Q4 2019 Earnings Call
Greetings and welcome to be Smile direct.
Fourth quarter 2019, Andy your and earnings Conference call.
All participants Arnie listen only mode. A question answer session will follow the formal presentation. If anyone should require operator systems. During the conference. Please press star there on the telephone keypad. Please note. This conference is being recorded I will now turn the conference over to your host Alison Sternberg Vice President.
Investor Relations.
The Sternberg you may begin.
Thank you operator good afternoon.
Before we begin let me remind you that this conference call include forward looking statements for additional information I Smile direct club. Please refer to the Companys SEC filings, including the risk factors described there and you should not rely on our forward looking statements as predictions of future that's.
All forward looking statements we make on this call are based on assumptions and beliefs as of today.
I refer you just liked your presentation, which can be obtained on our web site or 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., if the exchange 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.
I'm joined on the call today by our Chairman and Chief Executive Officer data Katzman, and our Chief Financial Officer, Kyle Wells.
Let me now turn the call over to David.
Thanks, Allison and good afternoon, everyone. Thank you for joining us on the call today.
No actually it was a major milestone you ever Smile direct club and I'm extremely proud of the progress or team has made over the course at that time.
As I've said it before we're in a very early innings of a massive untapped opportunity and before I go into the details associated with our adjusted EBITDA shortfall in the quarter and our associated thoughts on 2020 beyond I'd like to start by walking through some key highlights from the past year.
In 2019, we ship roughly 453000 unique align orders up 75% year over year at an A.S.P. over 70 $871.
Which true we achieved 750.4 million in total revenue up 77% year over year.
We saw 790 basis point improvement year over year in gross margin, which came in at 76.2%.
We laid the platform for global expansion successfully under five new countries outside North America.
Clean Australia, New Zealand, the United Kingdom, Ireland in Hong Kong, which strategically positions us for expansion across Europe and Asia.
We continue to cultivate relationships with major insurance providers, such as evident on United Health Care network Orthodontic coverage.
Develop strategic partnerships with retailers such as Walgreens Cvs, we launched a very innovative nighttime only clear aligners wants an oral care product line in approximately 3800, Walmart locations, which adds a new customer acquisition channel and increases the life time value of our club members.
Lastly, we completed our initial public offering.
And I situation by any standards. It was another incredible year. Despite these accomplishments we cannot ignore that we fell short of our adjusted EBITDA goals in the quarter, which came in a negative 60 million, resulting in a negative 100.2 million for the full year.
It's shortfalls due to a combination of factors, most notably inefficiencies in our manufacturing operations and inefficient back office processes driving higher than expected general and administrative expenses.
We will elaborate on this later in the call.
That said I think it's important to keep things a perspective, we grew to a certain her 50 million our company with approximately 6300 team members across southern countries and just a few short years.
Revenue in 2016 was only 22 million and we had six mile shops.
That being said we own these results we understand why we missed our profitability goals in the quarter, we have plans in place to address.
Oh, Hi, wait a few of the areas, which contributed to our negative EBITDA Kyle will specifically address the Q4 profitability mess.
Substantial investments in our <unk> infrastructure to support our continued growth in international expansion over the next few years.
Continued elevated legal and lobbying expenses to defend our mission against anti competitive behavior and to protect our position as a disruptive innovator in the oil care space.
Inefficiencies in our manufacturing facilities caused by a delay in automation of our manufacturing and treatment planning operations.
Aggressive hiring plans to support future growth.
Inefficient back office processes, driving higher than expected general and administrative expenses.
Additionally, as noted on our website in the fourth quarter 2019, we experienced shipping delays, which had a broad impacting customer experience.
But shipping delays occur and only impacts the time it takes for a club member to receive their liners, but also causes downstream impacts for our customer care team as well.
This is actually overall member experience as we saw in our NPS score in the fourth quarter switch dropped a few points, but it's still about 50.
C O. This business I'm faced with numerous decisions every day and as Carl will elaborate upon later, one very difficult, but important decisions, they're making given our club member experience and profitability in Q4.
Just to control our growth in order to provide the best consumer experience and reduce our costs to be adjusted EBITDA profitable by Q4 2020.
Our customer experiences the cornerstone of our business that we could not sacrifice that's in order to maintain or historical growth rates.
Now is a critical time for us to do this to ensure we are providing the best experienced every club member while also positioning us to capitalize on our global opportunity.
To accomplish this objective in achieved these savings were focused on the following.
Continued advancement in automating and streamlining our manufacturing treatment plant operations to loss to stay ahead of consumer demand.
Right sizing our production teams, which can flex up and down to conform to our business priorities long term growth rates.
Continued discipline around the deployment of marketing and selling dollars. If we are focused on pushing more demand through our existing small shop network, which has already been scaled in anticipation of future demand.
And overall rigorous cost discipline across the business.
For the past three years, we have over invested to own the category and dominate the space and we have accomplished this with over 50% aided awareness in a membership base that positions us as one of the largest providers clear aligner therapy in North America.
These investments will pay huge dividends as we expand globally in the future.
As I stated above 2020 is your control growth for Smile direct club and we see this year as our opportunity to fortify the foundation of our business to position us for strong revenue growth and margin expansion overtime.
We have tremendous unit economics with over 70% gross margins and no pricing pressure as a category leader.
For full year 2020, we expect the following revenue between one to 1.1 billion representing growth of 40% year over year at the midpoint of the range.
And adjusted EBITDA for the fiscal year is expected to be between negative 50 to negative 75 million.
Including turning adjusted EBITDA positive by Q4 2020.
Beyond 2020, we believe the actions, we're taking now will position us to achieve the falling over the next five years.
Average revenue growth of 20% to 30% prepare for the next five years.
Adjusted EBITDA margins of 25, 30% by the end of that time period, driven by achieving positive adjusted EBITDA by the fourth quarter of this year 2020, a wrapping up each year thereafter.
Our leadership in value proposition in the market provides us an opportunity to grow faster than us. However, based on the current maturities our business, we are making the strategic decision to further enhance our continued focus and our customer experience and our infrastructure, which we believe we can do while maintaining the growth rates noted above.
I will walk through these estimates in more detail later in the call.
Turning to growth drivers that will enable us to achieve these results.
Make no mistake about it we are growth company and we'll continue to be a growth company in the future.
