Align Technology (ALGN) Earnings Call Transcript & Summary

Good morning. Thank you all for coming. Clock just ticked to 8 a.m. So let me be the first person to welcome you to Piper's 37th Annual Healthcare Conference. If you are in this room, you are a client of our firm. So obviously, they're not all here. But I'd like to thank you very much for your business and your partnership. We obviously couldn't do it without you. It's my pleasure to introduce John Morici, the CFO, and Align Technology and Jason Bednar as Senior Analyst and Managing Director at Piper Sandler. Gentlemen?

Thanks, Jim. Yes, welcome everyone, and glad to have you all here. I'm really happy to kick off the the conference here with John. John, we were just talking and we've had a lot of interactions here just in the last 24 hours at the dental conference yesterday and also dinner last night. I think I'll start probably the same way I started each of those this time we talked with, I think, what's very pertinent for a lot of investors right now, the U.S. consumer. It's probably a very common question you get. The recent consumer confidence numbers didn't look great. I think we're also going to have a little bit of a vacuum just with government data here. But what are you seeing? I mean do you think that consumer right now is stable. Is the consumer under pressure? How are you seeing things with respect to the U.S. macro environment and the consumer you're selling into?

Yes, it's a good question. And you're right, we do get this a fair amount. When we look at the data that we see and kind of how the consumer is behaving, especially when it comes to our Invisalign and coming to doctors and so on, we would say it continues to be stable. We saw this in the third quarter. It really has stabilized, and that's kind of how we look at what's happening within the U.S. Obviously, there's puts and takes in different geographies and so on. But overall, we would say that stability is there. And I think when you put that against some of the consumer metrics that are there, Michigan and others that people use slight changes, it's not really that noticeable. There's dramatic changes, then there's an impact maybe one way or another. But I think when you look at some of the indices that are there, you haven't seen a broad dramatic change, and that's good for our business. We want that stability. We want to be able to operate in that environment, especially in the U.S., like you said, North America, big markets for us. And when you have that stability, coupled with the things that we're trying to do and we can get into a lot of that to drive that conversion, it's a better environment for us.

Okay. Pretty controllable environment you characterize it as for yourself?

That's how we would look at it because there are -- the work that we have, we do with our doctors to be able to help drive active conversion and there's a lot of new products that we have to get people interested in different types of treatment. There's marketing and co-marketing that we'll have with our doctors and our dental service organizations and others to try to create that activity, keep people interested in treatment, couple that with visualization and if the right pricing is there for that potential patient they'll transact. But it really starts from having a stable environment to be able to do that.

Are there any green shoots that you'd characterize as seeing in the U.S. specific income bands, geographies, adults versus teens DSOs, I'm sure you'd say DSOs, the DSOs versus private practice. Where are you seeing maybe some better performance within your business in the U.S. and then we can talk about the outside of the U.S. as well.

Well, certainly, within the U.S., when we talk about the dental service organizations, whether on the GP side or on the OSOs on the orthodontic side, they're doing a good job of what we would describe as active conversion. They're doing a great job of scanning every patient, showing them the visualization of what your teeth will look like before treatment and after treatment with a lot of in-phase and video visualization. They'll provide in many cases, great pricing that they'll fund to try to get that potential patient excited about treatment and then usually follow it up with some type of financing, so that per month payment is acceptable to that potential patient. So DSOs and OSOs are doing a great job with that. I would say if you looked at other parts within the U.S. we're seeing good uptake in some of the various products that we have. So when you think of the teen adoption of products like IPE, the palate expander, products that have mandibular block. They've really taken off, and we see better and better utilization as doctors get more familiar with those types of products. So that's helping us. That will help us on the team side. And then as we go and really try to be selling to more doctors and driving that utilization, we're taking that active conversion approach with our doctors. And the retail doctors are the most -- the predominant number of doctors you have in the U.S. and many of them individual practices, individually owned. And so taking products as well as the active conversion approach to help with co-marketing, help with helping drive patients in taking some of those activities to try to turn those potential patients into patients. So it's a ground game that you need. It starts with products. It's way to go to market. DSOs are a force multiplier for us. They take all the tools and all the products that we have and be able to help drive that conversion. But that's what we want to continue to do within the U.S. and other markets that we have. Once we can do that, we can be able to grow the business.

All right. When we touched on international yet, but we can maybe in this question. When we think about your business taking a step forward, I think we're all trying to wait to see if we can get back to that in the low end of that LRP that you put out there earlier this year, plus 5% to 15% on revenue growth. In order to get there, do you see that happening more with the U.S. getting better and some of these active conversion efforts helping? Is that the bigger impact? Or is it more international taking a bigger step forward than what it already has?

