SmileDirectClub, Inc.
Q4 2020 Earnings Call Transcript

Published: 4 Mar 2021

[Operator:]

Greetings, and welcome to the SmileDirectClub Fourth Quarter 2020 Earnings Call Please note, this conference is being recorded. I will now turn the conference over to our host, Alison Sternberg, Vice President, Investor Relations. Thank you. You may begin.

[Alison Sternberg:]

Thank you, operator. Good afternoon. Before we begin, let me remind you that this conference call includes forward-looking statements. For additional information on SmileDirectclub, please refer to the company's SEC filings, including the risk factors described therein. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today. I refer you to our Q4 2020 earnings presentation for a description of certain forward-looking statements. We undertake no obligation to update such information, except as required by applicable law.

[David Katzman:]

Thanks, Alison. Good afternoon, and thank you for joining us today. I'm pleased to report that Q4 results came in ahead of expectations and are consistent with the cadence of our controlled growth plan, which was enacted almost one year ago. Our fourth quarter was a solid finish to a year characterized by an unprecedented operating environment, and I am extremely proud of the progress our team made throughout 2020. Despite the swift onset of the pandemic and the macro uncertainty throughout 2020, our performance throughout the year was continued validation of the strength of our business model and the power of the competitive moats around our platform. It also demonstrated our ability to deliver on our continued focus of controlled growth with profitability. We outlined the strategy in Q4 of 2019, and we have been executing against it in the fourth quarter since. As a reminder, our controlled growth plan is firmly rooted in the integrity of the customer experience, and that remains our central focus. As we have cited before, we are still in the early stages of a massive opportunity, and we believe our focus on the customer experience is the most efficient way for us to capture long term market share. With this strategy, we expect to achieve continued growth into 2021, consistent with our long term targets, while also executing against our long term margin goals. I would also like to reiterate what we highlighted last quarter that we continue to see favorable industry dynamics and even broader acceptance of telehealth and specifically teledentistry, minimal penetration against our total addressable market. No real competitor that provides an end to end vertically integrated platform for the consumer and Clear Aligner is continuing to gain share in the overall industry. All of these are powerful tailwinds that over time will help drive our controlled growth strategy forward, off an increasingly efficient cost structure. These are nice tailwinds to have, but they don't change our long term financial targets.

[Kyle Wailes:]

Thank you, David. Our results in the fourth quarter closed out a year where we made meaningful progress against our plan of controlled growth with profitability. Similar to the rest of 2020, in Q4, the flexibility and scalability of our business model served us well, allowing us to come in ahead of expectations and on track towards our long term financial targets. Before turning to progress against our growth drivers and our results, I want to again remind everyone of the philosophy behind our controlled growth plan as laid out on our 2019 year end call one year ago. At that time, we explained that the integrity of our club member experience is the cornerstone of our growth plan, and we've been executing against that plan ever since. Over the course of the last year and every quarter, we have continued to see positive momentum against all of the key revenue growth drivers and cost levers that we outlined in our plan. We are managing the business to this plan which you’ll recall positions us to generate the following; average revenue growth of 20% to 30% per year for the next five years; adjusted EBITDA margins of 25% to 30% as we scale during that time period. This is driven by an 85% gross margin, 40% to 45% sales and marketing margin and 15% G&A margin. Now turning to progress against our growth drivers. In addition to our core business, we saw continued momentum in the quarter and since then, across the three growth drivers we have previously discussed. As a reminder, they are expanding our customer acquisition channels, expanding our presence in the team demographic and continuing our international expansion. On the first initiative, expansion of our acquisition channels, we continue to make good progress here. We have always been and remain agnostic as to how consumers start their journey to purchase aligners. We started with doctor prescribed impression kits, then smile shops and now through our professional channel partnerships, corporate insurance partnerships, mass retail locations and top up events, and we have expanded our reach to new segments of consumers. This supports our mission of democratizing access to care, which is foundational to what we do.

[Operator:]

Our first question comes from Jon Block with Stifel.

