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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to________
Commission File Number: 001-39037
SMILEDIRECTCLUB, INC.
(Exact name of registrant as specified in its charter)
Delaware83-4505317
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
414 Union Street37219
Nashville,TN(Zip Code)
(Address of principal executive offices)
(800) 848-7566
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A common stock, par value $0.0001 per share
SDC
The NASDAQ Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes      No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       Yes      No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”



“accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  No
The registrant has the following number of shares outstanding of each of the registrant’s classes of common stock as of August 10, 2020:
Class A Common Stock: 110,710,708
Class B Common Stock: 274,876,789




TABLE OF CONTENTS
PART I
Item 1




Item 2
Item 3
Item 4
PART II
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions, or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipates,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends,” and similar words or phrases. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors, some of which are beyond our control. For more information regarding these risks and uncertainties as well as certain additional risks that we face, refer to “Risk Factors” as well as the factors more fully described in “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” in this report and in our Annual Report on Form 10-K for the year ended December 31, 2019. Among the factors that could cause our financial performance to differ materially from that suggested by the forward-looking statements are:

our ability to effectively manage our growth, including international expansion; 

our ability to effectively execute our business strategies, implement new initiatives, and improve efficiency; 

our sales and marketing efforts; 

our manufacturing capacity and performance and our ability to reduce the per unit production cost of our clear aligners; 

our ability to obtain regulatory approvals for any new or enhanced products; 

our estimates regarding revenues, expenses, capital requirements, and needs for additional financing; 

our ability to effectively market and sell, consumer acceptance of, and competition for our clear aligners in new markets; 

our relationships with retail partners and insurance carriers; 

our research, development, commercialization, and other activities and projected expenditures; 

changes or errors in the methodologies, models, assumptions, and estimates we use to prepare our financial statements, make business decisions, and manage risks; 

our current business model is dependent, in part, on current laws and regulations governing remote healthcare and the practice of dentistry, and changes in those laws, regulations, or interpretations that are inconsistent with our current business model could have a material adverse effect on our business; 

our relationships with our freight carriers, suppliers, and other vendors; 

our ability to maintain the security of our operating systems and infrastructure (e.g., against cyber-attacks); 

the adequacy of our risk management framework; 

our cash needs and ability to raise additional capital, if needed; 

our intellectual property position; 

our exposure to claims and legal proceedings;

our ability to remain in compliance with our debt covenants;

1


our ability to manage the COVID-19 pandemic, including the protracted duration of COVID-19 and the potential resurgence of COVID-19 infections, through voluntary and regulatory containment measures and the related impacts on our business;
our ability to gauge the impact of COVID-19 and related potential disruptions to the operations of our suppliers, freight carriers and retail partners, including social and economic constraints, tariffs and trade barriers, facilities closures, labor instability, and capacity reduction; and

other factors and assumptions described in this Quarterly Report on Form 10-Q.

If one or more of the factors affecting our forward-looking information and statements proves incorrect, our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements. Therefore, we caution not to place undue reliance on any forward-looking information or statements. The effect of these factors is difficult to predict. Factors other than these also could adversely affect our results, and the reader should not consider these factors to be a complete set of all potential risks or uncertainties. New factors emerge from time to time, and management cannot assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statements only speak as of the date of this document, and we undertake no obligation to update any forward-looking information or statements, whether written or oral, to reflect any change, except as required by law. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the Securities and Exchange Commission (“SEC”) as exhibits to this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance, and events and circumstances may be materially different from what we expect.

2


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
3

SmileDirectClub, Inc.
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands)

