SmileDirectClub, Inc. (NASDAQ:SDC) Q3 2020 Earnings Conference Call November 16, 2020 4:30 PM ET

Company Participants

Alison Sternberg – VP, IR

David Katzman – Chairman and CEO

Kyle Wailes – CFO

Conference Call Participants

Jon Block – Stifel

Robbie Marcus – JP Morgan

Nathan Rich – Goldman Sachs

John Kreger – William Blair

Glen Santangelo – Guggenheim

Michael Ryskin – Bank of America

Kevin Caliendo – UBS

Steve Beuchaw – Wolfe Research

Operator

Greetings, and welcome to SmileDirectClub Third Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the presentation [Operator instructions]. Please note that this conference is being recorded.

I would now turn the conference over to our host Alison Sternberg, Vice President, Investor Relations. Thank you. You may begin.

Alison Sternberg

Thank you, operator. Good afternoon. Before we begin, let me remind you that this conference call includes forward-looking statements. For additional information on SmileDirectClub, please refer to the company’s SEC filings, including the risk factors described therein.

You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we will make on this call are based on assumptions and beliefs as of today. I refer you to our Q2 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 Web site. 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 Katzman; and Chief Financial Officer, Kyle Wailes.

Let me now turn the call over to David.

David Katzman

Thanks, Allison. Good afternoon, and thank you for joining us today. I’m pleased to report the Q3 results exceeded expectations and demonstrate continued execution against our long-term growth and margin targets.

Q3 was a pivotal quarter for us, and we were especially pleased to have reached adjusted EBITDA profitability for the quarter, while also outperforming our revenue growth expectations. We achieved EBITDA profitability one quarter ahead of plan, and we are now focused on ramping towards our long-term target of 25% to 30% adjusted EBITDA margins over the next several years.

Our performance in Q3 was continued validation of the strength of our business model and the power of the competitive moats around our platform. And also demonstrated our continued focus on controlled growth with profitability. We outlined this strategy in Q4 of 2019, and we have been executing against it in the three quarter since even with the COVID outbreak at the end of Q1. As a reminder, our controlled growth plan is firmly in the integrity of the customer experience, and that is our central focus.

As we have cited before, we are still in the early innings 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, along with profitability, as reflected in our Q3 results. We made good progress on this front within the quarter with referrals reaching 23% of all orders, which is up from 21% in Q2. And we also launched our second generation manufacturing in October as planned. Both developments not only reflect meaningful advancement against our customer service ambitions, but also accrue to our margin profile.

I would also like to highlight that we continue to see favorable industry dynamics with a 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 liners gaining share in the overall industry. All these things powerful tailwinds that overtime 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.

We constructed that plan 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% NOIs revenue growth targets.

Again, we believe that is the right amount of growth to provide the optimal club member experience based on what we have seen in prior quarters. For today, I would like the first call out some of the notable highlights from the third quarter, followed by a summary of how we are tracking against our growth and cost initiatives. We’ll then touch on the regulatory environment before turning it over to Kyle to walk through our financial results and current trends in more detail.

Turning to the results within the quarter. In Q3, we shipped roughly 93,000 unique aligner orders, which is 10% over the midpoint of the range that we provided on our Q2 earnings call. ASP came in at $1,794 flat with Q3 2019. Achieved $169 million in total revenue of 57% sequentially, and representing 94% of Q3 2019 revenue with a much smaller expenses structure.

So continued strong performance in our SmilePay program with delinquency rates and first pass credit card authorization rates remaining consistent with past history; generated positive $3 million of adjusted EBITDA for the quarter at $23 million sequential improvement, and a $48 million improvement year-over-year. And we attain profitability one quarter ahead of our plan.

I would also like to highlight that marketing and selling expenses came in at $67 million or 40% of net revenue in the quarter, compared to 73% of net revenue in Q3 of 2019. Despite this reduced spend compared to Q3 2019, approximately 70% of club members who purchased in Q3 were first-time leads. This again validates the sustainability of lower sales and marketing spend to support growth much like we saw in Q2. While it is extremely difficult to predict the future given our current macro environment, I would like to try to provide some insight into Q4.

In Q4, we expect to see unique aligner order shipments of a hundred thousand, and revenue of $180 million, both of 7% sequentially, and tracking well against our long-term targets. This is over 90% of our Q4 2019 revenue, but that was a quarter where we spent 72% of revenue on sales and marketing, and EBITDA was negative $60 million.

This year, we expect to continue to see the efficiency in sales and marketing that we saw in Q3. And we also expect to remain profitable. This is a dramatic change in a short period of time and positions us well to continue to execute against our long-term targets. I want to be very clear on this point. We are managing the business to drive towards our long-term financial targets, which includes 20% to 30% revenue growth per year with sustained profitability. We are not managing to outsize growth at the price of profitability and the club member experience controlled and profitable growth remains our mantra, which will also drive the best club member experience.

Now, turning to progress against our growth drivers. In addition to our core business, we saw continued momentum in the quarter across the three growth drivers we have previously discussed. As a reminder, they are expanding our customer acquisition channels, expanding our presence in the team demographic and continuing our international expansion, and the first initiative expansion of our acquisition channels, we continue to make good progress here. We’ve always been agnostic as to how consumers start their journey to purchase aligners.

