Thesis: Short ALGN May 2016 Kyle McAndrews · 13/6/2016 · shedding market share and to start ......

May 2016, McAndrews

Thesis: Short ALGN May 2016 Kyle McAndrews

Summary Overview

Thesis: Short ALGN, consumer discretionary with limited upside, significant downside given premium valuation o Base Case Valuation of $45 (-43% from current) o Downside of $20 (-74%) o Upside of $86 (+8%) o Consensus of $74 (-6%)

Why Short? o Company has guided street expectations for organic sales growth in the 15-25% through 2020, which has commanded a significant valuation

premium today based on the company’s mix of size ($6B+ market cap), growth profile (nominally 15-25%), and profitability (Gross margins today >75%); my view is this guidance and consensus expectations are unsustainable and company poised to disappoint. Upon the miss, investors will recognize current trading levels are vastly above a reasonable DCF valuation and the stock will re-rate meaningfully lower

o Despite considerable noise/concern raised by investors about three of ALGN’s 384 patents expiring beginning 2017, evidence suggests technology is fundamentally less differentiated than otherwise represented; regardless of patent expiration, I expect ALGN to continue shedding market share and to start experience significant, increasing pricing pressure going forward

May 2016, McAndrews

One-Page Summary / Teaser: Short ALGN

Company Align Technology, Inc. (NASDAQ: ALGN) Direction: Short

Trading Information Market Capitalization: $6.4B Avg. Historical Trading Volume (shares): 750,000 Avg. Daily Trading Volume ($): $56M 1-yr Performance: +31%; Performance YTD: +20%

Valuation & Target Price Current Price (5/29/2016): $79.18 Current Valuation: ~4.7x 2017E Consensus Sales of ~$1,200M Target Price: $45 (~2.9x 2017E Sales of ~$950M) Downside: (43%)

Short Business Description Align Technology, Inc. (“ALGN,” the “Company”) was founded in March 1997. ALGN designs, manufactures and markets a system of clear aligner therapy as an aesthetically advantageous alternative to traditional wire-and-bracket braces used for orthodontia therapies, correcting patient malocclusions, etc. The appliance is sold directly to dental physicians, both General Practitioners and Orthodontists.

Product Value Proposition Invisalign costs physicians ~$1300 vs. ~$300 for wire & bracket appliance for a comparable orthodontic patient case. Patients pay physicians ~$3,000-5,000 for orthodontia therapy, and physicians exchange the lower profit margin per case for reduced patient chair time (5-10 minutes vs. 30-40 for metal wire & brackets), marketing pull-through, and increased patient volumes

Relevant Situational Background

The density of dentists/100K population in the United States has been rising and will continue to rise, raising competition

With physician growth outstripping patient demand growth, appointment wait times are down, “idle hands” of dentists are up, negating some of the appeal of Invisalign’s “reduced chair time, improved throughput” value proposition

On the demand side, ALGN has benefited from an extended economic bull market. Affordability is a very real concern among potential dental patients – dentistry is usually elective healthcare, insurance rarely if ever covers ‘cosmetic’ cases

On-going industry consolidation is leading to increasingly large, private-equity backed and sophisticated business partners achieving scale and greater negotiating leverage with dental suppliers and distributors, actively seeking cost controls

Investment Thesis ALGN’s IP advantage is steadily eroding, whether from impending patent expirations or the incremental competitive pressure from new market entrants. This is substantiated by persistent ASP declines, from a 2014 high of $1400 to ~$1250 in 1Q’16

Greater-than-expected market penetration of Ortho/GPs has led to reduced yield on physician training; patient referral relationship of GPs to Orthos will further discourage incremental adoption/penetration of remaining physician market

Sirona Cerec Ortho Software leveled aligner playing field, and “brand” awareness is not a sticky consumer factor

Rising overhead/expenses should meaningfully depress operating profit margins relative to past performance

Management’s highly litigious competitive streak and customer-gauging practices have cultivated a hotly competed market environment while encouraging customers to embrace substitute vendors as alternative technologies are presented

Catalyst Sales miss, stock-rerating from current elevated trading levels

Risks to ALGN Short Mitigating Factors

“The Bull Case”:

ALGN is the Market Leader…

Conversely, ALGN

…Has been steadily shedding market share for years, now representing 80% of the market and heading lower per management’s most recent admission

With nearly 700 patents and best-in-class technology… …analysis suggests many patents are non-commercial and the technology does not appear significantly advanced or differentiated from competitors

With ample runway to further penetrate physician markets domestically… …but the physician market opportunity is deceptive, already showing signs of curbing adoption rates, and higher penetration than on first glance

and nascent expansion beginning abroad… …and the international markets are likely higher cost, lower margin, and lower yielding than the heavily penetrated North American region

offering a superior alternative to metal wires & brackets with less chair time…

…but a worse margin proposition to physicians, as they’re experiencing lower wait times, slowing earnings power, and PE-backed industry consolidation

With a strong, shareholder friendly management team… …but now competing in an increasingly consolidated market with competitors explicitly and aggressively competing based on price, with significant downward momentum just beginning

Successful Defense of IP: ALGN wins existing lawsuits vs. Clear Correct, defense of IP could shutdown existing or potential competitive entrants

Mitigant: This is candidly hard to judge, but the sustained market share loss over the years (management estimates ALGN is now 80% of the clear aligner market) suggests competition is here to stay, and likely to continue gaining share. An area for further scrutiny

Existing Shareholder Put on Stock Price via Buybacks: Management has consistently converted 60%+ of FCF into stock buybacks and ASRs, effectively subsidizing the stock price and is an incremental headwind to a short position. Consensus FCF of ~$250-300M in the next few year adds to their ~$700 cash balance as of 1Q’2016 vs. $6.3B market cap

Mitigant: share buybacks have been limited to ~3% of total shares outstanding, and as the OUS business continues growing less of the cash will be accessible for share buybacks. Also, management acquired the iTero scanner business in 2014 and other usages of cash may reduce that spend in the future

Takeout Risk: Given the challenges of building a world-class distribution network, the IP and product portfolio would seem like a natural complement to the large-cap conglomerate medical device majors such as JNJ, MDT, or ABT, who could rapidly reduce duplicative overhead and accelerate growth through existing, well-established sales channels

Mitigant: Given ALGN’s extreme multiple premium is currently trading at relative to ABT, JNJ, MDT market caps, dilution is a strong deterrent. Likewise, the absence of dental exposure to the respective bidders’ portfolios limits synergy appeal, and two of those large-caps are currently digesting other sizable acquisitions (MDT with COV and Mazor; ABT with STJ, ALR), such a takeout seems unlikely

Why is ALGN a short trade now? Shorts have argued this name for years, and it’s marched higher for the past 5 years. Why is 2016 different?

Physician market penetration has dramatically reduced the ramp for continued growth, as demonstrated by declining training yields for incremental new docs

ASPs have now anniversaried YOY declines and the industry drivers (consumer demand, physician income) should continue to pressure them

May 2016, McAndrews

Table of Contents

I. Company Overview

a. About the company b. ALGN Value proposition to Customers c. ALGN Sales Drivers & Operating Statistics

i. ALGN Customers: Practicing Physician Mix ii. Product Portfolio iii. Geographies iv. Core Operating Expenses

1. Gross Margins and Capacity Expansion 2. Sales & Marketing Spend and Doctor Training 3. Research & Development

II. Dental Market Overview a. Orthodontic Patient Market Sizing b. Physician Market Sizing c. Major United States Dentistry Market Trends

i. Trend #1: The density of dentists in the United States population has been rising and will continue to rise ii. Trend #2: Appointment wait times are down, “idle hands” of dentists are up, negating some of the appeal of Invisalign’s “reduced

chair time, improved throughput” value proposition iii. Trend #3: On the demand side, ALGN has benefited from an extended economic bull market. Affordability is a very real concern

among potential dental patients – dentistry is usually elective healthcare iv. Trend #4: On-going industry consolidation is leading to increasingly large, private-equity backed and sophisticated business

partners achieving scale and greater negotiating leverage with dental suppliers and distributors d. OUS Dentistry Market

III. Short Thesis, Company Performance a. Issue #1: ALGN’s IP advantage is steadily eroding, whether from impending patent expirations or the incremental competitive pressure from

new market entrants i. Competition Side-by-Side ii. Competitive environment and pricing iii. Historical ALGN ASP by Product and Physician Channel

b. Issue #2: Greater-than-expected market penetration Ortho/GPs leading to reduced yield on training and referral relationship of GPs to Orthos i. Complexity of orthodontia not to be underestimated – most patients need to be referred, treatment is not within realm of GPs’

abilities ii. GP Comfort in-housing orthodontia is relatively low iii. Company Performance: Beginning to show the cracks

1. Growth Driver: Docs Shipped To Growth 2. Growth Driver: Yield on Training 3. Growth Driver: Case/Doctor Utilization Rates

c. Issue #3: Sirona Cerec Ortho Software leveled software playing field, and “brand” awareness is not a sticky consumer factor d. Issue #4: Rising overhead/expenses e. Issue #5: Assessment of Management is Mixed, and Attention may be preoccupied

IV. Risks to the Thesis & Mitigating Factors V. Model & Valuation

a. Driver Overview – Major Drivers of the Operating Model b. Scenario Assumption Summary

i. Base Case: DCF Valuation of $43/share (-43%) ii. Downside Case: DCF Valuation of $18/share (-75%) iii. Upside Case: DCF Valuation of $86/share (+14%) iv. Consensus Case: DCF Valuation of $74/share (-1%)

c. Historical Multiple Valuation i. EV/NTM EBITDA and EV/NTM Sales, last 10 years ii. EV/FY+1 EBITDA and EV/ FY+1 Sales, last 10 years

d. Short Interest e. Major Stock Holders

VI. Remaining Questions – Areas for Further Scrutiny VII. Appendix

a. Operating, Financial, and DCF Outputs i. Base Case ii. Downside Case iii. Upside Case

b. Detailed Product Line Descriptions (source: 2015 10-K) c. Relevant Reading

May 2016, McAndrews

Part I: Company Overview About the Company:

Align Technology, Inc (NASDAQ: ALGN, “ALGN,” the “Company”) was founded in March 1997 and incorporated in Delaware in April 1997

Business Model: From 10-K: “Company designs, manufactures and markets a system of clear aligner therapy”

Company has 2 core business segments, Clear Aligners and CAD/CAM Scanners: o Clear Aligners

FY2015 Sales of $800M (95% of total), 78.5% Gross Margin ALGN designs, manufactures and markets a system of clear aligner

therapy as a value-enhanced, advanced technology alternative to traditional wire-and-bracket braces used for orthodontia therapies, correcting patient malocclusions, etc.

A “malocclusion” is a misalignment or incorrect relation between the teeth of the two dental arches when they approach each other as the jaws close

o CAD/CAM Scanners: FY2015 Sales of $45M (5% of total), 26.3% Gross Margin, moving to 45-

50% range with new iTero Element scanner Intra-oral scanners and CAD/CAM (computer-aided design and computer-

aided manufacturing) digital services used in dentistry, orthodontics, and dental records storage

Company protects its IP through 384 U.S. patents, 276 foreign issued patents, and 236 pending global patent applications.as of 12/31/2015

o Several patents begin to roll off beginning 2017 ALGN Value proposit ion to Customers: From ALGN 10-K, on Malocclusion and Traditional Orthodontic Treatment:

“In the U.S., orthodontists and GPs treat malocclusion primarily with metal arch wires and brackets, referred to as braces, and augment braces with elastics, metal bands, headgear and other ancillary devices as needed. Available options for improving treatment aesthetics include the use of ceramic, tooth-colored brackets or bonding brackets on the inside, or lingual surface, of the patient’s teeth. The average treatment takes approximately 12 to 24 months to complete and requires several hours of direct dental professional involvement, known in the industry as “chair time,” including the initial diagnosis, creation of an appropriate treatment plan and bonding of the brackets to the patient’s teeth, and attachment of arch wires to the brackets. Subsequent visits involve tightening or otherwise adjusting the braces approximately every six weeks until the final visit when the dental professional removes each bracket and residual bonding agent from the patient’s teeth. Upon completion of the treatment, the dental professional may, at his or her discretion, have the patient use a retainer.” -page 4, FY2015 10-K

To Physicians: o Time saver, Improved Throughput: with a simple, one-time oral scan, the physician is able to develop non-invasive schedule of aligners for

as many months as necessary (often 9-12 months or more), leading to fewer check-up visits and with less intensive or involved treatments, without wire/bracket cleaning and manual adjustments each regularly scheduled visit

Patient time in chair is reduced from ~30-40 minute (metal wires & brackets) to 5-10 minutes (clear aligners)

o Increased Patient Volume: In a similar fashion to the Stryker MAKO robotic orthopedic platform, which physicians can present as “latest, cutting edge technology,” or a “enhanced robotic solution superior to older, analogue methods”. Physician advertising to Patient pull-through from Direct To Consumer advertising prompting patients to respond positively to “latest technology” practice offerings

o Trade: Volume for Margins: While wire & bracket treatment typically costs physician ~$300-500 (~90% profit margin for practice), the Invisalign system is typically priced ~$1200 per case, with volume-discounts dropping ASPs as low as ~$700 once hurdles are cleared

To Patients: o Meaningful aesthetic advantage vs. wires & bracket o Faster office visits, less time spent in chair receiving adjustments to in-mouth appliance o Pricing is generally consistent vs. wire & brackets, $3,000-5,000 for treatment

ALGN Sales Drivers & Operat ing Stat ist ics In the midst of the company’s extensive reporting of various operating statistics, it’s important to remember the following:

ALGN % Sales Growth = (1+%Δ# of Doctors Shipped to (“Physician Market Penetration”))*(1+%Δ# of cases shipped per doctor (“Utilization Rate”))*(1+%ΔASP per Case) - 1 Put another way, for ALGN to grow topline, it must

increase the number of physicians performing the Invisalign procedure, or

increase the number of cases performed by each physician, or

increase the ASP of its product lines More detailed evaluation of some critical performance trends will be discussed later, but first let’s highlight the critical features of each driver:

Operating & Financial Statistics

FY2015 Sales

Case Revenue $749

Non-Case Revenue $51

Aligner $800

Scanners+CAD/CAM $45

ALGN Sales $845

% Total, Aligner 94.6%

% Total, Scanners+CAD/CAM 5.4%

Aligner Gross Margin 78.5%

Scanners+CAD/CAM Gross Margin 26.3%

ALGN EBITDA $202

ALGN EPS $1.71

2016E Consensus Statistics

ALGN Sales $1,035

ALGN EBITDA $251

ALGN EPS $2.16

2017E Consensus Statistics

ALGN Sales $1,210

ALGN EBITDA $314

ALGN EPS $2.77

Capitalization

5/27/2016 Price $79

FDSO 81.3

Market Capitalization ($M) $6,421

Net Cash (680.8)

Total Enterprise Value $5,741

TEV / 2016E Sales 5.5x

TEV / 2017E Sales 4.7x

TEV / 2016E EBITDA 22.8x

TEV / 2017E EBITDA 18.3x

Price / 2016E EPS 36.6x

Price / 2017E EPS 28.5x

Org. Growth Sales Guidance 15-25% thru 2020

May 2016, McAndrews

ALGN CUSTOMERS: PRACTICING PHYSICIAN MIX

General Practitioners o Estimated ~140,000 in North America, credentials based on completing dental school (no incremental training/schooling required) o Representing the vast majority of practicing dental physicians, they handle most primary care for patients, typically refer patients out to

relevant specialist (orthodontist, endodontist, periodontist, etc.) o Not entirely clear what fraction of patients experience malocclusion requiring orthodontia therapy o Schooling Required: undergraduate bachelor’s degree (typically four years), passage of the Dental Admission Test (“DAT”), followed by four

years of academic dental school, similar to medical school, passage of Board exams, and then some fraction may pursue a 1-2 year residency prior to commencing practicing

Orthodontists o Approximately ~12,000 in North America, drive the majority of the volume for malocclusion therapies, which represent 100% of their cases o Management estimates ~6.8M annually elect treatment by orthodontists worldwide, of which ~2.6M (or ~40%) have a mild to moderate

condition which can be treated by one of the ALGN products o Industry figures suggest Orthodontists can see as many as 250-350 cases per year, vs. the present ~25 ALGN cases/year suggesting only

10% market penetration . That said – ALGN has acknowledged their product portfolio only address ~60% of malocclusion cases, so the current ceiling is closer to ~180 cases/year

o Schooling Required: most programs involve an additional 3 years of graduate schooling with the option of subsequently passing the voluntary American Board of Orthodontics Certification exam. Requirements for state licenses to practice vary but typically require passage of a the prerequisite schooling, an exam, and continued education to maintain certification

PRODUCT PORTFOLIO

ALGN offers a suite of products that has expanded and diversified over time o Full (~65% of cases in FY2015): “used for a wide range of malocclusion,” includes unlimited aligner sets to fully treat o Express (10 & 5) / Lite (i7) (15%): lower-cost solutions with a reduced number of aligners o Teen (15%): includes Full features, plus other teen-specific needs such as “compliance indicators” (plastic coloring-over-time proves a teen’s

plan compliance & usage marker), additional replacement aligners (for lost cases), etc. o Assist (5%): Primarily marketed towards GPs, allows submission of new impression scans every nine stages

202.9 212.1 220.6 260.8

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2007-2015 Cases by Channel (000s)

NA Ortho NA GP Dentists International

07-'15 CAGR

NA Ortho 14.4%

NA GP Dentists 7.7%

International 26.6%

Total Cases 14.1%

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2011-2015 # of Doctors Shipped to, By Channel (000s)


11-'15 CAGR

NA Ortho 6.3%

NA GP Dentists 9.6%

International 21.2%

Total Docs Shipped to 12.4%

21.9 24.2

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International Total Utilization Rate

