Great. good afternoon, everyone. My name is Nathan Rich. I cover the dental space here at Goldman Sachs. very happy to be joined by Align Technology. We have the CFO, John Morici, here today. John, thanks so much for joining us.
Of course.
Thought we might just jump right into questions, if that's okay.
Yeah, that's fine.
Great. Maybe starting with kind of high-level utilization, you know, you kind of characterized the demand environment in the first quarter as stable. I guess maybe starting with the adult market, I think you've talked about the, you know, that market is, you know, being more sensitive to the macroeconomy, you know, varies kind of based on the consumer's level of confidence. You know, I guess, as we think about, you know, that over the past few months, consumer confidence has remained challenging. Obviously, a lot of uncertainty in the outlook. I guess, you know, maybe can you talk about what you're seeing? You know, are you seeing any sort of thawing or, you know, improvement in demand as the consumers maybe gotten used to this environment? Could you just talk about kind of where you feel like the adult consumer is?
Yeah, I think, when you look at our business, 75% of our business is adult, 25% is teens. Certainly, we have seen, over the last year or so, where inflation concerns really translating to what people felt about their own personal finances, and it shows up in some of these consumer indices that you mentioned. Last year, there was a lot of uncertainty in terms of the marketplace, where inflation was going to go, what interest rates were going to change to, unemployment, and so on. A lot of factors that came into it. What we've noticed, you know, really coming out of last year, just more stability.
We talked a lot about that at earnings, where some of these indices, just you're not seeing the decrease that we've seen in the past. Go back to look at, in the U.S., look at Michigan Consumer Confidence Index, or other countries have their own, we see that. We see either stability or, in some cases, some improvement in certain countries. I think that's a reflection of the marketplace.
It's not something that people look at and say, "Well, suddenly the, you know, inflation got dramatically better." It's just not getting worse, and we're seeing that, you know, we're not gonna return to a 2% inflation in any time, maybe in the near future, but people are accepting of the fact that we do have a higher inflation, and now they can manage their finances accordingly. I think it shows up in some of the consumer indices. We see it in our adult business, and we hope that stability continues because that's a better environment for us to operate in.
I guess, how would you contrast Europe with the U.S.? I think, you know, international and EMEA was a little bit maybe tougher in the first quarter on a relative basis. Is that, you know, Do you feel like the macro environment or the consumer environment over there is more challenging than here, or is it kind of tough to say?
I wouldn't say it's more challenging, it's as challenging. I think when you look at, you know, Europe, it's broke out. Obviously, certain countries may be doing better, other countries may be doing worse. It just varies. Obviously, in their backyard, they have, you know, Russia, Ukraine war, you know, kind of still going on, now over a year. There's maybe more of that.
There was a lot of concern amongst, you know, Europeans. You remember, not long ago, they were talking about some of the fuel prices and inflation related to energy and so on, that has now subsided a lot. Within EMEA, we think that ultimately, like the U.S. and like APAC, it's an under-penetrated market. We have a huge opportunity both on the adult and the teenage side. I think that underlying opportunity is there. You just have to sort through some of the economic headwinds that all of us are facing.
Kind of tying that to the second quarter guidance, you know, it seems like you're not guiding for the typical seasonal step up that you see for between first quarter and second quarter. I guess, you know, how do you think that plays out over the balance of the year? Like, what are you looking for for the business to get back to that normal seasonal cadence that we've typically seen with the business?
Well, with our business, we know that, you know, there's a certain amount of volume that happens as you go through the year. Typically, the seasonality that shows as an improvement from 1Q - 2Q is around teens. That kind of holds into the third quarter, and then we see another step up into the fourth quarter. You know, there's still, in the marketplace, you know, I think we wanna make sure that we continue to see some of that stability and see that continue. Like I said, last year was more of changes that were happening that consumers were trying to kind of realize how that impacts them on whether they wanted to go into treatment or not. With teens, it's maybe a little bit less discretionary.
We talked a little bit about that, and I tried to give some color on that for earnings. Just from the standpoint that, you know, teens, they get to a certain age, their jaw needs to be aligned. If they don't do it, you know, when it needs to be, they could need surgery later. If you're, you know, even a preteen and your permanent teeth are coming in, you need to get some adjustments and, in some cases, make space for those permanent teeth to come in. There's a point in time that you need that, and that's why it's maybe a little bit less discretionary. There's also a point in time of the year that that happens.