June 30,
2020
December 31,
2019
ASSETS
Cash and cash equivalents$388,971  $318,458  
Accounts receivable232,337  239,413  
Inventories28,571  18,431  
Prepaid and other current assets
16,902  14,186  
Total current assets666,781  590,488  
Accounts receivable, non-current79,504  106,315  
Property, plant and equipment, net174,892  177,543  
Operating lease right-of-use asset
33,120    
Other assets
11,291  11,299  
Total assets
$965,588  $885,645  
LIABILITIES AND PERMANENT EQUITY
Accounts payable$34,487  $52,706  
Accrued liabilities85,652  93,339  
Deferred revenue41,519  25,435  
Current portion of long-term debt
30,815  35,376  
Other current liabilities7,572    
Total current liabilities200,045  206,856  
Long-term debt, net of current portion389,513  173,150  
Operating lease liabilities, net of current portion
34,338    
Other long-term liabilities
43,768  47,354  
Total liabilities667,664  427,360  
Commitment and contingencies
Permanent Equity
Class A common stock, par value $0.0001 and 110,123,999 shares issued and outstanding at June 30, 2020 and 103,303,674 shares issued and outstanding at December 31, 2019
11  10  
Class B common stock, par value $0.0001 and 275,376,789 shares issued and outstanding at June 30, 2020 and 279,474,505 shares issued and outstanding at December 31, 2019
27  28  
Additional paid-in-capital
470,838  447,866  
Accumulated other comprehensive income (loss)42  (272) 
Accumulated deficit(170,562) (114,513) 
Noncontrolling interest(20,052) 125,166  
Warrants
17,620    
Total permanent equity
297,924  458,285  
Total liabilities and permanent equity
$965,588  $885,645  

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.
4

SmileDirectClub, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share amounts)

Three Months Ended June 30,Six Months Ended June 30,
2020201920202019
Revenue, net$94,409  $185,241  $278,337  $353,867  
Financing revenue12,664  10,553  25,386  19,663  
Total revenues107,073  195,794  303,723  373,530  
Cost of revenues48,776  31,767  108,553  72,238  
Cost of revenues—related parties  2,898    11,342  
Total cost of revenues
48,776  34,665  108,553  83,580  
Gross profit58,297  161,129  195,170  289,950  
Marketing and selling expenses34,518  113,413  176,842  209,146  
General and administrative expenses68,689  47,031  159,718  96,490  
Lease abandonment and impairment of long-lived assets24,633    24,633    
Other store closure and related costs4,476    4,476    
Income (loss) from operations(74,019) 685  (170,499) (15,686) 
Interest expense10,050  3,420  14,072  7,316  
Interest expense—related parties      75  
Loss on extinguishment of debt13,781  29,640  13,781  29,640  
Other (income) expense
(1,765) (37) 3,159  81  
Net loss before income tax (benefit) expense(96,085) (32,338) (201,511) (52,798) 
Income tax (benefit) expense
(1,419) 97  555  117  
Net loss
(94,666) (32,435) (202,066) (52,915) 
Net loss attributable to noncontrolling interest
(67,867)   (146,017)   
Net loss attributable to SmileDirectClub, Inc.
$(26,799) $(32,435) $(56,049) $(52,915) 
Earnings per share of Class A common stock:
Basic
$(0.25) N/A$(0.52) N/A
Diluted
$(0.25) N/A$(0.53) N/A
Weighted average shares outstanding:
Basic
109,048,411N/A106,819,870  N/A
Diluted
385,133,303N/A384,492,628  N/A

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.

5

SmileDirectClub, Inc.
Condensed Consolidated Statements of Comprehensive Loss (Unaudited)
(in thousands, except per share amounts)

Three Months Ended June 30,Six Months Ended June 30,
2020201920202019
Net loss$(94,666) $(32,435) $(202,066) $(52,915) 
Other comprehensive loss:
Foreign currency translation adjustment107    1,149    
Comprehensive loss(94,559) (32,435) (200,917) (52,915) 
Comprehensive loss attributable to noncontrolling interests(67,790)   (145,182)   
Comprehensive loss attributable to SmileDirectClub, Inc.$(26,769) $(32,435) $(55,735) $(52,915) 

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.


6


SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)