I would say it's both because when you look at our business, over 50% of our business is outside the U.S. So when we think of all the things I just described in the U.S., we want to be able to -- we start with the stable environment and then all the active conversion ways that we go, including the DSOs, that gets us some improvement there. And then when we build outside the U.S., which we have seen good growth where places like Southeast Asia, Latin America, Eastern Europe, really other parts of Europe, India and Turkey and so on, those places are growing double digits. We're at that double-digit growth. You're seeing good adoption of the products, a lot of the new products that I talked about. You've seen good adoption of things that we have to go to market with some of the products like doctor subscription program where the touchup cases and others, which really helping drive a significant amount of volume for us. So when we think about growing as a company, we want to continue the growth that we've seen in international. That's come back faster for us, certainly since COVID, we want to continue to grow there. And then as we build back in North America with the active conversion approach. DSO, a big piece of that, but then all the work that we're doing on the retail side.

Right. Do you think you have enough, call it, demand forecasting ability to say we can sit here today and say what the U.S. is -- we see path to U.S. getting better from where we're at right now as we look ahead through the coming quarters?

That's the plan. I mean we're not guiding for next year yet, but the plan is that we want to continue to see incremental improvements and if you looked at the year so far, you've seen that. I mean, first half, much different than I think what you're seeing in our second half, some of the volume, some of it that revenue improvement that we see on a year-over-year basis. It comes from having stability in the various markets, but we want to be able to push to try to drive growth, both in North America as well as outside.

Okay. And maybe the last question is on this macro topic. Can we do all of that and wrap it back together with where we started. Can we do all of that on the improvement and driving active conversion if the U.S. macro simply stays stable?

That -- we're not planning for -- when we think about our overall plan. If macros get better, that's a tailwind for us. We're expecting that based on what we see now, it stays the same. If there is some improvement in macro or some benefits that they see inflation gets more in check in certain countries or interest rate changes, and that helps stimulate demand. That's a good thing. That's a positive for us, but it's something that I would look at that as a tailwind. We're not factoring in.

Okay. All right. Perfect. Maybe transitioning over to some of your international markets, some of your bigger international markets. Those have been better Europe has been doing pretty well, as I say, across all the dental. It seems like just from our conversation last night, I thought you sounded pretty good on the overall China market and the demand environment as it stands right now. So maybe just to revisit some of those points, where are you seeing some of the investments pay off the most in Europe? And then when you focus on APAC, let's bring the [indiscernible] on having a more positive view or rosier view on China relative to other parts of med tech where it's a little choppy right now.

Well, when you look at our international business, just as a whole, when we think about even comparing it to North America, our international business is very under penetrated. In many cases, as we've gone direct and we're working our way through those markets. There's just a vast majority of cases are done with wires and brackets. So we start with that, where we think that as we come in, be able to come in with new products, training doctors, getting them to understand the digital orthodontic process that we bring, scanning every patient, visualization, helping them with ClinCheck to be able to help these doctors get through these cases and then build confidence to do more and more cases. That's the model that we've run and internationally, there's a lot of run rate for that. So when you look at markets that are relatively new to us, but we're seeing tremendous growth even in places like India, where we were almost nowhere just a few years ago. Now it's a significant part of our business and growing strong double digits. You look at Korea and other places that we've been for a while, but this underpenetration of the market gives us huge opportunity, same way in Brazil, same way in in Turkey, Eastern Europe. You mentioned other parts of Europe. We're seeing great growth there. It's coupled with some DSOs that we have there as well. But then it's also really the introduction of a lot of new products there that they've just started with IP, just started this year, DSP, our touch up subscription program just started this year. And as they get further and further adoption, it accelerates case growth. So great opportunities there in some of the newer markets that we're in because of just the newness of that and the underpenetration. And then even in markets that we are as we introduce new products and work with DSOs and so on, we're seeing an acceleration there. With China, China is -- it goes to the fact that the vast majority of cases, over 85% of the cases there are done with wires and brackets and less than 15% are done with clear aligners. We're the biggest within the clear aligner, but it's one where there's -- there's not a lot o reimbursement especially on the private side. People pay for brands. They pay for quality. And in many cases, it's out of pocket. So the majority of our business within China, 85% of our business is private. On the private side, we're usually in Tier 1, Tier 2 cities. So doctors end up charging more for Invisalign compared to other types of treatment and people pay for it. And so we're a little bit insulated from that in terms of how we go to market. But in China, we've been in that market for a long time. Even before COVID, we had manufacturing, we had treatment planning. We've got a direct sales force. We've got our entire China business contained within China. So when we see the dynamics that go on and what you have within that market, we're able to navigate because we're there. We've made those investment decisions and the growth opportunities that we've had there for a long period.

