. And I think even in a challenging market that we're in, you make changes like that, that can affect the doctor, the ortho or GP around products and what we do to go to market with them as well as their potential patients you can help overcome that. And that's what we're focusing on trying to drive.

Okay. And as I think about in the U.S. and the true globally as well, but in the U.S., you've launched DSPIP, some of the Invisalign First stuff that's going back several years now, but you have been launching a cadence of new products. This year at the start of the year, now NOAA has launched, you've got the Smile Advantage, I think, program from HFD on the financing side as you were kind of alluding to there. Have all of those efforts, I guess, in spite of all those efforts, the U.S. hasn't grown. Should we look at it as with those things in place as the macro improves, now you've got all these things that theoretically make you a better company and a better opportunity when the macro improves to like get that growth back?

Well, I think it's twofold. I think we're doing things to offset even the current macro, and we're seeing improvement. You're seeing that the business can -- in certain parts of it can grow, and we can get some of that back. We need the overall business, especially on the retail side for all the changes we're talking about to be able to help that grow. But I think we can see improvement even in the current environment. And then you're right. If you -- if there is maybe not as much headwind in the overall economy with inflation or concerns about fuel prices and so on, there's things that we can do that we're doing now. that will become a benefit in the future of some of those headwinds move away. But we're focused in on helping our doctors at the point of sale that they have, what products and capabilities that they have and then also translate in that to the patients that they're seeing and finding that right combination to drive the conversion.

Yes. And there's been some pressure on your stock just over the last several weeks. An independent data source that's out there talked about a weak July for ortho demand. You guys gave your third quarter guidance, though, in late July. So I guess, regardless of what the market did in July based upon that data source, which, by the way, has been variable and all over the place, and it's one of the reasons we don't actually buy the data. But would you argue that your visibility through July, at least you're still comfortable with that third quarter guidance?

Look, we gave guidance at a point in time based on all the conditions that we see, whether it's the U.S. or the rest of the globe. Obviously, we have the benefit of several weeks into the quarter and understanding where things are at. I think you rightly said that some of the data, it becomes very much what subset of doctors and orthos are they using, what's the period in time, whether it's July or August. I think it's it's less to do about some of these monthly fluctuations that comes through some of the data and survey. The reality is, from an overall macro standpoint, we've been in this environment for 6, 7 quarters. And this is the reality that we're in. And -- but it's what we do as a company to drive that initial demand generation, marketing and advertising, being able to arm our doctors with various types of tools to help their patients visualize what treatment is going to look like and then really partnering with them so that they can find the right financing. And what you do see during this time over the last 5 or 6 quarters, you start to see much more of financing, playing a big part. And that affects the U.S. You see it with HFD and other lenders that come into it. We're also seeing that shift in Europe and other places where that last mile that you have to overcome sometimes is around that financing where you can get that monthly payment that's maybe more affordable for those potential patients. And if you drive that right combination, you can see good results.

Yes. Fair enough. You talked about Europe. I mean I think if I look at your European numbers, your EMEA numbers, I guess, to be more precise and your Asia Pacific numbers. I think in those 2 markets, you've grown double digits now 4 quarters in a row. One, what's different about those markets? How much is something like IPE helped case volume growth in those markets given that does count as a case in your case volume calculations in that, so what's different about those markets? And how much has been new product driven versus the end markets themselves.

It's really a combination. And in those markets, you have -- they're more underpenetrated. Much more wires and brackets are done compared to even North America, which is still under penetrated. 75% of the cases in North America are still done with wires and brackets, when you include teens and adults together. So underpenetrated market, they've responded well to new products. So you have IPE and some of the touch-up cases. We expanded that into Europe. Now we've expanded that into APAC, very receptive to new types of products that really fit with the types of cases that they do. But if you take just on a broad basis, you say 55% of our business is outside of North America. And as you said, growing -- has been growing double digits. And even if I looked at North America, I say 45% of our business, 1/3 of that is DSO. And those DSOs have been growing double digits. So the focus and the focus that gets to the macro and trying to drive that conversion is really on that 30% of North America -- of our business, that's North America retail that we've got to be able to try to reach those potential patients and ultimately help our orthos and general dentists drive conversion. And that's our focus that we've been working and trying to overcome. And through all that, we've still been in this mid-single digits as a company, but our expectation is we can grow faster.

Okay. And when you cycle through now in EMEA and APAC to those double-digit comps, third quarter will be your first time coming up against those tougher double-digit comps. Anything we should think about there? I mean, is it tough to grow mid-single digits on a double-digit comp. I mean just how should we think about the split of your business between the Americas and EMEA and APAC, which has been much more biased from a growth perspective, the last few quarters in those international markets?