We started with doctor prescribed impression kits, then SmileShops and now through our professional channel partnerships, corporate and insurance partnerships and mass retail locations, 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 our corporate insurance partnerships, we continue to see progress across all of our programs including those with Allianz, Anthem, Blue Cross Blue Shield and Empire Blue Cross Blue Shield, United, Aetna, and others.

We continue to deepen our relationship with our existing partners while also identifying other partnerships. And we expect to announce more on this in the near future. On the retail side, our oral care products, which are available at Walmart and CVS, and soon to be available at Walgreens and Sam’s Club, continue to perform well and serve as a highly efficient lead source and brand building opportunity. These products provide consumers access to premium oral care products at an affordable price point while also increasing the lifetime value of our club members.

And turning to the professional channel, on our Q2 call we announced our partnership with Smile Brands and exciting for a step in our efforts to partner with GP and ortho providers. With the recent addition of DECA Dental and Unified Smiles, our partnership network has now extended across more than 1000 practices in the United States. And we have a deep sales pipeline both domestically and internationally.

As we have highlighted before, this acquisition channel complimentary to our current offering and represents a new on-ramp for consumers who want to start their journey in a dentist chair. This also allows dentists across the country the ability to offer SmileDirectClub clear aligner therapy to their patients.

On our last earnings call, we detailed the various go-to-market strategies we were employing as we operationalize this channel. While each one accommodates a different use case, all are highly efficient margin of creative sources of lead flow for both SDC and our partners. Equally as important this effort is again, reinforce the flexibility and adaptability of our platform and accommodating a new and different segment of consumers. We called it only 30% of GPs offer clear aligner therapy today, and most of the ones who do offer liners 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 more in future quarters. Our efforts to extend our value proposition to the team demographic is also making progress bolstered by the launch in August of our first ever campaign targeted to this important segment, which saw over 4 billion impressions on TikTok and which was executed across multiple digital, social and broadcast channels.

On the international front within the quarter, we announced our expansion into Spain, entrance into this market further extends our international footprint and we plan to launch into additional locations in Europe, Latin America, and Asia Pacific throughout the remainder of the year.

As you can see, we made good progress on our growth initiatives since the second quarter. And we will continue to update you in the future quarters as we execute against them. Turning to progress on the cost side of the business, you’ll recall that we’ve focused across three key areas to right-size our cost structure, and we have made good progress against those initiatives. These efforts drove our outperformance on the adjusted EBITDA line this quarter, and will continue to drive margin expansion 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 is live and currently producing over 10% of our aligners. We expect this to increase meaningfully during Q4 and while still early in the rollout, we are already seeing very positive trends.

We expect these new capabilities to reduce our turnaround time, reduce our scrap and provide a more consistent and superior product for our customers. Second, continue to discipline around the deployment of marketing and selling dollars. If we’re going to focus on pushing more demand through our existing SmileShop network and leveraging our referrals in awareness and highly efficient acquisition strategies as demonstrated in the third quarter.

All of these together allowed us to come in on the low-end of our long-term sales marketing targets as well percent of revenue. And last continued cost discipline across the business, while we saw a modest sequential increase in this line item, primarily as a result of team members returning from furlough, G&A across the quarter have largely remained stable resulting from our enterprise wide cost control initiative.

One important fact is that G&A labor and other costs remain down 22% since Q4 2019. We plan vigilant on this front throughout the remainder of this year and beyond, as we continue to drive towards our long-term target of 15% of revenue in G&A spending.

As we have stated before, we believe streamlining our cost profile through operational efficiencies will not only improve our margin profile, but more importantly, we’ll provide a consistently superior customer experience that meets our expectations and it pulls our brand promise.

Turning to the regulatory environment, as we’ve noted in prior earnings calls, we are well-positioned in our continued efforts to protect the access to care that consumers want. We continue to see more states passing teledentistry friendly laws and refusing to pass laws that put up 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 understood even further by the expansion of our professional partnership with well-established and respected national DSOs, which is further testaments that adoption of telehealth by the dental community.

In summary, Q3 represents continued execution against our controlled growth plan and meaningful progress towards our long-term financial targets. And growth, we are making good progress against our initiatives and the professional channel although early is off to a good start with over 1000 practices adopting a partnership model.

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In cost, we achieved adjusted EBITDA profitability ahead of plan, and able to buy our manufacturing initiatives, our sales and marketing efficiency, and our continued cost discipline across the business. And we are now on our way to achieving our long-term targets.

Lastly, in a very nice tailwind, is that 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 gaining share in the overall industry. All of these trends we expect to continue and position us well for long-term success.

None of this will be without the support of our 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 democratize access to a smile each and every person laws by making it affordable and convenient for everyone. Our most recent quarter keeps us well on our way to achieving that mission.

And now I’ll turn the call over to Kyle, who will provide a detailed overview of our Q3 results and our financial outlook. Kyle?

