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spk07: Greetings and welcome to the SmileDirectClub fourth quarter 2020 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during this conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to our host, Allison Sternberg, Vice President, Investor Relations. Thank you. You may begin.
spk01: Thank you, operator. Good afternoon. Before we begin, let me remind you that this conference call includes forward-looking statements. For additional information on Tamal Direct Club, please refer to the company's SEC filings, including the risk factors described therein. You should not rely on our forward-looking statements and 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. In this conference call, we will also have a discussion of certain non-GAAP financial measures, including adjusted EBITDA and free cash flow. Information required by Regulation G of the Exchange Act with respect to such non-GAAP financial measures is included in the presentation slides for this call, which can be obtained on our website. We also refer you to this presentation for a reconciliation of certain non-GAAP financial measures to the appropriate GAAP measures. I am joined on the call today by Chairman and Chief Executive Officer David Katzmann and Chief Financial Officer Kyle Wales. Let me now turn the call over to David.
spk09: 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 this strategy in Q4 of 2019, and we have been executing against it in the four quarters 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 aligners 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. off of the amount of growth we believe we can achieve while optimizing our club member experience. That may change in the future as we mature as a business, but for now you should expect outperformance as a result of these tailwinds to accrue to more efficient customer acquisition costs versus outperformance against our 20% to 30% annualized revenue growth targets. Again, we believe that this is the right amount of growth to provide the optimal club member experience based on what we have seen in prior quarters. For today's call, I'd like to first call out some of the notable financial highlights from the quarter, then highlights from the past year, followed by a summary of industry dynamics. And finally, I will touch on the regulatory environment before turning it over to Kyle to walk through our growth initiatives, Q4 results, and our financial outlook. Turning to results within the quarter, in Q4, we achieved $185 million in total revenue, up 10% sequentially and 3% higher than the guidance we provided on our Q3 earnings call. shipped roughly 102,000 unique aligner orders up 9% sequentially. ASP came in at $1,820, which is up 1% on a sequential basis. We saw continued strong performance in our small pay program with delinquency rates remaining consistent with past history. We generated positive $7 million of adjusted EBITDA for the quarter, a $4 million sequential improvement, and a $67 million improvement year over year. I would also like to highlight that marketing and selling expenses came in at $79 million, or 43 percent of net revenue in the quarter, compared to 72 percent of net revenue in Q4 of 2019, a massive swing. While it is extremely difficult to predict the future given our current macro environment, I would like to try to provide some insights into the first quarter. In Q1, we expect revenue to be in line with our long-term targets on a sequential basis, meaning up 5 to 7 percent over Q4 2020. We expect adjusted EBITDA to be profitable, but not necessarily focused to the level of Q4 2020. As we continue to ramp marketing spending quarters like Q1, where the ad rates are lower and we can build our lead funnel, which we expect to pay off in future quarters. As a reminder, marketing dollars we spend now have a long tail. Over 15% of our orders in Q4 became a lead at least 24 months ago. Kyle will elaborate more on this later. Looking back at 2020, it was a pivotal year for SDC. The agility of our business model was truly put to the test. It forced us to stay nimble, innovate against the customer experience, and we achieved that while making great strides towards our long-term growth and margin targets. We have always, first and foremost, been a telehealth business. We are excited to see the growing level of understanding, acceptance, and use of telehealth, especially for orthodontics. Some notable 2020 accomplishments. We focused on improving the club member experience at every touch point. This is the cornerstone of what we do in our North Star. We made good improvements on this, and online consumer sentiment for SDC is at an all-time high. We surpassed more than 1.2 million smiles made, established the Smile Direct Club partner network, and have quickly grown to over 1,000 affiliated doctor's offices with robust pipeline for additional partners both domestically and abroad. We launched in Germany, Singapore, Austria, and Spain, bringing us to 11 countries globally at the end of the year. We expect four to six additional country launches in 2021, including our recent launch in the Netherlands. We kicked off SDC Team with plans to aggressively go after this segment in 2021 and beyond, as it represents 75% of the market opportunity, but only approximately 10% of our current business. We launched our innovative second-generation manufacturing technology to offer the most advanced made-in-the-USA aligners in the marketplace. Rolled out aligners with ComfortSense technology, making clear