Be it at a more controlled profitable pace over the course of 2020, we will continue to execute against a significant opportunity to grow beyond the approximately 850000 plus members soon to hit our millionth customer we've gotten smiles at luggage our platform.
In particular, we will continue to improve conversion and member experience every touch point across our physician portal.
We remain focused on expanding our club members across all age demographics, especially teens represent approximately 5% of our business today, Yeah. Two thirds of total industry case starts.
We're also focused on leveraging our aided awareness by acquiring club members and new acquisition channels, such as our partnership with Walmart and our entrance into wholesale.
Both cases, we are expanding the lens of the business to accommodate different Iran asked for for both consumers and clinicians and then the case of Walmart also increasing the lifetime value of our club members.
International expansion as a key growth driver for US now is the right time for us to continue to expand quickly.
As we've alluded to before approximately 75% of the market up opportunities outside of the U.S. and we continue to focus on expanding our international footprint.
Since the middle of 2019, we have entered five new countries added two in 2020 already with Hong Kong and Germany.
We expect this pace to continue.
We have a robust international road map with an extremely strong effective international team plans to launch into additional regions throughout this year.
We continue to refine and improve our new market launch strategies and execution as strong early uptake in these new geographies further demonstrates our unique value proposition is successfully meeting a significant unmet need across the globe.
2019 was a great year for innovation and we will remain.
Just on product development.
As mentioned in December we launched an expanded suite of oral care products, including our patent pending toothbrush Smile Spa water flawless are bright on premium whitening insensitive and whitening toothpaste.
In late July we launched our very innovative nighttime clear aligner product, which enables our club members to straighten or teeth only while they sleep.
And there's more to come we continue to deploy resources towards our research and development efforts in support of lengthening our relationship with our members also enhancing our recurring stream of revenue and most importantly, continuing to improve our clinical outcomes with our better as better approach.
I've spoken about the competitive moats around our business model, which are significant individually.
But which collectively make it incredibly difficult for anyone to replicate what we have built.
Calling a few here our mission driven brand with a positive customer experience our omni channel approach our exclusive affiliated Dr. network.
Our smell pay captive financing.
A completely vertically integrated med tech platform delivering a true end to end consumer experience with six issued patents and does is pending in our manufacturing and custom treatment planning operations.
These lots are especially important because they allow us to stay nimble and provide many levers for us to grow profitably as our business matures.
As we continue to execute against our mission to democratize access to a smile, each every person laws and making it affordable and convenient for everyone.
Before I conclude I do want to take a moment to address a topic that is very important to me.
As a health care business nothing is more important than the safety and efficacy of our product.
And given the misinformation about our product and clinical outcomes I thought it was important take a moment so dresses.
Our smile direct club clear Aligner therapy is safe and efficacious.
Were 850000 club members, including co workers personal friends of mine I nieces and nephews and countless other relatives are model is safe and effective providing great outcomes for our club members.
And thereby transforming their lives for the better.
The data speaks for itself, we have over 65000, Google reviews at a four point then star rating and approximately 170000 local reviews on STC Dot com for the 4.6 star rating.
Our network of experienced and skilled Dennis orthodontists, a treated over 850000 patients by the same standard of care that they do in their brick and mortar offices.
As with any medical procedure, there are sometimes risks that the procedures as nacco completely as planned whether as a result of patient compliance or other individual factors.
But as is the case in a traditional brick and mortar practice, our doctors do their best to correct any country indications.
Our mid course correction refiner rates are inline if not better than industry norms, and our satisfaction ratings are better than industry norms.
Approximately 5% of our club members asked for some sort of a refund in the vast majority of instances concerns are not clinical in nature.
Our NPS is among the best health care in consumer brands in the World.
Looking at all this collectively it clearly demonstrates that our product is safe and effective that said, we will continue to fight the misinformation about our products are platform into the clinical care provided by our affiliated network of Dennis Orthodontist, while at the same time remain laser focused on improving the experience for our club members through investments in technology product innovation that address.
Consumer pain points.
Our mission to defend access to care relies upon a stepping up to those who are threatened by what our company represents the access to care we provide.
Consumers deserve a safe affordable and convenient option.
If it weren't for Smile direct club many of our club members will not be able to improve their smile and their confidence due to high prices in the marketplace and the fact that over 60% of counties in the U.S. don't even have an orthodontic office.
Lastly, I would like to notice that we will be building an independent clinical advisory board made up of some of the best Orthodontists and Dennis around the globe.
That will report directly to our board of directors.
We expect this advisory board to help set industry standards for told dentistry quality measures advise ensuring a quality data and help with strategies for continuous quality improvement among other things.
'cause entrepreneurs and Disruptors, we fight everyday against the backdrop of misinformation industry backlash and continued attempts on the part a big dental to engage in anti competitive behavior.
None of this will be possible without the support of our team members club members and investors and we thank you for your support.
No I will turn the call over the cow, who will provide a more detailed review of our Q4 results and walk you through our financial outlook.
Thank you David.
David mentioned, while we're pleased with our accomplishments over the course of the past year or fourth quarter results have provoked a deliberate set of strategic decisions impacting our plans for the ensuing year and beyond.
To ensure long term global growth, we need to provide the best customer experience and this can be accomplished in the short term by controlling growth managing profitability strategically selecting our international footprint and making very targeted investments.
Before I address our outlook for 2020 and beyond I'd like to walk through our results for the quarter and provide some additional contest.
Turning to the income statement.
Revenue for the quarter was 196.7 million, which represents an increase of 53% over the fourth quarter 2018.
This increase was driven primarily by 50.6% year over year increase in Atlanta shipments, which came in at a 115042.
ASP came in at 17, 71, which was down 1.4% year over year.
It's important to highlight that we actually would have come in at the high end of our revenue range that we've been able to keep pace with orders in the quarter, but due to certain challenges associated with the pace of fully automated or manufacturing capabilities. We are unable to fulfill the volume of demand.
As I will address more fully in a moment automating or manufacturing instrument plant facilities is one of our top priorities in 2022, improving member experience and reduce our costs.
Turning to expenses in margins gross margin for the quarter with 73% 200 basis point improvement versus the prior year.
This was driven by 100% insourcing or manufacturing.
Sequentially gross margin was down by 415 basis points, which was largely due to certain manufacturing inefficiencies of David alluded to earlier.
