SmileDirectClub, Inc. (NASDAQ:SDC) Q1 2023 Earnings Call Transcript May 10, 2023

Operator: Greetings, and welcome to the SmileDirectClub’s First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jonathan Fleetwood, Director of Investor Relations. Thank you, sir. You may begin.

Jonathan Fleetwood: Thank you, operator. Good morning. Before we begin, let me remind you that this conference call includes forward-looking statements. For additional information on SmileDirectClub, please refer to the company’s SEC filings including the risk factors described therein, you should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of today. I refer you to our Q1 2023 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 reconciliation of certain non-GAAP financial measures to the appropriate GAAP measures. I’m joined on the call today by Chief Executive Officer and Chairman, David Katzman; and Chief Financial Officer Troy Crawford. Let me now turn the call over to David.

David Katzman: Thanks, Jonathan, and good morning, everyone. Thank you for joining us today. I want to begin my comments by thanking the entire SDC team for continuing to deliver on both of our two key strategic initiatives through the enhancements and upcoming U.S. launch of our mobile scanning SmileMaker platform and the launch of our premium service CarePlus in four pilot markets, all while meeting our financial goals for the first quarter 2023. Our focus on producing innovative technology driven solutions, while maintaining disciplined cost controls allowed us to deliver sequential revenue improvement over Q4 of $33million or a 38% quarter-over-quarter increase and adjusted EBITDA improvement of $21 million. The revenue increase was driven by an initial aligner shipment volume increase of 44% which combined with our cost management not only improved the bottom line, but also delivered an improved free cash flow sequential performance of $23 million.

Let me start by providing an update regarding the status of our two key transformative innovations that will drive meaningful growth. The first innovation is our SmileMaker platform. As a reminder, SmileMaker or SMP features our mobile 3D scanning technology that allows customers to begin their teeth straightening journey from their own mobile device. We successfully launched SMP P in Australia at the end of November and are excited to announce our plans are on target for our U.S. launch in the next two weeks. We have made numerous improvements to our SmileMaker platform based on the learnings from our Australia launch, both in technology updates as well as customer journey enhancements. Which allowed us to develop a stronger solution and go to market strategy for the U.S. SmileMaker is our internally developed innovative AI technology that allows customers to digitally capture 2D images of their existing smile on a mobile device and submit the images to our enhanced AI engine to develop an automated 3D draft treatment plan that allows customers to buy their aligners immediately after seeing their potential new smile.

From a business perspective, this greatly shortens the timeline from initial customer engagement to making a buying decision from days or even weeks to mere minutes, while providing our customers with a great digital experience. As I mentioned, the U.S. launch remains on track to launch in the next couple of weeks. Since the U.S. is a completely different market in terms of advertising channels, consumer preferences, as well as our back end payment processor with SmilePay. Our plans are to have a soft launch introducing SmileMaker within select marketing platforms and gather learnings before full rollout. Our second growth initiative is our CarePlus offering. This elevated service model allows both dentists and orthodontics and specifically the underpenetrated general practitioners market to utilize SDC aligners and our robust telehealth platform to meet the demands of the more traditional orthodontic customer, higher income households and parent of teams.

We desire added access to in person dental professionals, but also want the convenience of telehealth for follow-up care. We believe that this offer will position SDC to capture a larger piece of the higher income consumer and team market, as well as provide a premium option for our existing customers who want the of both virtual and in person care. From our initial research, which has been confirmed at the launch of our pilot markets, both customers and dental practitioner value the unique turnkey orthodontics as a service nature of our hybrid CarePlus solution. From a practitioner’s perspective, this solution requires minimal incremental investment for equipment and product training without any upfront fees paid to SmileDirectClub. For consumers, they value the opportunity to purchase a premium service offering at an affordable price with a higher level of direct access for in person dental professional visits.