aligners more comfortable and tooth movement more predictable. We disrupted the oral care industry with products available at 6,800 Walmart and CVS stores and now Walgreens, expanding our oral care product footprint to over 10,000 retail stores nationwide. In 2020, SDC was the number one growth contributor to the U.S. whitening category and the U.S. power floss category. We now have the number one whitening gel product in the U.S. market. We launched insurance coverage on an in-network basis with Anthem, MetLife, and others so that we are now in network with most major dental insurance payers in the U.S. We had many new patents issued to add to our portfolio across manufacturing, scanning, oral care products, and our smile shops. This brings our total to 18 patents in our portfolio, with many more pending. We launched our enhanced tele-dentistry platform with advanced features, including a new updated consumer app and video chat, to improve the clinical experience for our members. Formalized our independent clinical advisory board, which is made up of some of the best orthodontists and dentists around the globe. And we achieved adjusted EBITDA profitability in Q3 one quarter ahead of plan and laid the foundation to execute against our long-term margin targets. Turning to our position within the market, I want to take a moment to remind everyone of our mission, to democratize access to a smile each and every person loves by making it affordable and convenient for everyone. Execution against this massive unmet need requires an unwavering commitment to a superior customer experience. Innovation and product development are also foundational to this. We are seeing great momentum across the business on these fronts, and they will continue to be an important investment area for us as we execute against our long-term plan. For too long, straightening teeth by orthodontists with invisible liners and braces has meant paying a huge three-time markup. Orthodontists have traditionally purchased invisible liners from a wholesaler or manufacturer, marked up the cost by three times, and then sold them to the consumer for $5,000 to $8,000. Our proprietary technology and platform offers consumers the ability to get the same clinically safe and effective treatment, but without the three-time mark. We do it by providing a doctor-directed digital end-to-end experience of teledentistry, 24-7 access to dental care, and it also comes with our lifetime smile guarantee. As long as our members are compliant with treatment protocols, we will guarantee their smile for life. This is the value proposition we are providing to consumers so that our mission becomes a reality. doctor-directed invisible aligner therapy with the ability to get the same clinically safe and effective treatment, but without the three-time markup. We took out the middleman markup and now provide a superior service. This is the same disintermediation that Amazon created, but in a much more complex healthcare procedure. That is what makes the barriers and moats so great. It is also a story that is just beginning to be told. Turning to the regulatory environment, As we noted in prior earnings calls, we are well-positioned in our continued efforts to protect the access to care that consumers want and deserve. We continue to see more states passing teledentistry-friendly laws and refusing to pass laws that put up artificial and clinically unsupported barriers to access to care. In addition, we continue to see growth in the adoption and use of teledentistry by the dental and orthodontic industries. This is underscored even further by the expansion of our professional partnership with well-established and respected national DSOs, which is further testament to the adoption of telehealth by the dental community. In addition, we are seeing acceptance of the use of telehealth for orthodontia by insurance providers, dental boards, and associations, as well as the ADA, which updated their guidelines to expand the use of teledentistry and to state that insurance providers should be covered in remote treatment by dentists. In summary, the most recent quarter brings a strong close to a year demonstrative of disciplined execution against our controlled growth plan and meaningful progress towards our long-term financial targets. On growth, we are making good progress against our initiatives, and we are executing against our long-term revenue growth targets. On cost, we saw continued margin expansion in the quarter, enabled by our manufacturing initiatives, our sales and marketing efficiency, and our continued cost discipline across the business. and we are on our way to achieving our long-term targets. Lastly, we continue to see favorable industry dynamics with broader acceptance of telehealth and specifically teledentistry, minimal penetration against our total addressable market, and clear aligners being shared in the overall industry. All these trends we expect to continue and position us well for long-term success. None of this would be possible without the support of our unwavering team members, club members, and investors, and we thank all of you for your support as we work to capture this massively underserved market. We remain laser-focused on our mission to provide doctor-directed T-straining without the three-time markup so that everyone has access to a smile they love by making it affordable and convenient for everyone. Now I'll turn the call over to Kyle, who will provide a detailed overview of our growth initiatives, Q4 results, and our financial outlook. Kyle?