In many cases with teenagers, they'll go into treatment in the summer because they're kind of going from one year, school year to the next, and that's just the time that that happens. That's normal seasonality that we have. China becomes a bigger part of our numbers in the third quarter, just for that, teen opportunity that they have. That's a big teen season in China, whereas EMEA is a little bit less in the summer because of holidays and so on. Broadly, I think as we see kind of the overall macro stabilization, and hopefully that continues, we saw some good results with inflation and so on, that if that, you know, continues to stabilize, we go back to more of our seasonality.
You know, and I think that's how we look at the business, because the underlying opportunity that we have in the business is, you know, 80+% of the cases, orthodontic cases are done with wires and brackets. We're a large part of the remaining, you know, 20% or so that's done with clear aligners. You know, there's a huge opportunity for us. Especially on the teen side, there's a huge opportunity for us because that's even more skewed to wires and brackets. We think we have a lot of products that we have now, as well as in the future, to really address the needs.
Got it. I do want to get into the teen market in a second. Maybe just a couple clarifications on what you just said. I think when we look at the 2Q - 3Q seasonality, it's not very seasonal on an overall basis. With the second quarter, it's kind of up 1%, 2%, 3%, and there's some moving dynamics with EMEA and China, like you said. Is the main reason for that step up, that China teen season that adds that, you know, maybe 1% or 2% to the business, you know, sequentially?
That's ultimately what leaves it there. You know, you end up with a little bit better China, and that kind of offsets maybe the EMEA slowdown just because of holidays in the summer.
Just in terms of what you're seeing in kind of China on the ground, I think, you know, one of your peers, I think, talked about, you know, demand in May being pretty stable with April. Despite some of the fears about, you know, COVID cases, you know, increasing, doesn't seem like it's meaningfully impacted consumer demand. I'd just be curious to get your perspective on that.
Well, I think in China, as we've all seen for the last three years, obviously, a lot of starts and stops kind of throughout within China. It really, prior to this year, it was really driven by the government closing things down, shutting down offices, and shutting down kind of the freedom for people to be outside and so on. Nobody's going to their dentists or orthodontists to get care. They're not being able to provide care. When it's a tops-down approach from the government, that impacts our volume.
We saw that on and off for three years. What we saw at the end of last year, as people know, I mean, you ended up with people kind of being out and about. A lot of people got COVID across the region. That keeps them kind of out a bit, but it seemed to be temporary. We talked about it in the first quarter, where, you know, we started seeing, you know, some improvement as you got into February. February better than January, March better than February. That's a reflection of people now being able to go out and not have these restrictions.
I think when you look at, you know, people getting whatever strain that they have from a COVID standpoint or getting sick, it kind of just comes and goes, and people then go on their way and transact like they normally would. As long as there's not a government kind of top-down approach to lock things up, we have the opportunity to sell through our doctors. We have the opportunity to provide for their patients. It's an important time of the year for us, because, like I said, with China, teen season really starts to ramp up now and into the third quarter.
You know, as long as there's not a government, kind of mandate to stay inside or to not go out, you know, we feel like we can operate, and that's really the first time that we've seen, you know, kind of on a, on a continued basis since prior to COVID.
Just need to see, hopefully, some consistency there in terms of...
We want to see that consistency, but, you know, like I said, we saw improvement as we went through the quarter. You know, it's something that you just need those offices to stay open. If they are, then we're in a good position to be able to deliver for those doctors.
I wanted to ask on VBP. It obviously hasn't come up, recently, but I guess, have your teams kind of heard anything in terms of, you know, potential rollout of the ortho VBP on a more national level?
Not more of a rollout. It's kind of there right now in some of the public hospitals that we really don't participate in. Y ou know, over, you know, 80%, 85% of our business is in the private side.
You know, it's certain products. I'll look at that, and we kind of feel that, look, this might give us opportunity to, you know, to get that right pricing to doctors and so on, to be able to help, you know, increase the volume that we have within China. I mean, China is 90% of the market's wires and brackets. Our opportunity there is to get a clear aligner. For the most part, on the private side, there's no reimbursement or anything else. It's out of pocket anyway, that we have. We have an opportunity there. On the teen side, it's even a more underpenetrated market. We have a lot of opportunity there. I think VBP kind of plays into kind of the overall market. From how we look at the business and kind of how we're positioned with our portfolio, we don't think it affects much right now.