Kyle Wailes

Thank you, David.

As David mentioned, we are pleased with our accomplishments over the course of the quarter and our continued progress against our plan of control growth with profitability. Similar to the second quarter, the flexibility and scalability of our business model served us well in Q3. As David alluded to earlier, in Q3, we made progress against the growth initiatives and our advancement on the cost side allowed us to turn adjusted EBITDA profitable one quarter ahead of our plan.

Before turning to our results, I want to remind everyone of the philosophy behind our control growth plan as laid out on our 2019 year-end call this past February. 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 last three quarters, we have continued to see positive momentum against all of the key revenue growth drivers and cost levers that we outlined in our plan.

We are managing a business to this plan, and this is especially important to bear in mind when looking at the year-over-year comparisons versus quarter-over-quarter. You’ll recall this plan 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. And now turn into our results for the quarter.

Revenue for the quarter was $169 million, which represents 94% of Q3 2019 revenue. This was driven primarily by 93,301 aligner shipments, which is 10% higher than the midpoint of our guidance at an ASP of 1794.

On a sequential basis, this was a 63% improvements in shipments and reflects continued recovery against pre-COVID levels. Providing some details on the other revenue items. Implicit price concessions were 9% of gross aligner revenue. And we are expecting similar performance in Q4.

Reserves and other adjustments, which includes impression kit revenue, refunds and sales tax came in at 10% of gross aligner revenue. We are expecting similar performance in Q4. Financing revenue, which is interest associated with our SmilePay program came in at $12 million. This is flat to Q2 and we expect similar performance in Q4.

Other revenue and adjustments, which includes net revenue related to retainers, whitening, and other ancillary products came in at $17 million, which is also flat to Q2. And again, we expect similar performance in Q4.

As David mentioned, it is extremely difficult to predict the future given the current macro environment. That said, our Q4 expectation of unique aligner order shipments of 100,000, and revenue of $180 million represents a 7% sequential improvement on both metrics. Even more notably, this puts us at over 90% of our Q4 2019 revenue, but also is a much more efficient cost structure, which is driving us to adjusted EBITDA profitability.

Now turning to SmilePay. In Q3 2020, SmilePay as percentage of total aligners purchase was consistent with past quarters. Overall, SmilePay has continued to perform well, that delinquency rates in Q3 and since Q3 were flat to prior quarters, because we keep a credit card on file and have a low monthly payment.

We expect SmilePay to continue to perform well. Our success rates on credit card attempts, which is a proxy for monthly payments. I’ve seen no degradation. Authorizations continue to show improvement, and we remained focused on improving operations and collection strategies.

Turning to expenses and margins. Gross margin for the quarter was 70%, representing a 1600 basis point sequential improvement. As previously noted, the gross margin pressure in Q2 was transitory. And we were starting to see gross margin trend back to historical levels, lower initial aligner volumes compared to history is still waiting on gross margins a little, as initial aligners were 64% of aligners shift in Q3, compared to 61% in Q2. And an average of 77% from Q3 2019 to 1Q 2020.

We expect gross margin to continue to strengthen as normalized volumes return. And we remain confident in our long-term gross margin target of 85% that we previously provided. Additionally, as we’ve also previously cited, we continue to focus on streamlining our manufacturing facilities. And as David indicated earlier, our second generation automation machines are now alive and producing roughly 10% of aligners.

At the end of the year, we anticipate the majority of our aligners will be produced by the gen two machines. And we expect these new capabilities to reduce our turnaround time, reduce our scrap and provide a more consistent and superior product. This rollout has been a key component of our adjusted EBITDA positive results in the quarter, and will continue to be a vital component of our traction towards our long-term adjusted EBITDA margin target.

Marketing and selling expenses came in at $67 million or 40% of net revenue in the quarter compared to 73% of net revenue in Q3 2019. Even with this reduced spend, approximately 70% of club members, who purchased the liners in Q3, were new leads. This is consistent with where we’ve come in historically on this metric at 60% to 70%, but achieved that reduced sale and marketing spend and underscores the sustainability of lower sales and marketing spend to support our revenue growth going forward.

Our efficient deployment of acquisition spend continued advancements in aided awareness and referral rates, which continue to climb, access to highly efficient lead sources and our network of SmileShops, which function as fulfillment centers, positioned us to continue to perform well against our long-term targets in quarters to come. General and administrative expenses were $74 million in Q3 compared to $69 million in Q2 2020. G&A expenses were up to $5 million sequentially, but labor and other G&A expenses remain down 22% since Q4 of 2019.

G&A expenses in July increased from June due to bringing back select team members from furlough to support the business. After July, G&A remained flat through the balance of the quarter. 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. In Q3, we had a one-time charge of $6 million associated with lease abandonment and impairment of long-lived assets. And we continue to optimize our shop footprint and corporate office portfolio in the new operating environment.