spk02: 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 the 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 have been executing against that plan ever since. Over the course of the last year, in 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 were managing the business 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 a 15% G&A margin. Now turning to progress against our growth record. In addition to our core business, we saw continued momentum in the quarter and since then across the three growth drivers we had previously discussed. As a reminder, they are expanding our customer acquisition channels, expanding our presence in the team demographics, 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 pop-up events. 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. On corporate and insurance partnerships, we continue to build out our partner roster, with MetLife joining in the quarter and with the more recent addition of Green Shield Canada, the first insurer in Canada to cover our clear line of therapy and network. Additionally, we continue to see progress across all of our existing programs, including those with Allianz, Anthem BCBS, Empire BCBS, United, Aetna, and others. We continue to deepen our relationships with our existing partners, while also identifying other potential partnerships, and we expect to announce more on this in the near future. On the retail side, our Earl Carroll products, which are available at Walmart, CVS, and now Walgreens and Sam's Club, continue to perform well and serve as highly efficient lead source and brand building opportunities. By the end of this year, our ancillary product portfolio will be available on every retail channel across the country, including drugstores, grocery stores, club stores, mass retailers, and through e-commerce. On the professional channel, We continue to extend our partnership network with a steady cadence of additions within the quarter, including Unified Smiles, Altius Healthcare, Platinum Dental Services, and just recently, National Dental, which was a nice win from a competitive incumbent. Our network is now extended across more than 1,000 practices in the United States, and we have a deep sales pipeline both domestically and internationally. As we've highlighted before, this acquisition channel is complementary to our current offerings. and represents a new on-ramp for consumers who want to start their journey in a dentist chair. This allows dentists across the country the ability to offer SDC clear aligner therapy to their patients. On recent earnings calls, we have detailed the various go-to-market strategies we are employing as we operationalize this channel. While each one accommodates a different use case, all are highly efficient margin and creative sources of lead flow for both SDC and our partners. Equally as important, this effort has again reinforced the flexibility and adaptability of our platform in accommodating a new segment of consumers. Recall that only 30% of GPs offer clear aligner therapy today, and most of the ones who do offer aligners are low-volume providers. So we see ourselves at the very outset of an incredible opportunity, both domestically and abroad. As these partnerships mature and grow, we will continue to share updates in future quarters, and although it is early in our rollout, we are encouraged by the results thus far. Our efforts with the teen demographic are also making progress as we continue to innovate on our core product offering by adjusting to the unique needs of teens. Similar to the professional channel, although early in our rollout, we are encouraged by the results thus far. On the international front, the same problems that exist in North America around access, convenience, and cost also exist globally. We launched into our first country outside of North America in the second quarter of 2019, and the rest of the world countries already represent 13% of revenue for the full year 2020. That said, the international market represents approximately 75% of our global opportunity, so we are still in the early stages of penetration. A recent launch into the Netherlands further expands our footprint, and we are now in 12 overseas markets with plans to launch into additional locations in Europe, Latin America, in Asia Pacific throughout the year. As you can see, we continue to make great progress on our growth initiatives, and we will continue to update you in future quarters as we execute against them. Turning to progress on the cost bias. You'll recall that we've been focused across three key areas to right-size our cost structure, and we have made consistent progress against those initiatives. Similar to the third quarter, these efforts drove our outperformance on adjusted EBITDA and Q4, and we expect them to continue to support our long-term margin targets going forward. These efforts include the following. Continued advancement in automating our manufacturing and treatment planning operations to allow us to reduce our scrap and keep pace with consumer demand. Our second