[JonBlock:]

I'll keep it out one and one follow-up. I guess if you can any more details on the DSO partnerships to push you a bit, how many of those practices are live, call it, how should that trend throughout 2021? Is there a way to think about the DSO contribution to case volume growth over the next 12 or so months? And then I've got a follow-up.

[DavidKatzman:]

I can take part of that and Kyle, you can address how it's going to contribute to revenue in 2021. But as far as pilots, we started out in early 2020 with more of a pilot mentality and that has really shifted as we onboard new DSOs and the GP offices. Most are coming on as a full roll out. It's a matter of whether we're going to -- starting out in certain areas of the country. But whether it's smile brands, who is one of the first pioneers we adopted this program with us, great partner, or some of the newer ones, DECA and some of the others, it's really more of a rollout and strategically getting their best shops or their best offices up first. There is some training that's required. We have to get them trained on our portal and process. So I think right now, we have a little over 1,000 offices, certainly a whole lot more as far as DSOs that have offices within their footprint. So by the end of the year, I think our goal is to have at least 10,000 offices up and running kind of on that, but also from a revenue standpoint, I think it's going to be hugely meaningful in 2021. It's going to be more of a 2022, we believe but I think in Q4, we'll start to see some of this come in. Kyle?

[KyleWailes:]

Yes, that's right. I would look at this as sort of a longer term growth opportunity as we think about it. So we've sold 1,000 practices to date. It's actually slightly above that now. The biggest bottleneck that we have is really the team that's training these practices and getting them live, implementing them and getting them submitted cases. And so that's ramping up nicely, but it's still in the very early stages of that. So from a P&L perspective, I would think about this as having a bigger impact more so in 2022 and beyond. And as we think about just the overall unit economics or profitability associated with it, at least for today, I would think about it as comparable to the core business or the traditional business. We do think long term there is some upside to that. But as we scale this business, I would model at least for now with the same unit economics as we have with the core business.

[JonBlock:]

And then, Kyle, for you on the second question, the 5% to 7% sequential revenue growth, you sort of land around $850 million for the year top line. When we think about the long term EBITDA margin of 25% to 30%, I mean is that linear? In other words, do we think about 500 bps, give or take, per annum? And if so, does that get you in and around $40 million in adjusted EBITDA for this year? Thanks guys.

[KyleWailes:]

So the full year is obviously difficult to predict. So we're not giving full year guidance at this point, just given the state of the macro environment. What I will say is if there was nothing that would change from today in terms of the macroeconomics, we would continue to expect on a quarter-over-quarter basis, as you pointed out, 5% to 7% sequential growth on the top line. And if you think about that in terms of profitability, it would have us exiting Q4 in and around 5% to 7% adjusted EBITDA. That's driven by about 75% gross margin. And I would say if you look at sales and marketing and how we're spending and ramping there, that would still be on the higher end of the longer term targets, maybe slightly even ahead of that as we continue to build the lead funnel, which will pay off in future quarters and future years. And so I would expect that to be on the low end, around 45%, which is the higher end of the targets and on the higher end, 48%, which is closer to where we would expect it to be for Q1. And just overall, on G&A, consistent with where we were throughout Q4, we're going to stay vigilant there on cost control. So the net of all of that is about 5% to 7% exit margin. And as you think about that for future years, I think as you alluded to that is a good assumption, at least for now, which is around 5% per year which takes us to about 25% to 30% over the next five years, which is our goal.

[Operator:]

Our next question comes from Robbie Marcus with JP Morgan.

[RobbieMarcus:]

I'm not sure, Kyle, or David, if you want to split this or one of you want to grab it. But as you think about the world reopening and a large portion of the population getting vaccinated here. In the US, it seems like Europe and rest of the world is a little behind, but especially in the US, how are you thinking about the cadence throughout the year? Anything to point out in terms of seasonality throughout the year that we should be thinking about within the 20% to 30% growth range? And then anything geographically we should be paying attention to, whether it's in fourth quarter or going forward in 2021?

