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 September 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 November 11, 2020:
Class A Common Stock: 113,546,706
Class B Common Stock: 272,512,403
| 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)
| September 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 September 30, | Nine Months Ended September 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 | ||||||||||||||
| Loss from operations | ( | ( | ( | ( | ||||||||||
| Interest expense | ||||||||||||||
| Interest expense—related parties | ||||||||||||||
| Loss on extinguishment of debt | ||||||||||||||
Other (income) expense | ( | |||||||||||||
| Net loss before income tax expense | ( | ( | ( | ( | ||||||||||
Income tax expense | ||||||||||||||
Net loss | ( | ( | ( | ( | ||||||||||
Net loss attributable to noncontrolling interest | ( | ( | ( | ( | ||||||||||
Net loss attributable to SmileDirectClub, Inc. | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
Earnings per share of Class A common stock: | ||||||||||||||
Basic | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
Diluted | $ | ( | $ | ( | $ | ( | $ | ( | ||||||
Weighted average shares outstanding: | ||||||||||||||
Basic | ||||||||||||||
Diluted | ||||||||||||||
The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.
5
SmileDirectClub, Inc.
Condensed Consolidated Statements of Other Comprehensive Loss (Unaudited)
(in thousands, except per share amounts)
| Three Months Ended September 30, | Nine Months Ended September 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 June 30, 2019 | $ | ( | $ | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||
| Net income prior to Reorganization Transactions | — | — | — | — | ( | ( | — | |||||||||||||||||||||||||||||||
| Preferred Unit redemption accretion | ( | ( | — | — | — | ( | ||||||||||||||||||||||||||||||||
| Share-based compensation prior to Reorganization Transactions | — | — | — | — | — | |||||||||||||||||||||||||||||||||
| Distributions payable | — | ( | — | — | — | ( | — | |||||||||||||||||||||||||||||||
| Effect of Reorganization Transactions | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||
| Balance at September 30, 2019 | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||
| Balance at December 31, 2018 | $ | $ | $ | ( | $ | ( | $ | |||||||||||||||||||||||||||||||
| Net income prior to Reorganization Transactions | — | — | — | — | ( | ( | — | |||||||||||||||||||||||||||||||
| Preferred Unit redemption accretion | — | ( | — | — | — | ( | ||||||||||||||||||||||||||||||||
| Redemptions prior to Reorganization Transactions | ( | ( | — | — | — | ( | — | |||||||||||||||||||||||||||||||
| Share-based compensation prior to Reorganization Transactions | — | — | — | — | — | |||||||||||||||||||||||||||||||||
| Distributions payable | — | ( | — | — | — | ( | — | |||||||||||||||||||||||||||||||
| Effect of Reorganization Transactions | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||
| Balance at September 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 Reorganization Transactions date | ||||||||||||||||||||||||||||||||
| Effect of Reorganization Transactions | — | — | — | |||||||||||||||||||||||||||||
| Issuance of Class A common stock in IPO, net of costs | — | — | — | — | — | — | ||||||||||||||||||||||||||
| Repurchases of Class A shares and LLC Units from Pre-IPO investors | ( | — | ( | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Issuance of Class A shares in connection with IBA vesting | — | — | ( | — | — | — | — | |||||||||||||||||||||||||
| Initial effect of the Reorganization Transactions and IPO on noncontrolling interests | — | — | — | — | ( | — | — | — | ||||||||||||||||||||||||
| Net loss subsequent to Reorganization Transactions | — | — | — | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||
| Equity-based compensation subsequent to Reorganization Transactions | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based payments subsequent to Reorganization Transactions | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Balance at Balance at September 30, 2019 | $ | $ | $ | $ | $ | ( | $ | $ | $ | |||||||||||||||||||||||
7
SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)
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 June 30, 2020 | $ | $ | $ | $ | $ | ( | $ | ( | $ | $ | ||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||
| Issuance of Class A shares in connection with RSU vesting | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Exchange of Class B common stock for Class A common stock | ( | ( | — | — | — | |||||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based payments | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Other | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Balance at September 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 September 30, 2020 | $ | $ | $ | $ | $ | ( | $ | ( | $ | $ | ||||||||||||||||||||||
The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.