generation automation production platform launched late in 2020 and is currently producing approximately 60% of our liners. Consistent with expectations, are seeing very positive trends with the consistency in our turnaround time higher productivity for team members reduction and scrap and most important a more consistent and superior product for our club members second continued disciplines around the deployment of marketing and selling dollars including a focus on leveraging our referrals aided awareness and highly efficient acquisition strategies as demonstrated in the fourth quarter all of these together allowed us to come well within our long-term sales and marketing targets of percentage of revenue. And last, continued G&A cost discipline across the business. Backing out one-time items, G&A across the quarter largely remained stable, resulting from our enterprise-wide cost control initiatives. We plan to remain vigilant on this front throughout 2021 and beyond as we continue to drive towards our long-term margin target of 15% of revenue in G&A spending. As we have stated before, we believe streamlining our cost profile for operational efficiencies will not only improve our margin profile, but more importantly, will provide a consistently superior customer experience that meets our expectations and upholds our brand promise. Now turning to our results for the quarter. Revenue for the quarter was $185 million, which is a 10% sequential improvement over Q3. This was driven primarily by 102,000 aligner shipments, at an ASP of $1,820. On a sequential basis, this was a 9% improvement in shipments and reflects continued execution against their long-term targets. Providing some details on other revenue . Implicit price concessions were 9% of gross aligner revenue, and we are expecting similar performance in Q1. Reserves and other adjustments, which includes impression kit revenue, refunds, and sales tax, came in at 9% of gross aligner revenue and we are expecting similar performance in Q1. Financing revenue, which is interest associated with our SmilePay program, came in at 12 million. This is flat to Q3, and we are expecting similar performance in Q1. Other revenue and adjustments, which includes net revenue related to retainers, whitening, and other ancillary products, came in at 18 million, which is consistent with Q3, and again, we're expecting similar performance in Q1. Now turning to SmilePay. In Q4 2020, SmilePay purchases as a percentage of total purchases were down slightly relative to past quarters, which came in at 60% of initial aligner purchases versus 65% historically. However, overall, SmilePay has continued to perform well, and our delinquency rates in Q4 and since Q4 were flat the prior quarters. Because we keep a credit card on file and have a low monthly we expect SmilePay to continue to perform well. Credit card authorizations continue to perform well, and we remain focused on improving operations and collection strategies. Turning to expenses and margins. Gross margin for the quarter was 74%, representing a 323 basis point sequential improvement, which was supported by the increase in aligners produced using our second-generation automated manufacturing. We expect gross margin to continue strengthening as volumes grow. and we remain confident in our long-term gross margin target of 85% that we had previously outlined. Additionally, we continue to focus on streamlining our manufacturing facilities. Our second-generation automation machines are now live and producing roughly 60% of aligners. While still early, these new capabilities have already begun to reduce our scraps and provide a more consistent and superior process. This rollout has been a key component for our adjusted EBITDA positive results over the last two quarters, and will continue to be a vital component of our traction towards our long-term adjusted EBITDA margin target. Marketing and selling expenses seeming at $79 million, or 43% of net revenue in the quarter, compared to 72% of net revenue in Q4 2019. Our efficient deployment of acquisition spend, continued advancements in aided awareness and referral rates, access to highly efficient lead sources, in our highly curated network of Smile Shops, have positioned us to continue to perform well against their long-term targets in the quarters to come. On Smile Shops, we had 114 permanent locations as of quarter end, and held 104 pop-up events over the course of the quarter, for a total of 218 location sites. These pop-up events are a critical component to supporting our demand, function in the same capacity as a permanent Smile Shop, and enable us to fully leverage our Smile Shop resources to fulfill demand that is coming through aided awareness, referrals, and marketing. General and administrative expenses were $78 million in Q4, compared to $74 million in Q3 2020. G&A expenses were up $4 million sequentially, but included $5 million in one-time expenses primarily associated with the non-recurring legal settlement. Adjusting for this, G&A expenses were down $1 million on a