[DavidKatzman:]

I'll take part of that. It's so hard to predict, Robbie. In terms of second wave of some new virus is coming. So as far as we're seeing, we are getting more adoption today right now from our SmileShops, so it's starting to shift a little bit where it was in the early stages of COVID, it was predominantly the kit business. So I think that's sort of a leading indicator as to how the communities feel about getting out and visiting a SmileShop. So we're not planning for any real seasonality. It's a steady drumbeat quarter-over-quarter in March on. Some of the things that will add to revenue as we go on in the quarters is adding five to six new countries, some of the countries that we added in 2020 maturing, starting to get from our other initiative in the partner network trying to get some of that revenue in Q4. But it is is very lumpy, and there isn't a lot of seasonality to it coming out of COVID. Kyle, do you want to add anything?

[KyleWailes:]

Yes, I think that's exactly right. So I think as you look at coming out of COVID, it's kind of similar to how we've looked at the tailwinds, Robbie. So if you look at the broader tailwinds that we've seen across the entire industry over the course of the back half of 2020, we saw broader acceptance of telehealth and specifically teledentistry. And obviously, we're still in the early stages of a massive market we're going after and we've talked about the competitive dynamics there before. But those tailwind dynamics don't necessarily change our top line growth on a sequential basis quarter-over-quarter and that's really because that top line was really driven by the amount of growth that we believe we can achieve. And most importantly, optimize our club member experience, which for us is what it's all about. So you should still expect the 5% to 7% top line on a quarter-over-quarter basis regardless of sort of macro recoveries here as we come out of COVID. And if we truly do see broad impact of that, I would expect more of that to accrue to the bottom line through sales and marketing efficiency, then driving sort of top line growth. And just to answer the second part of your question around sort of country dynamics and obviously, this is the first time we've broken out international revenue. It came in at about 13% of full year 2020 revenue. So we're seeing that business obviously grow nicely. But growth is truly fungible. So we've set our target at 5% to 7% on a sequential basis. And obviously, our international business is going to be a faster component in growth versus the US and Canada. And that's really a function of, as we look about it. Now is truly the right time for us to get a foothold in these markets. As we think about the great head start that we have here in the US, we've really invested to gain market share over a short period of time. And we see similar dynamics on an international basis. And so we believe now is the right time to start getting that foothold, which will support those longer term growth targets that we put out there over the next five years as well. And so you should expect that business as just an overall percentage to continue to grow. If you look at total industry case starts, it's, call it, 40%, 50% are outside the U.S., and it's 75% of the global opportunity, we think is outside the US. So that business will continue to ramp up like it has.

[RobbieMarcus:]

And as you think about -- you definitely talked about adjusted EBITDA profitability growing throughout the year. How do you think about some of the more impactful or different ways you can spend your marketing in 2021? Obviously, the world is going to be a little different than it was in 2020. Are there any changes you're expecting in terms of where your dollars are going? And just any material increases or decreases we should be thinking about throughout the year? Thanks.

[DavidKatzman:]

No, the mix is pretty much the same. We use a lot of different platforms and software as one of them is a mixed media model by new star and the percentages of TV, digital, possibly a little out of home, out of-home is billboards and things where people are out and about, we've actually killed all of that obviously in 2020, but that was a small part of our spend. I think the mix is about the same. We're just spending less. We don't anticipate, as Kyle said, 40% to 45%, a little bit more in Q1 because the rates are good and we can build a really good lead pool right now. But I think we're just more efficient in our marketing. We're getting more referrals. Our referrals are up to about 23% now. We're trying to hit a goal of 30%. So almost one in three people who come to SmileDirectClub will be a referral, which is obviously going to reduce our sales and marketing spend. And then also our footprint in shops, which is a much smaller footprint. We’re being smarter about these pop-ups, you'll continue to hear more about that where we leverage our SmileShop labor to go to another market for a few days to capture that demand, but it doesn't really cost us anything because these people are 40 hours a week anyway. So we're very excited about, we call it, the hub and spoke, and it's been piloted and now we're starting to launch and rolling it out in March.