SDC Financial (Prior to Reorganization Transactions)
Additional Paid in CapitalWarrantsAccumulated DeficitPermanent Equity (Deficit)Temporary Equity (Deficit)
UnitsAmountUnitsAmount
Balance at March 31, 2019108,878  $55,792  369  $315  $(168,909) $(112,802) $398,346  
Net income prior to Reorganization Transactions—  —  —  —  (32,435) (32,435) —  
Redemption of member units(20,710) (54,154) —  —  —  (54,154) —  
Preferred Unit redemption accretion—  (27,049) —  —  —  (27,049) 27,049  
Equity-based compensation—  435  —  —  —  435  —  
Balance at June 30, 201988,168  $(24,976) 369  $315  $(201,344) $(226,005) $425,395  
Balance at December 31, 2018108,878  $57,677  369  $315  $(148,429) $(90,437) $388,634  
Net income prior to Reorganization Transactions—  —  —  —  (52,915) (52,915) —  
Redemption of member units(20,710) (54,154) —  —  —  (54,154) —  
Preferred Unit redemption accretion—  (36,761) —  —  —  (36,761) 36,761  
Equity-based compensation—  8,262  —  —  —  8,262  —  
Balance at June 30, 201988,168  $(24,976) 369  $315  $(201,344) $(226,005) $425,395  
SmileDirectClub, Inc. Stockholders Equity
Class A SharesClass B SharesClass A AmountClass B AmountAdditional Paid-in CapitalWarrantsAccumulated DeficitNoncontrolling InterestAccumulated Other Comprehensive Income (Loss)Total
Balance at March 31, 2020108,171,207  276,454,886  $11  $27  $461,046  $  $(143,763) $47,805  $12  $365,138  
Net loss—  —  —  —  —  —  (26,799) (67,867) —  (94,666) 
Issuance of Class A shares in connection with RSU vesting742,045  —  —  —  —  —  —  —  —    
Issuance of Class B shares in connection with warrant exercise—  132,650  —  —  (15) —  —  15  —    
Exchange of Class B common stock for Class A common stock1,210,747  (1,210,747)     82  —  —  (82) —    
HPS Warrant issuance—  —  —  —  —  17,620  —  —  —  17,620  
Equity-based compensation—  —  —  —  10,821  —  —  —  —  10,821  
Equity-based payments—  —  —  —  (1,462) —  —  —  —  (1,462) 
Foreign currency translation adjustment—  —  —  —  —  —  —  77  30  107  
Other—  —  —  —  366  —  —  —  —  366  
Balance at June 30, 2020110,123,999  275,376,789  $11  $27  $470,838  $17,620  $(170,562) $(20,052) $42  $297,924  
Balance at December 31, 2019103,303,674  279,474,505  $10  $28  $447,866  $  $(114,513) $125,166  $(272) $458,285  
Net loss—  —  —  —  —  —  (56,049) (146,017) —  (202,066) 
Issuance of Class A shares in connection with RSU vesting1,263,223  —  —  —  —  —  —  —  —    
Issuance of Class B shares in connection with warrant exercise—  1,459,386  —  —  (15) —  —  937  —  922  
Exchange of Class B common stock for Class A common stock5,557,102  (5,557,102) 1  (1) 973  —  —  (973) —    
HPS Warrant issuance—  —  —  —  —  17,620  —  —  —  17,620  
Equity-based compensation—  —  —  —  27,217  —  —  —  —  27,217  
Equity-based payments—  —  —  —  (4,529) —  —  —  —  (4,529) 
Foreign currency translation adjustment—  —  —  —  —  —  —  835  314  1,149  
Other—  —  —  —  (674) —  —  —  —  (674) 
Balance at June 30, 2020110,123,999  275,376,789  $11  $27  $470,838  $17,620  $(170,562) $(20,052) $42  $297,924  

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.
7

SmileDirectClub, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

Six Months Ended June 30,
20202019
Operating Activities
Net loss$(202,066) $(52,915) 
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization25,357  9,723  
Deferred loan cost amortization1,666  475  
Equity-based compensation27,217  8,262  
Loss on extinguishment of debt13,594  17,693  
Paid in kind interest expense1,771    
Lease abandonment, impairment of long-lived assets and other store closure and related charges25,915    
Changes in ROU asset4,070    
Other non-cash operating activities  1,783  
Changes in operating assets and liabilities:
Accounts receivable33,887  (100,937) 
Inventories(10,140) (4,968) 
Prepaid and other current assets(4,009) (5,772) 
Accounts payable(6,001) 15,436  
Accrued liabilities(13,184) 28,461  
Due to related parties  (16,862) 
Deferred revenue
16,084  1,729  
Net cash used in operating activities(85,839) (97,892) 
Investing Activities
Purchases of property, equipment, and intangible assets(47,861) (38,148) 
Net cash used in investing activities(47,861) (38,148) 
Financing Activities
Payment of IPO related costs(1,155)   
Proceeds from warrant exercise922    
Repurchase of Class A shares to cover employee tax withholdings(4,529)   
Proceeds from HPS Credit Facility and Warrants, net388,000    
Borrowings on long-term debt16,807  151,300  
Payments of loan costs(11,336) (6,127) 
Principal payments on long-term debt(180,762) (152,400) 
Principal payments on related party debt  (20,598) 
Payments on finance leases(4,997)   
Other
1,263  (976) 
Net cash provided by (used in) financing activities
204,213  (28,801) 
Increase (decrease) in cash and cash equivalents70,513  (164,841) 
Cash and cash equivalents at beginning of period
318,458  313,929  
Cash and cash equivalents at end of period
$388,971  $149,088  

The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.