From a go to market strategy, we also discovered that many of our partner network practices appreciated having SmileDirectClub team members on-site to support the introduction and sale of the CarePlus offering. We have introduced SmileDirectClub sales specialists and targeted partner network practices to better educate customers on the differences between our two service offerings, CarePlus and our traditional VirtualCare offering. Based on these insights, we developed a dual journey offering that educates and allows customers with bookings at CarePlus Partner Network, practices the option to choose between CarePlus and VirtualCare regardless of the initial appointment type booked within the practice. We launched this premium service CarePlus offering at a price of $3,900 for our pilot phase to participating partner network doctors in Denver, Orlando, Sacramento and San Diego, and plan to expand to more markets in the upcoming months.

We continue to make progress with finding the right number of the locations within our partner network program, exclusive channel through which our customers will be able to receive our CarePlus offering. We ended the quarter with 1,095 active locations. It’s important to highlight that we do not need to have coverage of every general practice in our network, but want to ensure that we have a foundational presence in all key markets that allows a customer a short commute for an in person visit. The key part of the value proposition for the doctors’ practice is the ability to leverage the sales and marketing firepower of SDC to drive customers to any of our partner network offices for our CarePlus offering. Early partner feedback has indicated SDC CarePlus leads our driving new foot traffic to their practice, providing an opportunity for the practice to turn these customers into patients of their own for further dental care.

Additionally, some partners are benefiting from increased untapped revenue opportunities by selling the CarePlus solutions to their existing patient based, further monetizing chair time with their patients. Underlying the advancement of these strategic priorities is our commitment to rigorous financial discipline. Our first quarter bottom line results highlight our commitment to growing our business, while keeping a focus on our cost controls. We took actions in January to reduce costs by approximately $120 million to drive positive adjusted EBITDA by Q3 and positive free cash flow by Q4. With the results of Q1, we are on target to achieve our objectives. In addition to our January cost actions, we recently announced in our March 8-K filing, our discussions with some of our existing convertible bondholders.

For reference, we issued approximately $750 million in convertible debt in Q1 2021, which is scheduled to mature in February of 2026. However, based on market conditions, we are exploring an opportunity to reduce some of this outstanding debt, while also adding liquidity to our business. We are pleased to inform our investors that those negotiations have progressed with certain of the convertible debt holders with respect to a potential transaction. We anticipate being able to share more with our investors in the very near term. Any financing transaction the company would enter into will be focused on improving our capital structure by bringing in additional funding and lowering our overall debt. We continue to face a difficult and unpredictable macroeconomic environment.

However, it’s important to note that our dedication to maintaining financial discipline through our cost controls and cash deployment, regardless of top line results as we manage our business throughout 2023. We have the solutions, technology platform, team members and financial discipline to achieve our operational and financial targets. And now, I’ll turn the call over to Troy, who will provide more detail on our Q1 results. Troy?

Troy Crawford: Thank you, David. I will cover our financial results for the quarter. Please be sure to review our supplemental materials posted to our Investor website which provides additional details on everything I will cover. Revenue for the first quarter was $120 million, which is an increase of 38% sequentially and a decrease of 21% on a year-over-year basis. We are pleased with our sequential growth that exceeded our typical seasonal trend from the fourth quarter to the first quarter. Aligner revenue was driven by our shipment of over 59,500 initial aligners in the quarter, up 44% sequentially at an ASP of $1,949. The year-over-year revenue decline was primarily driven by continued challenging macroeconomic conditions driven by high inflation, which has been particularly difficult for our current core customer.

Providing some details on the other revenue items, implicit price concessions were 11% of gross aligner revenue, down from 14% in the fourth quarter. The percentage recognized in the current quarter is in line with our historical performance with the fourth quarter impacted by lower overall sales. Fluctuations in the quarterly IPC percentage are impacted by the overall level of revenue recorded in the period, which can drive deleveraging as well as rebalancing of the reserves. As we’ve mentioned on prior calls, we maintain separate reserves for IPC and cancellations and we analyze and regularly rebalance those reserves based on current information. While our results reflect the impact of the continued macro headwinds affecting our core customers, our restructuring plans drove meaningful improvements in our cost structure and free cash flow.