All right. Maybe double clicking on China and the whole VBP conversation that's very topical for investors right now. As you're going through your own strategic planning, budgeting process and thinking about the puts and takes about potential VBP hitting the orthodontic industry, Braxton Meyers and Clear Aligners. How are you, I guess, planning for that today, knowing that it's probably coming at some point next year?

You're right. It will, at some point, it was delayed a little bit this year. The expectation, just like most VBP plans that they have in China hits on the public side first and then usually makes its way to the private side. Like I said, most of our business is private versus public. So maybe it takes a little bit longer. But it's an interesting one because when you think about. There's a big difference between the cost to a doctor to provide Invisalign or any Clear Aligner treatment compared to wires and brackets, a big gap in terms of what we're providing wires and brackets might be $100 or $150, maybe and Clear Aligner might be $800 in China. So you're at a big difference in terms of the cost of the doctor. VBP will affect some of those prices. It will actually shrink the gap between wires and brackets and Clear Aligners and say, for Invisalign. So the expectation is, and I think what happens a lot with VBP is the products that get their cost impacted the volume goes up and you'll see that benefit in. And I said at the start of the China discussion. Vast majority of cases are done with wires and brackets. So if this gets us to a higher utilization, more doctors wanted to be trained. We've seen that within China, record number of doctors that want to be trained and signed up for things because I think they understand the changing landscape and so on. If it gives those doctors and then ultimately, patients more access to Clear Aligners and therefore, Invisalign, we think that's a good thing. On the private side, it's still going to be paid usually externally anyway. So it will kind of remain to be seen what doctors do in terms of how they pass things on or not. But also the fact that we're there kind of with our manufacturing and cost kind of contained within China. As the volumes change and cost change, we think we're properly positioned. If we weren't in China and we didn't have the footprint that we had there, I'd be more concerned with it. I think given the fact that we've made these decisions and we've been operating in China as a stand-alone basically there for a number of years, we think we have the right position.

So the glass half full view of all that is there might actually be opportunity to accelerate the conversion from Braxton wires to clear aligners because post VBP that dollar gap between the, call it, the cost to acquire each of those for the doctor is going to be narrower than where we're at today. Even if they both come down the same percentage, it's just the way the math works.

The math will work if you take take 50% out of both of those examples, $100 versus $800, okay, still 50% impact on both sides, but the gap is closer. And in the end, if this could help drive utilization and get doctors to do more cases and ultimately pass that on to the patients if your costs are positioned properly, that's not a bad thing. That our name of the game for the company, what we're trying to drive with Invisalign is to make this a standard of care. And there's different ways to do that. That's maybe more of a top-down approach that the government takes. But ultimately, we want to be able to make Invisalign the standard of care, digital orthodontics versus the analog process that mostly exists today.

All right. When we use this VBP conversation a segue a little bit into pricing. How are you thinking about -- you've got a lot of moving parts with that factor in the pricing. We hear them every quarter, but VBP could be a new one, maybe a new headwind next year depending it goes into effect and what the actual terms look like. I guess how does that factor into your thoughts on the pricing that you be talking to all of us about here soon. I think you've been mentioning down low single digits, down 1% to 2% is the right way to think about ASPs for Invisalign for the business over the long term. Does that still hold next year even with something like VBP coming into play?

That's the expectation. And that down 1 or 2 points on a year-over-year basis is -- I would look at that as purely mix. And there's 2 types of mix that hit our business. One is the geographical that you're just talking about China would be a good example of that. You're going to have -- there's countries that we operate in that are growing tremendous growing over 20% year-over-year that just have a lower list price for the products. You're in India or you're in China or you're in Turkey or Latin America and so on, the list prices are lower. It's just what that go-to-market is, what that market will bear. As they grow faster, you have that country mix. You see that play out, and I talked about it in the third quarter where China was so much larger than say, on a year-over-year -- quarter-over-quarter basis than even Europe. So Europe was down in volume on a sequential basis, it impacts ASP. You see the reverse of that on the country mix going from third quarter to fourth quarter where China is less as a part of the business and Europe is more. That's exactly what plays out on an annual basis as well. You have different growth rates for countries that have the different list prices. So that's one part of that mix that affects ASP. The other part is product mix. When you think about some of the new products that we have with palate expander and some of the touch-up cases that we have, they might be an ASP of $600 or $700 or $800. Now the cost to serve on that is also very low for us as well. So the gross margin on those products might be 75%, 80% because it's really almost touchless in terms of the AI that's used to be able to create that case and then the manufacturing, there's no refinements and so on. It's very straightforward for us. So the gross margin rate is better for us. But that's what the market is. The market is shifting in a way to be able to doctors want to have. Sometimes they don't want to have all these refinements built in. They want to have just maybe it's a simpler case or maybe as you train new doctors, those new doctors aren't going to do more complicated cases to start. They're going to start with more of the mild cases, and those are just lower list price products for us. So it's not -- the change in ASP is not through the discounting on a like-for-like product. It's really the doctor's behavior that operates within certain countries as well as the product portfolio that they choose.