8


SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)


Note 1—Organization and Basis of Presentation
Organization
SmileDirectClub, Inc. was formed on April 11, 2019 with no operating assets or operations as a Delaware corporation for the purpose of facilitating an initial public offering and other related transactions in order to carry on the business of SDC Financial LLC and its subsidiaries. Unless otherwise indicated or the context otherwise requires, references to “we,” “us,” “our,” the “Company,” “SmileDirectClub,” and similar references refer to SmileDirectClub, Inc. and its consolidated subsidiaries, including SDC Financial LLC and its subsidiaries. “SDC Financial” refers to SDC Financial LLC and “SDC Inc.” refers to SmileDirectClub, Inc. The Company is engaged by its network of doctors to provide a suite of non-clinical administrative support services, including access to and use of its SmileCheck platform, as a dental support organization (“DSO”). For purposes of these notes to interim condensed consolidated financial statements (unaudited), the Company’s affiliated network of dentists and orthodontists is included in the definition of “we,” “us,” “our,” and the “Company” as it relates to any clinical aspect of the member’s treatment. All of the Company’s manufacturing operations are directly or indirectly conducted by Access Dental Lab, LLC (“Access Dental”), one of its operating subsidiaries.

The Company’s direct-to-consumer model provides customers with a customized clear aligner therapy treatment delivered through its teledentistry platform. The Company integrates the marketing, aligner manufacturing, and fulfillment, and provides a proprietary web-based teledentistry platform for the monitoring of treatment by licensed dentists and orthodontists through the completion of a member’s treatment. The Company is headquartered in Nashville, Tennessee and has locations throughout the U.S, Puerto Rico, Canada, Australia, New Zealand, the U.K., Ireland, Hong Kong, Germany, and Costa Rica.

SDC Inc. is a holding company. Its sole material asset is its equity interest in SDC Financial which, through its direct and indirect subsidiaries, conducts all of the Company’s operations. SDC Financial is a Delaware limited liability company and wholly owns SmileDirectClub, LLC (“SDC LLC”) (a Tennessee limited liability company) and Access Dental (a Tennessee limited liability company). Because SDC Inc. is the managing member of SDC Financial, SDC Inc. indirectly operates and controls all of the business and affairs of SDC Financial and its subsidiaries.

Initial Public Offering

On September 16, 2019, SDC Inc. completed an initial public offering (“IPO”) of 58,537,000 shares of its Class A common stock at a public offering price of $23.00 per share. SDC Inc. received $1,286 million in proceeds, net of underwriting discounts and commissions. SDC Inc. used substantially all of the net proceeds after expenses to purchase newly-issued membership interest units from SDC Financial.

Reorganization Transactions

In connection with the IPO, the Company completed the following transactions (the “Reorganization Transactions”):

the formation of SDC Inc. as a Delaware corporation to function as the ultimate parent of SmileDirectClub and a publicly traded entity;

SDC Inc.’s acquisition of the pre-IPO membership interest units in SDC Financial (“Pre-IPO Units”) held by certain pre-IPO investors that are taxable as corporations for U.S. federal income tax purposes (“Blockers”), pursuant to a series of mergers (the “Blocker Mergers”) of the Blockers with wholly owned subsidiaries of SDC Inc., and the issuance by SDC Inc. to the equityholders of the Blockers shares of Class A common stock as consideration in the Blocker Mergers;

9


SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)

the amendment and restatement of the SDC Financial’s limited liability company operating agreement (the “SDC Financial LLC Agreement”) to, among other things, modify the capital structure of SDC Financial by replacing the different classes of Pre-IPO Units (including restricted Pre-IPO Units held by certain employees) with a single new class of membership interests of SDC Financial (“LLC Units”);
the issuance to each of the pre-IPO investors previously holding Pre-IPO Units (including restricted Pre-IPO Units) of a number of shares of SDC Inc. Class B common stock equal to the number of LLC Units held by it;

the issuance to certain employees of cash and shares of Class A common stock pursuant to their Incentive Bonus Agreements (“IBAs”); and

the equitable adjustment, pursuant to their terms, of outstanding warrants to purchase Pre-IPO Units held by two service providers into warrants to acquire LLC Units (together with an equal number of shares of SDC Inc.’s Class B common stock).