Other expenses include interest of $16 million related to the debt facility we entered into in Q2. Tax expense of $1.2 million due to the mix of earnings and losses in countries in which we operate and other gains of $1 million, which is primarily associated with currency gains and losses recognized in the quarter. All of the above produces an adjusted EBITDA of positive $3 million in the quarter with an all-in net loss of $44 million compared to $95 million net loss in Q2 2020 and a net loss of $388 million in Q3 of 2019. Of this $44 million net loss in Q3, $6 million is associated with one-time charges as noted above.

Moving to the balance sheet. We ended the quarter with $373 million in cash and cash equivalents. Cash from operations for the third quarter was positive $17 million. Cash spent on investment for the third quarter was $21 million, mainly associated with leasehold improvements, capitalized software and building our manufacturing automation. Free cash flow for the quarter, defined as cash from operations plus cash from investing was negative $4 million, which represents an 89% improvement in our cash burn rate quarter-over-quarter. Looking at Q3 2019, it was a 97% improvement or an improvement of $118 million on a year-over-year basis.

In closing, as David mentioned, our performance in the third quarter reflects progress against our long-term revenue and margin targets in support of our controlled growth plan. I would like to reiterate a few key points. Our efforts across all three of our main cost drivers have allowed us to turn adjusted EBITDA positive earlier than our plan and we expect this trend to continue. We’ve been encouraged by our ability to execute against our growth targets at efficient levels of sales and marketing spend. In Q4, assuming no changes in the COVID environment, we expect to ship 100,000 initial liner orders, which is a 70% sequential improvement.

On cost of goods sold, we’re making good progress on manufacturing automation with our second gen machines now live and producing approximately 10% of our liners. We plan to increase that percentage significantly by the end of the year. As we have often stated, we believe streamlining our cost profile through operational efficiencies by 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 SmileShops function primarily as fulfillment centers, not as sources of demand generation.

Today, we have 110 shops open with 76 of those in North America. We continue to see our shops performing well with higher utilization, which is a key part of meeting our long-term financial targets. On liquidity, we’re well positioned with almost $375 million of cash on our balance sheet as of Q3. This gives us ample liquidity to manage through a protracted COVID environment or alternatively to spend faster in a higher growth environment.

Lastly, I would like to 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, 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 national growth, and in penetrating new demographics to drive controlled growth while also executing against our profitability goals.

Lastly, we continue to see favorable industry dynamics with broader acceptance of telehealth and specifically teledentistry, minimal penetration against the 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 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.

Question-and-Answer Session

Operator

Thank you. At this time, we will be conducting our question-and-answer session. [Operator Instructions] Our first question comes from Jon Block with Stifel. Please state your question.

Trevor Brown

Hi, this is Trevor on for Jon. Thank you for taking my questions. I’ve just got two questions. I’ll put them out upfront. Just first one on case volume guidance, Kyle 100,000 case volume guide that you gave us, what are some of the puts and takes to that as we grew through the fourth quarter? And how can some of those dynamics improve through 2021? And then the second question is going to be on gross margin. You called out manufacturing improvements in the fourth quarter here. How much of that do you expect to impact the gross margin in 4Q? And then how can we think about things in the first quarter 2021? Thank you.

Kyle Wailes

Yes, thanks, Trevor. Look, I think, as you look at 2021, just given the macro state of the world right now, it’s going to be difficult to project, right. But what I will give some more detail on is Q4 as you’re asking. So if you look at Q4 and 100,000 shipments in particular, so that’s up 7% sequentially over Q3, revenue of $180 million is also up 7% sequentially over the third quarter. I think just as importantly though we’re doing it in a profitable way and we’re tracking very well against our long-term targets. And, as we said on the call, that’s what we’re focused on. It’s very difficult for us and we get this question a lot, but it’s difficult to look at this on a month to month basis.

And reason being is it really doesn’t give a complete picture, just given the complexity of our acquisition funnel, right. So with the acquisition funnel that we have and the overall complexity behind that, there’s puts and takes in any given month. And so you’ve got to look at this over a multi-month period, and that gives a much more accurate portrayal of the underlying demand that we see in the business. And when we look at it that way that’s effectively what we’re guiding to Q4, which is the 100,000 shipments and the 7% sequentially like we talked about.

We’re looking at gross margin, overall, as we talked about on the call. So, gen two is now live. It’s ramping up nicely. It’s currently doing about 10% of our orders overall. As I look at the fourth quarter with the volume that we’re expecting, I would expect gross margins to be in the mid-70s. As we’ve talked about, we still have a little bit of a correction just from the balance of initial aligners versus MCC or refining aligners that are shipped. And so, we expect a little bit of pickup from that in Q4. We expect a little bit of a pickup from our gen two as well and then just the overall volumes continuing to normalize. So the three of those together really drive us back to the mid-70s.

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Trevor Brown

Great. Thank you.

Operator

Our next question comes from Robbie Marcus with JP Morgan. Please state your question.

Robbie Marcus

Hi, thanks for taking the question and congrats on a good quarter. Kyle, I was hoping you could give us a little more color on the progress during third quarter. How did that trend versus your exit rate in second quarter exiting third quarter, just trying to get a sense of is fourth quarter may be a step down as you’re taking in a decent amount of conservatism given what’s going on around the world right now?