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2007-2015 Cases Shipped by Product (000s)

Invisalign Full Invisalign Express/Lite

Invisalign Teen Invisalign Assist

07-'15 CAGR

Invisalign Full 10.2%

Invisalign Express/Lite 15.9%

Invisalign Teen (since '09) 22.1%

Invisalign Assist (since '09) 24.0%

Total 14.1%

64%

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FY2015 Cases Mix by Product Line

Invisalign Full Invisalign Express/Lite

Invisalign Teen Invisalign Assist

May 2016, McAndrews

GEOGRAPHIES

As of 2010, only ~20% of ALGN sales were from Outside the United States (“OUS”), with the vast majority of the business focused on the states. Today, as of FY2015, OUS contribution includes:

o 30% of $ Sales o 35% of Doctors Shipped To o 32% of Cases

Major international market expansion began with EMEA and Japan – Japan just celebrating their 10 year anniversary

Further, the Company has substantially invested abroad to support the growing operations, including India (Mumbai, New Delhi, Pune) and South Korea in 2015, Japan, and 2016 China launch focusing on Beijing and Shanghai

In 2015, company spent ~$55M on capital expenditure (vs. ~$20-25M historically), most of which was incurred by the acquisition of a second manufacturing facility in Juarez, Mexico, which began manufacturing additional aligners in September 2015. After ~$70M of spend in 2016, consensus estimates for capex is in the ~$50M range for 2017-2018

CORE OPERATING EXPENSES

Gross Margins and Capacity Expansion: have been generally steady for the company. There is a meaningful difference between the aligners (75%+) and CAD/CAM scanners (25%) segments, but both margins have largely remained unchanged for several years

o Notably, Clear Aligner margins, after hitting a peak of 79.9% in 3Q’2013, have steadily marched lower o Also, the next-generation CAD/CAM gross margins are around 45-50% per mgmt. guidance, which can be seen in the step-up in the 1Q’2016

quarter (and is consistent with go-forward expectations)

Sales & Marketing Spend and Doctor Training: ALGN breaks out their S&M separately on the P&L, and has already detailed its training schedule by physician channel each quarter – as summarized below

o The $S&M Spend vs. Doctors Trained tracks very closely with the S&M %Sales margin, and seems like the appropriate measure to gauge the budget. Since September 2014, that $/training has been increasing, with a YOY growth creeping higher through the past 18 months

o Also worth noting, the International fraction of Doctors Trained has been near or exceeded 50% of the global total dating back to 2011 – and clearly remains a priority to drive company growth on a go-forward basis

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2010-2015 Gross Margin by Product

Clear Aligners Overall ALGN Scanners/CADCAM

HEADQUARTERS

MANUFACTURING

R&D CENTERS

TREATMENT PLANNING

May 2016, McAndrews

It’s worth highlighting: notice that going back to mid-2015, the Sales & Marketing spend began steadily marching higher, and 2-year stacked growth rates moved decidedly higher – I expect that trend to continue going forward due to the international focus going forward and other reasons highlighted later in the write-up.

Research & Development: R&D investments have developed and refined the aligner product portfolio over the past 20 years, with ALGN most recently spending approximately ~$340M in R&D from FY2007-2015

o During that time, R&D as % of Sales has ranged from 6-10% of Sales as the Company’s topline has grown from ~$375 to $850M in same period

o Despite the considerable spend, and management’s argument of “highly differentiated technology,” ALGN’s R&D spend seems conspicuously low

o Consider some of the large-cap Cardiovascular Majors (MDT, BSX, STJ), or some of the single-product, high-tech names (ISRG, EW, ABMD, ZLTQ) with a one-of-a-kind device. These peers have some differences, but the R&D as % of Sales are relatively consistent, with some disparities given the relative size of the some of the companies affording difference of scale

E.g. MDT spending the least at 11%, given their considerable scale advantage vs. the other three Notably, ALL of them have higher R&D as % of sales (11% or greater, more than ALGN ever spent from 2007-2015)

o On the other end of the spectrum, a variety of lower-end, more commoditized medical supplies company (TFX, BCR, BDX, BAX) offer product portfolios of value-additive, but lower margin consumable and reusable equipment. Here, the Gross Margin/R&D Spend ratio is several turns higher (7-8x+) but that clear relationship persists

o Looking at this relationship, ALGN appears to be achieving superior margins on some other basis rather than R&D – specifically, I’d argue, an absence of meaningful competition in the marketplace, which will be changing at an only-accelerating pace in the future

Equally importantly, I don’t expect that R&D spend to defend those gross margins going forward o It would make sense that there should be some sort of consistent ratio between Gross Margin (indicative of the relative complexity and

premium quality of product portfolio) and the annual R&D spend, and that ratio should vary by the complexity and long-lived differentiation of the value-additive device

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2007-2016 Doctors Trained by Channel, Region


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2-year Growth Stack S&M Spend per Doc Trained YOY Growth

May 2016, McAndrews

ALGN’s 10.5x ratio is pretty steep. The average for the 11 companies listed is 8.0x, or 6.9x if you exclude Teleflex, which has purchased more of its product portfolio than invested in R&D and developed internally. Notably, if you were to take ALGN’s 2012-2015 average R&D % Sales rate of 7.1%, multiply that by the peer set 7-8x range, it implies an ALGN Gross Margin range of 50-57% vs. 2015 rate of 75%.

FY2015 R&D as % Sales, Gross Margins

Large-Cap Cardio (Hi-Tech) Single-Product Med-Tech (Hi-Tech) Large-Cap Medical Supplies (Low-Tech)

Ticker ALGN MDT BSX STJ Average ABMD EW ISRG ZLTQ Average TFX BCR BDX BAX Average

Market Cap $6B $113B $30B $22B $4B $21B $24B $1B $6B $16B $35B $25B

GM/R&D Ratio 10.5x 6.6x 6.3x 5.7x 6.2x 5.3x 4.9x 8.0x 7.9x 6.5x 18.3x 8.8x 8.4x 7.3x 8.2x

R&D %Sales 7.2% 11.0% 11.4% 12.2% 11.5% 15.6% 15.4% 8.3% 9.0% 10.9% 2.9% 7.4% 6.2% 5.9% 6.5%

Gross Margin 75.7% 72.4% 72.0% 69.9% 71.4% 83.3% 75.2% 66.2% 70.9% 70.8% 52.7% 65.3% 52.0% 43.3% 53.5%

Actual R&D Spend ($M) $61 $1,640 $850 $674 $1,055 $36 $383 $197 $23 $201 $52 $253 $634 $589 $492

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ALGN R&D Spend vs. % Sales, 2007-2015

R&D Spend R&D % Sales

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May 2016, McAndrews

Part II: Dental Market Overview Market Segment Product Manufacturers Wholesale Distributors Dental Practices &

Physicians Patients

Description *Mix of large scale, diversified vendors and single-product manufacturers that design, produce, and market dental supplies, technology, and equipment *Manufacturers may rely on internal sales forces or third-party distributors to market goods to end-user physicians depending on market (US vs. OUS)

*Large, mature, consolidated, well-established market leaders. They provide distribution between the manufacturers and widely diffuse dental practices consuming the products *Top 3 companies have consistently dominated ~85% of the market for many years

Includes general practitioners, orthodontists, endontists, etc. Past decade, cost-conscious private equity firms acquiring and rapidly consolidating individual practices into Dental Service Organizations (“DSO”) Dental school graduation rates have led to steady increase in Dentists per Population (“DPP”) recently

Broad, diverse country population Patient care sought on a local mix of self-pay, private and public insurance coverages Affordable Care Act (“ACA”) didn’t significantly change picture, given many practices deliberately avoid low margin, public-coverage patients

Example Companies Aligners, single-product: ALGN, ClearCorrect Suppliers, Equipment: Sirona, Dentsply (manufacturer of MTM Clear Aligner), Danaher, Zimmer, MDT, 3M

1. Henry Schein (NASDAQ: HSIC, 35-40% market share) 2. Patterson Co. (PDCO, 35%) 3. Benco (private, 10%)

Birner Dental Management Services (Nasdaq: BDMS), the parent company of Perfect Teeth-branded dental offices; JLL’s “American Dental Partners”, Welsh Carson “Smile Brands,” HIG Capital’s “InterDent”

n.a.

Sustainable Competitive Advantages?

Some, depending on IP or operating scale which helps manufacturing costs and negotiating with counterparties

Definitely! Market leaders command sizable share, relatively stable market share, and strong, well-protected operating margins

Some. Certification requires 4-7 years of graduate school, depending on specialization; DSO EBITDA margins are ~15%

No/n.a. >1 million patients/customers >1 million practitioners

Examples of Barriers to Entry?

Single product: Predicated on intellectual property protecting differentiated technology S&E: large-scale, lowest cost production advantages

Operating scale including national & international footprint, scale advantages with facilities and logistics, fragmented customer base

Education requirement n.a.

Recent Trends & Competitive Pressure

Industry Consolidation with Dentsply-Sirona (XRAY-SIRO) merger

Multiple class action lawsuits recently accusing “Big 3” of anti-competitive/antitrust collusion to keep prices elevated; site above-average dental vs. non-dental distributors margins

Significant sponsor-led consolidation

US: ACA shifted coverage base OUS: growing middle class in emerging markets may have expanded overall patients demand dental care

Orthodontic Patient Market Sizing Medical Device Metal Wires & Brackets Clear Plastic Aligners

Total # of Orthodontic Patients Worldwide ~6.8M ~6.8M

Fraction of Patients Treatable with Appliance ~6.8M (100%) ~2.6M (40%)

ASP $ paid by physician performing procedure ~$400 ~$1,300

Price Paid by Patient for Appliance $3,000 $3,000

Implied Dental Practice Gross Margin ~87% ~66%

Total Addressable Market ($ Sales, WW) $2.7B (6.8M x $400) $3.4B (2.6M * $1,300)

ALGN FY2015 Clear Aligner Sales $800M

Implied ALGN Market Penetration ~25% At the 3/14/2016 Roth Growth Conference, management remarked the following:

“Basically, our technology allows us to do about 50% of the malocclusions that are out there today. There's about arguably between 8 million and 9 million case starts a year. When you look at our mix, about 75% of what we sell is adults, 25% is teens, but the growth rates are about the same of both of those areas right now. We obviously have, from a utilization standpoint, a much bigger opportunity on the teen side because about 75% of the market is teen and 25% is adult.”

Regarding Teen/Adult split, speaking with experts and the management team suggests Invisalign adoption among Teen’s is unlikely to be a major growth driver from a demographic perspective:

The parents of Teen patients see a couple downsides vs. wire & brackets: o Teen patient compliance: the prospect of babysitting a children’s aligner usage (vs. wire & brackets which have a 24-hour/100% compliance

rate by virtue of the installation) as “just another battle for the parents to fight”. This headache is daunting for a parent o Invisalign patients’ office visits, while far quicker (5-10 minutes vs. 30-40 minutes) require more office visits (perhaps every 2-4 weeks rather

than ever 4-8 weeks for wire & brackets). That’s twice as many car trips shuttling the child for an already-busy adolescent’s schedule

There’s typically little to zero price advantage for Invisalign vs. wire & bracket technology – ALGN is not a cheaper alternative

On compliance, dental/clinical argument that using Invisalign is fine if compliance is adequate to maintain constant improvement of the teeth moving towards correction. The treatment gets much more complicated, or risk of much worse consequences, if spotty compliance moves to “forward and back” teeth movement

Physician Market Sizing UNITED STATES ORTHODONTISTS AND GENERAL PRACTITIONERS

May 2016, McAndrews

High Level: Invisalign’s product launch first concentrated on training and cultivating the North American Orthodontist physician market, given the vast majority of malocclusion cases are treated in that setting. General Practitioner’s confidence with diagnosing and treating malocclusion can vary, while more of their practice is related to regular check-ups, teeth cleaning, etc. and then referring patient flow to the relevant specialist as patient needs demand. Notably, with ALGN’s focus on the NA Ortho base, they’re already shipping cases to more than 60% of the market as they aggressively sought out and trained the physician base which treats the vast majority of malocclusion patients

Note: Data as of 2015 or latest available. Sources: American Dental Association, U.S. Bureau of Labor Statistics, World Health Organization, Company reporting. Major United States Dentistry Market Trends ALGN has scoured the easy wins, and trends are undermining future prospects:

1. The Dentists / Population of the United States has been rising and is anticipated to continue rising going forward due to: o graduation rates o delayed retirements o formerly inactive dentists returning to the work force

2. Those expanding pool has a flow-through effect: patient wait times are down, dentists increasingly characterize themselves as “not busy enough” o As a result, the crucial value proposition of Invisalign, as a “time-saver”, volume-for-margin exchange – begins to lose its appeal

3. The passage of the Affordable Care Act as it related to dental coverage was likely a non-factor, and orthodontia and dental coverage generally is concentrated in the higher-earning segments of the US population

o Affordability is a very real concern 4. On-going industry consolidation is leading to increasingly large, private-equity backed sponsors and sophisticated business partners achieving scale and

greater negotiating leverage with dental suppliers and distributors Let’s examine each of these in greater detail. TREND #1: THE DENSITY OF DENTISTS IN THE UNITED STATES POPULATION HAS BEEN RISING AND WILL CONTINUE RISE Dentist Density (defined as Dentists / 100K population) is steadily increasing, driven by numerous factors

From 2001 to 2013, the average retirement age for dentists steadily increased from 65 to 69 years old, while the # of annual US dental school graduates rose from ~4,500 to >5,000 each year during the same period

As a result of these trends, the American Dental Association observed the # of dentists per 100K population, United States, has risen from ~59 per 100K in 2003 to 62 in 2013 – and expects that to exceed 63 over the next decade; the Inflow/Outflow disparity on the right highlights this imbalance

Global Ortho Physician Market Sizing and ALGN Penetration

# Count % Total

Total Addressable Physician Market

North American ("NA") GPs 154,719 43.6%

NA Orthos 10,539 3.0%

International Dentists 190,000 53.5%

Dentists Treating Malocclusions 355,258 100.0%

# Doctors ALGN Shipped Cases To

NA GPs 24,973 51.8%

NA Orthos 6,737 14.0%

International Dentists 16,460 34.2%

Dentists Treating Malocclusions 48,170 100.0%

Implied ALGN Physician Penetration

NA GPs 16.1%

NA Orthos 63.9%

International Dentists 8.7%

Dentists Treating Malocclusions 13.6%

16.1%

63.9%

83.9%

36.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

General Practice Orthodontics and DentofacialOrthopedics

ALGN Physician Penetration by US Practice Channel

Docs ALGN Shipped To Remaining NA Physicians

154,719

10,539

41,003

2015 US Dental Physician By Practice - 195,722 Total

(per American Dental Association)

General Practice

Orthodontics andDentofacialOrthopedics

Other (of 195K total)

May 2016, McAndrews

ADA’s “Base Line” case Assumes (a.) U.S. total annual dental school graduates will increase linearly to 2018 and then remain flat (b.) future outflow rates are same as 2008-2013 historical percentages. Source, Figures 1-5 just prior: “Supply of Dentists in the United States is Likely to Grow”; Authors: Bradley Munson, B.A.; Marko Vujicic, Ph.D. “; published October 2014; ADA; link: http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1014_1.ashx TREND #2: APPOINTMENT WAIT TIMES ARE DOWN, “IDLE HANDS” OF DENTISTS ARE UP, NEGATING SOME OF THE APPEAL OF INVISALIGN’S “REDUCED CHAIR TIME, IMPROVED

THROUGHPUT” VALUE PROPOSITION As the dentist density rises, outpacing demand, dentist satisfaction has been decreasing, as has the doctors’ take-home pay. Since 2005, these issues have worsened, and would be expected to undermine the relative appeal of Invisalign technology relative to lower-cost competitors or metal wire & bracket substitute appliances.

Average Waiting Times are declining, and the fraction of dentists feeling “not busy enough” is steadily rising in tandem:

Over the past 10 years, earnings have likewise shrunk, and margins at the practices are likely being compressed:

http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1014_1.ashx

May 2016, McAndrews

Source, Figures 1-4 just prior: “General Practitioner Dentist Earnings Down Slightly in 2014”; Authors: Bradley Munson, B.A.; Marko Vujicic, Ph.D.; published March 2016 ; ADA; link: http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1215_1.pdf?la=en TREND #3: ON THE DEMAND SIDE, ALGN HAS BENEFITED FROM AN EXTENDED ECONOMIC BULL MARKET. AFFORDABILITY IS A VERY REAL CONCERN AMONG POTENTIAL

DENTAL PATIENTS – DENTISTRY IS USUALLY ELECTIVE HEALTHCARE. High level: the passage of the Affordable Care Act was likely a non-factor, and dental coverage generally is concentrated in the higher-earning segments of the US population. Rather, over the past 5 years, steady improvement in the economy, particularly the decline in unemployment, increased commercial medical & dental insurance coverage, and expanded access to other subsidized benefits such as Flexible Spending Plans, maximizing affordability for consumers during this period

While there are numerous contributing factors to the stock’s meteoric rise over the past decade beyond the revitalization of the US consumer, I think it’s fair to characterize this elective medical device a Consumer Discretionary business, offering an aesthetically-advantageous, clinically comparable alternative at a high price point ($3,000-$8,000 per the company website)

Note: “EHUPUS INDEX” reflects the US unemployment rate, “CONSSENT INDEX” represents Michigan Consumer Sentiment Index, and “ALGN US EQUITY” is the Align Technologies stock price.

The Affordable Care Act did not likely materially affect the overall demand base for clear aligner treatment. From the ADA:

“Due to the Affordable Care Act (ACA), over 8 million adults could gain Medicaid dental benefits in 2014. Through 2018, up to 9 million children could gain dental benefits through Medicaid, their parents’ employer health insurance policies or though the health insurance marketplaces. These coverage expansions are likely to lead to increased demand for dental care. However, low reimbursement rates and burdensome administrative processes in Medicaid could potentially dissuade dental providers from participating in Medicaid programs, which may reverse the gains made by low-income children over the last decade and further increase access barriers for low-income adults.”