For the last three consecutive quarters, we have improved year-over-year EBITDA. In the current quarter, we improved adjusted EBITDA by $8 million and improved free cash flow by $36 million despite a $32 million year-over-year decline in revenue from the first quarter of 2022 compared to the current quarter. Reserves and other adjustments which include impression kit revenue, refunds and sales tax came in at 9% of gross aligner revenue compared to 10% in the fourth quarter. Financing revenue, which is interest associated with our SmilePay program, came in at approximately $7 million which is consistent with Q4 2022, and down approximately $2 million year-over-year due to the lower accounts receivable balance. Other revenue and adjustments, which includes net revenue related to retainers, whitening and other ancillary products came in at $18 million, an increase of $2 million over fourth quarter 2022 revenue and a decrease of $5 million compared to Q1 22.

As a reminder, in the comparable first quarter last year, we began the rollout of our innovative new retail products, including our whitening strips, which drove an initial increase in revenue. Now turning to SmilePay. In Q1, the share of initial aligner purchases financed through SmilePay program came in at 65.5%, which is above historical levels of approximately 60% and is reflective of the impact of the difficult macro environment on our core customer. Our SmilePay program is an important component to drive affordability with our customer base and overall, the program has continued to perform well with our delinquency rates in Q1 returning to more historical levels, particularly when compared to Q4, which on a lower sales base deleveraged.

The fact that we keep a credit card on file and have a low monthly payment gives us the confidence that SmilePay will continue to perform well. Turning to results on the cost side of the business, gross margin for the quarter was 72.5% which was up from 61% in the fourth quarter. As a reminder, the lower gross margin rate in Q4 2022 was driven by the deleveraging of fixed costs on lower sales volumes and higher impression kit volume, which carries a higher cost relative to sales, as well as lower retail margins and higher holiday shipping costs. As expected, in the current quarter, the efficiencies from our cost control initiatives drove improvement in margins as the top line grew and we benefited from the operating leverage. Marketing and selling expenses came in at $72 million or 60% of net revenue in the quarter compared to $97 million or 64% of net revenue in the first quarter of 2022.

While our marketing and selling expense increased $8 million from the fourth quarter of 2022 to take advantage of seasonal factors, we continue to drive additional efficiencies in our first quarter 2023 spend with an improvement of 1,400 basis points when compared to the fourth quarter. With a targeted focus on efficiency and quality leads, we are continuing to calibrate spend across a diversified platform base to optimize continuously throughout the period to achieve the right balance of high funnel leads and bottom funnel aligner sales. On SmileShop, we had 108 permanent locations as of quarter end and held 62 pop up events over the course of the quarter for a total of 170 location sites. The fluctuation in shop count is a result of detailed analysis we have undertaken to analyze the profitability of each store location, our ability to drive marketing efficiency, as well as convenience for our customer base.

We expect to expand our SmileShop footprint we optimize locations to support growth initiatives with our broader CarePlus rollout. Our end goal is to increase customer access to our solutions through the scaling of our partner network channel, expansion of our SmileShop footprint and the upcoming launch of our SmileMaker platform and app. We will continue to monitor our strategies to expand our reach that supports incremental demand without cannibalizing sales from existing channels. We now have 1,095 North America partner network locations that are active or pending training. The partner network team has been focused on optimizing productivity and preparing for our broader CarePlus solution launch based on the learnings from our test launch in four markets beginning in February.

Our partner network footprint will both scale our operations for our current Virtual Care business, but will also serve as a key channel as we fully roll out our CarePlus premium service offering to all U.S. markets. General and administrative expenses were $65 million in the quarter compared to $71 million in the first quarter of 2022. The decrease from the prior year quarter was driven by the cost savings initiatives we have put in place, as well as a continued focus on cost control. The increase in G&A compared to the fourth quarter of 2022 is primarily related to lower incentive compensation expense recorded in the fourth quarter as a result of adjustments based on full year operating results. The G&A cost control initiatives we announced at the beginning of the year have been implemented and we will see lower G&A costs throughout the rest of the year as we continue to focus on rightsizing our overall operating expenses based on core revenue expectations.