quarter-over-quarter basis. Excluding D&A, stock-based compensation, and other one-time items, G&A expenses remain down 10 million, or 14%, versus Q4 of 2019. We plan to continue to stay vigilant with cost control throughout the remainder of the year and beyond, and you can expect to see continued leverage from this line item. Other expenses include interest expense of 15 million related to our debt facility, tax expense of 1.4 million, to the mix of earnings and losses in the countries in which we operate a gain on lease abandonment and impairment of long-lived assets of 3.1 million primarily related to the settlement of lease liabilities that were previously recognized as expansion q2 associated with our powell texas facility other store closure and restructuring costs of 0.8 million related to optimizing our shop footprint postcode and other income of 3 million which is associated with currency gains and losses recognized in the quarter. All of the above produces an adjusted EBITDA of a positive $7.2 million in the quarter, with an all-in net loss of $33 million, compared to a $43 million net loss in Q3 2020, and a net loss of $97 million in Q4 2019. Moving to the balance sheet, we ended the fourth quarter with $317 million in cash and cash equivalents, Cash flow operations for the fourth quarter was negative $15 million. Cash spent on investing for the fourth quarter was $28 million, mainly associated with leasehold improvements, capitalized software, and building our manufacturing automation. Free cash flow for the fourth quarter, defined as cash from operations plus cash from investing, was negative $43 million. Looking at Q4 2019, this represents a 76% improvement of $138 million compared to the prior year quarter. In early February, we elected to pursue our convertible note offering. We launched the deal at a size of $350 million, which we later upsized to $650 million due to strong institutional demand. In addition, the book runners exercised their full green shoe option to purchase 97.5 million convertible notes, bringing the full offering size to $747.5 million. The notes were priced with a zero coupon and a 40% conversion premium. In conjunction with the convert, we entered into a cap call that will fully offset any potential equity dilution from the conversion of the notes up to a stock price of $25.80 per share, which was up 100% from the closing price of the convert. Minimizing equity dilution was an important component for us, and the cap call enabled us to do that. The all-in cost of capital, including the cap call, is approximately 2% at a 100% conversion premium. This convertible debt financing strengthens our balance sheet with minimal equity dilution and fortifies us against the protracted COVID environment while also enabling us to execute against our growth strategy over the coming years. It also enables us to continue investing in R&D, innovation, and other business development opportunities. This transaction was met with strong institutional demand and is consistent with our ongoing focus to optimize our cost of capital. After repaying our outstanding debt facility, we will have approximately $500 million of cash on the balance sheet. In closing, as David mentioned, our performance in the fourth quarter reflects progress against our long-term revenue growth and margin targets in support of our controlled growth plan. I would like to reiterate a few key points which are consistent with prior quarters. Overall, and as David alluded earlier, we continue to execute against the long-term targets outlined in our controlled growth plan. Accordingly, in Q1, We expect revenue to be in line with our long-term targets on a sequential basis, meaning up 5% to 7% over Q4 2020. We expect adjusted EBITDA to be profitable, but not necessarily focused to the level of Q4 2020, as we continue to ramp marketing spending quarters like Q1, where the ad rates are lower and we can build our lead funnel, which we expect to pay off in future quarters. As a reminder, marketing dollars we spend now have a long tail. over 15% of our orders in Q4 became a lead at least 24 months ago. On cost of goods sold, we were making good progress on manufacturing automation with our second-gen machines now live and producing approximately 60% of our liners. We plan to increase that percentage significantly over the course of the year, and we expect over 90% by the end of Q2. As we have often stated, we believe streamlining our cost profile through operational efficiencies will not only improve our margin profile, but more importantly, will provide a consistently superior customer experience that meets our expectations and upholds our brand promise. On sales and marketing, you'll recall that our small shops function primarily as fulfillment centers, not as sources of demand generation. As of quarter end, we had 114 permanent shops open, with 82 of those in North America, and held 104 pop-up events over the course of the quarter. for a total of 218 location sites. We continue to see our shops performing well with higher