Or is this still – have we hit a plateau here given the amount of SG&A spending you’re putting forward for advertisements. Just trying to get – understand how much as you pushing the throttle on SG&A spend and its relationship to sales or conservatism given rise in COVID rates?

Kyle Wailes

Yes. Look as we think about it and just to go back to some of the quarterly numbers that you mentioned, so – we shipped just over 57,000 shipments in the second quarter. We grew that about 60% in the third quarter to about 93,000. We’re expecting to be up sequentially again about 7% on a quarter-over-quarter basis to a 100,000.

And if you really look at what we talked about on the call and what we’re focused on, it goes back to executing against the plan that we put in place in Q4 of last year. That’s focused on controlled growth with profitability. And so, we’re driving to that plan on the top-line. If you extrapolate out that 7% on an annual basis that gets you in line with the top-line 20% to 30% growth that we’re expecting on a year-over-year basis, but we’re doing it in a profitable way.

So gross margin of 75% driving that to our longer-term target over the next several years of 85%. Sales and marketing in line with our expectations of 40% to 45% and G&A also continuing to get leverage out of it as well. So that’s what we’re really focused on is executing against the plan that we put out in Q4 of last year. And as we look at Q4 of this year and the 100,000 shipments that we’re expecting, it’s directly in line with executing against that plan.

Robbie Marcus

Great. And the other thing that stood out to me was the adjusted EBITDA profitability and within spin distance of free cash flow profitable, how should we think about those trends going forward? Is there a possibility it might backtrack as you ramp up spending as the economy starts to open post vaccine? Or do you think this is now you’re going in one direction and that’s positive from here? Thanks.

Kyle Wailes

Yes. Good question, Robbie. I would say we’re sticking with one direction and it’s positive. We’ve laid out a longer-term target of 25% to 30% EBITDA margins. This is our fourth quarter that we’re profitable and now we’re looking forward to ramping our EBITDA margins against that on a quarter after quarter basis.

So you should expect that to occur again in the fourth quarter off of the 100,000 shipments that we’ve outlined in the $180 million that we’ve outlined as well. In terms of overall free cash flow, I would expect CapEx to be in line with where it’s been historically, which is about that $25 million range in total.

Robbie Marcus

Thanks a lot.

David Katzman

Yes.

Operator

Our next question comes from Nathan Rich with Goldman Sachs. Please state your question.

Nathan Rich

Hi, good afternoon. Thanks for the question. Kyle, sorry to go back to the fourth quarter guidance, but I guess when we look at, I think, how the third quarter progressed, I think, you kind of had talked about 28,500 cases, I believe, in July, obviously coming in at 93,000 for the quarter.

You saw some sequential improvement over the course of the third quarter. But, I guess, when we look at the fourth quarter guidance, it doesn’t seem like much sequential improvement there. I kind of get that you can’t maybe isolate each month, but I think as we think about the fourth quarter, could you kind of just talk about some of the puts and takes that have informed the guidance that you gave?

Kyle Wailes

Obviously, we’re six weeks into the quarter. And so, we have pretty good insight into what we’ve seen thus far. And we have pretty good insight into what we expect to see for the remainder of the quarter based on the demand that we’re seeing in the business and the overall acquisition funnel that we see in the puts and takes around that acquisition funnel. And so, we have good insight into the 100,000. What I would say at a bigger picture is going back to what I had said before, but we’re really focused on and the 100,000 shipments that we have that we’ve outlined here, which is about 7% on a quarter-over-quarter basis, it executing our top line against the long-term plan that we’ve outlined.

Our long-term plan that we outlined in Q4 of last year was a plan that really focused on controlled growth and profitability. I think you saw that in the third quarter. I think with the guide that we outlined you’re seeing it again in the fourth quarter. And if you extrapolate the guidance that we put out there based on that, it’s directly in line with the 20% or 30% top-line growth that we should expect to see in future years. And so, that’s how we’re thinking about the fourth quarter.

Nathan Rich

Makes sense. And just to clarify what you just said. So, it seems like the business is on track to kind of active this year at a revenue run rate of over $700 million. Would you expect the growth next year to be in line with that 20% to 30% longer-term range just given the factors that you’ve kind of outlined?

Kyle Wailes

Yes, I would say overall it’s very difficult to predict overall what 2021 is going to look like, just given the nature of the macro environment. What I would say is that the 20% or 30% that we’ve outlined was not a limitation on the market factor or the ability to grow, right. The 20% or 30% that we set in Q4 of last year, when that plan was enacted was really driven by what we believe we can grow the business by based on what we’ve seen from a fulfillment perspective and from a customer service perspective.

And so at that point in time, what we had talked about is putting the club member experience first. And as we do that that’s really what is going to drive and optimize the long-term growth that we expect to see as a business. And so, although it’s difficult to predict what 2021 would look like. Our expectation is for it to be within that 20% to 30% based on the controlled growth plan that we put in place. And that’s a controlled growth plan that we’ve enacted for the next five years. And it’s a plan that we’re focused on both from a top-line perspective and a bottom line perspective as well.

Nathan Rich

Thanks for the comments.