Following the completion of the Reorganization Transactions and the IPO, SDC Inc. owns 26.9% of SDC Financial. Holders (other than SDC Inc.) of LLC Units following the consummation of the Reorganization Transactions and the IPO (“Continuing LLC Members”) own the remaining 73.1% of SDC Financial.

SDC Inc. is the sole managing member of SDC Financial and, although SDC Inc. has a minority economic interest in SDC Financial, it has the sole voting power in, and controls the management of, SDC Financial. Accordingly, SDC Inc. consolidates the financial results of SDC Financial and reports a noncontrolling interest in its condensed consolidated financial statements. As the Reorganization Transactions are considered transactions between entities under common control, the financial statements for periods prior to the IPO and Reorganization Transactions have been adjusted to combine the previously separate entities for presentation purposes.

In connection with the Reorganization Transactions and the IPO, the Company entered into a Tax Receivable Agreement (the “Tax Receivable Agreement”) with the Continuing LLC Members, pursuant to which SDC Inc. agreed to pay the Continuing LLC Members 85% of the amount of cash tax savings, if any, in U.S. federal, state, and local income tax or franchise tax that SDC Inc. actually realizes as a result of (a) the increases in tax basis attributable to exchanges of LLC Units by Continuing LLC Members and (b) tax benefits related to imputed interest deemed to be paid by SDC Inc. as a result of the Tax Receivable Agreement.
Basis of Presentation and Consolidation
The accompanying unaudited condensed financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01of Regulation S-X of the SEC and, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of results for the unaudited interim periods presented. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. The results of operations for the interim period are not necessarily indicative of the results to be obtained for the full fiscal year. All intercompany accounts and transactions have been eliminated in the unaudited condensed financial statements.
The interim condensed consolidated financial statements include the accounts of SDC Inc., which consolidates SDC Financial and its wholly-owned subsidiaries, as well as accounts of contractually affiliated professional corporations (“PCs”) managed by the Company.
The interim condensed consolidated financial statements include the accounts of variable interest entities in which the Company is the primary beneficiary under the provisions of Accounting Standards Codification (‘‘ASC”) Topic 810, Consolidation.” At June 30, 2020, the variable interest entities include 45 dentist owned PCs and at December 31, 2019 the variable interest entities included 44 dentist owned PCs. The Company is a dental service organization and does not engage in the practice of dentistry. All clinical services are provided by dentists and orthodontists who are engaged as independent contractors or otherwise engaged by the dentist-owned PCs. The Company contracts with the PCs and dentists and orthodontists through a suite of agreements, including but not
10


SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)