Generally, usage rates have been decreasing for the largest portion of the population (19-64 year olds), while the elderly and youth have been ticking higher over the past 10 years; the second bar chart highlights the same phenomenon, with more granular age groupings

http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1215_1.pdf?la=en

http://www.invisalign.com/cost

May 2016, McAndrews

Across all age groups, however, there is a clear and strong relationship between utilization and income level. For reference, the 2016 Federal Poverty Level for a family of one is $11,770, so the FPL 400%+ reflects income in excess of $47,080 or $97,000 for a family of 4. The decline in the 19-65 year old age bracket is clearly visible as well

Insurance type is likewise a clear predictor of dental patient participation. Generally this makes sense – employment and commercial dental insurance prompts greater usage, and Medicaid insurance coverage leads to sharply lower usage rates as far fewer practices are willing to accept the lower margin reimbursement

o Among minors, public (Medicaid) insurance coverage prompts some incremental usage above uninsured/self-pay dental activity o In the “working age” 19-64 year old bracket, there is minimal difference between Public and Uninsured activity; older than 65, the uptick in

“uninsured” is related to Medicare contribution

A note on the baskets per the ADA: “Public dental benefits include those provided through Medicaid or State Children’s Health Insurance Programs (SCHIP). Because pediatric dental services are a mandated benefit, children enrolled in these programs were defined as having comprehensive dental benefits. Medicaid coverage of dental benefits for adults is optional and varies considerably by state. MEPS does not allow us to identify the state of residence, however. Thus, we simply identify adults covered by Medicaid as publicly insured even though the majority will have either no dental benefits at all or very limited benefits. Because Medicare does not provide dental benefits, persons who only had Medicare coverage were considered uninsured for dental care.”

May 2016, McAndrews

Source, Figures 1-8 just prior: “Dental Care Utilization Rate Highest Ever among Children, Continues to Decline among Working-Age Adults”; Authors: Kamyar Nasseh, Ph.D.; Marko Vujicic, Ph.D.; published October 2014; ADA; link: http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1014_4.ashx

As the insurance coverage disparity might suggest, affordability is a significant consideration for patients considering potential dental usage: o Single greatest challenge for patients not obtaining needed Dental Care is cost

And those headwinds are a much greater challenge than availability issues, suggesting there’s plenty of dentists out there, but most are out of the relevant price range

Source, Figure 1-4 just prior: “Most Important Barriers to Dental Care Are Financial, Not Supply Related”; Authors: Thomas Wall, M.A., M.B.A.; Kamyar Nasseh, Ph.D.; Marko Vujicic, Ph.D.; published October 2014; ADA; link: http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1014_2.ashx

Lastly, would highlight dental spending trends vs. other healthcare spending, specifically the recent cooling off. While the broader healthcare spending has maintained healthy growth rates since 1990, there is a clear fall-off and stagnation in dental spending, particularly in the last 10 years. In



May 2016, McAndrews

the current environment, with decreased participation in the core “working age” demographic and with overall spending flat-lining, I would expect practices and physicians to be increasingly cost-conscious and actively encouraging price competition among their vendors

Source, Figures 1-3 just prior: “U.S. Dental Spending Continues to Be Flat”; Authors: Thomas Wall, M.B.A.; Marko Vujicic, Ph.D.; published December 2015; ADA; link: http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_1215_2.pdf?la=en TREND #4: ON-GOING INDUSTRY CONSOLIDATION IS LEADING TO INCREASINGLY LARGE, PRIVATE-EQUITY BACKED AND SOPHISTICATED BUSINESS PARTNERS ACHIEVING

SCALE AND GREATER NEGOTIATING LEVERAGE WITH DENTAL SUPPLIERS AND DISTRIBUTORS

Highly fragmented, ongoing consolidation via private-equity backed DSOs (“Dental Support Organizations”). Examples DSOs: o “Heartland Dental, Aspen Dental, Great Expressions Dental Centers, and Pacific Dental Services” o “Birner Dental Management Services (Nasdaq: BDMS). Birner, the parent company of Perfect Teeth-branded dental offices” o “In 2011, private equity firm JLL Partners purchased American Dental Partners -- a Nasdaq-traded DSO -- for $392 million” o Source: http://www.drbicuspid.com/index.aspx?sec=ser&sub=def&pag=dis&ItemID=318109

Consequence: reduced overhead vs. standalone/independent/private practices and institutional pressure to drive profits increases competition, drives down margins, increases pricing pressure

o Likewise – as these practices clump together, the easiest sales & marketing trainings have likely been achieved as priority low-hanging fruit; the remaining untrained market is likely the lower volume, more diffuse practice coverages which will be lower return-on-effort from a sales & marketing perspective – suggesting Sales & Marketing $ Spend / Doctor Train should increase and remain elevated (will revisit shortly)

o Between 2002 and 2012, ADA research highlighted noted uptick in the shift in total receipts collected by firms with >10 employees (43% > 48%), as well as firms with 500+ employees (a 3x increase during the same period)


http://www.drbicuspid.com/index.aspx?sec=ser&sub=def&pag=dis&ItemID=318109

May 2016, McAndrews

o While there is evidence of a distinct increase in the # of larger organizations, those remain in the minority and there remains plenty of runway for continued consolidation nation-wide

Source, Figures 1-4 just prior: “Very Large Dental Practices Seeing Significant Growth in Market Share”; Authors: Thomas Wall, M.A., M.B.A.; Albert H. Guay, D.M.D.; published August 2015; ADA; link: http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_0815_2.ashx

As margin constraints and competitive pressure mounts, companies are shifting onto the offensive: o Evolution Dental is a dental laboratory that works with medical device companies and provides practitioners with on-site education and training

for new devices o Evolution Dental filed class action lawsuit as plaintiff, suing the “Big 3” dental distributors (Henry Schein, Patterson Co., Benco) for treble

damages for anti-competitive/antitrust price collusion, leading to artificially elevated medical supply and equipment pricing o Source: http://orthopundit.com/wp-content/uploads/2016/02/Evolution-Dental-Science-Complaint.pdf ;

http://www.bizjournals.com/buffalo/news/2015/08/19/israeli-dental-firm-partners-with-noris-medical-on.html

Consolidation exists on the medical devices side also: September 2015, Sirona (SIRO) and Dentsply (XRAY) announced their own $13B+ merger agreement, further competition/consolidation should force practices to look elsewhere for savings

o As each of the major channels in the value chain consolidate, gain scale, and specialize, standalone operators should be expected to suffer increased pressure and reduced negotiating leverage

OUS DENTISTS Internationally, there is less clarity around the size and density of dentists in other countries, although none are remotely near the same scale of the United States. Below I’ve summarized the top 20 countries by GDP, including their GDP/Capita and the most recent estimates of physician density, or # of Dentists per 100K population. Among those 20 largest countries, only Iran does not have its own customized, invisalign.com web portal including “find a doc”. To leverage those web-portals, that would require Invisalign dramatically increasing its DTC spend which will now be targeting much-less-concentrated audiences going forward, having saturated the US market. These trends point to worsening S&M economics going forward.

Sources: 2015 IMF GDP and per-capita estimates, World Health Organization, Company disclosures.

Rank Country GDP, $B % Top 20 GDP GDP/Capita Dentists/100K ALGN?

North America

2. United States $17,947 21.0% $55,805 162.7 yes

11. Mexico $2,227 2.6% $17,534 11.7 yes

15. Canada $1,632 1.9% $45,553 126.2 yes

South America

7. Brazil $3,192 3.7% $15,615 122.1 yes

Europe

5. Germany $3,841 4.5% $46,893 80.7 yes

6. Russia $3,718 4.4% $25,411 32.0 yes

9. United Kingdom $2,679 3.1% $41,159 53.8 yes

10. France $2,647 3.1% $41,181 65.9 yes

12. Italy $2,171 2.5% $35,708 57.5 yes

16. Spain $1,615 1.9% $34,819 82.2 yes

17. Turkey $1,589 1.9% $20,248 28.7 yes

Asia

1. China $19,392 22.7% $14,107 10.6 yes

3. India $7,965 9.3% $6,162 9.6 yes

4. Japan $4,830 5.7% $38,054 79.1 yes

8. Indonesia $2,842 3.3% $11,126 9.9 yes

13. South Korea $1,849 2.2% $36,511 45.0 yes

19. Australia $1,138 1.3% $47,389 53.8 yes

20. Thailand $1,108 1.3% $16,097 25.8 yes

Middle East

14. Saudi Arabia $1,683 2.0% $53,624 6.9 yes

18. Iran $1,371 1.6% $17,251 19.0 no

Top 20 Aggregate $85,436 100.0% $18,835 34.9 19/20

--

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

United S

tate

s

Canada

Bra

zil

Spain

Ge

rmany

Japan

Fra

nce

Ita

ly

United K

ingdom

Austr

alia

South

Kore

a

Russia

Turk

ey

Thaila

nd

Ira

n

Mexic

o

Chin

a

Indone

sia

India

Saudi A

rabia

GDP/Capita Dentists/100K


http://orthopundit.com/wp-content/uploads/2016/02/Evolution-Dental-Science-Complaint.pdf

http://www.bizjournals.com/buffalo/news/2015/08/19/israeli-dental-firm-partners-with-noris-medical-on.html

May 2016, McAndrews

Source: http://www.worldmapper.org/posters/worldmapper_map218_ver5.pdf

http://www.worldmapper.org/posters/worldmapper_map218_ver5.pdf

May 2016, McAndrews

Part III: Short Thesis, Company Performance Issue #1: ALGN’s IP advantage is steadily eroding, whether from impending patent expirations or the incremental competitive pressure from new market entrants COMPETITION SIDE-BY-SIDE Company ALGN ClearCorrect MTM Clear Aligner (“Minor

Teeth Movement”, Dentsply) U-Tooth

Headquarters San Jose, US Round Rock, Texas York, PA Seoul, South Korea

Product Suite Invisalign Full Invisalign Express/Lite Invisalign Teen Invisalign Assist

ClearCorrect U-Tooth Aligner

Clear Aligner Market Share 80% (per management remarks at 3/14/16 Roth Conference)

#2 unclear unclear

Malocclusions Treated Gapped Teeth Overbite Underbite Open Bite Overly Crowded Crossbite

Crowding Spacing Tipping Rotation Midline, anterior, posteria misalignment Torquing

Crowding Midline Discrepancy Rotation Spacing Tipping Torquing

Crowding Space Closure Crossbite Leveling (extrusion, intrusion) Extraction Mixed dentition Mid-line correction

Software Offering Invisalign Doctor Site (“IDS”), 3Shape dental system

CEREC Ortho portal – direct communication to ClearCorrect labs and ClearComm portal

U-TOOTH Program U-TOOTH Editor for lab U-TOOTH Viewer for dentist

Scanner Compatibility ALGN “iTero”, SIRO CEREC “OmniCam”, 3Shape “Trios”, 3M “True Definition”

SIRO CEREC ALGN, SIRO CEREC, 3Shape, 3M, Carestream

CAMPRO

Cost to Doctors ~$1,200-1,300 per case Cheaper than Invisalign (unclear the disparity in pricing)

Unclear

Regarding cost, there is admittedly some difficulty verifying, but indications are it’s a significant discount, in the +$500, 30-50% range In 2011, ALGN sued ClearCorrect alleging the of sale of clear aligners at “uneconomic” pricing, “damaging” the clear aligner market

Advertised Cost to Patients $3,000-$10,000 $1,000 - $7,000

Distribution US: ALGN (in-house) OUS: mix, in-house and third-party distributors

US: Dentsply (in-house) OUS: Dentsply (in-house)

“Please contact us via email or telephone for purchase..”

Marketed Point of Differentiation

Cost: “Unlike some other clear aligner services, MTM is priced on a flat fee basis. There is no limit to the number of aligners included in your plan.”

Note, other major competitors include

Ormco, a division of Danaher, a large-cap multinational industrial company with an abundance of resources at its disposal

OrthoCaps, in Germany, where the Federal Patent Court invalidated two patents of ALGN in May 2014 which were also under suit from ClearCorrect o Invalidation announcement: http://blog.clearcorrect.com/post/Ortho-Caps-Invalidates-Two-Align-Patents-in-in-Germany.aspx o OrthoCap website: http://www.orthocaps.com/

Side-by-Side Sources:

Company websites (product suite, malocclusion, software & scanner information) o Invisalign (http://www.invisalign.com/how-invisalign-works/treatable-cases) o ClearCorrect (http://blog.clearcorrect.com/) o MTM Clear Aligner (http://www.mtmclearaligner.com/content/case-studies/index.cfm)

Cost comparison: http://www.mtmclearaligner.com/pub/cost-saving o U-TOOTH (http://www.u-tooth.com/en/_html/main/main.html)

2011 ALGN lawsuit against ClearCorrect alleging “unlawful business practices, specifically the unlawful offering and selling of its products at prices below ClearCorrect's average total cost of producing and distributing the products, thus damaging the marketplace for clear aligner systems” (https://www.thestreet.com/story/11026265/1/align-technology-files-lawsuits-against-clearcorrect.html)

http://blog.clearcorrect.com/post/Ortho-Caps-Invalidates-Two-Align-Patents-in-in-Germany.aspx

http://www.orthocaps.com/

http://www.invisalign.com/how-invisalign-works/treatable-cases

http://blog.clearcorrect.com/

http://www.mtmclearaligner.com/content/case-studies/index.cfm

http://www.mtmclearaligner.com/pub/cost-saving

http://www.u-tooth.com/en/_html/main/main.html

https://www.thestreet.com/story/11026265/1/align-technology-files-lawsuits-against-clearcorrect.html

May 2016, McAndrews

COMPETITIVE ENVIRONMENT AND PRICING ALGN is already employing already every available lever to maintain pricing – there’s no upside to current levels and competition will only drive it down further. Among the levers ALGN has already employed to sustain pricing:

Dental Insurance: this is highly unlikely even for commercial insurance, given it is typically treated as a “cosmetic” procedure

Flexible Spending Accounts: available, and able to provide up to $2,500.00 for the procedure, although typically some amount is already utilized for other healthcare expenditures annually; this option has already been tapped and spotlighted for consumers, so no “upside surprise” offered

Payment plans: the alternative is some payment plan, at the behest of the physician’s office and discretion, giving incremental leverage to the ALGN’s boom/bust sales cycle

Free Replacement Cases: in 2015 ALGN announced they’d be offering lost/extra case replacements at no-additional charge, nominally unrelated to the headline price of the procedure, but yet another incremental, net-negative to the operating margins for the product

Source: ALGN Company Website http://www.invisalign.com/cost They’re running out of options, and generally the Average Selling Price (ASPs) of the product portfolio, and across the physician channels, have begun to reflect this erosion As a reminder, here are the Average Selling Prices of the ALGN portfolio by product line and physician channel. Admittedly, this is wide jumble bracketed between $800 and $1700, but might provide general frame of reference. The small text labels reflect the overall, worldwide ASP by quarter.

When you drill down into individual line growth rates, a stark trend appears beginning after the 1Q’2014 peak of $1406. I’ve included the 2-year stack growth rates on the quarterly basis to better highlight the multi-year trend and smooth out any individual quarter or aberrant rates. It can be seen across the product portfolio:

$1,343 $1,311

$1,375 $1,378 $1,394 $1,415 $1,361 $1,354 $1,367

$1,321 $1,289

$1,373

$1,313 $1,343 $1,336

$1,401 $1,406 $1,403 $1,394 $1,372 $1,336

$1,301 $1,257 $1,251 $1,256

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

$1,700

Mar-

10

May-1

0

Jul-1

0

Se

p-1

0

Nov-1

0

Jan

-11

Mar-

11

May-1

1

Jul-1

1

Se

p-1

1

Nov-1

1

Jan

-12

Mar-

12

May-1

2

Jul-1

2

Se

p-1

2

Nov-1

2

Jan

-13

Mar-

13

May-1

3

Jul-1

3

Se

p-1

3

Nov-1

3

Jan

-14

Mar-

14

May-1

4

Jul-1

4

Se

p-1

4

Nov-1

4

Jan

-15

Mar-

15

May-1

5

Jul-1

5

Se

p-1

5

Nov-1

5

Jan

-16

Mar-

16

2010-2016 ALGN ASP ($) by Product & Physician Channel

Invisalign Full Invisalign Express/Lite Invisalign Teen Invisalign Assist

NA Ortho NA GP Dentists International Worldwide ALGN

http://www.invisalign.com/cost

May 2016, McAndrews

And across the physician channels:

(20.0%)

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Ma

r-1

2

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Jun

-15

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 Full ASP %Change & 2-Year Stack

Invisalign Full 2-year Invisalign Full

(20.0%)

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Jun

-15

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 Express/Lite ASP %Change & 2-Year Stack

Invisalign Express/Lite 2-year Invisalign Express/Lite

(20.0%)

(10.0%)

--

10.0%

20.0%

30.0%

40.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Jun

-15

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 Teen ASP %Change & 2-Year Stack

Invisalign Teen 2-year Invisalign Teen

(20.0%)

(10.0%)

--

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Jun

-15

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 Assist ASP %Change & 2-Year Stack

Invisalign Assist 2-year Invisalign Assist

(12.0%)

(10.0%)

(8.0%)

(6.0%)

(4.0%)

(2.0%)

--

2.0%

4.0%

6.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Jun

-15

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 NA Ortho ASP %Change & 2-Year Stack

NA Ortho 2-year NA Ortho

(20.0%)

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Ju

n-1

5

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 NA GP ASP %Change & 2-Year Stack