All right. That's also a perfect segue. And the next thing I wanted to touch on, we're down to a few minutes here. So portfolio evolution, this has been constant at Align. I do think we might be on the cusp of one of the bigger evolutions in the portfolio as move down this path of fewer or zero refinements and fewer additional aligners. Am I wrong on that? Do you think this really shakes up the industry? And I ask it that way because I'm convinced others can't follow you in doing exactly that and drop -- effectively dropping the price in you're not dropping like-for-like, you're dropping the price moving doctors to a certain product that I don't think that other competitors can follow you to. So am I right on that? Or is that -- would you refine any parts of that characters?

No, it's a good starting point. And just so everybody understands where we're coming from when we came up 10 years ago, we had a product that was the comprehensive unlimited, the ultimate, where it was 5 years unlimited refinement. And why did we do that? We wanted to drive orthodontists, especially but all of our doctors give them the confidence that they can finish a case, 5 years, you have 5 years to finish a case, unlimited refinement and getting doctors to say, "Yes, I'm going to use Invisalign to try to finish this case, and we were going to show it. 10 years ago, and you think about how many hundreds of millions of dollars we spend in investments to make our products better and better. As that has improved over the years, what we're finding is that we can help doctors finish cases faster. Good example of that, 3 years ago, we introduced a product that -- it's a comprehensive, but it's now instead of 5 years, it's 3 years. And instead of unlimited refinements at 3 refinements over those 3 years. That's our #1 selling product right now. And what it does is it gives doctors confidence to be able to finish cases, it reflects the technology that we put into the product and they're able to finish faster. Now as the products evolve and giving doctors more options, we'll have a product that will be 3 years. It's a 3-year treatment, but it's no refinement. And if they want a refinement, then they can pay for it as they go. So think about it, it's a -- these are products, they're still comprehensive products, but it's giving doctors a choice. Do I want essentially a service plan that I want to buy upfront. That would be the comprehensive unlimited, unlimited refinement that will help you finish the gate or do you just want to buy the product and do this and finish the case, maybe you don't need to refinement. If you do need a refinement, then you end up having a -- to pay for that as you go. And we think and we've seen this as we've tested that, that gives doctors choices. And when they have choices, especially when they're comparing them to wires and brackets. And again, that initial cost that they have, that gives them the ability to use more cases. And if we can help -- if this can help drive that utilization and therefore, get doctors to do more and more cases and move from the share of care where they're at to something higher we think that's a good thing. And this is just an evolution. It's a technology that's gone into the product to make them better, to give doctors more confidence to finish cases in a predictable and reliable way. And we think it's something only we can do given the technology that we put in. And so it's just part of our portfolio. You're not retiring something else. You're just adding to the portfolio to give doctors more choices.

All right. Quick one-word answers here in the last 30 seconds on 2 different things. So hopefully, I'm not opening up a can of worms. But when do we end up seeing zero refinements rolled out across the globe. And then a separate question, direct fab, what does that look like in 2026?

So 2 quick ones. In terms of the zero refinements, it's already rolled out to some of our DSOs that we have in North America and other places. We'll see it broader in North America starting in the first quarter and we'll see what that uptake looks like. But again, giving those doctors options. Direct fab, we continue to work through scale-up. We'll start to see some of the first products coming out in the middle of next year that start with retainers and maybe more of the complicated retainers to start. They give doctors some unique ability to hold some of the spaces that they need in patient's mouth. And that as we build from retention, it will get into some of the more complicated products that we have to manufacture like mandibular advancement with theclusal blocks and some of these other manual processes that we have to do to Aligners now. We'll start direct fabbing those later next year and then start our scale-up process on Aligners into 2027.

All right. Excellent. Thanks so much, John. I appreciate it. We're out of time.

Great. Thank you.