limited to, management services agreements, supply agreements, and licensing agreements, pursuant to which the Company provides the administrative, non-clinical management services to the PCs and independent contractors. The Company has the contractual right to manage the activities that most significantly impact the variable interest entities’ economic performance through these agreements without engaging in the corporate practice of dentistry. Additionally, the Company would absorb substantially all of the expected losses of these entities should they occur. The accompanying consolidated statements of operations reflect the revenue earned and the expenses incurred by the PCs.
All significant intercompany balances and transactions are eliminated in consolidation.
In January 2020, the Company adopted lease accounting guidance as discussed in Note 2 and Note 6 to the unaudited condensed consolidated financial statements. Adoption of the new lease accounting guidance had a material impact to the Company’s unaudited condensed consolidated balance sheets and related disclosures, and resulted in the recording of additional right-of-use assets and lease liabilities as of the date of adoption. This guidance was applied using the optional transition method which allowed the Company to not recast comparative financial information but rather recognize a cumulative-effect adjustment to retained earnings as of the effective date in the period of adoption. No material adjustments to retained earnings were made as a result of the adoption of this guidance. Consistent with the optional transition method, the financial information in the condensed consolidated balance sheets prior to the adoption of this new lease accounting guidance has not been adjusted and is therefore not comparable to the current period presented. The standard did not materially impact the Company’s condensed consolidated statements of operations, comprehensive loss, changes in equity (deficit), or cash flows. For additional information, including the required disclosures, related to the impact of adopting this standard, see Note 2 and Note 6 to the unaudited condensed consolidated financial statements.
COVID-19 Pandemic
The impacts of COVID-19 unfolded globally throughout the first quarter of 2020, growing in strength from what the World Health Organization (“WHO”) declared a Public Health Emergency of International Concern in January, to an increased threat assessment by the WHO from high to very high in February, culminating with the WHO characterization of COVID-19 as a pandemic in March 2020. In response to COVID-19 and the related containment measures, the Company took the following steps to ensure the health and safety of its employees and its members: transitioned its employees, where possible, to a remote working environment; temporarily closed all of its SmileShops (except in Hong Kong); reconfigured its production lines to observe social distancing; and implemented enhanced cleaning and sanitizing routines, thermal temperature screening, mandatory personal protective equipment (“PPE”) protocols and other health and safety measures at its manufacturing facilities. The Company also enacted a resilience policy that provides its employees paid leave for COVID-19 testing and any required self-quarantine. Further, the Company’s manufacturing employees who were able to work during the quarter received a temporary wage increase for recognition of their service during this unprecedented time.
During the second quarter of 2020, the Company performed a review of its real estate needs and initiated restructuring actions related to a real estate repositioning program. As a result of these changes, the Company incurred a one-time charge of $29,109 for the three and six months ended June 30, 2020. This one-time charge was primarily associated with the closure of its manufacturing facility in Kyle, Texas; the consolidation of several floors at Company headquarters in Nashville, Tennessee; the closure and consolidation of many of the SmileShops, which is an on-going evaluation; and the impairment of right of use assets and leasehold improvements at the closed SmileShops. Given the uncertain operating environment and the shift to work-from-home, the Company made the strategic decision to align its rent costs with the current needs of the business, while also ensuring that the Company has sufficient capacity to support future growth. The Company continues to evaluate its SmileShops and other properties to determine if it will further rationalize its footprint to better align with marketplace demand, including the direct and indirect effects of the COVID-19 pandemic. For a complete discussion of the Company’s restructuring actions, see “Note 5—Lease Abandonment, Impairment of Long-lived Assets and Store Closure and Other Related Charges” in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
In April, the Company continued to repurpose certain of its 3D printing capabilities in order to manufacture PPE at cost for healthcare organizations and government agencies. Additionally, the Company took the following actions in an effort to fortify the short-term financial position of the business: reduced its marketing spend as a percentage of
11


SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)

revenue; furloughed much of its headquarters and retail workforce, bringing employees back on an as-needed basis; suspended cash pay temporarily for its executive and leadership teams; and bolstered its business continuity plans.
In May, the Company took action to secure its financial condition and liquidity needs by entering into the new HPS Credit Facility, under which it can borrow up to $500,000. For a complete discussion of the new HPS Credit Facility, see “Note 10-Long-Term Debt” in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
In June, the Company began to re-open SmileShops, in line with its real estate repositioning program, based on local public health guidelines and evolving customer behaviors and expectations. As of June 30, 2020 the Company had 42 SmileShops in operation. As part of this process and the repositioning actions more generally, the Company realigned its workforce to be commensurate with the needs of its business, which required a portion of its employees to continue to be furloughed, and in some instances, separated from the Company.
Note 2—Summary of Significant Accounting Policies
Management Use of Estimates
The preparation of the interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that impact the reported amounts. On an ongoing basis, the Company evaluates its estimates, including those related to the fair values of financial instruments, useful lives of property, plant and equipment, revenue recognition, equity-based compensation, long-lived assets, and contingent liabilities, among others. In connection with its credit facility with HPS Investment Partners, the Company issued warrants to certain affiliates of HPS Investment Partners. The warrants were recorded at fair value within equity on the condensed consolidated balance sheets using the Black-Scholes option pricing model (see Note 10). Each of these estimates varies in regard to the level of judgment involved and its potential impact on the Company’s financial results. Estimates are considered critical either when a different estimate could have reasonably been used, or where changes in the estimate are reasonably likely to occur from period to period, and such use or change would materially impact the Company’s financial condition, results of operations, or cash flows. Actual results could differ from those estimates.
Revenue Recognition
The Company’s revenues are derived primarily from sales of aligners, impression kits, whitening gel, and retainers, and interest earned through its SmilePay financing program. Revenue is recorded for all customers based on the amount that is expected to be collected, which considers implicit price concessions, discounts and returns.
The Company identifies a performance obligation as distinct if both of the following criteria are met: the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer and the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Determining the standalone selling price (“SSP”) and allocation of consideration from a contract to the individual performance obligations, and the appropriate timing of revenue recognition, is the result of significant qualitative and quantitative judgments. Management considers a variety of factors such as historical sales, usage rates (the number of times a customer is expected to order additional aligners), costs, and expected margin, which may vary over time depending upon the unique facts and circumstances related to each performance obligation, in making these estimates. Further, the Company’s process for estimating usage rates requires significant judgment and evaluation of inputs, including historical data and forecasted usages. Changes in the allocation of the SSP between performance obligations will not affect the amount of total revenues recognized for a particular contract. The Company uses the expected cost plus a margin approach to determine the SSP for performance obligations, and discounts are allocated to each performance obligation based on the relative standalone selling price. However, any material changes in the allocation of the SSP could impact the timing of revenue recognition, which may have a material effect on the Company’s financial position and result of operations as the contract consideration is allocated to each performance obligation, delivered or undelivered, at the inception of the contract based on the SSP of each distinct performance obligation.
The Company estimates the amount expected to be collected based upon management’s assessment of historical write-offs and expected net collections, business and economic conditions, and other collection indicators.
12


SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)

Management relies on the results of detailed reviews of historical write-offs and collections as a primary source of information in estimating the amount of contract consideration expected to be collected and implicit price concessions. Uncollectible receivables are written-off in the period management believes it has exhausted its ability to collect payment from the customer. The Company believes its analysis provides reasonable estimates of its revenues and valuations of its accounts receivable.
A description of the revenue recognition for each product sold by the Company is detailed below.
Aligners and Impression Kits: The Company enters into contracts with customers for aligner sales that involve multiple future performance obligations. The Company determined that aligner sales comprise the following distinct performance obligations: initial aligners, modified aligners, refinement aligners, and retainers for international sales only which can occur at any time throughout the treatment plan (which is typically between five to ten months) upon the direction of and prescription from the treating dentist or orthodontist.
The Company allocates revenues for each performance obligation based on its SSP and recognizes the revenues as control of the performance obligation is transferred upon shipment of the aligners. The Company recognizes aligner revenue on amounts expected to be collected during the course of the treatment plan.
The Company bills its customers either upfront for the full cost of aligners or monthly through its SmilePay financing program, which involves a down payment and a fixed amount per month for up to 24 months. The Company’s accounts receivable related to the SmilePay financing program are reported at the amount expected to be collected on the consolidated balance sheets, which considers implicit price concessions. Financing revenue from its accounts receivable is recognized based on the contractual market interest rate with the customer, net of implicit price concessions. There are no fees or origination costs included in accounts receivable.
The Company sells impression kits to its customers as an alternative to an in-person visit at one of its retail locations where the customer receives a free oral digital imaging of their teeth. The Company combines the sales of its impression kits with aligner sales and recognizes the revenues as control of the performance obligation is transferred upon shipment of the aligners. The Company estimates the amount of impression kit sales that do not result in an aligner therapy treatment plan and recognizes such revenue when aligner conversion becomes remote.
Retainers and Other Products: The Company sells retainers and other products (such as whitening gel and tooth brushes) to customers, which can be purchased on the Company’s website or certain retail outlets. The sales of these products are independent and separate from the customer’s decision to purchase aligner therapy for domestic sales. The Company determined that the transfer of control for these performance obligations occurs as the title of such products passes to the customer.
The following table summarizes revenue recognized for each product sold by the Company:
Three Months Ended June 30,Six Months Ended June 30,
2020201920202019
Aligner revenue, net of implicit price concessions$77,897  $181,471  $248,832  $346,723  
Financing revenue, net of implicit price concessions12,664  10,554  25,386  19,664  
Retainers and other products revenue16,512  3,769  29,505  7,143  
Total revenue$107,073  $195,794  $303,723  $373,530  
Implicit price concessions included in total revenue$11,319  $20,719  $34,688  $39,084  
Deferred Revenue: Deferred revenue represents the Company’s contract liability for performance obligations associated with sales of aligners. Of the Company’s revenues during the three and six months ended June 30, 2020 and 2019, $4,759, $3,325, $16,867, and $14,550 was previously included in deferred revenue on the consolidated balance sheets as of March 31, 2020 and 2019 and December 31, 2019 and 2018, respectively.
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)