This decrease quarter over quarter contributed to half of our Miss on adjusted EBITDA in the fourth quarter 2020.
I want to elaborate on what we mean by manufacturing inefficiencies or manufacturing facilities are partially automated today.
Well components like Thermoforming and aligner trimming our automated there's still a heavy labor component to our operations.
Oftentimes as an arts moves down the production line, there's rework and scrap involved which causes lower production output for the same labor spent and thereby higher cost Berliner.
This is what you saw in the fourth quarter 2019.
All righty quality and operations teams understand how to fix that problem and are actively addressing it.
Part of achieving positive adjusted EBITDA in the fourth quarter of 2020 is addressing this problem, which we have incorporated into the back half in 2020.
Marketing and selling expenses were in line with our expectation that 141 million or 72% of net revenue in the quarter compared to 54% of net revenue in Q4 2018.
Sequentially marketing and selling as a percentage of revenue improved by 100 basis points.
During the quarter, we continue to make significant strategic investments in launching international markets and building on our already strong brand recognition in the face of anti competitive behavior against our business model.
General and administrative expenses were 94.5 million in Q4 compared to 44.2 million in the prior year period.
Excluding stock based compensation and onetime costs DNA expenses were up 14 million sequentially.
This increase quarter over quarter drove half of our adjusted EBITDA Miss in the quarter and part of the reason for the pivot to rationalize our costs in 2020 and beyond.
Our legal in lobbing expenses increased 18% sequentially quarter over quarter.
As we've stated before you can expect to see elevated legal spend continue as we maintain our proactive stance to defend our mission in support of consumer access to care.
Looking at DNA overall, it's important to note that our DNA structure was conceived based on aggressive hiring plans designed to conform to an earlier revenue outlook for 2020.
Additionally, we saw higher than expected spanned across the fallen categories legal technology consulting Dino insurance coverage and international expansion.
So maybe for onetime in nature, such as Deno, IPO insurance Sox compliance and lease accounting standards.
Well the other expense items associated with the need for broader cost controls that we will be implemented in 2020 and beyond.
As David mentioned earlier, we have grown to 750 million in revenue with approximately 6300 team members across seven countries over the course in just a few years.
That's rapid growth also comes with increased challenges as the growth of our business has outpaced the maturity of infrastructure as demonstrated by the customer experience issues, we had in the fourth quarter.
Accordingly, we have given extensive consideration to our current operations and we've already enacted a plan to rightsize our production team to support our plan for controlled growth in 2020 and beyond.
Q4, net loss was 95.7 million compared to 26 million net loss in Q4 2018.
In summary, there were two factors that influence our adjusted EBITDA shortfall for the corner.
One inefficiencies in our manufacturing operations and to increase non labor DNA expenses on a quarter over quarter basis.
Adjusted EBITDA came in at negative 60 million.
Adjusted EBITDA margin was negative 31%.
Moving to the balance sheet. We ended the fourth quarter were 318 million in cash and cash equivalents.
Cash from operations for the fourth quarter was negative 141 million.
Cash spent on investing for the fourth quarter was 40 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 as cash from investing was negative 181 million.
That includes approximately 40 million of onetime payments associated with the IPO.
Quickly turning to Smile Pat.
Q4, 2019, 65% of members elected to purchase using smile pay which is down from 66% in Q4 2018.
Implicit price concessions as a percentage of total revenue was also try to down we're going associate delinquency rate of 9% of gross liner revenue in Q4, 2019, which is down from 10% of course aligner revenue in Q4 2018.
Now turning to 2020 and beyond.
As we've stated 2020 is Europe significant, albeit controlled growth for Smile direct club.
Our number one priority is to improve our club member experience.
We will also bill on the international infrastructure, we have already built and position our business for long term global growth.
Profitability will be a big focus for us in 2020, and we understand the levers we have to pull to achieve profitability.
Our revenue growth will come from following areas.
Continued penetration into our core North American market, we intend to expand farther into our core demographics will also penetrating new ones such as teens.
He is represent two thirds of industry K starts you had approximately 5% of our business.
We also intend to focus on new acquisition channels, such as wholesale and retail.
Our growth will also come from international markets, where we've already made meaningful progress in our existing overseas markets in of Architected, a strategic roadmap for continued expansion throughout 2020 and beyond.
You'll recall that we see 75% of the total market opportunity outside of North America.
On the cost side as David referenced earlier, we've already inactive initiatives designed to put us on track for profitability in the fourth quarter at 2020, including.
Rightsizing, our production seemed to conform to our business priorities and long term growth targets.
Continued advancement in automating and streamlining our manufacturing instruments lending operations to allow us to reduce our scrap keep pace with consumer demand.
Continued discipline around a deployment marketing and selling dollars, including a focus on pushing more demand for our existing smile shop network, which has already been scaled in anticipation of future demand.
And just overall rigorous cost discipline across the business.
We believe streamlining our cost profile for operational efficiencies will not only improve our margin profile, but more importantly will improve and provide consistent customer experience that meets our demanding expectations.
With all of this in mind I'd like to turn to our outlook for 2020 and beyond.
For fiscal year 2020, we expect the following.
Revenue between 1 billion to 1.1 billion representing growth of 40% year over year at the midpoint of the range.
Limiting factor on this growth is controlling our club member experience and growing the profitability.
Adjusted EBITDA for the fiscal year is expected to be between negative 50 to negative 75 million.
Mostly associated with losses in the first half of the year as we right size our cost profile anything positive adjusted EBITDA. This year in Q4.
I'd like to highlight that for now we do not plan to provide quarterly guidance for 2020, given the inter quarter Weve dynamics of our business and specifically given our investments in rapidly scaling the markets.
We do envision providing one quarter forward guidance at some point in the future as our operations continue to evolve.
Our plans for 2020 are designed to optimize our club member experience, while positioning us for long term global growth.
In 2020, we expect 20 or 30% annual topline growth and long term EBITDA margins of 25% to 30%.
Our long term revenue targets are derived from 10% to 20% annual topline growth in North America.
Which is inline with the clear aligner market.
20, or 30% annual top line growth from our existing international markets and approximately 100 million per year from new international markets.
These forecasts do not include material expansion in the wholesale channel.
We will update or forecast at the appropriate time as we begin to penetrate that market.