So the international markets still have a huge opportunity because, like I said, underpenetrated market to start with. And then introducing many new products that take some time to get the adoption. And now you start new just in the second half of this year, it's having that DSP in Asia, the touch-up cases that you have. The no AA products goes to other locations as well. And you see some of that with moderate and other products that don't have refinements and many doctors like that. You see tremendous growth in places that we have invested our go-to-market resources with sales and marketing in places like India and Southeast Asia and Brazil and other places that we've seen really good growth. So we think that starts with an underpenetrated market. There's markets that we can find ways to win with our technology and products there. And then you add to that some of the consumer financing, which is just as important, if not more important, in some of those markets where that patient is reluctant to maybe go into into treatment. And if you get that financing right, get it down to a monthly amount that they're more comfortable with, you can end up with varying degrees of of success from a conversion standpoint, and that's what we want to play for in those markets.

Okay. And just kind of a gut check on the third quarter guidance. You are guiding to mid-single-digit year-over-year case growth against a mid-single digits because again, EMEA and APAC both hit double digits for the first time in a while last year in the third quarter. So that your third quarter comp this year is 5 or 6 points tougher than it was last quarter, but you're guiding to about the same level of year-over-year case growth. It just doesn't feel like in this economy, that a comp-adjusted acceleration. But what am I missing there?

I think you have to look at kind of what you do when you guide, you're looking at our business. We're looking at what we've been doing recently, where is the marketplace now? Let's start with that, where the marketplace is. And then you layer in new products that you're introducing that you didn't have last year. DSP didn't exist in APAC last year as it exists now. And for the most part, really wasn't much in Europe and how it is. And then you go into a lot of the patient financing and other things that was just a small part of what you had in the past. So you have to look at what you've been doing to understand that I'm going to look at what I did prior month, prior quarter and then be able to say, okay, based on that, here's the expectation that you have you go into teen season in China, Europe becomes a little bit slower for holidays on a sequential basis, and you build your guidance off of that. But it's more relevant to see what's actually happening in the prior month or prior quarter and then be able to project that forward and then you look at those numbers. I think if you looked at just from an overall year-over-year standpoint, first half, we -- our volume grew about 7% or so on average. And if I just look at the year-over-year in the second half, our guidance reflects 5% or 6% on a year-over-year basis. I get your stack point, but it's relevant when you think of what are you doing lately to be able to help change that trajectory in a relatively stable market and then you use that current data to be able to project forward and year-over-year just more or less becomes a result.

Yes, fair enough. And then just remind us where you are with the rollout of the NOAA product or the refinement product? How broadly rolled out is that in the U.S. at this point, but also then across other markets, the plans?

Yes. In the U.S., it started with some of the DSOs that we have. They look for different options to keep their upfront costs at a lower point and then pay for refinements as it goes forward. We're happy to do that. Revenue recognition wise, we'll make that trade. You're just going to get maybe less cash upfront, but you get the cash later and therefore the -- and that revenue later, so we can manage through that. And I think our technology has really evolved to really allow for many times you can do a comprehensive case or even a moderate case with just no refinements or maybe one refinement. So we're seeing that adoption across DSOs. We're introducing that across many of our retail doctors and the adoption has been good. We doctors need to make sure that they plan a case properly so that they're -- they expect to be able to finish in a relatively short period of time with not a lot of refinement. And if they were used to a lot of refinements, they have to make sure that upfront, they manage that setup. But once they do that, and they understand some of those trade-offs, the whole purpose of a no refinement type product is to keep that upfront cost more manageable compared to wires and brackets. This is a utilization expansion. This is getting doctors who would say, I don't want to pay the upfront cost of the lab bill. I'm going to stick to wires and brackets. We're trying to offset that and say, look, it's a little bit more expensive than wires and brackets, but it's not the bigger difference that you would have if it was a comprehensive unlimited. And I look at that as like wanting to win in the gray areas with those doctors. When those doctors are deciding, do I use Invisalign do I not, sometimes this upfront pricing can help with that. And when we look at that, it ASP is very manageable because you recognize the same upfront. But the important part is, and as we see our shift more and more to these comprehensive or moderate without refinements, it helps our gross margin. And we've been able to see that. You looked at really second half of last year when it was started to to take off and then into this year, our gross margin has improved. A lot of it is around productivity and programs that we have, but some of it is due to some of the mix that we see with these NOAA products.

Yes. Just 1 question on NOI and then I want to move on. But on NOI, so let's put some round figures on things. If it was $800 upfront for NOAA case, let's say, that would have been paying $1,200 for a full comprehensive. One of the things you've talked about is docs are getting more comfortable going to a NOAA product because the need for refinements are going down because the system is getting more and more predictable. But at the end of the day, does that run the risk that instead of charging them that physician, that doctor for a couple of refinements in year 1 or 2 if they do no refinement, you ultimately still are ending up with less per case. -- your deferred revenue is going to start coming down pretty aggressively in years 2 and 3 post NOAA.