utilization, which is a key part of meeting our long-term financial targets. Additionally, we have seen great success with our strategy of pop-up locations, which allow us to fulfill demand without the addition of fixed locations and associated costs. On liquidity, we're well positioned with approximately $500 million of cash in our balance sheet after repaying our outstanding debt facility. This gives us ample liquidity to manage through a protracted COVID environment, or alternatively, to spend faster in a higher growth environment, while also investing in strategic initiatives, R&D, and innovation. Lastly, I would like to again reiterate what I have said in prior quarters and reemphasize that our long-term objectives have not changed. We remain laser focused on providing the best club member experience, and our mantra remains to drive controlled and profitable growth. We remain the low-cost provider, with brand presence and no pricing pressure, and no real competitor that provides an end-to-end vertically integrated platform for the consumer. As we have said in previous quarters, and as recently demonstrated, we will continue to make strategic investments in the professional channel, international growth, and in penetrating new demographics to drive control growth, while also executing against our profitability goals. Lastly, we continue to see favorable industry dynamics with broader acceptance of telehealth, specifically teledentistry, minimal penetration against their total addressable market, and clear aligners gaining share in the overall industry. All of these position us well for long-term success. We look forward to continuing to update you on progress in the days and weeks to come. Thank you to everyone for joining today. With that, I'll turn the call back over to the operator for Q&A.
spk07: Thank you. And at this time, we'll be conducting our question and answer session. If you would like to ask a question, please press star one on your telephone keypad. That's the star key followed by the number one key on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press the star key followed by the number two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. In the interest of time, and so we can get to everyone, please limit yourselves to one question and one follow-up. Thank you. Our first question comes from John Block with Steeple. Please state your question.
spk10: Thanks, guys. Good afternoon. A lot of good color. I'll keep it to that one follow-up. I guess to begin, any more details on... the DSO partnerships to push you a bit. You know, 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 to follow up.
spk09: Yeah, 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 go, you know, we started out in early 2020. 2020 with more of a pilot mentality, and that has really shifted as we onboard new DSOs and GP offices. Most are coming on as a full rollout. It's a matter of whether we're going to be starting out in certain areas of the country. But whether it's Smile Brands, who was one of the first pioneers who 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. By the end of the year, I think our goal is to have at least 10,000 offices up and running. Kyle, you can fact check me 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?
spk02: Yeah, that's right. No, 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 and 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. You know, we do think long-term there is some upside to that, but as we scale this business, I would model it at least for now with the same unit economics as we have with the core business.
spk10: Okay, great. That's very helpful. And then, Kyle, for you on the second question, you know, the 5% to 7% sequential revenue growth, you'd sort of land around $850 million for the year top line. And when we think about the long-term EBITDA margin of 25% to 30%, Is that linear? In other words, do we think about 500 BIPs, 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.
spk02: Yeah, 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 a 75% gross margin. 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 percent, which is the higher end of the targets, and on the higher end, 48 percent, 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 controls. The net of all of that is about a 5% to 7% exit margin. 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 that 25% to 30% over the next five years, which is our goal.
spk10: Perfect. That's it for me. Thanks, guys.
spk02: Yep.
spk07: Thanks, John. Our next question comes from Robbie Marcus with J.P. Morgan. Please go ahead.
spk08: Great. Thanks for taking the question. I'm not sure, Kyle or David, if you want to split this or one of you want to grab it. But, you know, as you think about the world reopening and a large portion of the population getting vaccinated here in the U.S., it seems like Europe and the rest of the world is a little behind, but especially in the U.S., 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 was in fourth quarter or going forward in 2021?