Well wholesale still in the early stages of our launch we're very excited about this opportunity.
Let me conclude by saying that we believe we are taking the important necessary steps to drive the best customer experience, along with disciplined global growth and margin expansion.
This approach along the product innovation will best position the company as a global leader in oral care category.
With that I'll turn the call back over to the operator for today.
At this time, we will be conducting a question answer session. If you'd like to ask your question. Please press star one under telephone keypad, a confirmation tone would indicate your line is in the question Q you May press Star too if you would like to remove your question from the Q4 participants using speaker equipment. It may be necessary to pick up your handset before pressing the star Keith one moment, please while we.
Pull for questions.
Our first question is from Robbie Marcus JP Morgan. Please proceed with your question.
Hi, Thanks for taking the question this is actually Lilly on for Robby.
A few questions you're all rolled into one starting with the guiding for 2020 the range came in a little bit below the street.
What do you think the primary driver if that is.
And second how should we be thinking about U.S.
You asked adoption, particularly in the new markets you're launching in.
And one more item can you comment on any negative trends that you've seen falling yeah.
New York Times, and NBC segments that were.
Published in the last few weeks.
Yes. So this is kind of I'll take the first part men David I'll take the last part. So if you think about 2020, it's really about controlling our growth and that's really in an effort to provide the best member better experience as we talked about on the call.
We believe by doing that in 2020, it's going to ensure our long term global growth.
It's about strategically positioning ourselves around the world to support that growth as well. So if you look at the you asked today, we've got a great headstart, we've over invested over the past three years to gain market share and we believe the investments that we've made in that market are going to pay off and continue to pay off in terms of referrals.
Awareness and overall margin expansion in the future.
If you look at the U.S. today, we are the low cost provider with the brand presence that we have and we have no pricing pressure. So we think right now given all of that it's the right time to position ourselves for the global footprint.
At the same time, it's also making strategic investments as we've talked about in wholesale and product innovation investing in new demographics like the team market as well and again all of this to position us for sustainable long term growth.
And lastly lot not least obviously on profitability, we talked about being profitable by the fourth quarter of 2020 and that is a that is a big focus for us.
Yes on the third party or question really the negative press I think you mentioned, New York Times NBC specifically.
This is this has been going out of since we started the business. It's been an every disruptive business I've been in for the last 30 years. It's been in the model. We knew was coming I think it's been a high tightening that highlighted since since we took the company public spent a lot more attacks on it.
It's really there's a lot of attention to it and strategically we are as I stated last time on the call, we're going to be shifting from being more reactionary to more proactive.
Really calling out how effective and safe our told the street platform is working with state dental boards across the country to put model held up tele dentistry legislation in place.
Really truly protects the patient by ensuring access to care, but we're working with some now they have announcement shortly.
And we're in agreement with with what it takes to have a true told dentistry platform Tele health has been out there for years and we're just following the same type of model, what we will be doing and you'll see in the next few weeks and months to calm as exposing.
Those are using their platform for anti competitive behavior, because that's what's going on out there right. Now what is troubling is the allied lies to protect higher prices unfair competition that we will expose and you'll see that.
The only hurting access to care by millions of people couldn't otherwise it for the high cost of getting a better smile.
And we look when we look forward to us to getting to the truth of this educating the the various legislatures the various trade organizations about our model and how safe and effectiveness.
Great. Thank you and one more quick one with the push out of EBITDA profitability.
How confident do you feel that you won't have to raise additional capital on the next year.
Yes. So if you look our cash position today, we've got about 318 million at year end. We also have a 500 million dollar facility with JPM in both of those together I really supporting the growth that we have I.
I will say, we will look at additional options to better support our international growth in particular, because the ABS facility that we have today.
Not fund that international growth overall.
If you look at 2020 at the midpoint of the range. Obviously, we guided to about negative 62.5 million of EBITDA that is a great proxy overall as you know port for cash.
Spec about 100 million in Capex similar to what you saw in in 2019, and then working capital as percentage of change in revenue revenue trending similar also to what you saw in in 2019 as well so putting all that together and we feel good about our cash position.
Great. Thanks for taking my question.
Our next question is from.
Jon Block with Stifel. Please proceed with your question.
Thanks, guys good afternoon.
Trevor maybe some more details on 2020, so just kind of revenue guidance.
Anything that you can break down in terms of us contribution versus international as you alluded to you did launch in a bunch of markets and then also for the 2020 guidance. What are you still just from a regulatory standpoint in other words is it sort of business as usual or is there some buffer in there from an AB 15, 19 standpoint, and then I've got a follow up thanks.
Yes on regulatory it's business as usual as we've talked about in the past for maybe 15 19, we havent seen an impact on our business and more operating as normal in California.
If you look at the breakdown John in international versus the U.S.. So we're not providing that level of detail yet I think if you look at how we're trending.
Likely be at some point later this year will start to break that out as it crosses the 10% barrier.
But for now we're not breaking out that level of detail if you get into overall, what what breaks it down and look at 2020 in particular, because we're not giving quarterly guidance I think it would be helpful. Just a little more details around what that looks like in 2019 in particular, we saw about 24% of our revenue in the first quarter, we thought too.
26% of a revenue in the second quarter, we saw about 26 again in the third.
Sorry, 24 in the third and 26 in the heart so fairly evenly split throughout the quarter as result of the international expansion that we had in particular approximately 15 countries coming on line throughout the course of this year I would expect Q3 Q4 to me a little bit higher the most percentages in 2019, a comparison in 2020 in comparison to what you saw in 2019.
Okay very helpful. The next one might be a little bit long, but any more color on the wholesale initiative. Another would you mentioned a couple of times.
With all due respect RPL diligence from a couple of weeks ago was a little bit more tepid. So why are the DRSKO embraces what is the price point need to be and David sort of as a follow up you mentioned also on the call a couple times ramping up your teen initiative and how does that improved customer experience. It by default teams are usually more complex case.
It is our those are right cases to take on from Intel Dentistry standpoint, Thanks for your time guys.
Yeah well.
Last part of your question on the team is we're not going to take on cases that we can't handle yes. We do teams now we have not actively gone and marketed.
So those teams.
It was it was ironic that when we launched last year. The nighttime only product we had a lot of inbound requests from parents who said.
For compliance I would go with clear aligners, but if I'm going to spend $5000 only make sure strapped on nice insight.