NA GP Dentists 2-year NA GP Dentists

May 2016, McAndrews

Very clearly – ASPs are beginning to decline significantly, both by product (Full) and channel (NA GP, Int’l). Worldwide ASP rates have now declined at 5-10%+ rate on a 2-year stack, showing this downturn is anniversarying beyond a single year and will only further pressure topline expectations. WW ASPs have already declined to ~$1,250, the lowest rates on record and still hundreds of dollars ahead of most clear aligner competitors; further weakness could be seen. To stave off price competition – or to sustain the current ASP levels, ALGN needs to maintain an IP/technology advantage edge to justify the premium pricing. Remember – for the Company to achieve its 15-25% topline growth through 2020, any unit volume improvements, either through incremental doctors being trained, or per-doctor utilization rising, will have to more than offset ASP declines to meet or exceed management guidance. Lastly, “The Amos Dudley Story”: March 2016, a college student named Amos Dudley published a blog post detailing his success fabricating his own aligner set with the help of his university’s 3D printer, computer graphics program, and some cursory googling to identify the maximum safe distance each aligner stage could safely move his teeth. Amos, having previously worn wires & braces in his youth, had had his teeth “relapse” out of alignment and was seeking a low-cost alternative as a broke college student. His solution ended up costing him less than $60 all-in. Also significant: Amos’ solution was a 12-case therapy (not a 5-7-9-10 “mini” version). Student accounted for “the total distance of travel, and divided it by the maximum recommended distance a tooth can travel per aligner” – and came out to 12. By Amos’ own admission, and the blog comments below agreed, this was a minor case, a mere restoration of prior orthodontia, and still required 12 steps

This seems sensible that naturally, most patient cases are distributed in that “full” range anyway – would leads one to believe greater competition outside of that pure Express/Lite as guided by management. This is also why Express/Lite and Assist won’t major product drivers or pushing any mix-shift; they’re marginal contributions in the market

Source: http://amosdudley.com/weblog/Ortho Issue #2: Greater-than-expected market penetration of the Ortho/GP channels is leading to reduced yield on training; in addition, the GP-Ortho referral relationship further cools incremental adoption rates COMPLEXITY OF ORTHODONTIA NOT TO BE UNDERESTIMATED – MOST PATIENTS NEED TO BE REFERRED, TREATMENT IS NOT WITHIN REALM OF GPS’ ABILITIES Remarks from an April 2007 volume of “Inside Dentistry”, a recurring publication within Aegis Communications, a leading dental and oral hygiene media content provider, highlighted this skill gap between General Practitioners and Orthodontists:

“Comparatively speaking, dental school graduates know more or have a better background in endodontics, periodontics, or other specialties than they do in orthodontics, suggests Ron Austin, DDS, a general dentist who has been able to focus 90% of his practice on orthodontics since about 2002. Those general dentists graduating from dental school who want to learn more about orthodontics have to realize that it takes a lot of time, a great deal of effort, and a considerable financial investment, he says.”

"‘It’s not something you can learn on the weekend,’ explains Austin, who has been an instructor for the Academy of Gp Orthodontics (AGpO, www.academygportho.com) for more than 10 years. ‘It really involves a lifetime of learning, so it’s not for everybody.’”

Source: https://www.dentalaegis.com/id/2007/04/the-straight-story-on-orthodontics-in-the-general-practice#sthash.yzFhuuO5.dpuf

(25.0%)

(20.0%)

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%M

ar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

Dec-1

2

Mar-

13

Ju

n-1

3

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

Dec-1

4

Mar-

15

Ju

n-1

5

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 OUS Dentist ASP %Change & 2-Year Stack

International 2-year International

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

Mar-

11

Jun

-11

Se

p-1

1

Dec-1

1

Mar-

12

Jun

-12

Se

p-1

2

De

c-1

2

Mar-

13

Jun

-13

Se

p-1

3

Dec-1

3

Mar-

14

Jun

-14

Se

p-1

4

De

c-1

4

Mar-

15

Jun

-15

Se

p-1

5

Dec-1

5

Mar-

16

2011-2016 Worldwide ASP %Change & 2-Year Stack

Implied Total Pricing 2-year Implied Total Pricing

http://amosdudley.com/weblog/Ortho

https://www.dentalaegis.com/id/2007/04/the-straight-story-on-orthodontics-in-the-general-practice#sthash.yzFhuuO5.dpuf

May 2016, McAndrews

GP COMFORT INHOUSING ORTHODONTIA IS RELATIVELY LOW A survey from 2004 showed the General Practitioner segmentation by confidence treating orthodontics

Despite the 2004 vintage, these survey results are likely still an appropriate gauge given the clinical complexity. This finding suggests that of the 140K GPs in the United States, 60% of all NA GPs

never had interest in ALGN’s applicable target market

will never consider using ALGN for their patients

would always refer out to an orthodontist Further, the ~25K general practitioners ALGN did ship cases to in 2015 represents ~18% of the total GPs that might consider using ALGN products, or nearly half of the 40% that would-be receptive, and almost certainly the bulk of the “5%” that are confident in treating malocclusions, leaving only the more difficult sales/conversions left to train and begin adoption. If we revisit that physician penetration summary from earlier, we have a different picture:

Further, there is a symbiotic relationship between GPs and Orthos, who refer one another patients between practices, and are expected to maintain that exchange as a working relationship. Evidence of that phenomenon can be seen in additional comments volunteered by GPs as part of the survey:

“Referrals to the general dentist are an important part of the relationship.”

“I expect my orthodontist to refer restorative patients to me.”

“It is very important to get new patient referrals from an orthodontist.”

“Emphasizing routine dental cleanings and check-ups is critical!” Source: “JCO Survey of Referring Dentists” - Journal of Clinical Orthodontics, Robert G. Keim, DDS, EDD, PHD; Eugene L. Gottlieb, DDS; Allen H. Nelson, PHD; David S. Vogels III; 2004 (found via Google). That sensitivity only fuels skepticism that many GPs are

1) equipped to treat malocclusion 2) would risk in-housing that orthodontic patient flow at the expense of an existing relationship.

COMPANY PERFORMANCE: BEGINNING TO SHOW THE CRACKS Going back to our old Formula, the actual company performance has been summarized below. The sales growth thesis hinges on the aggregate contribution of new doctors, and cases performed per doctor (or “utilization”) can increase enough to offset any ASP declines. The historical results show the following:

ALGN % Sales Growth = (1+%Δ# of Doctors Shipped to (“Physician Market Penetration”))*(1+%Δ# of cases shipped per doctor (“Utilization Rate”))*(1+%ΔASP per Case) - 1

16.1%

63.9%

83.9%

36.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

General Practice Orthodontics andDentofacialOrthopedics

ALGN Physician Penetration by US Practice Channel

Remaining NA Physicians

Docs ALGN Shipped To

16.1%

63.9%23.9%

36.1%60.0%

0%

20%

40%

60%

80%

100%


ALGN Physician Penetration by Receptivity to In-Housing

Orthodontics

NA GPs Unable to Treat Ortho

Remaining Receptive Physicians


40.4%

63.9%

59.6%

36.1%

0%10%20%30%40%50%60%70%80%90%

100%


ALGN Receptive Physician Penetration by US Practice

Channel

Remaining Receptive Docs


May 2016, McAndrews

Growth Driver: Docs Shipped To Growth – the following charts summarizes the “Doctors Shipped To” growth by physician channel over the past several years:

Growth Rate Driver Summary & Go-Forward Growth Requirement

2011A 2012A 2013A 2014A 2015A 10-'15 CAGR 2016E 2017E 2018E 2019E 2020E

%Δ Docs Shipped To 7.1% 13.3% 11.4% 13.7% 11.1% 11.3%

%Δ Utilization Rate / Doc 10.7% 3.7% 4.3% (0.4%) 9.7% 5.5%

%Δ Reported ASP (0.9%) (2.7%) (0.3%) 3.5% (7.8%) (1.7%)

Implied Aligner %Δ 17.5% 14.3% 15.9% 17.2% 12.4% 15.4%

Actual Aligner %Δ 16.8% 14.8% 14.4% 14.8% 16.3% 16.5%

Target Growth Rates

Management Guidance (High) 25.0% 25.0% 25.0% 25.0% 25.0%

Management Guidance (Low) 15.0% 15.0% 15.0% 15.0% 15.0%

Bloomberg Consensus Sales %Δ 22.4% 16.9% 15.2% 11.2% 15.5%

Minimum Doctor Growth AND Minimum Utilization Growth Required (i.e. square root of Target Growth)

Assuming 0%Δ ASP 2016E 2017E 2018E 2019E 2020E




Assuming (-5%)Δ ASP




? (answer below)

?

?

?

?

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

2008-2016 NA Ortho "Docs Shipped To" %Growth & 2-year Stack

NA Ortho 2-year stack NA Ortho 7.5% hurdle

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%

2008-2016 NA GP "Docs Shipped To" %Growth & 2-year Stack

NA GP Dentists 2-year stack

NA GP Dentists

7.5% hurdle

--

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

2008-2016 International "Docs Shipped To" %Growth & 2-year Stack

International 2-year stack International

7.5% hurdle

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2008-2016 Worldwide "Docs Shipped To" %Growth & 2-year Stack

Total Docs Shipped to 2-year stack

Total Docs Shipped to

7.5% hurdle

May 2016, McAndrews

NA Ortho has clearly begun to dip, as seen in the 2-year growth stack declining from 2013 peaks; GP growth is similarly beginning to walk back from 20%+ 2-year stacks, while International is growing steadily. Overall, the company is sustaining its ~10%, or low-double-digit growth in “Docs Shipped To”, driven by the International expansion. Growth Driver: Yield on Training – ALGN also discloses the “Doctors Trained” in any particular period, which I used to compare the Sales & Marketing training “yield” for S&M budget spent. I estimated that training effort “yield” by dividing Prior-Period Change in # of Doctors Shipped To / Doctors Trained that Period (assumes that after the training period, the doctor would commence shipments the following quarter). So, if the Company’s count of “Docs Shipped To” increased by 50 docs in Q1, and they trained 100 docs that quarter, I estimate they had a 50% yield on training for the quarter. We’ve already established the S&M $/Spend per Doctor Trained has been increasing (remember back to the “Core Operating Expenses” section) – we’d expect that trend to continue as the market penetration of the doctors grows, and for the “yield” of training to decline as the obvious, immediate, and most enthusiastic physicians converts begin shipments and the more skeptical hold-outs are targeted. The Training Yield and Market Penetration by physician channel reflect the following:

NA Ortho has visibly declined from the steady training yield improvement from 2008 > 2013, which makes sense as the company’s market penetration has creeped past 60% of all available NA orthos. Further – consider the mix of those newly converted docs: these will almost certainly be among the lower priority, lower volume, smaller scale, less significant remaining ortho accounts, which will only dilute the utilization rates going forward relative to the earlier and more earnest adopters. There should be no diamonds in the remaining NA Ortho rough. NA GP training yield reached ~60% (well below Ortho rates) and is beginning to tick lower too, even though the market penetration nominally remains <20% of all available GPs. Again – this makes sense! As we identified earlier, MOST GPs (~60%) are uncomfortable treating orthodontic patients AT ALL – and GPs generally look to exchange referrals with dental specialists as a way to drive patient volume, so training to case shipments would naturally happen at a slower rate and should tail off much sooner than nominal “penetration” might suggest. Internationally, there has been improvement since 2011, but the training consistency is more variable and difficult to predict. The company has made tremendous strides broaching new international markets, but generally those markets, while ostensibly strong drivers of future growth, I would expect to be smaller, more diffuse, higher-cost to penetrate, and more price sensitive than the United States (lower GDP/Capita and discretionary spending generally). More importantly, this is the #1 driver for growth going forward, and not painting a robust picture.

--

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

(20.0%)

--

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

(Physic

ian M

ark

et P

enetr

ation

(Physic

ian T

rain

ing Y

ield

)

Annual NA Ortho Training Yield & Market Penetration

NA Ortho Market Penetration NA Ortho Training Yield

--

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

(60.0%)

(40.0%)

(20.0%)

--

20.0%

40.0%

60.0%

80.0%

(Physic

ian M

ark

et P

enetr

ation

(Physic

ian T

rain

ing Y

ield

)

Annual NA GP Training Yield & Market Penetration

NA GP Dentists Market Penetration

NA GP Dentists Training Yield

--

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

--

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

(Physic

ian M

ark

et P

enetr

ation

(Physic

ian T

rain

ing Y

ield

)

Annual International Training Yield & Market Penetration

International Market Penetration

International Training Yield

--

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

--

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

(Physic

ian M

ark

et P

enetr

ation

(Physic

ian T

rain

ing Y

ield

)

Annual Worldwide Training Yield & Market Penetration

Total Market Penetration Total Training Yield

May 2016, McAndrews

Growth Driver: Case/Doctor Uti l izat ion Rates – Lastly, we have Cases Shipped / Doctor, or the “utilization” rate of the existing accounts. This is a crucial value driver for sustained topline growth, and there should be relative headroom for the foreseeable future:

We’ve read orthodontists will typically see 250-350 cases/year, or maybe 1.0-1.5 cases/day, and 100% of their flow is malocclusion, or teeth alignment

ALGN management commented at an March 2016 conference that their current suite of products is able to treat up to 50% of those cases, so for Ortho, we’re at ~125—175 cases/year should be the best case scenario for utilization, and that utilization curve should grow steadily until it approaches that ceiling

The only countervening argument would be the lower profit margins, competitive incentives, relative devaluation of the “chair time saved” argument that Invisalign presents to its NA Orthos. The results are summarized as follows, including the ~7.5% growth contribution hurdle needed to meet the consensus growth estimates:

NA Ortho, after enjoying an initial surge post-Great Recession in the 2010-2012 time, slowed a bit and has now stabilized at the 20% 2-year stack (or 10% annually). This is good, although it’s no longer ripping in the 20%+ range and clearly has some sensitivity to the economic environment, where it weakened meaningfully during the most recent downturn. NA GPs have never achieved the growth-rates that were seen among the specialists. More importantly, there’s no indication there’s ample headroom or underpenetrated utilization rate it should be churning towards – and 7.5% is a steep hurdle here. Internationally it’s been similarly weak, although steadily improving since a low point in 2012 and rarely meeting that 7.5% hurdle. It has improved from the multi-year lows, but the performance is soft given it’s going to be so crucial for go-forward outperformance. This is where the growth requirement breaks down – the incremental Cases/Doctor necessary to offset any slowdown in new doctor acquisition is going to be difficult to achieve. Issue #3: Sirona Cerec Ortho Software leveled software playing field, and “brand” awareness is not a sticky consumer factor ALGN is a company predicated on differentiated, ahead-of-the-pack technology, and the management team represents itself that way, accentuating the enormous reservoir of data and sophisticated technology Comment re: core ALGN distinction:

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

2008 2009 2010 2011 2012 2013 2014 2015

2008-2016 NA Ortho Utilization %Growth & 2-year Stack

NA Ortho 2-year Stack 15% 2-year stack hurdle

NA Ortho YOY Growth 7.5% hurdle

(20.0%)

(15.0%)

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%

2008 2009 2010 2011 2012 2013 2014 2015

2008-2016 NA GP Utilization %Growth & 2-year Stack

NA GP Dentists 2-year Stack

15% 2-year stack hurdle

NA GP Dentists YOY Growth

7.5% hurdle

--

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

2008 2009 2010 2011 2012 2013 2014 2015

2008-2016 International Utilization %Growth & 2-year Stack

International 2-year Stack 15% 2-year stack hurdle

International YOY Growth 7.5% hurdle

(10.0%)

(5.0%)

--

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2008 2009 2010 2011 2012 2013 2014 2015

2008-2018 Worldwide Utilization %Growth & 2-year Stack

Total Utilization Rate 2-year Stack

15% 2-year stack hurdle

Total Utilization Rate YOY Growth

7.5% hurdle

May 2016, McAndrews

“According to Gheewalla, the concept of clear aligners for minor tooth movement based on a series of impressions isn’t new. However, he says that with Invisalign, one impression is taken that is integrated with a computer projection of how the patient’s teeth would incrementally move, so a multitude of sequential aligners can be manufactured from one impression, thereby simplifying the process.”

Source link: https://www.dentalaegis.com/id/2007/04/the-straight-story-on-orthodontics-in-the-general-practice#sthash.yzFhuuO5.dpuf Remarks from ClearCorrect, ALGN’s primary competitor, similarly referenced the same technology:

“Before CEREC, dental industry was what it was for hundred of years, an analogue process… CEREC changed all that, moved to the digital realm… changed a lot for us”

“full scans, much easier to get the data, and portal direct to ClearCorrect, no need to go through back doors, much more streamline, much more efficient – go on the portal, prescription information…”

“anyone using CEREC or digital scanners, it makes it so much easier”

Source: ClearCorrect Physician Video 1 (https://clearcorrect.com/doctors/) Notably – on ALGN’s primary competition and competitive dynamic:

“One of the main attractive things was the price difference – clear correct offered as a choice; as it’s developed itself as an industry and product, it’s gained more interest of colleagues

Source: ClearCorrect Physician Video 2 (https://clearcorrect.com/doctors/) On the consumption side – remember, this is an aesthetic, invisible alternative to metal wires & brackets correcting cosmetic defects in an individual’s smile. This is not a medical procedure – hence the typical absence of private insurance coverage or reimbursement – and it’s fixing a blemish or otherwise vanity issue of the patient. This is not a brand, appliance, consumer experience one touts as a status symbol – the only ostensibly “status” feature of this treatment is the premium pricing! I expect consumer brand loyalty is minimal, and so long as competing treatments achieve the same clinical results, physician brand loyalty will not be a significant driver of sales or market share retention. Instead, most sales & marketing is more focused on procedure awareness and physician education – but without the constraints of volume commitments, leaving increasingly cost-sensitive doctors to solicit competitive bids. Issue #4: Rising overhead/expenses S&M Spend: From the “Core Operating Expenses” section, we already highlighted the rising S&M$/Spend per Doctor Trained is on the rise – and it’s reasonable to expect that trend of $Spend/Training and Doctor %yield/Training to both worsen as most readily available, willing converts have been largely realized on the Ortho side Investments Abroad: lack the leverage of existing infrastructure, many countries based on third-party-distributors rather than an in-house sales force. Also, the dentists-per-population rates are generally going to be lower with less potential to expand profitability given the incongruity of demand and investment Comment from 4Q’2015 Earnings Transcript:

“Secondly, to go into Korea, to go into Taiwan, to move into India, those aren't just sales people; there's certain infrastructure, certain compliance, certain things that you just need to invest in to ensure that you adequately go into those markets, we'll continue to do that.”