spk09: Yeah, I'll take part of that. You know, it's so hard to predict, Robbie. You know, you turn on one news channel and you hear we're out of the woods in the spring, and another one says hang on because a second wave of some new virus, you know, is coming. So as far as we're seeing, we are getting more adoption today right now from our smile shops, 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 smile shop. So we're not planning for any real seasonality. You know, it's a steady drumbeat quarter over quarter. We march on. Some of the things that we'll add to revenue as we go on in the quarters is adding five or six new countries. Some of the countries that we added in 2020 maturing, starting to get from our other initiative with the Partner Network, so we're trying to get some of that revenue in Q4. But it isn't very lumpy, and there isn't a lot of seasonality to it due to coming out of COVID. Kyle, you want to add anything?
spk02: Yeah, I think that's exactly right. So, you know, 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, you know, 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 than driving sort of top-line growth. And just to answer the second part of your question around sort of country dynamics, so 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, you know, growth is truly fungible, right? 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 U.S. and Canada. And that's really a function of it 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 U.S., 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, call it Forty, 50% are outside the U.S., and it's 75% of the global opportunity we think is outside the U.S. So that business will continue to ramp up like it has.
spk08: Great. And as you think about, you know, 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's 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.
spk09: Yeah, I can take that one, Robbie. You know, the mix is pretty much the same. We use a lot of different platforms and software. One of them is a mixed media model by New Star. And, you know, the percentages of TV, digital, you know, possibly a little out of home. Out of home is, you know, billboards and things where people are out and about. We 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. It's almost one in three people who come to Smile Direct Club will be a referral, which is obviously going to reduce our sales and marketing spend and 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 small shop 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 anyways. So we're very excited about it. 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.
spk07: Great.
spk08: Thanks.
spk07: Thanks. Our next question comes from Nathan Rich with Goldman Sachs. Please state your question.
spk03: Good afternoon. Thanks for the questions. Kyle, I maybe 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, you know, if you will. You know, do you see kind of most leads convert kind of immediately, you know, 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, you know, once you get the lead for them 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.
spk02: Yeah, happy to address that. So, you know, without giving sort of too much specifics around numbers, I can give you a sort of directionality. You know, and we've talked about this in the past as well. So, you know, it truly is a highly considered purchase, right? 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, you know, some sort of event, right? So something is driving them to say, now is the right time for me to straighten my teeth. That could be, you know, a wedding or the new year, as an example, which is also an attractive time comes sort of the new year, new you 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 just because we have millions and 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.
spk03: That's helpful. And then just a quick follow-up on gross margin. As you shift more cases to the Gen 2 manufacturing, what type of gross margin progression, I guess, should we see over the course of the year as you get to that 90% target of aligners being produced by Gen 2, I think, around mid-year?
spk02: Yeah, so we talked about this a little bit last year. You know, when it's fully ramped up, we'd expect a couple hundred basis point impact as a result of Gen 2 coming online. You know, we're at about 60% of orders today that are being produced on Gen 2. That's a little bit behind where we want it to be, but it is, you know, 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. 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 you know 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'll be additional components of automation around that, right? So call it Gen 3, if you will. We're not done automating the lines that we have. And those capabilities, along with treatment plan automation and 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 1 as well. If you think about Gen 1, it took us well over a year to get to the productivity levels that we saw when we moved towards Gen 2. And so... You know, I'd be thinking about it as mid-70s for now around gross margin.
spk03: That's helpful. Thank you. Yep.
spk07: Our next question comes from Dylan Cardin with William Blair. Please state your question.
spk06: Thank you very much. I guess first just a sort of modeling housekeeping question. Is there any sense you can give to the scale, the marketing, how much that ran 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?
spk02: Yeah, 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%. You know, that's slightly under where we want it to be, and that's driven by, you know, some of the broader tailwinds that we saw throughout the quarter as we've talked about. If you look at what we had guided to around that, it was closer to the mid-40s. So around 45% of revenue is the target that we are driving to. When we get into the new year, what happens is ad rates are lower and we can build our lead funnel in a more efficient way, you know, 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, you know, for 15% of the orders over a multi-year period as well. And so I would think about, you know, 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. You know, if you look at Q2 in particular, obviously with the business being lower with COVID, you know, 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 would model it that way in future years as well. Even as we start to be on the lower end of the longer-term targets, so say 40%, I would think about SKU1 as being a little bit higher than that as we spend into the quarter, generate leads, and have those pay off in future quarters.