Great. I wanted to get into the teen business, maybe starting with a high-level question. You know, it sounds like you guys are obviously very enthusiastic about what you have, you know, in the teen market and what you're gonna be rolling out. I guess, you know, when we look at kind of the past performance of teen, it's been about five years since it's really sustainably outperformed the corporate average. I guess you've done a good job knocking down barriers from a, you know, compliance standpoint, you know, doctor education, parent education. I guess, you know, kind of the heart of the question is: What it, you know, in your mind, it kind of will take to kind of get that accelerated growth in teen that people have been looking for?
That's good. It's a good question. I'll answer it a couple different ways to kind of get at the teen, because, look, when we think of the market opportunity, because teen is typically, it's orthodontic side of things, not typically on the, you know, the wider market. It's specifically orthodontic. You think about there's 21 million orthodontic case starts every year, 15 or 16 million of them are teens. Teen is a big piece of that. I said earlier that our portfolio that we have at Align Technology, 75% is adult and only 25% is teen. In the marketplace, it's 75% teen and 25% adult. We have a huge opportunity to go after.
When we look at the market, as it stands now, if you have that 15 or 16 million case starts that are teen every year, you know, 85+% of them are done with wires and brackets. In many countries, like we were talking about with China and so on, 90+% of the cases are done with wires and brackets. Huge, huge market opportunity in terms of us to be able to go after that market. The question becomes, what do you do to try to go after this market? What can you try to do? Well, it's first and foremost, products. Having products to be able to give doctors the confidence to be able to treat, in many cases, complicated cases.
When you have products like Invisalign First, Invisalign First is a product that it's a preteen product. When that child, six or seven year old, is getting permanent teeth, they have mixed dentition, and they're needing space to be able to create. This is arch expansion, so this is kind of widening the arch so that those permanent teeth can come in on a, you know, straight and not need the crowding that gets created with teeth if they're not moved the right way. Having those products. Another product that we released a few years earlier is Mandibular Advancement.
In 10% or so of the cases, teenage cases, their jaw needs to be aligned as well, and Mandibular Advancement aligns their jaw and positions it properly, as well as straightens their teeth. These are products that, you know, they're technical, they're dependent on certain age of patients. It's dependent on how they're, you know, positioned and so on. There's a lot of work that goes in to be able to provide these products, you know, for teenage. We've got a product that's coming out, that's in testing now, it's a Rapid Palatal Expander. Invisalign First expands the arch.
Rapid Palate Expansion actually breaks the suture on top and slowly moves that upper palate, so that six or seven year old, that right now are treated with a metal plate that goes on from the orthodontist, and then the parent, every night for a month, kind of cranks that metal device and it expands out. It's painful, for those of you who have kids that have had it works, it expands it up, but it's just a different mechanism.
From what we have, we'll have a 3D printed product that you'll take a scan, or a doctor takes a scan, dials in a certain amount of space, expansion that he or she wants, and then every night, the parent can help pop that into the top of the child's mouth, slowly expands out for that day. The next night, takes out that one, puts in another one, and you're creating now a much, a much better experience. It's our first direct fab 3D printed product. It's one where it just helps serve the needs of, you know, when we talk about 15 or 16 million teenage orthodontic case starts, 10% of them or so need this type of palate expansion. It's a market that's new for us.
It's in trials in Canada, seeing great results. Kids are compliant, there's no effect other than creating the space that's needed to an FDA approval within the U.S. From a product standpoint, we think we have product like that, which Rapid Palate Expansion, we hope by the end of this year. We have a whole host of other products to be able to help doctors serve the needs of their teenage patients coming through. We think the added piece that we have, you have to start with products, and we have that product portfolio. You also have to look at driving that marketing awareness.
There's a certain amount of awareness that we have to continue to drive, keep those teenagers, their parents, and others, knowing something about Invisalign, knowing the uses that it can bring, giving parents confidence that they can put their children in, and some of the myths that they have about maybe the compliance and other things we can address through some of the marketing. You'll see us do more marketing and targeted marketing to really look at, highlight the differences between Invisalign and wires and brackets, and really kind of make sure that people understand.
