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
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
| (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 | ||||||
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 filer | ☐ | Accelerated filer | ☐ | ||||||||
| ☒ | Smaller 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 | $ | $ | ||||||
| Accounts receivable | ||||||||
| Inventories | ||||||||
Prepaid and other current assets | ||||||||
| Total current assets | ||||||||
| Accounts receivable, non-current | ||||||||
| Property, plant and equipment, net | ||||||||
Operating lease right-of-use asset | ||||||||
Other assets | ||||||||
Total assets | $ | $ | ||||||
| LIABILITIES AND PERMANENT EQUITY | ||||||||
| Accounts payable | $ | $ | ||||||
| Accrued liabilities | ||||||||
| Deferred revenue | ||||||||
Current portion of long-term debt | ||||||||
| Other current liabilities | ||||||||
| Total current liabilities | ||||||||
| Long-term debt, net of current portion | ||||||||
Operating lease liabilities, net of current portion | ||||||||
Other long-term liabilities | ||||||||
| Total liabilities | ||||||||
| Commitment and contingencies | ||||||||
| Permanent Equity | ||||||||
Class A common stock, par value $ | ||||||||
Class B common stock, par value $ | ||||||||
Additional paid-in-capital | ||||||||
| Accumulated other comprehensive income (loss) | ( | |||||||
| Accumulated deficit | ( | ( | ||||||
| Noncontrolling interest | ( | |||||||
Warrants | ||||||||
Total permanent equity | ||||||||
Total liabilities and permanent equity | $ | $ | ||||||
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, | |||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||
| Revenue, net | $ | $ | $ | $ | ||||||||||
| Financing revenue | ||||||||||||||
| Total revenues | ||||||||||||||
| Cost of revenues | ||||||||||||||
| Cost of revenues—related parties | ||||||||||||||
Total cost of revenues | ||||||||||||||
| Gross profit | ||||||||||||||
| Marketing and selling expenses | ||||||||||||||
| General and administrative expenses | ||||||||||||||
| Lease abandonment and impairment of long-lived assets | ||||||||||||||
| Other store closure and related costs | ||||||||||||||
| Income (loss) from operations | ( | ( | ( | |||||||||||
| Interest expense | ||||||||||||||
| Interest expense—related parties | ||||||||||||||
| Loss on extinguishment of debt | ||||||||||||||
Other (income) expense | ( | ( | ||||||||||||
| Net loss before income tax (benefit) expense | ( | ( | ( | ( | ||||||||||
Income tax (benefit) expense | ( | |||||||||||||
Net loss | ( | ( | ( | ( | ||||||||||
Net loss attributable to noncontrolling interest | ( | ( | ||||||||||||
Net loss attributable to SmileDirectClub, Inc. | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
Earnings per share of Class A common stock: | ||||||||||||||
Basic | $ | ( | N/A | $ | ( | N/A | ||||||||
Diluted | $ | ( | N/A | $ | ( | N/A | ||||||||
Weighted average shares outstanding: | ||||||||||||||
Basic | N/A | N/A | ||||||||||||
Diluted | N/A | 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, | |||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||
| Net loss | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
| Other comprehensive loss: | ||||||||||||||
| Foreign currency translation adjustment | ||||||||||||||
| Comprehensive loss | ( | ( | ( | ( | ||||||||||
| Comprehensive loss attributable to noncontrolling interests | ( | ( | ||||||||||||
| Comprehensive loss attributable to SmileDirectClub, Inc. | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
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 Capital | Warrants | Accumulated Deficit | Permanent Equity (Deficit) | Temporary Equity (Deficit) | ||||||||||||||||||||||||||||||||||
| Units | Amount | Units | Amount | |||||||||||||||||||||||||||||||||||
| Balance at March 31, 2019 | $ | $ | $ | ( | $ | ( | $ | |||||||||||||||||||||||||||||||
| Net income prior to Reorganization Transactions | — | — | — | — | ( | ( | — | |||||||||||||||||||||||||||||||
| Redemption of member units | ( | ( | — | — | — | ( | — | |||||||||||||||||||||||||||||||
| Preferred Unit redemption accretion | — | ( | — | — | — | ( | ||||||||||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||
| Balance at June 30, 2019 | $ | ( | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||
| Balance at December 31, 2018 | $ | $ | $ | ( | $ | ( | $ | |||||||||||||||||||||||||||||||
| Net income prior to Reorganization Transactions | — | — | — | — | ( | ( | — | |||||||||||||||||||||||||||||||
| Redemption of member units | ( | ( | — | — | — | ( | — | |||||||||||||||||||||||||||||||