8
SmileDirectClub, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
| Nine Months Ended September 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 and related fees | ( | |||||||
| Repurchase of Class A shares to cover employee tax withholdings | ( | ( | ||||||
| Settlement of canceled awards | ( | |||||||
| Issuance of Class A common stock | ||||||||
| 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 financing activities | ||||||||
| Increase 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.
9
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.
SmileDirectClub is an oral care company and creator of the first MedTech platform for teeth straightening. Through the Company’s cutting-edge teledentistry technology and vertically integrated model, it is revolutionizing the oral care industry, from clear aligner therapy to its affordable, premium oral care product line. SmileDirectClub’s mission is to democratize access to a smile each and every person loves by making it affordable and convenient for everyone. SmileDirectClub is headquartered in Nashville, Tennessee and operates in the U.S., Costa Rica, Puerto Rico, Canada, Australia, New Zealand, United Kingdom, Ireland, Germany, Austria, Hong Kong, Singapore and Spain.
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;
10
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. owned 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”) owned 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 September 30, 2020, the variable interest entities include 52 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
11
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 Company continues to navigate the uncertain and unprecedented economic and operating conditions resulting from COVID-19 and its protracted duration. In response to COVID-19 and the related containment measures, the Company made the following operational changes to ensure the health and safety of its employees and its members: transitioned its team members, where possible, to a remote working environment; closed a portion of its SmileShops based on the Company’s real estate repositioning program as well as local public health guidelines and evolving customer behaviors and expectations; reconfigured its SmileShops to reduce customer overlap in the waiting area and require touchless temperature screening upon arrival; heightened the personal protective equipment protocol (“PPE”) requirements for Smile Guides; reconfigured its production lines to observe social distancing; and implemented enhanced cleaning and sanitizing routines, thermal temperature screening, mandatory PPE protocols and other health and safety measures at its manufacturing facilities. The Company also enacted a resilience policy that provides its team members paid leave for COVID-19 testing and up to two weeks of paid leave for any required self-quarantine due to the team member testing positive for COVID-19.
Additionally, the Company took the following actions in an effort to fortify the financial position of the business: reduced its marketing spend as a percentage of revenue; reduced its headquarters and retail workforce; secured the HPS Credit Facility; and initiated a real estate repositioning program.
Beginning in the second quarter, the Company performed a review of its real estate needs and initiated restructuring actions related to a real estate repositioning program that remains ongoing. As a result of these changes, the Company incurred one-time charges of $5,674 and $34,783 during the three and nine months ended September 30, 2020, respectively, primarily associated with: the closure of its manufacturing facility in Kyle, Texas; the consolidation of several floors at its headquarters in Nashville, Tennessee; the closure and consolidation of a portion of its SmileShops; 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 decisions to align its rent costs with the current needs of the business, while also ensuring that it 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 our restructuring actions, see “Note 5—Lease Abandonment, Impairment of Long-lived Assets and Store Closure and Other Related Charges” in the Notes to the Unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
12
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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. 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.
13
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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 doctor prescribed impression kits to its customers as an alternative to an in-person visit at one of its SmileShops or Partner Network locations, comprised of affiliated dentist and orthodontist offices, 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 September 30, | Nine Months Ended September 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 nine months ended September 30, 2020 and 2019, $2,684 , $1,882 , $19,547 , and $16,386 was previously included in deferred revenue on the consolidated balance sheets as of December 31, 2019 and 2018, respectively.
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 $5,891 , $4,481 , $18,516 and $12,082 in outsourced shipping expenses for the three and nine months ended September 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.
14
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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 nine months ended September 30, 2020 and 2019, the Company incurred marketing and selling costs of $66,722 , $131,263 , $243,564 and $340,409 , 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 September 30, | Nine Months Ended September 30, | |||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||
| Cost of revenues | $ | $ | $ | $ | ||||||||||
| Marketing and selling expenses | ||||||||||||||
General and administrative expenses | ||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||
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.