On leveraging existing investments, or moving to new countries: “I've been doing business in China and India for 15 years, 20 years, and I think they are always in jeopardy of comparing those two markets and trying to make them similar. They're just night and day. I think India has a good opportunity for us. You can see we're going into Tier 1 kind of cities that we'll start in. You can see that there's a good number of orthodontic case starts that are similar to China. But the similarity really stops there. And so we expect good growth, but I don't expect a lot of what we're doing in China to be transferrable to India in a sense from a commercial standpoint, and we're going to have to get in each one of those cities and learn and adapt properly as we move forward. But it is a focus for us. We're going to have to be successful there. We're going to take it. We're going to start one step at a time, and 2016 will be a foundational year for us.”

Management is taking a strategic approach to expansion, focusing on specific cities India (Mumbai, New Delhi, Pune) where the Dentists/Population density is much higher than in the rural areas. The focused urban area approach is wise – that’s obviously where they’ll get more mileage:

“According to World Health Statistics – 2014, the ratio is 10:100K. However, the ratio suggests that there are still not enough no. of dentists in India, but it is not the sole factor, there is one more factor which cannot be ignored is inequality in distribution of dentists. In rural areas, the dentist population ratio is very less as compared to urban areas. In year 2004, India had 10 dentist per 100K people in urban areas and one dentist per 250K people in the rural areas.”

However – those are not necessarily verdant, untapped markets to exploit. The market is unbalanced and strained, and I’d be highly skeptical of much penetration given the punitive cost differential for physicians vs. metal wires & brackets. I expect pricing to be conceded to entice participation – and that’s seen in the Int’l ASP price declines beginning in 2014:

“Mushrooming of dental colleges in past few years in India has led to unemployment among Indian dentists… Very less number of posts are available for dentists in the government sector. Only 5% graduated dentists are working in the government sector. Self-practice in urban areas is not very easy due to saturation of the dental market. In rural areas, private clinics are not viable because of less awareness for oral health among the rural population. Dental graduates are facing serious financial constraint. News of suicidal attempts by dentists is also not rare now days. Unemployment not only psychologically affects the person but also promotes crime in society. Unemployed dentist are left with no choice but to leave their profession and work in call centers or commit suicide.”

Sources: http://www.ncbi.nlm.nih.gov/pmc/articles/PMC4385734/ Issue #5: Assessment of Management is Mixed, and Attention may be preoccupied POSITIVES:

Strategic commercial mindset: they’ve been proactive about developing new products and expanding into new international markets. They’ve proven inventive and creative, identifying possible financing sources (highlighting Flexible Spending Plans, promoting financing terms for potential patients)

They’re responsive to feedback: after implementing a “mandatory minimum” volume requirement that evoked a strident backlash among the physician community, they unraveled the program within 12 months of launch – realizing their mistake and reacting quickly to fix it

Proven shareholder friendly stewards of their capital, clearly understand optimized capital allocation, again reflecting a constructive mindset. Specifically, management has a history of funding meaningful shareholder buybacks, focused on TSR:

https://www.dentalaegis.com/id/2007/04/the-straight-story-on-orthodontics-in-the-general-practice#sthash.yzFhuuO5.dpuf

https://clearcorrect.com/doctors/

https://clearcorrect.com/doctors/

http://www.ncbi.nlm.nih.gov/pmc/articles/PMC4385734/

May 2016, McAndrews

Lastly, comments during investor meetings and on transcripts reiterate healthy “paranoia” of competition – they’re aware of increasing competition, and

striving to stay ahead and maintain their leading market share NEGATIVES

History of litigiousness, reflecting a competitive, combative market environment – this only increases the rivalry and competitive vigor of new entrants (which have steadily appeared)

o OrthoClear Lawsuit: established in 2005, OrthoClear was a competitor of ALGN by a former founding member of ALGN. ALGN ended up successfully suing OrthoClear and reached a settlement and closure of the business in 2006

o ClearCorrect: established in 2006, filed a declaratory judgment against ALGN in 2009, various lawsuits and countersuits have been engaged related to accusations of patent protection and damaging pricing behavior since then and some remain outstanding today

“Proficiency Program” Misstep: Company burned physician relationships with suspending certification/licenses due to the June 2009 announcement introducing the “Proficiency Program” – requiring minimum case volume per year – which was rapidly repealed in April 2010 ten months later after SEVERELY negative reaction from the physician and dental community

o These sort of missteps and memories of callous overreach on the part of ALGN often prove long-lived and stoke physician appetite and interest in finding competitive alternatives

o Source: 2009 announcement: http://investor.aligntech.com/releasedetail.cfm?ReleaseID=387581 2010 repeal: http://investor.aligntech.com/releasedetail.cfm?releaseid=462343

Management attention is likely spread thin at the moment ,with the recent plant expansion in Mexico, acquisition of the iTero CAD/CAM scanner technology (lower growth)

o iTero is an “also ran” technology – not a major differentiator among the existing competing scanners and margin dilutive relative to the aligner segment

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http://investor.aligntech.com/releasedetail.cfm?ReleaseID=387581

http://investor.aligntech.com/releasedetail.cfm?releaseid=462343

May 2016, McAndrews

Part IV: Risks to the Thesis & Mitigating Factors

Risks to ALGN Short Mitigating Factors “The Bull Case”: ALGN is the Market Leader…

Conversely, ALGN …Has been steadily shedding market share for years, now representing 80% of the market and heading lower per management’s most recent admission

With nearly 700 patents and best-in-class technology…

…analysis suggests many patents are non-commercial and the technology does not appear significantly advanced or differentiated from competitors

With ample runway to further penetrate physician markets domestically…

…but the physician market opportunity is deceptive, already showing signs of curbing adoption rates, and higher penetration than on first glance

and nascent expansion beginning abroad…

…and the international markets are likely higher cost, lower margin, and lower yielding than the heavily penetrated North American region

offering a superior alternative to metal wires & brackets with less chair time…

…but a worse margin proposition to physicians, as they’re experiencing lower wait times, slowing earnings power, and PE-backed industry consolidation

With a strong, shareholder friendly management team… …but now competing in an increasingly consolidated market with competitors explicitly and aggressively competing based on price, with significant downward momentum just beginning

Successful Defense of IP: ALGN wins existing lawsuits vs. Clear Correct, defense of IP could shutdown existing or potential competitive entrants

Mitigant: This is candidly hard to judge, but the sustained market share loss over the years (management estimates ALGN is now 80% of the clear aligner market) suggests competition is here to stay, and likely to continue gaining share. An area for further scrutiny

Existing Shareholder Put on Stock Price via Buybacks: Management has consistently converted 60%+ of FCF into stock buybacks and ASRs, effectively subsidizing the stock price and is an incremental headwind to a short position. Consensus FCF of ~$250-300M in the next few year adds to their ~$700 cash balance as of 1Q’2016 vs. $6.3B market cap

Mitigant: share buybacks have been limited to ~3% of total shares outstanding, and as the OUS business continues growing less of the cash will be accessible for share buybacks. Also, management acquired the iTero scanner business in 2014 and other usages of cash may reduce that spend in the future

Takeout Risk: Given the challenges of building a world-class distribution network, the IP and product portfolio would seem like a natural complement to the large-cap conglomerate medical device majors such as JNJ, MDT, or ABT, who could rapidly reduce duplicative overhead and accelerate growth through existing, well-established sales channels

Mitigant: Given ALGN’s extreme multiple premium is currently trading at relative to ABT, JNJ, MDT market caps, dilution is a strong deterrent. Likewise, the absence of dental exposure to the respective bidders’ portfolios limits synergy appeal, and two of those large-caps are currently digesting other sizable acquisitions (MDT with COV and Mazor; ABT with STJ, ALR), such a takeout seems unlikely

Why is ALGN a short trade now? Shorts have argued this name for years, and it’s marched higher for the past 5 years. Why is 2016 different?

Mitigant: •Physician market penetration has dramatically reduced the ramp for continued growth, as demonstrated by declining training yields for incremental new docs •ASPs have now anniversaried YOY declines and the industry drivers (consumer demand, physician income) should continue to pressure them

May 2016, McAndrews

Part V: Model & Valuation Driver Overview – Major Drivers of the Operat ing Model DOCTOR TRAINING YIELD dictates first core sales driver of # of Doctors treating patients. This also dictates the S&M spend by estimating the $/Doctor Trained spend and adjusting by the # of doctors trained each period UTILIZATION growth – as discussed, this is another core sales driver and varies by Scenario ASP SHIFTS vary by case, as assumed to be relatively consistent across the product portfolio; the various Scenarios target different end-point ASPs for reaching a new market equilibrium, rather than sussing out specific product lines where limited disclosures or insights are available OTHER ASSUMPTIONS

# of Doctors Trained is held relatively static in most cases, with overall practicing physician growth predicated on Training Yield by physician channel

Invisalign Product Mix is assumed to be static, not a significant value driver and has been relatively stable with some minor mixing

S&M $ Spend/Doctor Trained is kept at a steady ~6%/2-year stack (or ~3% YOY) growth rate during the period, consistent with the midpoint of the 2014-2015 period. In the downside case, the S

COGS / Aligner is maintained at effectively flat, consistent with historical performance, so aligner gross margins are wholly a function of ASP shifts

Non-Case Aligner Revenue is held steady at ~6% of overall ALGN sales

Scanners+CAD/CAM Revenue grows ~5% YOY following a product cycle push in 2016 Assumption Summary (Financial, Operat ing, and DCF detai ls can be found in the Appendix) BASE CASE: DCF VALUATION OF $45/SHARE (-43% DECLINE)

Training Yield continues to drop following the declining trend from 2015, settling near 40% overall after several years of declines from the Yield peak of 60% in 2012

o NA Ortho falls to 20% by 2017 o NA GP continues to 5% drops in yield each year, settling at 35% (down from 45% in FY2015) o Int’l deteriorates slightly, settles at 45% by 2017 (had ranged in the 40-55% range from 2013-2015)

Utilization sits around a consistent low- to mid-teens 2-year stack %Growth (implying high-single-digits YOY), consistent with recent trend

ASP prices maintain their recent 5% annual price concessions until they settle long-term around $900/case, which should be competitive with most outstanding aligner alternatives as currently quoted

S&M $Spend/Doctor Trained grows at the aforementioned ~6% per 2-year stack, or 3% YOY roughly growth rate Case Comparison vs. Bloomberg Consensus Estimates:

DOWNSIDE CASE: DCF VALUATION OF $20/SHARE (-74% DECLINE)

Training Yield continues to drop following the declining trend from 2015, settling near 30% overall after several years of declines from the Yield peak of 60% in 2012

o NA Ortho falls to 10% by 2017 o NA GP continues to 10% drops in yield each year, settling at 25% (down from 45% in FY2015) o Int’l deteriorates, settles at 35% by 2017 (had ranged in the 40-55% range from 2013-2015)

Utilization stagnates, grinding to about flat as physician penetration on a per-account basis is tapped out

ASPs plummet 20%/year under extreme competition until they settle long-term around $600/case, implying aligner gross margins around the 60% range – much more in line with the Gross Margin/R&D % margin ratio of ~9x the 7% R&D spend

S&M $Spend/Doctor Trained is slashed by 40% in 2017 following a severe ASP decline to help offset margins somewhat Case Comparison vs. Bloomberg Consensus Estimates:

Period FY 2016 FY 2016 FY 2017 FY 2017 FY 2018 FY 2019 FY 2020

Date Units Mar-16 Jun-16 Sep-16 Dec-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Dec-17 Dec-18 Dec-19 Dec-20

Sales

KM $M $239 $224 $212 $238 $913 $242 $234 $218 $255 $948 $1,024 $1,090 $1,164

BBG (5/27/2016) $M $239 $258 $257 $281 $1,035 $282 $300 $303 $331 $1,210 $1,394 $1,550 $1,791

BBG YOY Growth % 22.4% 18.0% 16.2% 17.9% 17.6% 16.9% 15.2% 11.2% 15.5%

Difference % (13.0%) (17.5%) (15.4%) (11.8%) (14.0%) (22.1%) (28.2%) (23.0%) (21.6%) (26.6%) (29.7%) (35.0%)

Gross Margin

KM % 75.7% 72.6% 72.1% 73.7% 73.6% 74.6% 72.6% 73.1% 73.3% 73.4% 72.1% 71.9% 70.4%

BBG (5/27/2016) % 75.3% 75.6% 75.2% 75.5% 75.9% 76.0% 76.1% 75.9% 75.8% 76.3%

Difference % (2.7%) (3.5%) (1.5%) (1.9%) (1.4%) (3.4%) (3.0%) (2.6%) (2.3%) (4.2%) 71.9% 70.4%

Operating Profit / EBIT

KM $M $53 $45 $48 $53 $198 $57 $39 $36 $57 $190 $210 $231 $263

BBG (5/27/2016) $M $50 $54 $70 $232 $63 $71 $69 $84 $295 $360

Difference % (11.4%) (11.3%) (24.4%) (14.5%) (9.0%) (45.2%) (47.7%) (31.8%) (35.7%) (41.5%) #DIV/0! #DIV/0!

EBITDA

KM $M $59 $49 $52 $58 $218 $63 $43 $41 $63 $210 $232 $254 $288

BBG (5/27/2016) $M $251 $314 $378

Difference % #DIV/0! #DIV/0! #DIV/0! (13.1%) n.a. n.a. n.a. n.a. (33.2%) (38.6%) #DIV/0! #DIV/0!

Adj. EPS

KM $M $0.50 $0.39 $0.43 $0.53 $1.85 $0.55 $0.35 $0.34 $0.60 $1.84 $2.06 $2.27 $2.61

BBG (5/27/2016) $M $0.48 $0.53 $0.66 $2.16 $0.63 $0.66 $0.70 $0.81 $2.77 $3.37 $4.04 $4.86

Difference % (18.7%) (17.3%) (20.5%) (14.5%) (11.6%) (47.1%) (51.2%) (26.2%) (33.5%) (38.8%) (43.8%) (46.4%)

Capex

KM $M ($20) ($17) ($17) ($17) ($70) ($12) ($12) ($11) ($13) ($47) ($51) ($54) ($58)

BBG (5/27/2016) $M ($19) ($19) ($19) ($76) ($13) ($13) ($13) ($13) ($50) ($51)

% Sales % (7.3%) (7.3%) (6.7%) (7.4%) (4.4%) (4.2%) (4.1%) (3.8%) (4.1%) (3.7%)

Difference % (11.2%) (11.2%) (11.2%) (8.3%) (3.1%) (6.6%) (13.0%) 1.9% (5.2%) (0.2%)

May 2016, McAndrews

UPSIDE CASE: DCF VALUATION OF $86/SHARE (+8% UPSIDE)

Training Yield declines halt – go-forward yields stay at 2015 levels, 50% overall, while docs trains remained at today’s elevated levels, driving sustained market penetration. Overall “Doctors Shipped To” growth of 5-10% throughout forecast period achieved

o NA Ortho remains at 30%, exceeds 75% market penetration by 2020 o NA GPs remains at 60%, exceeds 22% market penetration by 2020 o International remains at 50%, exceeds 16% market penetration by 2020

Utilization growth of 10-15% by physician channel achieved through 2017, and then falling to ~3%/year

ASP prices remain flat, 0% shifts, thoughout the projection period – static ~$1250

S&M $Spend/Doctor Trained same as Base Case Case Comparison vs. Bloomberg Consensus Estimates:

CONSENSUS CASE: DCF VALUATION OF $74/SHARE (-6% DOWNSIDE)

Illustrative case pipes in Bloomberg Consensus Estimate financials to approximate market-implied valuation Case Comparison vs. Bloomberg Consensus Estimates:



Sales

KM $M $239 $184 $174 $196 $793 $200 $154 $142 $164 $660 $639 $611 $592

BBG (5/27/2016) $M $239 $258 $257 $281 $1,035 $282 $300 $303 $331 $1,210 $1,394 $1,550 $1,791

BBG YOY Growth % 22.4% 18.0% 16.2% 17.9% 17.6% 16.9% 15.2% 11.2% 15.5%

Difference % (28.6%) (32.2%) (30.4%) (23.4%) (29.1%) (48.5%) (53.2%) (50.4%) (45.5%) (54.2%) (60.6%) (66.9%)

Gross Margin

KM % 75.7% 68.8% 68.2% 70.1% 71.1% 71.2% 64.2% 64.7% 65.2% 66.7% 63.3% 61.2% 57.2%

BBG (5/27/2016) % 75.3% 75.6% 75.2% 75.5% 75.9% 76.0% 76.1% 75.9% 75.8% 76.3%

Difference % (6.6%) (7.4%) (5.1%) (4.5%) (4.8%) (11.8%) (11.4%) (10.6%) (9.1%) (13.0%) 61.2% 57.2%


KM $M $53 $18 $24 $24 $119 $51 $24 $27 $30 $131 $95 $87 $60

BBG (5/27/2016) $M $50 $54 $70 $232 $63 $71 $69 $84 $295 $360

Difference % (64.0%) (56.3%) (66.1%) (48.8%) (19.8%) (65.4%) (61.3%) (64.8%) (55.5%) (73.7%) #DIV/0! #DIV/0!