spk06: Excellent. Thank you. And then kind of bigger picture here, as you're positioning the long-term targets Can you hear me, by the way? I'm getting some crackling. I just wanted to double-check you.
spk02: Yeah, I'm getting it as well, but I can hear you okay.
spk06: 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 our product and DSO side. And I guess from an automation and sort of front-end perspective, 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 know, you're already in this quarter. I get that there's some sort of artificial things going on, but you're already kind of at the midpoint of the marketing, and I get that it drifts back up. But, again, as you kind of think about these newer partnerships, these newer sort of acquisition channels, You know, could you even come in below that over a longer horizon? Does that make sense?
spk02: It does, yeah. So, you know, as I think about to your point on automation, so we're at, you know, call it mid-70s today, around 75% gross margin overall. And what drives us to that 85% over time is continued manufacturing automation. So it's a little bit of upside from that mid-70s, as I said before, as a result of Gen 2 changes. and just continued automation. But what drives us from 75 to 85 is a combination of continued manufacturing automation, treatment plan 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 you know, certainly scales, and we're seeing great efficiencies from that. And 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 45% of revenue. Excellent.
spk06: Thank you very much.
spk07: Our next question comes from Derek DeBruin with Bank of America. Please state your question.
spk05: Hi. Good afternoon. So just one for me. You talked about being more in-network with insurance. Are you seeing any benefit from that higher adoption? Just some color on sort of what it's meaning to sort of be more in-network. Thank you.
spk02: Yeah. So, you know, 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, right? It's just been a very manual process for the 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 it's, you know, the member can pay us only what they owe. So if they would owe, 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, you know, 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, is part of a multiyear strategy where if you think about the broader industry, there's, you know, 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, you know, it's not adult ortho coverage. And so this strategy is part of a multiyear strategy. We're going to continue to go and network and partner with insurance companies to 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 multi-year 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. Great. Thank you.
spk07: Thank you. And we have time for one more question. Our final question comes from Steve Bouchard with Boff Research. Please, to your question.
spk04: Thanks for letting me run the anchor leg here. That's a lot of responsibility. So I'll ask two, and then I'll get back into you. Oh, I suppose 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. And I understand getting into 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 five to seven that we're seeing here prospectively in terms of quarter-to-quarter growth would be international. And, again, thank you very much for fitting in here.
spk09: Yeah, no problem. So I'll take the first part and tell you how you can handle the international. So on the oil care products, it's both adding new retailers that we're making good progress on. There are announcements on launching the grocery chain space that we have not cracked yet. More masks, more drugs. But it's also, it's not just about more doors, it's also about more products. So we've got, we just launched a new product called our Pro Whitening System, which is an upgrade. So based on the demand and the appetite for the whitening product, we've 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 a really good business. It's going to grow. But from a billion-dollar revenue business, it's not that meaningful. It's more about, as Kyle said, 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 we're setting the track on this, is a lead gen for liner 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 a million three members now who have gone through our platform, really the adoption of this 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 members. Kelly, do you want to take the next question?
spk02: yeah sounds good so yeah as you as you pointed out the uh for all of 2020 uh call it 13 or so percent uh 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 uh as to where that's actually and we'll start to report on that so the expectation is we'll break that out in terms of revenue for 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 you know, 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, you know, 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 had said this before, you know, 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 U.S. versus on an international basis, we've got a great head start in the U.S. We've overinvested for many, many years, and we're seeing that pay off 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.
spk04: Really appreciate the perspective there.
spk07: Thank you. Thank you. And that's all the questions for today. And that concludes our conference for today.
spk04: All parties may disconnect.
spk07: Have a great day.
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