Other expenses include interest expense of $7.7 million, of which, $6.3 million is related to the secured debt facility issued in April 2022 and $1.4 million is related to deferred loan costs associated with the convertible we issued in 2021. Additionally, onetime cost related to lease abandonment, impairment and other store and restructuring costs were $8.7 million consisting primarily of costs related to our January restructuring actions including costs associated with severance, as well as store and facility closure costs. In other expense, we recognized gains of $1.5 million primarily due to unrealized foreign currency translation adjustments recorded in the quarter. All the above produced adjusted EBITDA of negative $27 million in the first quarter, which is an $8 million improvement over the first quarter of 2022 despite a $32 million decrease in revenue.

This quarter represents our third consecutive quarter of reporting improving year-over-year adjusted EBITDA results and we are on track for continued improvement with our efficiency and cost control initiatives put in place at the beginning of the year. Our first quarter net loss was $66 million compared to Q1 2022 net loss of $73 million. Breaking out adjusted EBITDA regionally for the first quarter, the U.S. and Canada came in at negative $15 million and rest of world adjusted EBITDA was negative $12 million. Moving to the balance sheet, we ended the first quarter with $86 million in cash and cash equivalents, $184 million in net accounts receivable, and $136 million drawn on our $255 million debt facility with HPS. Cash from operations for the first quarter was negative $33 million, while cash spent on investing for the quarter was negative $8 million.

Free cash flow for the first quarter defined as cash from operations less cash from investing was negative $41 million, which is a $36 million improvement over the first quarter of 2022. Cost changes we have put in place continue to drive us on a path to positive adjusted EBITDA by the third quarter of 2023 and toward positive free cash flow by the fourth quarter. We recognize that in this difficult sales environment, we needed to realign our cost structure to attain EBITDA profitability on our core business and any upside that we see from our initiative launches will be additive to results at a very high efficiency level. As noted in our press release, we have reaffirmed our 2023 guidance as well as the underlying assumptions that we provided on February 28, 2023.

It’s important to note that this outlook does not factor any contributions from our SmileMaker platform rollout in the U.S. or the launch of our CarePlus program. As David mentioned earlier, we’ve been negotiating with certain of our holders of our convertible notes and those have progressed with respect to potential transactions. We anticipate being able to share more with our investors in the very near term. Any financing transactions the company would enter into will be focused on improving our capital structure by bringing in additional funding and lowering our overall debt. With our upcoming SmileMaker platform launch in the U.S. and our CarePlus solution now live in limited geographies, our investments in innovations are becoming a reality in the market.

We’ve gained valuable insights from our test market launches, which will enhance our go to market strategies as we roll out these solutions to the broader market. We are well positioned to participate across an increasing number of channels in the clear aligner category to meet customers wherever they wish to begin their SDC journey. From their own home to one of our small shop retail locations from an in person visit at one of our partner network providers and now from the technologies enabled from their own mobile device. In addition, we are on track to meet our positive EBITDA and free cash flow goals in the back half of the year to stabilize our balance sheet and enable us to execute on our new initiatives. With that, I would now like to turn the call back over to David for some closing remarks.

David Katzman: Thanks, Troy. We look forward to our upcoming U.S. launch of our SmileMaker platform over the next few weeks and the expanded rollout of our CarePlus offering to additional U.S. markets. We will continue to update the market with additional insights regarding these initiatives along with any of our other exciting innovations and achievements or key milestones. Thank you to everyone for joining today. And with that, I’ll turn the call back over to the operator for Q&A.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from John Block with Stifel. Please proceed with your question.

Operator: Our next question comes from Brandon Couillard with Jefferies. Please proceed with your question.

Operator: Our next question comes from Dylan Carden with William Blair. Please proceed with your question.

Operator: [Operator Instructions] Our next question comes from Robbie Marcus with JPMorgan. Please proceed with your question.

Operator: Our next question comes from Michael Ryskin with Bank of America. Please proceed with your question.

Operator: We have reached the end of our question and answer session. This concludes today’s conference. Thank you for your participation. You may disconnect your lines now.