EBITDA

KM $M $59 $22 $27 $28 $136 $55 $28 $30 $33 $146 $109 $100 $72

BBG (5/27/2016) $M $251 $314 $378

Difference % #DIV/0! #DIV/0! #DIV/0! (45.9%) n.a. n.a. n.a. n.a. (53.7%) (71.3%) #DIV/0! #DIV/0!

Adj. EPS

KM $M $0.50 $0.16 $0.21 $0.23 $1.10 $0.49 $0.22 $0.25 $0.30 $1.27 $0.92 $0.85 $0.58

BBG (5/27/2016) $M $0.48 $0.53 $0.66 $2.16 $0.63 $0.66 $0.70 $0.81 $2.77 $3.37 $4.04 $4.86

Difference % (67.4%) (59.7%) (64.7%) (49.0%) (22.1%) (66.8%) (64.0%) (62.2%) (54.2%) (72.7%) (79.0%) (88.1%)

Capex

KM $M ($20) ($17) ($17) ($17) ($70) ($10) ($8) ($7) ($8) ($33) ($32) ($31) ($30)

BBG (5/27/2016) $M ($19) ($19) ($19) ($76) ($13) ($13) ($13) ($13) ($50) ($51)

% Sales % (7.3%) (7.3%) (6.7%) (7.4%) (4.4%) (4.2%) (4.1%) (3.8%) (4.1%) (3.7%)

Difference % (11.2%) (11.2%) (11.2%) (8.3%) (20.2%) (38.2%) (43.2%) (34.4%) (34.0%) (37.7%)



Sales

KM $M $239 $252 $247 $271 $1,009 $279 $293 $285 $317 $1,173 $1,320 $1,463 $1,622

BBG (5/27/2016) $M $239 $258 $257 $281 $1,035 $282 $300 $303 $331 $1,210 $1,394 $1,550 $1,791

BBG YOY Growth % 22.4% 18.0% 16.2% 17.9% 17.6% 16.9% 15.2% 11.2% 15.5%

Difference % (2.2%) (4.0%) (3.5%) (2.5%) (1.1%) (2.3%) (5.8%) (4.3%) (3.0%) (5.3%) (5.6%) (9.4%)

Gross Margin

KM % 75.7% 75.8% 75.5% 75.4% 75.6% 76.1% 76.8% 77.4% 76.2% 76.6% 76.3% 76.9% 76.5%

BBG (5/27/2016) % 75.3% 75.6% 75.2% 75.5% 75.9% 76.0% 76.1% 75.9% 75.8% 76.3% 76.3% 76.3%

Difference % 0.5% (0.1%) 0.2% 0.1% 0.1% 0.8% 1.3% 0.3% 0.9% 0.0% 0.6% 0.3%


KM $M $53 $66 $72 $75 $266 $80 $80 $81 $99 $339 $409 $484 $576

BBG (5/27/2016) $M $50 $54 $70 $232 $63 $71 $69 $84 $295 $360

Difference % 31.4% 33.9% 7.2% 14.8% 27.3% 12.9% 16.5% 17.4% 15.0% 13.7% #DIV/0! #DIV/0!

EBITDA

KM $M $59 $71 $78 $81 $288 $87 $86 $87 $105 $364 $438 $515 $611

BBG (5/27/2016) $M $251 $314 $378

Difference % #DIV/0! #DIV/0! #DIV/0! 14.7% n.a. n.a. n.a. n.a. 16.0% 15.7% #DIV/0! #DIV/0!

Adj. EPS

KM $M $0.50 $0.58 $0.66 $0.75 $2.48 $0.78 $0.73 $0.77 $1.03 $3.30 $4.00 $4.76 $5.71

BBG (5/27/2016) $M $0.48 $0.53 $0.66 $2.16 $0.63 $0.66 $0.70 $0.81 $2.77 $3.37 $4.04 $4.86

Difference % 21.0% 25.1% 13.0% 14.8% 24.0% 9.7% 9.4% 27.5% 19.0% 19.0% 17.9% 17.5%

Capex

KM $M ($20) ($17) ($17) ($17) ($70) ($14) ($15) ($14) ($16) ($59) ($66) ($73) ($81)

BBG (5/27/2016) $M ($19) ($19) ($19) ($76) ($13) ($13) ($13) ($13) ($50) ($51)

% Sales % (7.3%) (7.3%) (6.7%) (7.4%) (4.4%) (4.2%) (4.1%) (3.8%) (4.1%) (3.7%)

Difference % (11.2%) (11.2%) (11.2%) (8.3%) 11.4% 17.2% 14.1% 26.7% 17.3% 28.7%

May 2016, McAndrews

Historical Multiple Valuation EV/NTM EBITDA AND EV/NTM SALES, LAST 10 YEARS



Sales

KM $M $239 $257 $251 $276 $1,023 $284 $304 $296 $329 $1,213 $1,390 $1,570 $1,774

BBG (5/27/2016) $M $239 $258 $257 $281 $1,035 $282 $300 $303 $331 $1,210 $1,394 $1,550 $1,791

BBG YOY Growth % 22.4% 18.0% 16.2% 17.9% 17.6% 16.9% 15.2% 11.2% 15.5%

Difference % (0.4%) (2.2%) (1.7%) (1.1%) 0.7% 1.4% (2.2%) (0.6%) 0.2% (0.3%) 1.3% (0.9%)

Gross Margin

KM % 75.7% 75.3% 75.6% 75.2% 75.5% 75.9% 76.0% 76.1% 75.9% 75.8% 76.3% 76.3% 76.3%

BBG (5/27/2016) % 75.3% 75.6% 75.2% 75.5% 75.9% 76.0% 76.1% 75.9% 75.8% 76.3% 76.3% 76.3%

Difference % -- -- -- -- -- -- -- -- -- -- -- --


KM $M $53 $50 $54 $70 $232 $63 $71 $69 $84 $295 $360 $422 $495

BBG (5/27/2016) $M $50 $54 $70 $232 $63 $71 $69 $84 $295 $360

Difference % -- -- -- -- -- -- -- -- -- -- #DIV/0! #DIV/0!

EBITDA

KM $M $59 -- -- -- $251 $68 $75 $74 $89 $314 $378 $443 $518

BBG (5/27/2016) $M $251 $314 $378

Difference % #DIV/0! #DIV/0! #DIV/0! -- n.a. n.a. n.a. n.a. -- -- #DIV/0! #DIV/0!

Adj. EPS

KM $M $0.50 $0.44 $0.49 $0.70 $2.18 $0.61 $0.64 $0.66 $0.87 $2.89 $3.55 $4.19 $4.94

BBG (5/27/2016) $M $0.48 $0.53 $0.66 $2.16 $0.63 $0.66 $0.70 $0.81 $2.77 $3.37 $4.04 $4.86

Difference % (8.1%) (6.7%) 5.4% 1.0% (2.8%) (2.9%) (6.2%) 8.5% 4.2% 5.4% 3.7% 1.7%

Capex

KM $M ($20) ($17) ($17) ($17) ($70) ($14) ($15) ($15) ($16) ($61) ($70) ($79) ($89)

BBG (5/27/2016) $M ($19) ($19) ($19) ($76) ($13) ($13) ($13) ($13) ($50) ($51)

% Sales % (7.3%) (7.3%) (6.7%) (7.4%) (4.4%) (4.2%) (4.1%) (3.8%) (4.1%) (3.7%)

Difference % (11.2%) (11.2%) (11.2%) (8.3%) 13.5% 21.7% 18.5% 31.5% 21.3% 35.5%

May 2016, McAndrews

EV/FY+1 EBITDA AND EV/ FY+1 SALES, LAST 10 YEARS

SHORT INTEREST

is quite low today, as the stock has recently reached new highs

Major Stock Holders

most major holders have been selling out at these levels

May 2016, McAndrews

May 2016, McAndrews

Part VII: Remaining Questions – Areas for Further Scrutiny

Common commercial terms between ALGN and dental physicians – are they volume commitments or multi-year exclusive terms as part of the agreements?

o Susceptibility for practices to bid ALGN vs. ClearCorrect and other clear aligner competitors, help gauge the stickiness of the relationship

Detailed review of the upcoming patent expirations, what IP expires when, what’s currently subject to legal disputs o One study by M-CAM/Patently Obvious in January 2014 suggested that 80%+ of the patents were “non-commercial” and less than 20%

scored as commercial per their assessment. They viewed the majority of the ALGN IP to be “built on weak market controls o and is subject to fragmentation or invalidation” o Source, patent expiry: http://www.m-cam.com/sites/www.m-cam.com/files/Patently%20Obvious%20Report%20-

%20Align%20Technology_0.pdf

Diligence on brand value, leading decision factors for consumers, relative penetration of Invisalign products and marketing vs. other technologies o Want to know where the marketing spend is concentrated vs. competitors, whether there are likely scale advantages in particular metro

markets or regions, concentration of sales teams o Also want to know what are the critical pull-through factors for consumers, if there’s any significant press of Invisalign vs. Clear Correct or

others, and patient tolerance for interchange of appliances – do patient ask for Invisalign vs. ClearCorrect or any generic clear aligner? Is this “I want a Coke, I hate Pepsi” or “I want a beer, Michelob vs. Amstel doesn’t matter to me”

International Diligence on market penetration o What countries have they already expanded to? Which are penetrated? – sounds like Japan is among the most entrenched of the international

locations, how did that ramp look to better gauge China, India, etc.?

http://www.m-cam.com/sites/www.m-cam.com/files/Patently%20Obvious%20Report%20-%20Align%20Technology_0.pdf

http://www.m-cam.com/sites/www.m-cam.com/files/Patently%20Obvious%20Report%20-%20Align%20Technology_0.pdf

May 2016, McAndrews

Appendix Detailed Model Outputs: Operating, Financial, DCF BASE CASE

Operating Statistics Fiscal Year Ending LTM Projected Year Ending

Year Units Dec-12 Dec-13 Dec-14 Dec-15 Mar-16 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

Physician Market Summary

# Docs Cases Shipped to

NA Ortho # 5,665 6,040 6,401 6,737 6,823 7,081 7,320 7,568 7,803 8,027 8,240

NA GP Dentists # 19,285 21,290 23,489 24,973 25,346 26,466 27,620 28,928 30,085 31,395 32,554

International # 9,285 10,800 13,450 16,460 17,171 19,305 21,968 24,737 27,368 29,867 32,241

Total Docs Shipped to # 34,235 38,130 43,340 48,170 49,341 52,852 56,908 61,233 65,256 69,289 73,035

YOY - NA Ortho % 7.3% 6.6% 6.0% 5.3% 5.2% 5.1% 3.4% 3.4% 3.1% 2.9% 2.6%

YOY - NA GP Dentists % 11.4% 10.4% 10.3% 6.3% 6.2% 6.0% 4.4% 4.7% 4.0% 4.4% 3.7%

YOY - International % 21.8% 16.3% 24.5% 22.4% 20.9% 17.3% 13.8% 12.6% 10.6% 9.1% 7.9%

YOY - Total Docs Shipped to % 13.3% 11.4% 13.7% 11.1% 10.8% 9.7% 7.7% 7.6% 6.6% 6.2% 5.4%

Doctors Trained by Geography

NA Ortho 000s 380 375 410 1,007 1,114 1,146 1,192 1,240 1,178 1,119 1,063

NA GP Dentists 000s 3,315 3,765 3,735 3,313 3,206 3,755 3,319 3,762 3,326 3,770 3,332

International 000s 3,145 3,825 5,290 5,475 5,535 5,692 5,920 6,157 5,849 5,557 5,279

Doctors Trained Worldwide 000s 6,840 7,965 9,435 9,795 9,855 10,594 10,432 11,159 10,353 10,445 9,674

YOY - NA Ortho % 4831.5% (1.3%) 9.3% 145.6% 108.9% 13.8% 4.0% 4.0% (5.0%) (5.0%) (5.0%)

YOY - NA GP Dentists % 2154.5% 13.6% (0.8%) (11.3%) (15.2%) 13.3% (11.6%) 13.3% (11.6%) 13.3% (11.6%)

YOY - International % 64.6% 21.6% 38.3% 3.5% (0.7%) 4.0% 4.0% 4.0% (5.0%) (5.0%) (5.0%)

YOY - Doctors Trained Worldwide % 16.1% 16.4% 18.5% 3.8% (0.4%) 8.2% (1.5%) 7.0% (7.2%) 0.9% (7.4%)

Physician Training Yield

NA Ortho % 101.3% 100.0% 88.0% 33.4% 35.0% 30.0% 20.0% 20.0% 20.0% 20.0% 20.0%

NA GP Dentists % 59.7% 53.3% 58.9% 44.8% 56.2% 39.8% 34.8% 34.8% 34.8% 34.8% 34.8%

International % 52.8% 39.6% 50.1% 55.0% 40.3% 50.0% 45.0% 45.0% 45.0% 45.0% 45.0%

Total Training Yield % 58.8% 48.9% 55.2% 49.3% 44.9% 44.2% 38.9% 38.8% 38.9% 38.6% 38.7%

Implied Market Penetration

NA Ortho % 55.3% 58.5% 61.3% 63.9% 64.5% 66.4% 68.0% 69.5% 71.0% 72.2% 73.4%

NA GP Dentists % 12.8% 14.0% 15.4% 16.1% 16.4% 17.1% 17.5% 18.3% 18.8% 19.6% 19.9%

International % 4.9% 5.7% 7.1% 8.7% 9.0% 10.2% 11.6% 13.0% 14.4% 15.7% 17.0%

Implied Market Penetration % 9.8% 10.8% 12.3% 13.6% 13.9% 14.9% 16.0% 17.1% 18.1% 19.2% 20.0%

Case Volumes & Utilization Rates

Cases by Physician Channel

NA Ortho 000s 137.0 159.6 177.3 214.3 225.8 236.7 258.3 285.8 315.3 347.0 381.2

NA GP Dentists 000s 139.7 154.3 161.4 184.1 191.9 199.2 214.2 233.4 252.4 273.9 295.4

International 000s 86.8 108.5 139.5 184.8 198.3 214.0 241.3 290.8 344.2 402.0 464.3

Total Cases 000s 363.5 422.3 478.2 583.2 616.1 649.9 713.9 809.9 911.9 1,022.9 1,140.9

YOY - NA Ortho % 18.8% 16.4% 11.1% 20.8% 22.5% 10.5% 9.1% 10.6% 10.3% 10.1% 9.8%



YOY - Total Cases % 17.5% 16.2% 13.2% 21.9% 24.0% 11.4% 9.9% 13.4% 12.6% 12.2% 11.5%

Utilization per Physician

NA Ortho case/doc 24.2 26.4 27.7 31.8 33.1 33.4 35.3 37.8 40.4 43.2 46.3

NA GP Dentists case/doc 7.2 7.2 6.9 7.4 7.6 7.5 7.8 8.1 8.4 8.7 9.1

International case/doc 9.4 10.0 10.4 11.2 11.6 11.1 11.0 11.8 12.6 13.5 14.4

Total Utilization Rate case/doc 10.6 11.1 11.0 12.1 12.5 12.3 12.5 13.2 14.0 14.8 15.6

YOY - NA Ortho % 10.7% 9.2% 4.8% 14.8% 16.4% 5.1% 5.6% 7.0% 7.0% 7.0% 7.0%

YOY - NA GP Dentists % 1.7% 0.1% (5.1%) 7.3% 10.2% 2.1% 3.1% 4.0% 4.0% 4.0% 4.0%

YOY - International % 0.8% 7.4% 3.2% 8.3% 10.6% (1.3%) (0.9%) 7.0% 7.0% 7.0% 7.0%

YOY - Total Utilization Rate % 3.7% 4.3% (0.4%) 9.7% 12.0% 1.6% 2.0% 5.4% 5.7% 5.6% 5.8%

Average Selling Price

ASP by Product Line and Region

Invisalign Full $/case $1,441 $1,456 $1,490 $1,345 $1,325 $1,274 $1,210 $1,150 $1,092 $1,038 $986

Invisalign Express/Lite $/case $877 $917 $972 $875 $862 $829 $788 $748 $711 $675 $641

Invisalign Teen $/case $1,389 $1,424 $1,440 $1,442 $1,443 $1,392 $1,322 $1,255 $1,193 $1,133 $1,076

Invisalign Assist $/case $1,332 $1,432 $1,512 $1,453 $1,429 $1,376 $1,306 $1,241 $1,178 $1,120 $1,064

Implied Total Pricing $/case $1,337 $1,349 $1,393 $1,284 $1,266 $1,215 $1,153 $1,096 $1,041 $989 $939

YOY - Invisalign Full % (1.7%) 1.1% 2.3% (9.7%) (10.0%) (5.3%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)

YOY - Invisalign Express/Lite % (9.0%) 4.5% 6.0% (9.9%) (10.1%) (5.3%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)

YOY - Invisalign Teen % (2.9%) 2.5% 1.1% 0.2% 1.3% (3.5%) (5.1%) (5.0%) (5.0%) (5.0%) (5.0%)

YOY - Invisalign Assist % 0.6% 7.5% 5.6% (3.9%) (4.0%) (5.3%) (5.1%) (5.0%) (5.0%) (5.0%) (5.0%)

YOY - Implied Total Pricing % (3.1%) 1.0% 3.3% (7.8%) (8.0%) (5.4%) (5.1%) (5.0%) (5.0%) (5.0%) (5.0%)