And so that compliance issue is one that parents wrestle with while she's wants to clear aligners.
This is paying for it says.
I don't want to risks.
Oh, Jeez, Australia because of compliance issues. So that I talked product is perfect. It's still mild to moderate there's a lot of teams out there.
That's a big category. So we're going to go after what we can do and do well and it's both from marketing and moving into more comp I would say complex that mix dentition.
We're working on some of that in our treatment planning Donna Costa Rica, so you'll get more that to come with wholesale.
Also was really drive done a lot of inbound requests we had a lot of of our doctors dentists soon which has a patient says because of our strengthened brand 50% aided awareness in the marketing spend that we have a lot of patients coming into these Dennis north of that US all the same due to the smile direct club brand and so.
To the inbound requests we develop these programs the first of which we're testing currently.
That's what we call the collaborative model, that's that's a very low touch for us as far as I see and capex to convert into that it's something that its explained on our website and those are really designed for dentist, who currently do not offer a clear aligner product I think there's about 150000.
On the adult and so what will ease into that market and then eventually go straight wholesale like other clear aligner wholesale products out there that's that take a little more development time for us. So we do anticipate that a launch in 2020.
Got it thanks for talking to us.
Our next question is from Glenn Santana row.
Guggenheim. Please proceed with your question Oh, Yeah. Thanks for taking the questions David just sort of follow up on this controlled growth.
Point, you're making to approve the customer experience you highlighted some operational issues such as shipping delays, but is controlling the growth at all related to the clinical issues raised by your members, particularly as it relates to the regulatory landscape and kind of as a follow up to that how do you go about controlling the growth as the plant.
To ultimately spend less on marketing or slow the international expansion relative to your thought how how you're going to put the brakes on us.
Yes, good controlled growth was really a reflection of what you saw the fourth quarter and some of the operational difficulties. We had an manufacturing it was not related to the clinical outcomes. Our clinical outcomes are improving all the time I guess the mail relatives have nieces and nephews My sister law Kyle's wife isn't it Susan our chief legal counsel.
Daughters, and that so that has nothing to do with our slowing down our growth to become EBITDA prop positive in Q4.
Got the second part of the question was the second part.
The question was right how do you slow the growth I mean, do you expect to spend less on marketing or slow the international expansion, how do you put the brakes on it.
Yes, I can take that when you I would say overall as we've always said, especially over a long period of time, there's a good correlation between our sales and marketing spend and how that correlates to revenue.
And so we have got lever particular within the U.S. business as well, but as you look at the international side.
For us quite that eliminate factor on that growth is optimizing the club member experience, obviously, there's a ceiling there for what we can push through the channel. We believe given all the dynamics that I talked about earlier in the call around the U.S. market that now it's the right time to position ourselves globally around the world, which will optimize that that long term growth.
So it's a combination of controlling that spend within the U.S. that has a high correlation to our sales and marketing spend while also positioning ourselves around the world in certain regions.
And spending appropriately within those regions as well Hey, How's that was maybe going to be my follow up question to you I mean, theres that we get a lot of questions around the correlation between the marketing spend and customer volumes and as your base of members gets bigger are you seeing.
Being able to leverage that though those marketing dollars and your customer acquisition cost at all or is it still pretty correlated as you're suggesting and I'll hop off thanks.
So obviously, we don't break out our acquisition costs from our small shop spend but I'll talk about in the couple of different ways. We did see about 100 basis point improvement sequentially quarter over quarter.
Within our sales and marketing spend overall I think when you when you look at the marketing side.
And some of the things that we're doing this year. If you look at Walmart. If you look at wholesale for example have opportunities to both increased the lifetime value of our club members, but are also new acquisition channels and give us the opportunity to reduce our acquisition costs over time.
Looking at the big ramp that we've had over the past several years and sales and marketing a big portion of that is associated with building, our small shop network in advance of future demand.
And one of the things that we're looking at in 2020.
As putting more demand through the existing network that we built out we believe that we've we've rightsize the operations that we haven't we have an opportunity to push more leverage of course more demand through that I'm starting to get leverage from that footprint 2020 beyond so as part of our turning.
But up profitable by the fourth quarter 2020, we're expecting to get more leveraged that small shop network.
Thank you.
Our next question is from Alex Nowak.
Craig Hallum Group. Please proceed with your question.
Great. Good afternoon, everyone. David just follow up on another question. There just on the team work you do actually from a marketing perspective on teens, because this needs to be more apparent focus instead of the actual patients is going to be using it.
Yes, so we're working with plans right now that I've worked with the marketing teams that will be launching in may which is sort of the beginning of seeing season.
Thats going after both the team and the parents as well.
As shown on our website, you'll see in social media, we actually have TV ads that we are producing that really speak to the product the compliance with our nighttime product and teens, one our product you're asking about smile direct club the CCR ads seat on social media. So I don't think it's me a difficult.
Yes, we just it's something that we just haven't focused on in the past and once again through demand and I think it was really highlighted when we launched our nighttime product seen all the parents that came out. So this is what I've been looking for.
My My team has wanted clear Aligners I was hesitant to do it so.
We're very excited about.
Okay understood I know how is the dentist recruitment going for smile direct here within the recent months because.
What I mean, theres been a lot of mega negative commentary going around with the dental boards polling or potentially pulling licenses from those who are working to smile direct. So I'm. Just curious are you hearing any concern within your dentists installed base and is it the team finding its part of the recruit dentist because of.
Not at all I mean, when you said that if one of the room their faces kind of drop.
Listen there's been a lot of inquiries starting when we launch and we knew is coming from the.
Orthodontic boards shifted in some of the dental board state the state dental boards, we have never lost any case, we've never had any of our.
Dennis Orthodontists and network lose their license or have any kind of negative adverse reaction. We've not lost a single Dennis in that network 250 of them to all of this publicity.
And investigation and media attention so I'm not sure we you heard that but.
We're not seeing that at all as matter of fact, it makes us stronger mix I want to fight for access to care more that's what we hear pushback from our desk, let's go lets flight.
You're seeing more them come out and be more noticeable in public we've had some of them on talk shows recently.
Talking about all the care that they're providing so I don't I.