The third part to this is really making sure that we're working with doctors, training doctors, educating doctors, giving them the latest information and understanding about how the products work, what's useful for them and not, and being able to make sure that we can work directly with those doctors with our direct sales force. I think it's the product, it's the marketing, and it's the direct interaction with those doctors that works to try to keep this going. Prior to COVID, teen business was growing 30+% a year, and in adults, maybe the upper teens, low 20s, and you'd get that mix of 25+% growth. That's the expectation when we think about the opportunities going forward. That's how we're thinking about things.
That teen business is one, it's a large market. We think we have kind of the right go-to-market strategies for that. We just want to get past some of the economic concerns that we have and be able to execute with that strategy.
From a product standpoint, do you feel like you have what you need to address that entire 16 million kind of TAM in terms of case volume?
With Rapid Palate Expansion? I mean, you know, you could argue that maybe we have 85%-90% of the capability now. You add Rapid Palate Expansion, unless there's some strange tooth movement that's needed that, you know, that we can't do, we have many doctors who treat 100% of their cases now with Invisalign. I think once you have Rapid Palate Expansion, there's nothing that we can't address that's, you know, pretty much the regular part.
What's nice about that Rapid Palate Expansion, when you have a six or seven year old, even though they might not need their teeth straightened until they're 12 or 13, you know, you build that ability then with that phase one technology, where they're now used to a plastic device in their teeth, in their mouth to move their teeth. Mom might be used to it as well, and then when you get into Invisalign treatment, when they're 12, 13, and they have more of their permanent teeth in, maybe it lends itself to a higher utilization as well. These are good things that help, but it really helps expand that TAM and make sure that we can really address those 15 million-16 million, you know, teens that come into the market every year.
Maybe on palatal expansion, I guess, how do you think about the education process that might be there? Obviously a new way to expand the palate, but Invisalign is obviously a very familiar technology when it comes to, you know, moving teeth or, you know, the palate in stages. Just, you know, how kind of the receptivity, and then, you know, do you think there's going to be an education process involved for doctors?
There's some. I think with doctors, I mean, it's the appliances that they use now, the metal device, I think they've been in the market for a long time and they move, and I think they'll find that this product is, you know, it's customized for that child. It kind of snaps in, it moves, it dials i n.
Unlike maybe other treatments, which might take months and years to kind of go through, rapid palates, I mean, this is a product that in 30 - 45 days, you're kind of done with the treatment. You need some retention to kind of hold the upper palate where it needs to be. I think doctors are going to find out pretty quickly that it does work. It creates the space that's needed, and I think, you know, in terms of an education, I think doctors will see this and try it. Like every product that we put out, they try it first and they kind of go through.
I think with the KOLs and the other training that we have, you know, and some of the things that we're doing, kind of letting teenagers, preteens, and especially parents know of maybe alternatives with Invisalign and so on, this should fit into that product portfolio. I think you start with making sure doctors understand it, and they'll test it, and they'll see. Everything that we've seen so far, it's been well received.
Yeah, you obviously have some experience with selling it in Canada. I guess, how should we think about, like, the price point for that product? Is it going to be a much lower price point than Invisalign, typically, I'd imagine, or at least that's how.
It would be lower. I mean, it, you know, it'd be lower than a typical treatment. You remember, you're maybe only talking about 30 different, you know, kind of aligners or expanders that you need for this.
Less of a product, in terms of what you would normally need for full Invisalign treatment, but, and it's direct printed, too. From a cost standpoint, you could not have some of the other costs associated with the materials. You know, I mean, look, products that we put out, we want them to be margin, you know, neutral to accretive. In scale that we have, once we can scale things up, we know that, you know, we can produce things that help us from a margin standpoint. Like I said, this gets us more into some of the direct fab 3D printing, and that's a good thing. That's using our technology that, we're the only one who could come up with a product like this.
Yeah. Maybe moving over to DSP, I think there's been a lot of attention on that program because it's gotten pretty good traction out of the gates and is a, you know, unique alternative to, you know, the traditional cases that the dentists are used to. I guess, you know, how do we think about the growth opportunity? Is this something that, like, mainly appeals to the orthodontist community because they, you know, they're the ones that, you know, maybe need that flexibility to finish cases in a certain way or retention is maybe bigger for them. Do you feel like this is, you know, Do you, have you seen GPs kind of also, you know, sign up and use this, you know, program?