[Operator:]

Our next question comes from Nathan Rich with Goldman Sachs.

[NathanRich:]

Kyle, maybe I wanted to follow-up on your comment about 15% of orders became a lead over two years ago. I was just wondering if you could give us any more detail on what that conversion curve looks like, if you will. Do you see kind of most leads convert kind of immediately, call it, the first, like three to six months and it kind of tails off to that 15%, or is it more kind of like bell curve where it might take a little bit of a time once you get the lead for then to decide to move forward with treatment? I'd just be curious to get kind of a better view on the pace of conversion that you guys typically see?

[KyleWailes:]

So without giving sort of too much specifics around numbers that can give you a sort of directionality, and we've talked about this in the past as well. So it truly is a highly considered purchase. So this has been for many people, a lifelong problem where they've had crowding or spacing and for whatever reason have not been able to fix their teeth. And so typically, they become a lead at some point, which is driven by some sort of event. So something is driving them and say now is the right time for me to straighten my teeth. It could be a wedding or the new year, as an example, which is also an attractive time come sort of a new year new effect. And what happens is about half of those people who become leads or members who become leads convert relatively quickly, so it's within the first few months. And the other half, there's a pretty long tail where it comes in over 24 months and even beyond. And so the 15% is a great example of that where over 15% is from over 24 months ago. And as we continue to grow that lead pool, that number slightly continues to grow over time as well is just because we have millions of millions of people now in that lead pool, which has grown over time. And so that's sort of the directionality of it. It's kind of half that happens pretty quickly after they become a lead and half that has a pretty long tail over a few year period.

[NathanRich:]

And then just a quick follow up on gross margin. As you ship more cases to the gen two manufacturing, what type of gross margin progress I guess should we see over the course of the year as you get to that 90% target of aligners being produced by gen two I think around mix here?

[KyleWailes:]

Yes, so we talked about this a little bit last year. When it's fully ramped up, we'd expect a couple hundred basis point impact as a result of gen two coming online. You're right about 60% of orders today that are being produced on gen two, that's a little bit behind where we want it to be. But it is, I would say, overall, it is ramping up nicely in terms of quality and getting to the numbers that we're ultimately looking to achieve long term. So we're expecting that to be about 90% by the end of Q2 in terms of aligners produced. But the real metric that's going to drive profitability there is associated with just the overall productivity of those lines and that's going to take time ultimately to ramp up. So as you think about the cadence for this year, I would still be modeling in and around that mid-70s for gross margin for the remainder of the year. And over time as productivity ramps, there's likely a little bit of upside from that but I would think about that more as a 2022 and beyond upside. And then there will be additional components of automation around that. So call it gen three, if you will, we're not done automating the lines that we have. And those capabilities along with treatment plan automation just overall economies of scale will drive us to that 85% over the next five years, which is the long term target. And it worked that way with gen one as well. If you think about gen one, it took us well over a year to get to the productivity levels that we saw when we moved towards gen two. And so I'd be thinking about it as mid 70s for now around gross margin.

[Operator:]

Our next question comes from Dylan Carden with William Blair.

[DylanCarden:]

I guess, first, just the sort of modeling housekeeping question. Is there any sense you can give as to the scale of the marketing, how much that went back up in the quarter as we think about sequential? And should we think of marketing go forward as sort of a seasonal line item whereby there's certain quarters where you would expect to see some sequential shifts that don't necessarily follow the top line?