I would agree with that the opinion, okay. No. That's good to hear and then when the decision to switch to more controlled growth goal PENSCO you only got to the lower end of the guide here that you gave back in Q threes I'm curious did the growth slowing Q4 and that kind of spawn. This decision to pivot to a slower growth more connect controlled growth in 2020.
Focus on profitability.
Yes, I do think you just to point out as I mentioned on the call. So it's important to remember we did have the demand to hit the high end of our range and because of the manufacturing issues that drove some of the poor customer experience issues that we had in the fourth quarter, we weren't able to ship it out so it definitely evolved over the course of the quarter, where we got more back up.
In our shipments in particular that MCC and refinement shipments as well we continue to get backed up there.
That's been improved over the course of January and February we're back within.
The normal shipping times than we've seen.
It's been online change as a result of that so it's not it's not a demand issue. It's a function of us making commitment to our customers, where we believe the right thing to do is to make sure we control our growth. So thats every single customer all 850000 and soon to be a million get the same experience across the board and that's why we're doing.
No look it's David and we know these are all of the discussions we had internally if you're in a dog fight lift Hooper.
Lowe's home depot Officemax off.
There's a reason that you've got to gain market share and sometimes investors will give you a break and say look grab market share about profit profitability later for us it's about customer experience. We don't have those competitive threats, we own the space. We were the pioneers in it there are no other medtech direct to consumer platforms.
There so for us, it's only about being ourselves and as we tried to maintaining that 70% plus growth rate as we got larger.
We realized really putting ourselves in the consumer experience and we're not we're just have no tolerance for that we're very very consumer focus and you can see that pivot out of that pretty quickly.
A lot of the that sentiment out there and the complaints on social media about acting in my liners on time.
We took up the heart and so we don't need to grow this fast but slow it down as a result of that in a better customer experience you get profitable and so it's a win win for everybody. We all feel good about it.
And the company I think it's a testament to this platform as extreme modes and barriers to entry.
It's been five years now we haven't had any real competitive threat. There is no one in the space like us and we don't see anybody in the foreseeable future. So, let's let's grow at a pace that makes sense and then we can provide a good customer experience.
Okay understood. Thank you appreciate it.
Thank you. Our next question from Brandon Couillard Jefferies. Please proceed with your question.
Thanks, Good afternoon.
Well, maybe a question for you Kyle just.
Chris if you sort of collaborate kind of on what's going on in the U.S. I mean by our math.
Suggests that the U.S. market was maybe only up single digits sequentially, even coming out of a depressed third quarter can confirm whether that's.
It is in fact the case.
Yes, so like I said earlier, we don't want to break down.
International versus domestic versus North America, I think as we get to a point later this year and international becomes a bigger portion of our business.
We will start to provide more granular details around the individual markets in particular, but I think you can look at Q4 in particular.
We were up 53% year over year in the fourth quarter, obviously, we're not providing quarterly quarterly guidance for this year, but you can see at the midpoint of the range at 40% that we've put out there we still see very strong growth across the business.
Okay, then maybe as far as the 20 outlook is concerned campus with maybe a couple numbers as far as the number of planned smile shop openings.
I would also love the Capex numbers give me the Opex number if you can as well as the stock comp add back for the year. Thank you.
Yes, so I can I confirm stock based comp side. So it starts.
I would estimate about 90 million in stock based comp for 2020.
There is still at portion of the I.B. A's from the IPO that are running through that on a normalized basis, an outer years that are expected to be about half that approximately $90 million for 2020 on shop openings I think if you look at what we said overall in 2020, our focus is really to force more demand through the existing footprint.
And that's part of our strategy to be profitable by the fourth quarter. So we've built the network over the past several years.
Support the future growth in 2020 and beyond so as of now I would not expect material openings. In 2020 now that said, we are working with Buxton to test certain geographies in those tests are looking at if we can have better locations or optimize locations to improve things like booking rates in the DNA or show rates and ultimately, thereby conversion.
And if those Tesco well we've.
Started those task, we expect those to be done by middle of the year you could see some ads in the back half year, if those as well, but in the numbers you see here for 2020.
Not expected additional material ads in the us on international basis, we've modeled approximately 100 locations across the countries that we're entering into for this year.
Okay anything as far as just the operating expenses go sales marketing DNA for the year.
Yes. So look we are not I'm, not giving an exact number within sales and marketing in particular, but what I would point I would say overall is we are expecting leverage we ended the fourth quarter at 72% of sales and marketing on revenue given the demand that we're picking up it is an important component of our strategy overall.
To achieve that profitability by the fourth quarter.
If you look at our cost of goods sold in particular I would expect over the course of the year as we continue to improve our manufacturing automation to have about a 200 basis point improvement in the second half of the year over the over the first half year as we execute on those problems. There is additional upside to that so we've talked a bit in the past about moving.
Into a second generation of manufacturing, we havent factored those into the numbers that we have here.
That could be additional upside to the 200 basis point improvement in the second half the year.
Then on on the DNA side, obviously, if you look at the numbers for the full year 19, it's a little bit distorted because of the IPO at 77% of revenue overall Q4, we ended up 46% of revenue and we are expecting incremental improvements in 2020.
Over the course of the year to achieve that profitability in that in Q4.
Alright, thank you.
Our next question is from John Kreger.
William Blair. Please proceed with your question.
Hi, Thanks, very much maybe sticking with that same line of questions. If we think about the 16 million in EBITDA losses, this quarter and sounds like you guys are firmly committed to being profitable by the fourth quarter. If next year can you just maybe take us give us a bit of a bridge. How you get there are and get I. Just are you say that you think about.
200 basis points of gross margin improvement is one of the keys or does it need to be higher than that.
No. That's right. That's that's one of the keys that we have to execute over the back half the year versus the first half the year I think if you look at the bridge overall.
And we've said this before over over a long period of time, we're confident in the revenue projections. I think you can look at 2019 as a good example, with our sales and marketing spend we have fairly good correlation with sales and marketing to revenue overall, where that correlation breaks down as over a four to 12 week period, because if you look at Q4 as an example, even in a period.
Where we have the ability to have the demand it doesn't necessarily mean.
That we can fulfill that demand within manufacturing so there's a little bit less of a correlation there over a short term period.
But if you look at the bridge itself, obviously, we have the cost coming out in late Q1 on the head count side.
Thats, mostly going to have an impact on Q2 through Q4 for the costs.