For those that don't know, the DSP is a Doctor Subscription Program, really, it was targeted to go initially after, like, high- volume orthos. Really what it is orthos that were using our comprehensive product to move, many cases, teenage products, teenage, you know, cases that they have, as well as adult, but it was really targeted for those high- volume orthos. What we found with some of those high- volume orthos, they, even though they were giving us the comprehensive cases, they weren't giving us kind of that low stage, either some of the retention or some of the low stage cases where they needed maybe just a few aligners to touch things up.
What they were doing is most likely printing them themselves or going to a lab just to print a few, three of these aligners. What we did is we went to these doctors and really targeted through segmentation, found out doctors that were maybe doing a lot of this. They now have a subscription program from us, where they pretty much sign up for a certain amount of aligners that they want for the year, and they use that, plus they still use the comprehensive product that they're using. Having this now allows them at a good price, but it's also margin, you know, neutral to accretive for us on the, on the per aligner, to be able to provide them products that they need.
In many cases, these doctors now are, they might need a couple sets of aligners to kind of straighten teeth. We actually see that in our subscription, because they're using this as good subscription, but those cases don't show up in our volume. That's the adjustment that we talked about making, and we'll have to make sure that that's clear, because some volume, for those that just look at volume in our business, is getting kind of absorbed by DSP or some of that subscription. The vast majority of the DSP is just falling through retention. This is incremental business that we wouldn't normally have. We've kind of started this in North America, and with the teams, they'll be expanding this out to other countries.
We find this is a good way for doctors to be able to use our products that they were using, but also use additional volume and meet their needs in terms of how they wanna use our products.
I think you said that you estimate that it shifted 10,000 cases or maybe slightly more than 10,000 cases that might have otherwise shown up as, like, traditional cases in the reported case volume number out of that and into the DSP program. I guess that would still mean that in terms of usage of DSP, it's a relatively small percentage of what the total DSP volume is, you know, maybe under 20% is used for these alternative to cases. The rest is.
Yeah, I would say the majority is retention. I would put it at, let's just say, 75%+ is done with retention and the rest. Some doctors that were using, you know, they used to buy an E5, a 5-stage product from us. Now, they don't need to. They just use it as part of their program. It's just a better way to sell to doctors. It helps expand. And look, DSP, where it shows up, it's obviously revenue for us. We get revenue on the shipment of, actually, of the aligners, so they're paying us on a monthly basis, but we recognize revenue as we ship. It shows up in our other revenue. When we look at our other revenue, which includes DSP plus retainers, commerce, and everything else, that other revenue in the first quarter was as high as that it's ever been.
More so than anything else, it's getting that incremental volume, and it's helping sell the way doctors wanna buy, and that should be kind of how we view things. It's really only been North America and really targeted to a few doctors. We'll expand it out. It doesn't say that you can't use it for some high-volume GPs, so we'll look at that as well. You really have to find that right profile. They do a lot of product with us, but then they're missing something in the, in the profile where they don't do as much retention or anything else. What we find is a lot of doctors are just scrapping their entire kind of that manufacturing that they're doing by themselves and using us.
We've dedicated lines to be able to have a fast turnaround and so on. When you think about it, doctors can focus in on the front end of their business and let the manufacturing and the operational piece come to us.
Makes sense. You know, the thing about the long-term model, you know, your long-term guidance is for revenue, and I think, you know, what you're talking about with DSP, maybe, you know, take some of the focus off of case volumes. You know, we think about that as, like, you're kind of more focused on just kind of driving overall revenue growth within that 20%-30%, and maybe less of a, you know, that historical model where, you know, the volume was the main driver and, you know, you didn't have these other pieces that exist today.
Yeah, look, when you look at our long-term model, it's not a volume model. It was revenue to start with. Yes, like, 20% - 30% is what we say from a revenue standpoint. I almost don't even put a top boundary on it, 'cause sometimes. It's not like I'm stopping growth to go above 30%.
20%+ is kind of how we look at it, 'cause there's many years that we were above 30%. It's revenue, that piece of it. What I'm highlighting here, and for all of you to know, is there's just a lot of different ways that you can generate revenue in this business. When it's as under-penetrated as it is, you're gonna get these opportunities. Like, we were talking about the rapid palatal expansion. That most likely won't show up in volume either. You know, it'll show up for sure in revenue, but it's a different volume number compared to, you know, what you would have for an Invisalign treatment.