Operator

Our next question comes from John Kreger with William Blair. Please state your question.

John Kreger

Hi, thanks very much. I was hoping you could expand a little bit on the professional channel. I know that’s a fairly new strategy for you. It sounds like you’ve got maybe a couple of additional partnerships. Where do you stand with that? Is that – have you sort of optimized the economic model and are we in a rollout phase or would you still characterize it as more of a pilot phase at this point?

David Katzman

Yes, I can take that one, Kyle. So we’re definitely out of pilot phase, very early innings to this program, but we’ve seen good adoption. We’ve had some of the key DSO leaders step forward and go from pilot. Now, we’re going to start rolling out into all their offices. It started out as a pilot. And we just signed DECA Dental, Unified Smile. We’re also working on some large DSOs in the UK and Australia as well.

So, we actually just had a call today about ramp up on the sales team, the internal G&A team to support this. So we’re very excited about it the GPs and some ortho offices as well have really adopted this. I think that the timing was right with COVID and telehealth having much more broad acceptance. So the GPs are liking this program.

It also – I think what is really unique to it is that it allows the dentist and ortho for this type of product to continue and not have to give up share time. So we’re using our telehealth platform to take care of these customers. We’re also introducing new customers to their dental home for care. So, increasing traffic, increasing patient count is something – especially right now when revenue is down for a lot of GPs is very important. So we’re putting a plan together to roll this – to start rolling this out of pilot mode in hiring up and staffing up. So you’ll see more of this in 2021.

John Kreger

Great. Thanks, David. That’s helpful. Another follow-up, where do you feel international stands at this point? How has that been ramping relative to your expectations? And are you going to be handling fulfillment and customer service out of your U.S. production capabilities? Or will you be looking to add facilities in Europe? Thanks.

David Katzman

Yes. So as of now all of our production and shipments are coming out of the U.S. There’s no plans until we get to much larger scale to put any kind of manufacturing facility in Europe or in Asia. Even during the COVID environment, we continued to expand. We opened up Spain.

And we’ve got two shops open there, doing very well. We also opened up in Singapore recently, doing well, and we’re going to be announcing several more countries. So we’ve got a really great international team that has gated all these various countries, and you’ll continue to see those rollout in the future. As far as customer care goes, we do have facilities. There is one in Greece, that’s serving Germany and as we open up the Netherlands and then we also have the Philippines that we just opened up that is servicing Asia.

John Kreger

Great. Thank you.

Operator

Our next question comes from Glen Santangelo with Guggenheim. Please state your question.

Glen Santangelo

Hi, thanks for taking my question. Hi, David, I just want to follow-up on the sales and marketing issue a little bit more, certainly a big change in the company in the past couple of quarters in terms of customer acquisition costs, it’s obviously a pretty big inflection. Two quarters ago, we had over 400 SmileShops. That number has been cut by over 70%.

I’m kind of curious in your mind, what were the biggest drivers of that inflection and does that mean that sales and marketing should stay in this 40% to 45% range going forward as we think about 4Q in 2021, which I think is kind of consistent your long-term targets in that 40 to 45 range, I just want to be clear in terms of what you’re thinking in terms of the near-term expectations versus your long-term targets? Thanks.

David Katzman

Yes. So, during COVID, we actually shut down all of our shops, and we rebuilt from the ground up. We have spent a lot of time with our analytics team and really understanding the incrementality of those shops. As we’ve stated many times, they’re not demand drivers, they’re really fulfillment centers. They’re really there to have incrementality above the kits in a market where a customer doesn’t want to start their journey with a kit.

So we’ve become very proficient now in understanding, and COVID allowed us to do that. How many shops do we need in a market, where those shops should be, and so we’ve been strategically opened them and we’re not done, but the bigger markets, the largest seventy-five DMAs, we’ve opened up these shops, we’re now incrementally opening up a few more here and there.

But as far as the 40%, which is a big part of that, because we’re getting – the utilization we’re getting out of these shops now is much, much higher than we had pre-COVID. And so that’s accruing to the bottom line at 40%, 40% to 45% is where we are going to be on sales marketing.

That’s a key driver to our controlled growth and profitability. We will not go over that number that’s not part of the plan. And that’s an all countries. So you’ll continue to see that. And I think, what you’re seeing too with some of the clear aligner tailwinds that’s going on here, where consumers, who may have been looking at braces in the past as an option for teeth straightening because of COVID and the amount of offices that are required with braces are looking more to clear aligner therapy. We’re seeing that and we will continue to see that in more efficient sales and marketing spent. So expect that in the future as well. Kyle, you want to add anything to that?

Kyle Wailes

Yes, I think you said it very well, David, that the targets that we’ve outlined are consistent with where we expect to be in future quarters. I would expect in the fourth quarter to be on the higher end of that range, as we continue to ramp up spend in preparation for Q1.

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And as David said, as we look at the very favorable industry dynamics that we’re seeing across the industry. We’re enabling that to accrue to our bottom line. And we’re seeing that efficiency in the sales and marketing spend as a percentage of revenue.