May 2016, McAndrews

Financial Performance Fiscal Year Ending LTM Projected Year Ending


Clear Aligners $M $517 $615 $713 $800 $833 $845 $881 $950 $1,015 $1,082 $1,146

Scanners/CADCAM $M $43 $46 $49 $45 $53 $68 $67 $74 $74 $81 $83

Total Revenues $M $560 $660 $762 $845 $886 $913 $948 $1,024 $1,090 $1,164 $1,229

YOY Growth % 16.7% 19.0% 15.9% 12.3% n.a. 1.4% 4.3% 7.8% 6.9% 6.6% 5.9%

NFX Growth % 18.3% 18.0% 15.8% 15.1% n.a. 8.3% 3.9% 7.9% 6.4% 6.8% 5.6%

FX Impact % (1.5%) 1.0% 0.1% (2.8%) n.a. (6.9%) 0.4% (0.2%) 0.5% (0.2%) 0.3%

Clear Aligners $M $406 $485 $563 $628 $652 $652 $676 $716 $761 $795 $836


Gross Profit $M $417 $498 $578 $640 $670 $672 $696 $738 $783 $819 $861

Clear Aligners % 78.6% 78.9% 79.0% 78.5% 78.3% 77.2% 76.7% 75.4% 74.9% 73.5% 73.0%

Scanners/CADCAM % 26.2% 29.1% 31.7% 26.3% 32.6% 29.2% 30.0% 30.0% 30.0% 30.0% 30.0%

Gross Margin % 74.5% 75.4% 75.9% 75.7% 75.6% 73.6% 73.4% 72.1% 71.9% 70.4% 70.1%

Sales and marketing $M $151 $180 $217 $253 $268 $259 $284 $287 $297 $283 $292

% Margin % 27.0% 27.3% 28.5% 29.9% 30.3% 28.3% 29.9% 28.0% 27.2% 24.3% 23.8%

General and administrative $M $96 $113 $115 $142 $146 $150 $156 $168 $179 $192 $202

% Margin % 17.1% 17.1% 15.1% 16.8% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5%

Research and development $M $42 $44 $53 $61 $62 $64 $67 $72 $77 $82 $87

% Margin % 7.6% 6.7% 6.9% 7.2% 7.0% 7.1% 7.0% 7.0% 7.0% 7.0% 7.0%

EBIT $M $128 $161 $194 $184 $193 $198 $190 $210 $231 $263 $280

% Margin % 22.8% 24.4% 25.4% 21.7% 21.8% 21.7% 20.0% 20.6% 21.2% 22.6% 22.8%

EBITDA $M $146 $178 $211 $202 $212 $218 $210 $232 $254 $288 $307

% Margin % 26.0% 27.0% 27.8% 23.9% 24.0% 23.9% 22.1% 22.7% 23.3% 24.7% 24.9%

Interest/other inc (expense) $M ($1) ($1) ($3) ($3) ($2) ($2) ($2) ($2) ($2) ($2) ($2)

Income Taxes $M $31 $33 $45 $42 $43 $48 $45 $49 $52 $58 $61

Net Income $M $96 $128 $146 $139 $148 $149 $143 $160 $176 $202 $217

Fully Diluted Shares (Non-GAAP) #M 83 82 82 81 81 81 78 78 78 78 78

Diluted EPS $/share $1.16 $1.56 $1.77 $1.71 $1.83 $1.85 $1.84 $2.06 $2.27 $2.61 $2.80

YOY Growth % 21.5% 34.4% 13.9% (3.5%) 3.5% 1.1% (0.2%) 11.8% 10.3% 14.8% 7.4%

DCF Assumptions

Valuation Date 5/31/16 Case Toggle 1 1, base; 2, downside; 3, upside; 4, consensus

Discount Factor 11.0% Sales Toggle 1 1, base; 2, downside; 3, upside; 4, consensus

Terminal Value Growth Rate 3.0% P&L Toggle 1 1, base; 2, downside; 3, upside; 4, consensus

DCF Forecast Share Dilution

Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 Dec-24 Dec-25 Current Share Price $79

Revenue $913 $948 $1,024 $1,090 $1,164 $1,229 $1,302 $1,434 $1,583 $1,742

YOY Growth 3.9% 7.9% 6.4% 6.8% 5.6% 5.9% 10.1% 10.4% 10.0% Basic Shares Outstanding 80.2

Incremental Dilution 1.2

Gross Profit $683 $709 $753 $798 $836 $878 $909 $1,011 $1,108 $1,219 FDSO 81.4

Gross Margin 74.8% 74.8% 73.5% 73.2% 71.8% 71.4% 69.8% 70.5% 70.0% 70.0%

Shares Ex. Price Share Dilution

EBITA $210 $203 $225 $245 $279 $297 $323 $386 $459 $505 Options 0.5 $15.14 0.4

% Margin 23.0% 21.4% 22.0% 22.5% 24.0% 24.2% 24.8% 26.9% 29.0% 29.0% RSUs, DSUs 2.1 $49.45 0.8

Amortization ($0) -- -- -- -- -- -- -- -- --

Taxes ($51) ($49) ($53) ($57) ($63) ($65) ($70) ($81) ($94) ($94) Total 1.2

Tax Rate 24.4% 24.0% 23.5% 23.0% 22.5% 22.0% 21.5% 21.0% 20.5% 20.5%

EBIAT $158 $154 $172 $189 $216 $231 $254 $305 $365 $410

+ Amortization $0 -- -- -- -- -- -- -- -- --

+ Depreciation $19 $20 $22 $29 $37 $45 $62 $68 $75 $83

% Capex 25.6% 40.5% 42.6% 52.6% 62.6% 72.6% 95.0% 95.0% 95.0% 95.0%

- Change in NWC ($9) ($9) ($10) ($11) ($12) ($12) ($13) ($14) ($16) ($17)

% Margin (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%)

- Capex ($76) ($50) ($51) ($55) ($58) ($62) ($65) ($72) ($79) ($87)

% Margin (8.4%) (5.3%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)

Free Cash Flow $93 $115 $133 $152 $183 $202 $237 $287 $345 $389

Discount Factor 0.94 0.85 0.76 0.69 0.62 0.56 0.50 0.45 0.41 0.37

Discounted Cash Flow $87 $97 $101 $105 $113 $113 $119 $130 $141 $143

Less: Partial Year Stub ($36)

Net Cash Flows $51 $97 $101 $105 $113 $113 $119 $130 $141 $143

Total DCF $1,113

Terminal Value Implied FY2017 EV/Sales Multiple

FY+1 Cash Flow $400 FY2017 Sales $948

Growing Purpetuity Value $5,004

Discount Factor 0.37 Estimated Enterprise Value

PV of Terminal Value $1,841 Share Price $45

FDSO 81.4

ALGN Enterprise Value $2,954 ALGN Equity Value $3,635

+ Cash $681 Current Cash ($681)

- Debt -- Plus 2016-2017 Cash ($208)

ALGN Equity Value $3,635 Enterprise Value $2,746

FDSO 81.4

ALGN Share Price $45 Implied EV / 2017E Sales: 2.9x

Premium/(Discount) to Current (43%)

May 2016, McAndrews

DOWNSIDE CASE





NA Ortho # 5,665 6,040 6,401 6,737 6,823 7,081 7,201 7,325 7,442 7,554 7,661

NA GP Dentists # 19,285 21,290 23,489 24,973 25,299 26,278 27,100 28,032 28,856 29,790 30,615

International # 9,285 10,800 13,450 16,460 17,100 19,020 21,091 23,244 25,290 27,234 29,080


YOY - NA Ortho % 7.3% 6.6% 6.0% 5.3% 5.2% 5.1% 1.7% 1.7% 1.6% 1.5% 1.4%





NA Ortho 000s 380 375 410 1,007 1,114 1,146 1,192 1,240 1,178 1,119 1,063

NA GP Dentists 000s 3,315 3,765 3,735 3,313 3,206 3,755 3,319 3,762 3,326 3,770 3,332

International 000s 3,145 3,825 5,290 5,475 5,535 5,692 5,920 6,157 5,849 5,557 5,279


YOY - NA Ortho % 4831.5% (1.3%) 9.3% 145.6% 108.9% 13.8% 4.0% 4.0% (5.0%) (5.0%) (5.0%)





NA Ortho % 101.3% 100.0% 88.0% 33.4% 35.0% 30.0% 10.0% 10.0% 10.0% 10.0% 10.0%

NA GP Dentists % 59.7% 53.3% 58.9% 44.8% 56.2% 34.8% 24.8% 24.8% 24.8% 24.8% 24.8%

International % 52.8% 39.6% 50.1% 55.0% 40.3% 45.0% 35.0% 35.0% 35.0% 35.0% 35.0%



NA Ortho % 55.3% 58.5% 61.3% 63.9% 64.5% 66.4% 66.9% 67.3% 67.7% 67.9% 68.2%

NA GP Dentists % 12.8% 14.0% 15.4% 16.1% 16.3% 17.0% 17.2% 17.8% 18.0% 18.6% 18.8%

International % 4.9% 5.7% 7.1% 8.7% 9.0% 10.0% 11.1% 12.2% 13.3% 14.3% 15.3%




NA Ortho 000s 137.0 159.6 177.3 214.3 225.8 228.3 229.5 233.5 237.2 240.8 244.2

NA GP Dentists 000s 139.7 154.3 161.4 184.1 191.9 188.5 182.6 179.5 175.5 172.1 168.0

International 000s 86.8 108.5 139.5 184.8 198.3 213.0 230.7 267.0 305.0 344.9 386.7

Total Cases 000s 363.5 422.3 478.2 583.2 616.1 629.8 642.9 679.9 717.8 757.8 798.9

YOY - NA Ortho % 18.8% 16.4% 11.1% 20.8% 22.5% 6.6% 0.5% 1.7% 1.6% 1.5% 1.4%

YOY - NA GP Dentists % 13.4% 10.5% 4.7% 14.0% 17.0% 2.4% (3.1%) (1.7%) (2.2%) (1.9%) (2.4%)


YOY - Total Cases % 17.5% 16.2% 13.2% 21.9% 24.0% 8.0% 2.1% 5.8% 5.6% 5.6% 5.4%


NA Ortho case/doc 24.2 26.4 27.7 31.8 33.1 32.2 31.9 31.9 31.9 31.9 31.9




YOY - NA Ortho % 10.7% 9.2% 4.8% 14.8% 16.4% 1.4% (1.1%) -- -- -- --

YOY - NA GP Dentists % 1.7% 0.1% (5.1%) 7.3% 10.4% (2.7%) (6.1%) (5.0%) (5.0%) (5.0%) (5.0%)

YOY - International % 0.8% 7.4% 3.2% 8.3% 11.0% (0.3%) (2.3%) 5.0% 5.0% 5.0% 5.0%

YOY - Total Utilization Rate % 3.7% 4.3% (0.4%) 9.7% 12.2% (0.7%) (3.5%) (0.0%) 0.4% 0.7% 1.1%



Invisalign Full $/case $1,441 $1,456 $1,490 $1,345 $1,325 $1,126 $902 $812 $730 $657 $657


Invisalign Teen $/case $1,389 $1,424 $1,440 $1,442 $1,443 $1,238 $985 $886 $798 $718 $718

Invisalign Assist $/case $1,332 $1,432 $1,512 $1,453 $1,429 $1,220 $973 $876 $789 $710 $710

Implied Total Pricing $/case $1,337 $1,349 $1,393 $1,284 $1,266 $1,075 $859 $774 $696 $627 $627

YOY - Invisalign Full % (1.7%) 1.1% 2.3% (9.7%) (10.0%) (16.3%) (19.9%) (10.0%) (10.0%) (10.0%) --

YOY - Invisalign Express/Lite % (9.0%) 4.5% 6.0% (9.9%) (10.1%) (16.1%) (20.0%) (10.0%) (10.0%) (10.0%) --

YOY - Invisalign Teen % (2.9%) 2.5% 1.1% 0.2% 1.3% (14.2%) (20.4%) (10.0%) (10.0%) (10.0%) --

YOY - Invisalign Assist % 0.6% 7.5% 5.6% (3.9%) (4.0%) (16.0%) (20.2%) (10.0%) (10.0%) (10.0%) --

YOY - Implied Total Pricing % (3.1%) 1.0% 3.3% (7.8%) (8.0%) (16.3%) (20.1%) (10.0%) (10.0%) (10.0%) --

May 2016, McAndrews



Clear Aligners $M $517 $615 $713 $800 $833 $725 $593 $565 $537 $511 $538


Total Revenues $M $560 $660 $762 $845 $886 $793 $660 $639 $611 $592 $621

YOY Growth % 16.7% 19.0% 15.9% 12.3% n.a. (12.9%) (18.3%) (4.7%) (4.9%) (4.8%) 5.4%

NFX Growth % 18.3% 18.0% 15.8% 15.1% n.a. (5.9%) (16.8%) (3.2%) (4.3%) (3.1%) 4.9%

FX Impact % (1.5%) 1.0% 0.1% (2.8%) n.a. (7.1%) (1.5%) (1.5%) (0.6%) (1.8%) 0.5%

Clear Aligners $M $406 $485 $563 $628 $652 $544 $420 $382 $352 $315 $336


Gross Profit $M $417 $498 $578 $640 $670 $564 $440 $404 $374 $339 $361

Clear Aligners % 78.6% 78.9% 79.0% 78.5% 78.3% 75.0% 70.8% 67.6% 65.5% 61.6% 62.4%

Scanners/CADCAM % 26.2% 29.1% 31.7% 26.3% 32.6% 29.2% 30.0% 30.0% 30.0% 30.0% 30.0%

Gross Margin % 74.5% 75.4% 75.9% 75.7% 75.6% 71.1% 66.7% 63.3% 61.2% 57.2% 58.1%


% Margin % 27.0% 27.3% 28.5% 29.9% 30.3% 32.6% 23.3% 24.9% 23.5% 23.7% 20.3%


% Margin % 17.1% 17.1% 15.1% 16.8% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5%


% Margin % 7.6% 6.7% 6.9% 7.2% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%

EBIT $M $128 $161 $194 $184 $193 $119 $131 $95 $87 $60 $89

% Margin % 22.8% 24.4% 25.4% 21.7% 21.8% 15.0% 19.9% 14.8% 14.2% 10.1% 14.3%

EBITDA $M $146 $178 $211 $202 $212 $136 $146 $109 $100 $72 $102

% Margin % 26.0% 27.0% 27.8% 23.9% 24.0% 17.2% 22.1% 17.0% 16.4% 12.2% 16.5%


Income Taxes $M $31 $33 $45 $42 $43 $28 $31 $22 $20 $13 $19

Net Income $M $96 $128 $146 $139 $148 $89 $98 $71 $66 $45 $68



YOY Growth % 21.5% 34.4% 13.9% (3.5%) 3.5% (39.7%) 15.1% (27.7%) (7.7%) (31.6%) 51.3%

DCF Assumptions






Revenue $793 $660 $639 $611 $592 $621 $658 $691 $731 $805

YOY Growth (16.8%) (3.2%) (4.3%) (3.1%) 4.9% 6.0% 4.9% 5.9% 10.0% Basic Shares Outstanding 80.2


Gross Profit $574 $453 $419 $389 $355 $377 $395 $420 $439 $483 FDSO 81.4

Gross Margin 72.4% 68.7% 65.6% 63.6% 60.0% 60.8% 60.0% 60.8% 60.0% 60.0%


EBITA $130 $145 $110 $102 $76 $105 $117 $146 $158 $174 Options 0.5 $15.14 0.4

% Margin 16.4% 22.0% 17.2% 16.7% 12.8% 17.0% 17.7% 21.2% 21.6% 21.6% RSUs, DSUs 2.1 $49.45 0.8

Amortization ($0) -- -- -- -- -- -- -- -- --

Taxes ($31) ($35) ($26) ($24) ($17) ($23) ($25) ($31) ($33) ($33) Total 1.2

Tax Rate 24.2% 24.3% 23.8% 23.3% 22.8% 22.3% 21.8% 21.3% 20.8% 20.8%

EBIAT $98 $110 $84 $78 $59 $82 $91 $115 $125 $141

+ Amortization $0 -- -- -- -- -- -- -- -- --

+ Depreciation $17 $14 $14 $18 $22 $28 $50 $53 $56 $61

% Capex 22.2% 28.2% 26.6% 36.6% 46.6% 56.6% 95.0% 95.0% 95.0% 95.0%

- Change in NWC ($8) ($7) ($6) ($6) ($6) ($6) ($7) ($7) ($7) ($8)

% Margin (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%)

- Capex ($76) ($50) ($51) ($49) ($48) ($50) ($53) ($55) ($59) ($65)

% Margin (9.6%) (7.6%) (8.0%) (8.0%) (8.0%) (8.0%) (8.0%) (8.0%) (8.0%) (8.0%)

Free Cash Flow $31 $67 $40 $41 $27 $54 $82 $106 $115 $129

Discount Factor 0.94 0.85 0.76 0.69 0.62 0.56 0.50 0.45 0.41 0.37



Net Cash Flows $17 $57 $30 $28 $17 $30 $41 $48 $47 $48

Total DCF $363


FY+1 Cash Flow $133 FY2017 Sales $660



PV of Terminal Value $613 Share Price $20

FDSO 81.4

ALGN Enterprise Value $976 ALGN Equity Value $1,657


- Debt -- Plus 2016-2017 Cash ($98)

ALGN Equity Value $1,657 Enterprise Value $878

FDSO 81.4


Premium/(Discount) to Current (74%)

May 2016, McAndrews

UPSIDE CASE





NA Ortho # 5,665 6,040 6,401 6,737 6,823 7,081 7,439 7,811 8,164 8,500 8,819

NA GP Dentists # 19,285 21,290 23,489 24,973 25,525 27,184 29,138 31,354 33,312 35,532 37,494

International # 9,285 10,800 13,450 16,460 17,173 19,312 22,277 25,361 28,292 31,075 33,719


YOY - NA Ortho % 7.3% 6.6% 6.0% 5.3% 5.2% 5.1% 5.1% 5.0% 4.5% 4.1% 3.8%





NA Ortho 000s 380 375 410 1,007 1,114 1,146 1,192 1,240 1,178 1,119 1,063

NA GP Dentists 000s 3,315 3,765 3,735 3,313 3,206 3,755 3,319 3,762 3,326 3,770 3,332