Just like we sell millions of retainers every year, that doesn't show up in our volume either. We'll make sure we highlight kind of those differences and understand it, but when we think about the revenue opportunity, it's a massive market, and retainers are just as under-penetrated as everything else. You have the scanner and services business that we don't get volume either, b ut it shows up in our total revenue numbers.
Yeah. Maybe spend a couple of minutes on margins. I think I wanted to focus on the cadence between the first half and the second half, going from 19% EBIT margin to 21% in the back half. I guess, you know, if the business just kind of continues to see that stability, can you maybe talk us through, like, what drives the step-up in margins over the back half of this year?
I think as you look through this year, you get some, you know, you get some volume leverage as you go through. I mean, we are a flow-through business, so as you have, you know, more volume coming through, it helps us utilize our facilities more and more. Poland is a good example of that. As we utilize Poland, we put that in a year ago, and as we utilize that facility more and more, We drive more productivity, we'll see that continue in the back half. you know, and we have a lot of initiatives to be able to drive some of that productivity and that margin accretion. We talk about 20%+ for the year.
We've said that, you're right, first half 2019, we'll get some of that leverage and a full benefit of the price increase that we have. We have some mixed benefit in terms of what countries things come through and, you know, as we go into teen season and so on, and also some of the product mix. We introduced some products at the beginning of this year that help us from a revenue standpoint, one of them being the comprehensive product that we called the 3-in-3, which is three years of treatment with three additional refinements. From a product standpoint and a revenue recognition standpoint, we've recognized more revenue in a shorter period of time, that helps us from a price standpoint as well.
That's how we've called it, and, you know, we'll update things as we go through, you know, after the second quarter.
I guess, you know, with where you end the year, you know, there's typically been some seasonality in the margin. Do you feel like you can kind of continue to build off of those back half levels as we think about 2024 and beyond?
That's how we look at it. I mean, that's how I look at it. When I think about investing in the business, we're investing with our long-term growth model in our minds. We're thinking, you know, 20%+ revenue opportunities for all the things that we talked about with product and market opportunity and so on. That should be, you know, 25%+ from a profit standpoint, not margin standpoint. We're not always at that every quarter, and we know that, you know, during some of these challenging times with COVID and so on, you fall, you could fall below. Conversely, we've gone above, in 2021 and so on.
When we think about how we're exiting this year and how we're looking at things, the investments that we're making, the productivity that we drive, the products that we have, and so on, we want that to be sustainable. When we think about DSP, when we think about retainers, we think about, you know, the Rapid Palate Expander and so on, those are products that have, you know, as good or better gross margin than the products that they're either replacing or that we're supplementing. That's the right focus that we've had, and we think with the market opportunity, we've got that, you know, structure in place to be able to be at that margin rate.
How are you approaching sales and marketing? Obviously, you're gonna need to kind of, you know, promote and, you know, expand these products as they launch. It's also a, you know, more competitive market, and so I just, you know. Has the calculus on that front changed in your mind at all?
Look, I think you have, you know, a certain amount of go-to-market activities that you have, sales and marketing, to be able to continue to go direct, get your name, Invisalign, you know, as you're marketing to kids or parents, adults, and so on, to be able to provide that. You get leverage at certain points. I mean, you go live in a country, you kinda make that investment, but then it maybe takes a little bit before you actually start to generate sales and so on. We have an understanding of how to do this. We have an understanding that, you know, we've gone direct in most countries or the countries that we want to be in.
We want to be able to have that right go-to-market strategy to be able to help grow in those businesses. Fundamentally, when you look at every market that we're in, including the U.S., it's a wires and brackets business that we're in. After all these years, we've made a lot of progress, you know, 26 years, I guess, this year, in business, and, you know, we look at the opportunities are still in front of us. We've got a lot of technology that's coming, we've got a lot of go-to-market initiatives that we're bringing, but, you know, hopefully, as the economy continues to stabilize, it gives us the opportunity to grow.
Great. Well, we're just about out of time. Let's stop there. John, thanks very much. Really appreciate it.
Of course. Thank you.
Great. Thanks again.