We've got to continue to execute on the automation that we're talking about here, you're pushing more demand through the small shop network, which we expect to happen from Q2 through Q4.
And it's also implementing a new international markets as I talked about before on the call.
If you look at 2019 at 24% to 26% the revenue on a quarterly basis was fairly evenly disbursed across the year I would expect this year to be a little more backend weighted as we continue to ramp up the international markets that have already been gated in here.
Great. Thank you can you talk a little bit more about how the at nine United relationships are doing did you get any uptake on January one and do you expect to add other payers to to the list and 20.
So we do expect to add other payers that we're in.
Skus into negotiations right now with with many payers and we expect the sign more in the near future and we'll be announcing that was when we do.
In terms of the uptick it's a much longer term growth strategy for us. So we do have a recent win that we'll be talking about here in the near future, where we partnered with United.
One a self insured or large self insured employer, where they are actually now adopting adult ortho coverage.
And we'll have that release coming out here in the near future.
But that's the opportunity that we see it's a much longer term play to sell adult worth of coverage to self insure employers, but it's not having a material near term impact numbers you have here for 2020.
Great. Thank you and just one last thing can you clarify our year manufacturing issues largely resolved at this point and have you altered the plans to bring on the second production facility.
Yes on the resolution that from the labor side, yes. So we right size the team that we need to be able to fill that demand that we've outlined here for 2020.
If you look at the overall rework in that scrap in the inefficiencies that we talked about that's a continual evolution we know.
We know exactly what we have to do to address those but thats not fix that happens overnight that'll happen over several months as we iterate and improve those processes.
Which is why you see that improvement not come online immediately within Q2. It comes online over the course of the year as we implement that you see that within the gross margin.
Other question was facility yeah, right. So as part of the bridge in the savings we decided while we have the building we have not fully built out and invest invested all the capital needed to bring that online as of now the plans are to bring that hold off of Q1, possibly we'll see where it goes as far as Jan.
To automation so the works and we the prototype should be on the floor here in Nashville.
Next month or so so that is that as a potential savings of have not bringing that second facility up online until 2021.
Okay. Thank you.
Our next question is from Erinn right Credit Suisse. Please proceed with your question.
Great. Thanks can you breakout how much is embedded in your guidance in terms of legal expense in 2020 or how much is incremental relative to your experience in 2019 from a legal expense perspective. Thanks.
Yes, so we haven't given an exact number directly from the one lobbying our legal in loving expenses. When we were up about 18% sequentially in Q4 over Q3.
We have also talked about in third quarter, obviously, our cost doubled in the second quarter as well we would expect the trend to continue from where we are today as we as David talked about earlier become much more proactive.
On the regulatory side compared to where we've been historically what those numbers are built into the model. It's all built into the model.
Okay. Okay, Great and then can you give us an update on the regulatory dynamics in other countries outside the U.S. here.
Oh, I guess today in the UK. Thanks.
I'm not aware of the news are you. Okay. We have Susan saying here, who is our chief legal officer.
Hi.
So the news that came out in the UK is you know, it's just guidance a lot of de concern expressed by the GDC similar to what we have seen here in the United States. The difference being that we are far more experience and handling be sorry to ask questions as to the safety and efficacy of arm.
Model.
We have already been in communication with the GDC in terms of educating them as you all clinical decisions being made by the Dennis and Orthodontists and our network and not by Smile direct club and it's really just a question of educating them and making sure that they're aware, but not something we're concerned about.
Okay all right. Thank you.
Our next question is from Nathan Rich Goldman Sachs.
Please proceed with your question.
Hi, good afternoon, thanks for the questions.
I wanted to start with the longer term revenue outlook for 20% to 30% I think that was a little bit lower than maybe what the initial expectations are you know I understand some of the near term challenges but.
No. It would just be curious that kind of get your view on what's kind of change on the longer term outlook relative to what those initial expectations might have been.
Yes, you will get goes back to exactly what we had said before the outlook that we have here is really about controlling our growth to provide the best club member experience and as we sit here today. We believe we can achieve the growth rates that you've seen here and be able to do that.
If you look at the U.S. and particular area, we've outlined 10% to 20% growth.
The the rationale behind that is really want in line with the market, but too.
We want to position ourselves strategically around the world. So that we optimize our long term growth and given the.
Manufacturing issues that we had within the fourth quarter. We felt there was important to control our growth for the next several years. So that we provide everyone. That's the best experience possible.
And about 10 to 20 assumes no additional penetration of new demographics.
So 5% of our business today is teams and 50% it or excuse me, 20% is 50, an older and an issue. It seems that same penetration by end of that range tenant 20 in the U.S. would assume more penetration into the team market. In particular also factored into that as I mentioned on the call we've assumed.
20% to 30% from our current international markets that we're in today like UK in Australia.
I would grow at about 20% to 30% on an annual basis and about 100 million per year from new at new international markets as well.
Okay, Great and then Kyle a follow up on the 2020 revenue guidance.
The guidance or ASP, it looks like it's a pretty significant step down from just where you ended the fourth quarter.
I was wondering if you could just kind of help us think through what the dynamic there. Thank you.
Yes, so it is and it's lower as we force more international So what happens is as we expand internationally, we typically launch with a lower price point.
To bring price out of the equation and then we typically bring that up over a period of about six months or so and that's our expectation for 2020 as well we had that playbook in Canada. We launch that we raise prices. We just did is Australia.
UK, we'll do the same thing.
Yes, there is obviously, it's not in the plan there is an opportunity to raise our price here in United States. We've had five price increases over five years. We've got asked that question on the last call.
No plans to break the 2000 barrier.
Research shows that that would not be wise, even though the next competitor is still a long ways away from 2000.
Just from consumers mindset, but where it 80 95, theres theres, so theres a price point, possibly somewhere in between and there's also on the roadmap of possibility of getting a premium price for a premium product in our nighttime only product. So we that's something that's on the roadmap as well not it's built into the model today, but opportunities for.
Okay.
Increased price.
Thank you.
Our next question is from Michael Hi, Skin Bank of America. Please proceed with your question.
Thanks, guys.
I won't talk about the small shops on some of the your comments on.
Putting more into the existing network.
I see how the stuff that you see the small shops is currently being only 25% utilize I was wondering if that was for a lot of your more stable shops, if that sort of the you know the average including a lot of the new shop, you have international just could give us an update on how that's trended over time and through why isn't that number higher given given the massive demand you're seeing in terms of.