[DavidKatzman:]

So as you think about Q1, the way I would think about it is, well, let me start on Q4. So Q4, we came out at 43%, that's slightly under where we want it to be and that's driven by some of the broader headwinds that we saw throughout the quarter as we talked about. If you look at what we have guided to around that is closer to a mid 40s, around 45% of revenues, the target that we are driving to. When we get into to the New Year, what happens is ad rates are lower and we can build our lead funnel in a more efficient way, in particular, in January, but really over the course of Q1, and then we expect that to pay off, as I mentioned, over multiple quarters, and for 15% of the orders are over a multiyear period as well. And so I would think about really Q1 of this year around that 48% level. And then I would think about it between that on the lower end 45%, on the higher end 48%, really for the rest of the year as we think about rebuilding that lead pool. If you look at Q2, in particular, obviously, with the business being lower with COVID, as we think about rebuilding that to support future growth, I would think about it in and around that sort of 45%, 48%. And that'll drive us, as I said before, to exiting the year from EBITDA perspective around 5% to 7%. And I wouldn't model it that way in future years as well. Even as we start to be on the lower end of the longer term targets, let’s say, 40%, I would think about Q1 as being a little bit higher than that as we spend into the quarter generate leads and have those pay off in future quarters.

[DylanCarden:]

And then kind of bigger picture here. As you are thinking the long term targets -- can you hear me by the way, I'm getting some…

[DavidKatzman:]

Yes, I'm getting it as well, but I can hear you okay.

[DylanCarden:]

Okay. I'll try to be gentle here. So as you think about sort of both top line and marketing long term targets, I'm wondering how much you envision or how much is being sort of packed in when it comes to automation and some of the partnerships you have, both on a product and DSO side? And I guess from an automation and sort of front end customer service level, I would think that the product is better and you just mentioned this a second ago, the automation allows for sort of greater efficiency. Should that naturally drift you to the higher end of your long term revenue targets? And then on the marketing side, again, you're already in this quarter. I guess that there's some sort of artificial things going on, but you're already kind of at the midpoint of the marketing. I mean I get that it drifts back up. But again, as you kind of think about these newer partnerships, these newer sort of acquisition channels, could you even come in below that over a longer horizon? Does that make sense?

[DavidKatzman:]

It does. Yes. So as I think about, to your point on automation, so we're at, call it, mid 70s today, around 75% gross margin overall. And what drives us to that 85% over time is continued manufacturing automation. So there's a little bit of upside from that mid 70s, as I said before, as a result of gen two and just continued automation. But what drives us from 75% to 85% is a combination of continued manufacturing automation, treatment plant automation as well. It's a pretty manual process for us still today around treatment planning. And just overall sort of general purchasing power as we scale the business and get leverage from our volume. It's really those three factors together that drive us to that. And then in terms of just overall sales and marketing, I think for now 40% to 45% is a good target and we'll continue to spend into that level and keep it around that level. As I look at opportunities from some of the partnerships, as you pointed out, we do think there is potential upside from that. We're certainly not factoring that into our models today. So if our professional channel business certainly scales and we're seeing great efficiencies from that, but that's something that we might look to alter the long term targets in the future. I would say for now, I would expect it in and around that 40% to 25% of revenue.

[Operator:]

Our next question comes from Derik De Bruin with Bank of America.

[DerikDeBruin:]

So just one for me. You talked about being more in network insurance. Are you seeing any benefit from that higher adoption just drive us there? Just some color on sort of what it's meaning to sort of be more in network.

[DavidKatzman:]

So as I look at the insurance overall, it's part of really a longer term strategy as we go in network. So we've always accepted insurance. It's just been a very manual process with a club member where they would have to pay us and we would help them ultimately get reimbursed from their insurance company. By going in network, it's a much better experience, and the member can pay us only what they owe. So if they would all say, on average, $600 to $800 out of pocket, they can pay the $250 down, they can finance the remainder using SmilePay. And so it's a very cost attractive option for that member. And we collect the remainder of that directly from the insurance company. So there is a benefit there as we do go in network for the consumer with insurance companies. The real driver, though, as we look at it as part of a multiyear strategy, where if you think about the broader industry, there's, call it, approximately 120 million covered lives that have dental insurance and maybe 25 million, approximately, that have ortho coverage. A lot of those ortho coverage lives though are teens that are covered, it's not adult working coverage. And so this strategy is part of a multiyear strategy. We're going to continue to go in network and partner with insurance companies really to have self insured larger employers continue to adopt ortho coverage without age caps as part of their policy. So that's part of a multiyear strategy. For now, it's still 5% or less of orders are coming through insurance, so a relatively small portion. And we're sort of building the infrastructure to have that pay off in 2022 and beyond.