Shipping and Handling Costs
Shipping and handling charges are recorded in cost of revenues in the consolidated statements of operations upon shipment. The Company incurred approximately $5,961, $2,945, $11,352 and $7,601 in outsourced shipping expenses for the three and six months ended June 30, 2020 and 2019, respectively.
Cost of Revenues
Cost of revenues includes the total cost of products produced and sold. Such costs include direct materials, direct labor, overhead costs (occupancy costs, indirect labor, and depreciation), fees retained by doctors, freight and duty expenses associated with moving materials from vendors to the Company’s facilities and from its facilities to the customers, and adjustments for shrinkage (physical inventory losses), lower of cost or net realizable value, slow moving product and excess inventory quantities.
Marketing and Selling Expenses
Marketing and selling expenses include direct online and offline marketing and advertising costs, costs associated with intraoral imaging services, selling labor, and occupancy costs of SmileShop locations. All marketing and selling expenses are expensed as incurred. For the three and six months ended June 30, 2020 and 2019, the Company incurred marketing and selling costs of $34,518, $113,413, $176,842 and $209,146, respectively.
General and Administrative Expenses
General and administrative expenses include payroll and benefit costs for corporate team members, equity-based compensation expenses, occupancy costs of corporate facilities, bank charges and costs associated with credit and debit card interchange fees, outside service fees, and other administrative costs, such as computer maintenance, supplies, travel, and lodging.
Depreciation and Amortization
Depreciation includes expenses related to the Company’s property, plant and equipment, including finance leases. Amortization includes expenses related to definite-lived intangible assets and capitalized software. Depreciation and amortization are calculated using the straight-line method over the useful lives of the related assets, ranging from three to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the related lease terms or their useful lives. Depreciation and amortization are included in cost of revenues, selling expenses, and general and administrative expenses depending on the purpose of the related asset. Depreciation and amortization by financial statement line item were as follows:
Three Months Ended June 30,
Six Months Ended June 30,
2020201920202019
Cost of revenues$5,887  $2,327  $11,441  $4,414  
Marketing and selling expenses1,628  1,184  3,271  2,061  
General and administrative expenses
6,401  1,557  10,645  3,248  
Total$13,916  $5,068  $25,357  $9,723  
Fair Value of Financial Instruments
The Company measures the fair value of financial instruments as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 — Quoted (unadjusted) prices in active markets for identical assets or liabilities.
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)

Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 — Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.
The Company’s financial instruments consist of cash, receivables, accounts payable, debt instruments, warrants, and derivative financial instruments. Due to their short-term nature, the carrying values of cash, current receivables, and trade payables, approximate current fair value at each balance sheet date. The warrants are recorded at their initial fair value. The Company had $401,228 and $150,448 in borrowings under its debt facilities (as discussed in Note 10) as of June 30, 2020 and December 31, 2019, respectively. Based on market interest rates (Level 2 inputs), the carrying value of the borrowings under its debt facilities approximates fair value for each period reported.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with applicable accounting standards for such instruments and hedging activities, which require that all derivatives are recorded on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company had no outstanding derivatives at June 30, 2020 or December 31, 2019; however, the Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards.
Certain Risks and Uncertainties
The Company’s operating results depend to a significant extent on the ability to market and develop its products. The life cycles of the Company’s products are difficult to estimate due, in part, to the effect of future product enhancements and competition. The inability to successfully develop and market the Company’s products as a result of competition or other factors would have a material adverse effect on its business, financial condition, and results of operations.
The Company provides credit to customers in the normal course of business. The Company maintains reserves for potential credit losses and such losses have been within management’s expectations. No individual customer accounted for 1% or more of the Company’s accounts receivable at June 30, 2020 or December 31, 2019, or net revenue for the three or six months ended June 30, 2020 and 2019.
Some of the Company’s products are considered medical devices and are subject to extensive regulation in the U.S. and internationally. The regulations to which the Company is subject are complex. Regulatory changes could result in restrictions on the Company’s ability to carry on or expand its operations, higher than anticipated costs or lower than anticipated sales. The failure to comply with applicable regulatory requirements may have a material adverse impact on the Company.
The Company’s reliance on international operations exposes it to related risks and uncertainties, including difficulties in staffing and managing international operations, such as hiring and retaining qualified personnel; political, social and economic instability; interruptions and limitations in telecommunication services; product and material transportation delays or disruption; trade restrictions and changes in tariffs; import and export license requirements and restrictions; fluctuations in foreign currency exchange rates; and potential adverse tax consequences. If any of these risks materialize, operating results may be harmed.
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