Shipments.
Yes, so that's an average across all shops, we have some that are higher we have some that are lower but that's an average across all you know over time, we've had a strategic plan to add those shops in advance of future demand.
So you've seen utilization will shops go down as we've done that if you were to go back in 2017 and they as an example, we had significantly fewer shops, where we had today utilization was as high as 75% or above and some of those shops.
Have a model in the get back to those levels in 2020, but we have assumed incremental improvements in utilization as we push more demand through that footprint, we're getting smarter with it and we did internal modeling that we've now higher buxton their world renowned for retail footprint modeling.
They work with Dsos other professional help companies and so.
We're doing it where we get the having 75% utilizations netsmart, either because you're leaving you're leaving customers on the table, who can't get times, you can never going to be 100% utilize if you will come from nine to seven pm.
The fringes, you're not going to fill up everyone wants to lunch hour everyone wants.
Ceredase, so you've got to be opened the red number of hours or 25%. We believe is there's too much excess capacity there and so we're trying to find the optimal level I think working with Buxton. Some of the testing that we're doing over the next two months, we're really give us some answers there as to exactly how many shops, we need where they should replace the.
Hours that it needs to be open or they don't drive demand, but when someone comes to the site to book if they don't see available something thats convenience that has the right.
The book in percentages will go down or the show rates or whatever so it's something we're really excited about that now that we take on more professional approach to it I think we'll get to the right answers.
Alright, Thanks, I know the follow up as a follow up on some of the prior questions.
Reconciled point 19 resolve the 2020 outlook given some of the longer term points.
The way I see it the correct me if I'm wrong, the slightly more conservative view on 2020 deals with some of the manufacturing issues you had at some of the customer experience sort of running the company Rightside itself as you grow into the the footprint you've established both in DNA self in marketing and things like what the small shop, then if you do.
Correct those issues and you do work through over the course of the year on year turning proper by the end of the year. Then why is your longer term growth rates sort of down much more below because if you know if that tend to 20% of North American for example, if you said of the sort of the five year average you've got into 40% overall in 2020 set apart from the out years, you, even well below that average.
Can you help me bridged why once you get through the 20 point 2012 period, and you're turning profitable you're not able to reaccelerate back to us and improved growth rate.
Yes, obviously in the in the near years, we'd expect to be at the higher end of that range and as we continue to mature at the lower end, but an average of that that 20 or 30% over that time period.
Again, it's all driven by the customer experience. So as we get to Q4 2020 in into 2021.
If we had the infrastructure and the capability to grow quicker than this and we certainly will so it's not it's not a market issue that's causing.
The limiting growth that we put in here for 2020 and beyond it truly is what we believe the business can absorb on an annual basis from net new business and still provide the best club member experience maintain our NPS scores the customer experience entering.
Hold on all the new markets the plant the C.
We believe this is the right approach so that could change, but there's no governor we don't have to grow faster.
Customer experience number one profitability in order to getting the cash flow positive.
Within within the timeframe is that we've laid out that's going be the driver of this not too.
50% or 60% growth company. There's no reason for we still need to do it doesn't mean a billion dollar company five years in growing 30% is not such a bad thing and having great unit economics with no competition.
I think it's a good invest.
And just to be clear on that last point you did say the following some of the work you did and what the manufacturing.
And in genuine trouble you are thinking a customer experience and some of the of course trend back higher to start the or is that correct.
Absolutely, yes, you could see.
We live in diabetes, social media were social media company right its and what happens in social media 850000 customers. The overwhelmingly majority of those have great experience doesn't doesn't take many start getting loud in social media and that's that's the power of Instagram and Facebook.
And so and it was real it really was real we got behind we were out eight weeks to get People's MCC refinements.
My own daughter had an MCC that that she wasn't getting on time and so listen we that's not who we are we didnt need to do that.
And we're already seeing better better social media sentiment out there and from our own customers thanking us for turning things around so we're excited about approach we're taking up.
All right. Thanks.
Our next question is from Kevin Kelly Endo.
Yes. Please proceed with your question.
Hey, guys. Thanks for taking my call. So I just want to college trying to go back through the statement around the cash and the cash burn you may you made a comment that the working capital it's likely to be the same I think working capital in 2019 was like a negative $200 million.
Is there any reason why it would be better any chance you know the dsos or a our or is there any improvements you can make and working cap.
Yes, so just to clarify that the comment is that the change in working capital as percentage change in revenue, we would expect those percentages to be similar to what you've seen historically.
As the business does grow we talked about this before.
We're growing quicker this year than the prior two years combined.
Then there is a burn associated with that because of smiles reprogramming.
Self but as as we continue to to control growth in the face of receivables that we have in the prior two years is bigger than the current year.
We do see ourselves turn cash flow positive and as we've said before we still expect that to occur in 2022.
Okay. So okay side.
I got it is there a smile pay as a percent still in the 65% range is there any change in the fourth quarter there.
In terms.
If you're me.
That's right so 65% of members you purchase that was down from 66 the prior year.
Implicit price concessions, we've seen continued to trend down as well down to about 9% of gross line of revenue from 10% the prior year.
What we've seen we've seen good progress there as well.
All right I mean.
Confused about than the Dsos have come up they spiked up in the third quarter and that kind of been because of the revenue issue in the quarter, but even this quarter. The dsos are up a couple of days sequentially again is this the new normal level that we should be thinking about or is there an opportunity.
On the receivable side is there anything there that we should be thinking about going forward.
Yes look we've talked about it in the past, we don't think Dsos as a metric is necessarily the right metric to be managing how to model. They are I think you've really got to look at it on a curve basis for the 65% of our members and how that cash comes in over a period of 24 months, which is offset by the unpleasant price concessions or the 9%.
Okay revenue that we've talked about.
So there is continued opportunity for improvement there we've seen improvements even in the past several months that we've continued to optimize our processes. We've hired the had a credit who was formerly with corn and other consumer financing companies.
So we continue to make progress there and that's that's definitely on the road map for 2020 and beyond.
[music].
Okay, great. Thanks, thanks much.
Thank you.
We have reached the end of the question answer session and this does conclude today's conference you may disconnect. Your lines at this time. Thank you for your participation have a great day.