Glen Santangelo

Maybe if I could just ask one quick question on the balance sheet. I mean, you’re talking a lot more about controlled profitable growth, and it’s great. The company has crossed profitably, but EBITDA here a quarter early, but as you think about the opportunity, I mean, it seems like kind of the balance sheet would support a more aggressive strategy.

And so how are you thinking about, you know, balancing that going forward with respect to sort of the needs of the business versus the current cash burn. I mean, where do you see the path to free cash flow generation relative to that, I think it is $373 million in cash. You still have on the balance sheet. Do you to have to raise additional capital to sort of hit your goals, or do you feel like you can do it based on your outlook for free cash flow going forward?

David Katzman

Yes, I don’t see us having to raise additional capital, and with the $375 million we have on the balance sheets, that puts us in a really good position, be it in a resurgence of COVID, and things slow down again in the alternative in a faster growth environment as well. I think that puts us in a good position.

If you look at our cash flow overall, as we become either the positive like we were in the third quarter. Overall, EBITDA less CapEx is a great proxy for our free cash flow. We’re expecting to spend about 25 million per quarter on CapEx, we’ve got about 15 million per quarter with our new debt facility as well.

And as I look at our overall cash burn at least within the foreseeable future, I would expect us to be in the range of approximately $15 million per month as you look at the fourth quarter of this year, so sufficient cash and sufficient liquidity to support the long-term growth needs of the business.

Glen Santangelo

Thank you.

Operator

Our next question comes from Michael Ryskin with Bank of America. Please state your question.

Michael Ryskin

Hi guys, thanks for taking the question. I want to follow-up on something that was kind of came up tangentially a few times and prior questions about the sort of the go-to market strategy and the various channels you’re pursuing now. I mean as you said, a small shops are starting to come back, you’re up to 92 at the end of quarter. I think you said you’re at around 110 now and clearly ramping that back up, but you’ve also got the dental office, the other TSOs, you’ve got the referral networks. There is a bunch of different channels that you’re pursuing to go after the customer that’s out there.

If I was just sort of take a step back and look forward a couple of years, how would you stratify these opportunities for you and what this feeds into sort of the question of where the spend is going to go, which channel are you going to push the most? Is it going to – are you really leaning on the dental channel or is it going to go back to the small shops, more just sort of general sales and marketing to get the referrals. Is there any particular way you could stratify these to help us think about the go-to-market strategy longer-term?

David Katzman

Yes, at this point in time, the core business and how we operate with kits and scans that’s how we started. That’s what was delivered to us off the shelf. One of the things we haven’t talked about on this call is innovation and R&D. And we are really focused including myself with the team on new ways of going to market beyond a SmileShop in a scanner in a impression putty kit that goes to the home.

So hopefully some of those things will come to fruition in 2021, if not 2022. It’s not a matter of – if it’s a matter of when. So those types of things that are not in our plan. We’re working very, very hard on which will make it easier and less friction for the customer.

I say today, all of these channels we’re supporting, we’re investing in, and so it’s hard to say two years from now, which is going to be the main driver, but we’re optimizing all of them today. It is a kit and scan business, and that’s we’re making sense of that with our 40% to 45% sales and marketing target.

This new acquisition channel in the professional channel is very exciting to us.

So that could something that could really, really take off come 2021, but our projections are pretty conservative on it right now, even though we’re seeing good adoption. So I would say it’s really where we’re at today. And as things change quarter-by-quarter, we’ll definitely keep you informed.

Michael Ryskin

All right. Thank you.

Kyle Wailes

Yes, Michael. I would just add to that a little bit as well. I think it’s important to remember we’re agnostic to where consumers want to start their journey, right? Whether it’s a kit or a SmileShop or a dental office, we’re driving consumers to the website and we’re empowering them to make that decision. And I think you can look at Q2 through now. Prior to COVID, we were doing 90% of the business through SmileShops. During the second, it was 90% through kits.

And today it’s back more to 50% to 60% split between the two. And so, what that really demonstrates is just the overall importance of the omni-channel approach and the flexibility of the business model overall. And because we’re driving that demand to the website and empowering that consumer to decide how they want to start their journey. We’re pretty agnostic to which channel they choose. It’s more about providing the on ramps for them to be able to start that journey.

Michael Ryskin

Thanks. Yes, it’s exactly that swaying from 90% one way to 90% the other way that I was kind of getting that, but I appreciate that color and the update on where you are now. Thanks.

Operator

Our next question comes from Kevin Caliendo with UBS. Please state your question.

Kevin Caliendo

Hi, thanks for taking my call. I guess I just want to make sure I understand the commentary around the 20% to 30% long-term growth targets and the context of 2021. I’m not asking you to guide for 2021, but given the easier comps that you experienced because of COVID. I mean, is it still that sort of range that you’re expecting? Or do you expect maybe something better if COVID goes away you up – you’re spending a little bit like can you talk us through how we should think about that because obviously 2Q is a pretty easy camp even 3Q should be a pretty easy comp for you despite of the solid quarter that you just put up.