[Operator:]

Thank you. And we have time for one more question. Our final question comes from Steve Beuchaw with Wolfe Research. Please state your question.

[SteveBeuchaw:]

Thanks for letting me run the anchor leg here, it’s a lot of responsibility. And so I’ll ask two and I'll get back in queue unless there's no queue remaining. One is on the whitening and broader oral care line this year, there's just been a lot of progress in terms of getting into new destinations. But then when I look at that line, it sounds like you're looking for that to be sequentially flat in the first quarter. I understand getting new locations takes a little time. It would be helpful if you could give us a sense for how much of a growth driver this year out of that five to seven, that initiative is? And then the second one I was going to ask is sort of revisiting the question on international. You gave a really helpful statistic in your prepared remarks. I believe it was 13% on international mix. I wonder if you'd be comfortable talking about what that statistic was exiting the year, and how much of the 5% to 7% that we're seeing here prospectively in terms of quarter to quarter growth would be International? And again, thank you very much for letting me in here.

[DavidKatzman:]

So I'll take the first part and then Kyle you can . So on oral care products, it’s both adding new retailers and there’s been some good progress on the announcements on large accounts sort of in grocery chains space really have not that cracked yet, more drugs but it's also it’s not just about more doors, it's also about more products. So we just launched a new product called our Pro Whitening System, which is an upgrade. So based on the demand and the appetite with the whitening product, we kind of reinvigorated categories. Our retail partners are asking us to innovate, to come up with more advanced products that we're working on. So I think, look, it's really good business. It's going to grow. But from $1 billion revenue business, it's not that meaningful, it's more about the counts of lead gen, getting people introduced to the brand, having the brand on shelf, we're getting really good positioning. So when people walk by at Walmart, or Walgreens, or CVS, we're getting a really nice amount of space on the shelf. All that we believe, and is there’s a lead gen for aligner sales down the road. So that's really the effort and why we're excited about it. It's also a good lifetime value with 1.3 million members now who have gone through our platform, there’s really the adoption of this after -- while they're going through treatment and then after has been probably better than we expected. So toothbrush, toothpaste, whitening, all of it. So it's a nice lifetime value prop for our numbers. Kyle, you want to take the other question?

[KyleWailes:]

So as you pointed out, for all of 2020, call it, 13 or so percent international revenue as a percentage of total. As we look at exiting the year and obviously, it's higher than that in Q4 as that business has continued to grow throughout the year. So without giving specifics, I would say, around 15% is a good estimate as to where that's exited. And we'll start to report on that. So the expectation is we'll break that out in terms of revenue for Q1, and that's a metric that we'll provide going forward. But as we think about it, that's really part of the three initiatives that we've talked about. So professional channel, team and international are the three growth initiatives that we've spent a lot of time investing in and supporting the longer term growth of the business. And as I think about it in terms of the 5% to 7%, it's completely fungible. We have a fixed amount that we believe we can grow the business at to support to meet that longer term growth expectation, but most importantly, do it in a way that's meeting the club member satisfaction standards that we make as sort of our true north star and the most important point. And so I would think about that international growth truly as fungible and within that 5% to 7%. And as we look at the market dynamics, and I think I have said this before, now is truly the right time for us to continue to grow that business and get a foothold around the world. Because as we look at the dynamics in the US versus on an international basis, we've got a great head start in the US. We've overinvested for many, many years, and we're seeing that payoff in terms of aided awareness in overall referrals and in margin expansion as well. And so now we're investing into that international business, which obviously is a drag on margins as we do ramp that up. But all of that is included within the top line targets that we put out being 5% to 7% on a quarter-over-quarter basis, so 20% or 30% per year. And then ramping to that 25% to 30% EBITDA target over the next five years.

[Operator:]

Thank you. And that's all the questions for today and that concludes our conference for today. All parties may disconnect. Have a great day.