International 000s 3,145 3,825 5,290 5,475 5,535 5,692 5,920 6,157 5,849 5,557 5,279


YOY - NA Ortho % 4831.5% (1.3%) 9.3% 145.6% 108.9% 13.8% 4.0% 4.0% (5.0%) (5.0%) (5.0%)





NA Ortho % 101.3% 100.0% 88.0% 33.4% 35.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%

NA GP Dentists % 59.7% 53.3% 58.9% 44.8% 56.2% 58.9% 58.9% 58.9% 58.9% 58.9% 58.9%

International % 52.8% 39.6% 50.1% 55.0% 40.3% 50.1% 50.1% 50.1% 50.1% 50.1% 50.1%



NA Ortho % 55.3% 58.5% 61.3% 63.9% 64.5% 66.4% 69.1% 71.7% 74.3% 76.4% 78.5%

NA GP Dentists % 12.8% 14.0% 15.4% 16.1% 16.5% 17.5% 18.5% 19.9% 20.8% 22.1% 23.0%

International % 4.9% 5.7% 7.1% 8.7% 9.0% 10.2% 11.7% 13.3% 14.9% 16.4% 17.7%




NA Ortho 000s 137.0 159.6 177.3 214.3 225.8 253.5 296.0 326.4 358.2 391.6 426.6

NA GP Dentists 000s 139.7 154.3 161.4 184.1 191.9 212.3 240.5 258.8 275.0 293.3 309.5

International 000s 86.8 108.5 139.5 184.8 198.3 231.2 283.7 339.2 397.2 458.2 522.0

Total Cases 000s 363.5 422.3 478.2 583.2 616.1 697.0 820.3 924.3 1,030.4 1,143.0 1,258.0

YOY - NA Ortho % 18.8% 16.4% 11.1% 20.8% 22.5% 18.3% 16.8% 10.3% 9.8% 9.3% 8.9%



YOY - Total Cases % 17.5% 16.2% 13.2% 21.9% 24.0% 19.5% 17.7% 12.7% 11.5% 10.9% 10.1%


NA Ortho case/doc 24.2 26.4 27.7 31.8 33.1 35.8 39.8 41.8 43.9 46.1 48.4




YOY - NA Ortho % 10.7% 9.2% 4.8% 14.8% 16.4% 12.6% 11.2% 5.0% 5.0% 5.0% 5.0%

YOY - NA GP Dentists % 1.7% 0.1% (5.1%) 7.3% 9.4% 5.9% 5.7% -- -- -- --


YOY - Total Utilization Rate % 3.7% 4.3% (0.4%) 9.7% 11.6% 7.5% 7.1% 2.8% 3.1% 3.0% 3.3%



Invisalign Full $/case $1,441 $1,456 $1,490 $1,345 $1,325 $1,325 $1,324 $1,324 $1,324 $1,324 $1,324


Invisalign Teen $/case $1,389 $1,424 $1,440 $1,442 $1,443 $1,444 $1,445 $1,445 $1,445 $1,445 $1,445

Invisalign Assist $/case $1,332 $1,432 $1,512 $1,453 $1,429 $1,429 $1,429 $1,429 $1,429 $1,429 $1,429

Implied Total Pricing $/case $1,337 $1,349 $1,393 $1,284 $1,266 $1,262 $1,262 $1,262 $1,262 $1,262 $1,262

YOY - Invisalign Full % (1.7%) 1.1% 2.3% (9.7%) (10.0%) (1.6%) (0.0%) -- -- -- --

YOY - Invisalign Express/Lite % (9.0%) 4.5% 6.0% (9.9%) (10.1%) (1.6%) 0.0% -- -- -- --

YOY - Invisalign Teen % (2.9%) 2.5% 1.1% 0.2% 1.3% 0.1% 0.0% -- -- -- --

YOY - Invisalign Assist % 0.6% 7.5% 5.6% (3.9%) (4.0%) (1.6%) (0.0%) -- -- -- --

YOY - Implied Total Pricing % (3.1%) 1.0% 3.3% (7.8%) (8.0%) (1.7%) (0.1%) -- -- -- --

May 2016, McAndrews



Clear Aligners $M $517 $615 $713 $800 $833 $941 $1,106 $1,246 $1,389 $1,541 $1,695


Total Revenues $M $560 $660 $762 $845 $886 $1,009 $1,173 $1,320 $1,463 $1,622 $1,778

YOY Growth % 16.7% 19.0% 15.9% 12.3% n.a. 13.0% 17.6% 12.7% 11.4% 10.9% 10.0%

NFX Growth % 18.3% 18.0% 15.8% 15.1% n.a. 19.7% 16.3% 12.5% 10.8% 10.9% 9.6%

FX Impact % (1.5%) 1.0% 0.1% (2.8%) n.a. (6.7%) 1.3% 0.2% 0.6% 0.1% 0.4%

Clear Aligners $M $406 $485 $563 $628 $652 $732 $866 $970 $1,088 $1,200 $1,328


Gross Profit $M $417 $498 $578 $640 $670 $763 $899 $1,007 $1,125 $1,241 $1,370

Clear Aligners % 78.6% 78.9% 79.0% 78.5% 78.3% 77.8% 78.2% 77.8% 78.3% 77.9% 78.4%

Scanners/CADCAM % 26.2% 29.1% 31.7% 26.3% 32.6% 45.0% 50.0% 50.0% 50.0% 50.0% 50.0%

Gross Margin % 74.5% 75.4% 75.9% 75.7% 75.6% 75.6% 76.6% 76.3% 76.9% 76.5% 77.0%


% Margin % 27.0% 27.3% 28.5% 29.9% 30.3% 25.6% 24.2% 21.7% 20.3% 17.4% 16.4%


% Margin % 17.1% 17.1% 15.1% 16.8% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5%


% Margin % 7.6% 6.7% 6.9% 7.2% 7.0% 7.1% 7.1% 7.1% 7.1% 7.1% 7.1%

EBIT $M $128 $161 $194 $184 $193 $266 $339 $409 $484 $576 $659

% Margin % 22.8% 24.4% 25.4% 21.7% 21.8% 26.4% 28.9% 31.0% 33.1% 35.5% 37.1%

EBITDA $M $146 $178 $211 $202 $212 $288 $364 $438 $515 $611 $697

% Margin % 26.0% 27.0% 27.8% 23.9% 24.0% 28.6% 31.0% 33.1% 35.2% 37.6% 39.2%


Income Taxes $M $31 $33 $45 $42 $43 $65 $82 $97 $112 $130 $146

Net Income $M $96 $128 $146 $139 $148 $200 $256 $311 $370 $443 $510



YOY Growth % 21.5% 34.4% 13.9% (3.5%) 3.5% 35.7% 32.9% 21.5% 18.9% 19.9% 15.2%

DCF Assumptions






Revenue $1,009 $1,173 $1,320 $1,463 $1,622 $1,778 $1,950 $2,120 $2,307 $2,538

YOY Growth 16.3% 12.5% 10.8% 10.9% 9.6% 9.7% 8.7% 8.8% 10.0% Basic Shares Outstanding 80.2


Gross Profit $763 $899 $1,007 $1,125 $1,241 $1,370 $1,495 $1,636 $1,771 $1,948 FDSO 81.4

Gross Margin 75.6% 76.6% 76.3% 76.9% 76.5% 77.0% 76.7% 77.2% 76.8% 76.8%


EBITA $267 $339 $409 $484 $576 $659 $756 $848 $950 $1,045 Options 0.5 $15.14 0.4

% Margin 26.4% 28.9% 31.0% 33.1% 35.5% 37.1% 38.8% 40.0% 41.2% 41.2% RSUs, DSUs 2.1 $49.45 0.8

Amortization ($0) -- -- -- -- -- -- -- -- --

Taxes ($65) ($82) ($97) ($112) ($131) ($147) ($164) ($180) ($197) ($197) Total 1.2

Tax Rate 24.4% 24.2% 23.7% 23.2% 22.7% 22.2% 21.7% 21.2% 20.7% 20.7%

EBIAT $201 $257 $312 $371 $445 $512 $591 $668 $753 $848

+ Amortization $0 -- -- -- -- -- -- -- -- --

+ Depreciation $22 $25 $28 $37 $47 $59 $72 $78 $85 $94

% Capex 28.2% 50.1% 54.9% 64.9% 74.9% 84.9% 95.0% 95.0% 95.0% 95.0%

- Change in NWC ($10) ($12) ($13) ($15) ($16) ($18) ($20) ($21) ($23) ($25)

% Margin (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%) (1.0%)

- Capex ($76) ($50) ($51) ($57) ($63) ($69) ($76) ($82) ($90) ($99)

% Margin (7.6%) (4.3%) (3.9%) (3.9%) (3.9%) (3.9%) (3.9%) (3.9%) (3.9%) (3.9%)

Free Cash Flow $137 $220 $276 $337 $413 $484 $568 $643 $726 $818

Discount Factor 0.94 0.85 0.76 0.69 0.62 0.56 0.50 0.45 0.41 0.37



Net Cash Flows $75 $187 $211 $232 $256 $270 $286 $291 $296 $301

Total DCF $2,405


FY+1 Cash Flow $842 FY2017 Sales $1,173



PV of Terminal Value $3,874 Share Price $86

FDSO 81.4

ALGN Enterprise Value $6,278 ALGN Equity Value $6,959


- Debt -- Plus 2016-2017 Cash ($357)

ALGN Equity Value $6,959 Enterprise Value $5,921

FDSO 81.4


Premium/(Discount) to Current 8%

May 2016, McAndrews

CONSENSUS CASE n.a. Detailed Product Line Descriptions (source: 2015 10-K)

o Invisalign Full: Used for a wide range of malocclusion, the Invisalign Full treatment consists of the number of aligners necessary to achieve the doctor’s treatment goals. Invisalign Full treatment aligners are manufactured and then delivered to the dental professionals in a single shipment. Invisalign Full is sold in the U.S., Canada, and our international regions

o Invisalign Teen: The Invisalign Teen treatment includes all the features of Invisalign Full treatment, plus additional features that address the orthodontic needs of teenage patients such as compliance indicators, compensation for tooth eruption and six free single arch replacement aligners. This product is predominantly marketed to orthodontists who treat the vast majority of malocclusion in teenage patients. Invisalign Teen treatment aligners (other than the replacement aligners) are manufactured and then delivered to the dental professionals in a single shipment. Invisalign Teen is sold in the U.S., Canada, and our international regions. The Invisalign Teen product is included in "Invisalign Full Products"

o Invisalign Assist: Used for anterior alignment and aesthetically-oriented cases, the Invisalign Assist treatment offers added support to our dental practitioners throughout the treatment process, including progress tracking that allows the dental professional to submit new impressions every nine stages. When the progress tracking feature is selected, aligners are shipped to the dental professional after every nine stages thereby helping to achieve successful treatment outcomes. Predominantly marketed to GPs, Invisalign Assist is intended to make it easier to select appropriate cases for their experience level or treatment approach, submit cases more efficiently and manage appointments with suggested tasks. Invisalign Assist is sold in the U.S. and Canada.

o Invisalign Express (10 and 5) and Invisalign Lite/i7: Invisalign Express treatment, Invisalign Lite treatment and Invisalign i7 treatment are lower-cost solutions for less complex orthodontic cases, non-comprehensive treatment relapse cases, or straightening prior to restorative or cosmetic treatments such as veneers. Invisalign Express 10 and Invisalign Express 5, which are sold in the U.S. and Canada, uses up to 10 and 5 sets of aligners, respectively, and are also available as a single arch option. Invisalign Lite and Invisalign i7, sold in our international regions, uses up to 14 and 7 sets of aligners, respectively. For Invisalign Express/Lite/i7, aligners are manufactured and then delivered to the dental professionals in a single shipment.

o Retention: We offer two products for post treatment retention. The first is a single set of custom clear aligner retainers. The second is offered as a set of four custom clear aligners called Vivera Retainers made with proprietary material strong enough to maintain tooth position and correct minor relapse if necessary. Each set of Vivera Retainers is intended to be used for three consecutive months and deliver one year of retention. Doctors can prescribe Vivera Retainers for their Invisalign and their non-Invisalign patients

o Invisalign non-case revenues: Invisalign non-case revenues represent retainer products discussed above, Invisalign training fees and sales of ancillary products, such as cleaning material and adjusting tools used by dental professionals during the course of treatment

o ALGN Product Line Feature Enhancements. We have consistently introduced enhanced features across the Invisalign System over the past several years, such as Invisalign G3 (launched in October 2010), Invisalign G4 (launched in November 2011), and Invisalign G5 (launched in February 2014). In 2015, we did a phased launch of Invisalign G6 clinical innovations for first premolar extraction. These feature enhancements are a collection of clinical innovations designed to address some of the most significant treatment challenges doctors encounter.

o Invisalign G5 is our first set of innovations designed specifically as an integrated solution to enhance treatment predictability for deep bite, a specific type of malocclusion. Invisalign G5 feature enhancements include:

Precision Cuts, which are custom mesial and distal hooks used to provide anchorage for elastics and button cutouts to accommodate buttons bonded to the tooth aimed to help treat patients with Class II and Class III malocclusion.

SmartForce features engineered to achieve more predictable tooth movements using custom optimized attachments and Power Ridges designed to provide additional force in cases where certain types of root movement are prescribed.

Precision aligner bite ramps designed to disocclude the posterior teeth for improved efficiency in deep bite treatments o Invisalign G6 is engineered to improve clinical outcomes for orthodontic treatment of severe crowding and bimaxillary protrusion. Invisalign

G6 clinical innovations was launched in Asia Pacific, Europe, Middle East and Africa, and Latin America geographies throughout 2015 and will be launched in North America in early 2016. Invisalign G6 feature enhancements include:

New SmartStage programmed tooth movements that optimize the progression of tooth movements and provide aligner activation, engineered to eliminate unwanted tipping and unwanted anterior extrusion during retraction.

New SmartForce features that are designed to deliver the force systems necessary to achieve predictable tooth movements. These new features include Optimized Retraction Attachments, designed to work with SmartStage technology for effective bodily movement during canine retraction, with or without elastics, and new Optimized Anchorage Attachments, designed to work with SmartStage technology to maximize posterior anchorage.

o SmartTrack ™ Aligner Material. SmartTrack is a proprietary, custom-engineered Invisalign Clear Aligner material that delivers gentle, more constant force considered ideal for orthodontic tooth movements. Conventional aligner materials relax and lose a substantial percent of energy in the initial days of aligner wear, but SmartTrack maintains more constant force over the two weeks that a patient wears the aligners. The flexible SmartTrack material also more precisely conforms to tooth morphology, attachments, and interproximal spaces to improve control of tooth movement throughout treatment.

Relevant Reading

o https://scholar.google.com/scholar?rlz=1C1LENP_enUS461US461&espv=2&biw=1920&bih=979&bav=on.2,or.&ion=1&um=1&ie=UTF-8&lr&cites=11328818848906215935

o http://challenge2707.slu.edu/Documents/cade/thesis/Hudson_Thesis_2010.pdf o http://www.angle.org/doi/pdf/10.2319/011108-15.1 o http://www.ada.org/~/media/ADA/About%20the%20ADA/Files/code_of_ethics_2012.ashx o http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPIBrief_0316_5.pdf?la=en o http://www.aapd.org/assets/1/7/SurveyofDentalPracticeReport.pdf o http://amosdudley.com/weblog/Ortho o https://ny.matrix.ms.com/eqr/article/webapp/d214d980-0658-11e6-8bef-

7915bcd9c91d?t=1461680965%3A418%3A31229%3Avmias1106655&m=1&ch=Outlook%20Blastmail o https://portal.leerink.com/IRPDocumentViewer/Web/DocumentViewerCache.aspx?docId=46444F577879324E5A7A553D&pad=66385631534

C2F514E4669714C596565664D746A71773D3D&userId=59596553623264476138383D

https://scholar.google.com/scholar?rlz=1C1LENP_enUS461US461&espv=2&biw=1920&bih=979&bav=on.2,or.&ion=1&um=1&ie=UTF-8&lr&cites=11328818848906215935

https://scholar.google.com/scholar?rlz=1C1LENP_enUS461US461&espv=2&biw=1920&bih=979&bav=on.2,or.&ion=1&um=1&ie=UTF-8&lr&cites=11328818848906215935

http://challenge2707.slu.edu/Documents/cade/thesis/Hudson_Thesis_2010.pdf

http://www.angle.org/doi/pdf/10.2319/011108-15.1

http://www.ada.org/~/media/ADA/About%20the%20ADA/Files/code_of_ethics_2012.ashx


http://www.aapd.org/assets/1/7/SurveyofDentalPracticeReport.pdf

http://amosdudley.com/weblog/Ortho

https://ny.matrix.ms.com/eqr/article/webapp/d214d980-0658-11e6-8bef-7915bcd9c91d?t=1461680965%3A418%3A31229%3Avmias1106655&m=1&ch=Outlook%20Blastmail

https://ny.matrix.ms.com/eqr/article/webapp/d214d980-0658-11e6-8bef-7915bcd9c91d?t=1461680965%3A418%3A31229%3Avmias1106655&m=1&ch=Outlook%20Blastmail

https://portal.leerink.com/IRPDocumentViewer/Web/DocumentViewerCache.aspx?docId=46444F577879324E5A7A553D&pad=66385631534C2F514E4669714C596565664D746A71773D3D&userId=59596553623264476138383D

https://portal.leerink.com/IRPDocumentViewer/Web/DocumentViewerCache.aspx?docId=46444F577879324E5A7A553D&pad=66385631534C2F514E4669714C596565664D746A71773D3D&userId=59596553623264476138383D

Thesis: Short ALGN May 2016 Kyle McAndrews · 13/6/2016 · shedding market share and to start ......

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