Kyle Wailes

Yes, look what I would say overall, if you look at 3Q, we were almost 95% of where we were last year, but we did it in a much more profitable way whereas last year we had an EBITDA loss of $45 million. And so as you’re thinking about sort of comps and ramping from there, so that’s growing again 7% sequentially into Q4 both for shipments and for overall revenue. It’s very difficult just given the macro environment for us to be able to predict what 2021 is going to look like. I think what I would focus on overall is that sequential growth that we’re seeing in the business from Q3 and the Q4. And if you look at the long-term targets and growth targets that we’re expecting to see, we’re still expecting that 20% to 30% growth on a year-over-year basis, year in your out for the next five years.

And again, it’s not to say it might be slightly higher than that if the COVID environment gets better. But if you recall that entire plan was designed around – for us capturing market share, but most importantly, not forfeiting the integrity of our customer experience.

And so I would expect us to be in that 20% or 30% range year in and year out based on that, because that’s the amount that we believe we can grow the business by and do it in a profitable way, but more importantly do it in a way that’s not going to forfeit the integrity of the customer experience.

Kevin Caliendo

Understood, that’s helpful. My follow up is that you mentioned the credit facility, any update on that. I know that was a goal for the company to maybe get a new credit facility improved terms. Where are we with that? I would think that given the profitability in the quarter that maybe – there were some progress made on that regard.

Kyle Wailes

So, we’re always looking at different options around that. So we signed that deal in Q2 of this year. We do have a non-call provision under that credit facility where we could call it, but the rate at which we would have to do that would be a pretty high penalty for that. So I would look more at the Q2 timeframe of next year for when we would look at potentially refinancing that.

And as you point out, I think given the EBITDA profitability that we’re seeing, it opens up a lot of different avenues for us to look at refinancing that facility. And we also continue to look at factoring relationships as well. So if you look at the performance of SmilePay, it performed very well in the third quarter. Our delinquency rates continue to improve. Our credit card authorization rates continue to improve. And so that sets us up well to also look at a variety of factoring scenarios as well.

Kevin Caliendo

Got it. Thanks so much.

Operator

Our next question comes from Steve Beuchaw with Wolfe Research. Please state your question.

Steve Beuchaw

Hi, thanks for the time here. I’ll ask a two parter on retail and then just one follow up. So as we try to fill in the rest of the model, you mentioned in your repaired remarks that you have two additional partners coming along here in the fairly near-term, Walgreens and Sam’s Club. So I wonder first could you talk about within the efforts that you’ve gone through so far with Walmart, how close are you to getting full exposure there, all the shelf space, all the impacts that you want. And should we think about Walgreens and Sam’s Club as being incremental to that effort? And at a scale that’s at least in the ballpark of what we’ve seen so far within Walmart? And then I do have one follow-up.

David Katzman

Yes, I can take that. So at Walmart, we feel that we’ve done very well for a new brand going in last year, especially on the whitening category, we went in with a variety of oral care products, but the whitening has really taken off. And so we’re coming up with a lot of new innovative whitening products that will be introduced back into Walmart next year and the year after.

Good partners to have. CVS also, we’re in 3,000 doors, so not quite complete count, I think there are 7,000 to 8,000 doors, but also a good partner. So Walgreens, we look at it as incremental as well. Sam’s Club, we’re doing a – I believe, it’s a 200 store test and we’ll see how that goes.

And we’re talking to other retailers as well. So for us look at it’s a nice business. It continues to grow. It’s really a lead channel as we look at it for teeth straightening. And we’re starting to track that as customers, who get introduced to SmileDirectClub by being in a retail store and then shifting after they like the products into teeth straightening. So we’re doing things to get emails, get leads, offer coupons inside the packaging and things like that. So – and we’re also looking at this internationally, Watsons in Asia, we’re going to be launching a whitening program there, and we’re talking to other retailers in the UK and other countries.

Steve Beuchaw

Okay. I appreciate the color. And then the one thing in my model, the one line in my model that we haven’t talked about here in Q&A is Teen. And I know it’s very early. I wonder if you could just give any color commentary around what you’re seeing in terms of the receptivity within Teen market. And how long you think it takes to get that part of the business to being a material contributor? Thanks much.

David Katzman

Yes, so, it’s early. We just launched Teens this year right before COVID. We’re very excited about it. I think it’s a long-term process to shift over to Teens. It was less than 10% of our total business. And we have seen that ramp now. It does represent 75% of case starts in the industry. So there’s a lot of opportunity there that we – when we first launched SmileDirectClub, we were not going after.

Some of the things that we put together for this program in the case for the Teen, the ability for parents to get notifications, or I want to change out the aligners, guaranteed replacement program if the Teen loses the aligner, all these kinds of things are helping to get adoption.

We’re also very excited that with the professional channel. So a lot of parents want their Teen to start at in a dentist chair or ortho chair. And so by having this partnership with them, we’re starting to see Teens come in through that on ramp. So I think more of that to come. We’re committed to it. It’s one of our pillars of growth initiatives, and we’re going to continue to penetrate that channel.

Operator

Thank you. Ladies and gentlemen, that’s all the time we have for questions today. All parties may now disconnect. Have a great day. Thank you.



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