| Preferred Unit redemption accretion | — | ( | — | — | — | ( | ||||||||||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||
| Balance at June 30, 2019 | $ | ( | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||
SmileDirectClub, Inc. Stockholders’ Equity | ||||||||||||||||||||||||||||||||
| Class A Shares | Class B Shares | Class A Amount | Class B Amount | Additional Paid-in Capital | Warrants | Accumulated Deficit | Noncontrolling Interest | Accumulated Other Comprehensive Income (Loss) | Total | |||||||||||||||||||||||
| Balance at March 31, 2020 | $ | $ | $ | $ | $ | ( | $ | $ | $ | |||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||
| Issuance of Class A shares in connection with RSU vesting | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Issuance of Class B shares in connection with warrant exercise | — | — | — | ( | — | — | — | |||||||||||||||||||||||||
| Exchange of Class B common stock for Class A common stock | ( | — | — | ( | — | |||||||||||||||||||||||||||
| HPS Warrant issuance | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based payments | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Other | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Balance at June 30, 2020 | $ | $ | $ | $ | $ | ( | $ | ( | $ | $ | ||||||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||
| Issuance of Class A shares in connection with RSU vesting | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Issuance of Class B shares in connection with warrant exercise | — | — | — | ( | — | — | — | |||||||||||||||||||||||||
| Exchange of Class B common stock for Class A common stock | ( | ( | — | — | ( | — | ||||||||||||||||||||||||||
| HPS Warrant issuance | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based payments | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Other | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Balance at June 30, 2020 | $ | $ | $ | $ | $ | ( | $ | ( | $ | $ | ||||||||||||||||||||||
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, | ||||||||
| 2020 | 2019 | |||||||
| Operating Activities | ||||||||
| Net loss | $ | ( | $ | ( | ||||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation and amortization | ||||||||
| Deferred loan cost amortization | ||||||||
| Equity-based compensation | ||||||||
| Loss on extinguishment of debt | ||||||||
| Paid in kind interest expense | ||||||||
| Lease abandonment, impairment of long-lived assets and other store closure and related charges | ||||||||
| Changes in ROU asset | ||||||||
| Other non-cash operating activities | ||||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | ( | |||||||
| Inventories | ( | ( | ||||||
| Prepaid and other current assets | ( | ( | ||||||
| Accounts payable | ( | |||||||
| Accrued liabilities | ( | |||||||
| Due to related parties | ( | |||||||
Deferred revenue | ||||||||
| Net cash used in operating activities | ( | ( | ||||||
| Investing Activities | ||||||||
| Purchases of property, equipment, and intangible assets | ( | ( | ||||||
| Net cash used in investing activities | ( | ( | ||||||
| Financing Activities | ||||||||
| Payment of IPO related costs | ( | |||||||
| Proceeds from warrant exercise | ||||||||
| Repurchase of Class A shares to cover employee tax withholdings | ( | |||||||
| Proceeds from HPS Credit Facility and Warrants, net | ||||||||
| Borrowings on long-term debt | ||||||||
| Payments of loan costs | ( | ( | ||||||
| Principal payments on long-term debt | ( | ( | ||||||
| Principal payments on related party debt | ( | |||||||
| Payments on finance leases | ( | |||||||
Other | ( | |||||||
Net cash provided by (used in) financing activities | ( | |||||||
| Increase (decrease) in cash and cash equivalents | ( | |||||||
Cash and cash equivalents at beginning of period | ||||||||
Cash and cash equivalents at end of period | $ | $ | ||||||
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.
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
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, | |||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||
| Aligner revenue, net of implicit price concessions | $ | $ | $ | $ | ||||||||||
| Financing revenue, net of implicit price concessions | ||||||||||||||
| Retainers and other products revenue | ||||||||||||||
| Total revenue | $ | $ | $ | $ | ||||||||||
| Implicit price concessions included in total revenue | $ | $ | $ | $ | ||||||||||
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.
13
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.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||
| Cost of revenues | $ | $ | $ | $ | ||||||||||
| Marketing and selling expenses | ||||||||||||||
General and administrative expenses | ||||||||||||||
| Total | $ | $ | $ | |||||||||||