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.
15
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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 September 30, 2020 or December 31, 2019, or net revenue for the three or nine months ended September 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.
The Company purchases certain inventory from sole suppliers, and the inability of any supplier or manufacturer to fulfill the supply requirements could materially and adversely impact its future operating results.
16
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Property, Plant and Equipment, net
Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Routine maintenance and repairs are charged to expense as incurred. At the time property, plant and equipment are retired from service, the cost and accumulated depreciation or amortization are removed from the respective accounts and the related gains or losses are reflected in the consolidated statements of operations.
Leases
On January 1, 2020, the Company adopted the new leases standard using the modified retrospective transition method, which requires that it recognizes leases differently pre- and post-adoption. See “Recently Adopted Accounting Pronouncements—ASU No. 2016-02” below for more information. The Company categorizes leases at their inception as either operating or finance leases. Lease agreements cover certain retail locations, office space, warehouse, manufacturing and distribution space and equipment. Operating leases are included in operating lease right-of-use assets, other current liabilities, and long-term right-of-use operating lease obligations in the condensed consolidated balance sheet. Finance leases are included in property, plant and equipment, net, current portion of long-term debt, and long-term debt.
Leased assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease right-of-use assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company uses a secured incremental borrowing rate as the discount rate for determining the present value of lease payments when the rate implicit in the contract is not readily determinable. Leases that have a term of twelve months or less upon commencement date are considered short-term in nature. Accordingly, short-term leases are not included on the condensed consolidated balance sheets and are expensed on a straight-line basis over the lease term, which commences on the date we have the right to control the property.
Impairment
The Company evaluates long-lived assets (including finite-lived intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the future undiscounted net cash flows that the asset or asset group is expected to generate. Factors the Company considers important which could trigger an impairment review include significant negative industry or economic trends, significant loss of customers and changes in the competitive environment. If an asset or asset group is considered to be impaired, the impairment to be recognized is calculated as the amount by which the carrying amount of the asset or asset group exceeds its fair market value. The Company’s estimates of future cash flows attributable to long-lived assets require significant judgment based on its historical and anticipated results and are subject to many assumptions. The estimation of fair value utilizing a discounted cash flow approach includes numerous uncertainties which require significant judgment when making assumptions of expected growth rates and the selection of discount rates, as well as assumptions regarding
17
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Debt Issuance Costs
The Company records debt issuance costs related to its term debt as direct deductions from the carrying amount of the debt. The costs are amortized to interest expense over the life of the debt using the effective interest method.
Income Taxes
SDC Inc. is the managing member of SDC Financial and, as a result, consolidates the financial results of SDC Financial in the unaudited condensed consolidated financial statements. SDC Financial and its subsidiaries are limited liability companies and have elected to be taxed as partnerships for income tax purposes except for a subsidiary, SDC Holding, LLC (‘‘SDC Holding”) and its domestic and foreign subsidiaries, which are taxed as corporations. As such, SDC Financial does not pay any federal income taxes, as any income or loss is included in the tax returns of the individual members. SDC Financial does pay state income tax in certain jurisdictions, and the Company’s income tax provision in the consolidated financial statements reflects the income taxes for those states. Additionally, certain wholly-owned entities taxed as corporations are subject to federal, state, and foreign income taxes, in the jurisdictions in which they operate, and accruals for such taxes are included in the consolidated financial statements. The Company further evaluates deferred tax assets in each jurisdiction and recognizes associated benefits when positive evidence of realization exceeds negative evidence, and otherwise records valuation allowances as necessary.
Tax Receivable Agreement
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 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. The Company recognizes this contingent liability in its consolidated financial statements when amounts become probable as to incurrence and estimable in amount.
Recent Accounting Pronouncements
In January 2020, the Company adopted FASB ASU 2018-07, “Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.
In fiscal year 2020, the Company adopted FASB ASU 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This update clarifies the accounting treatment for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. The adoption of ASU 2018-15 did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.
18
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Note 3—Inventories
Inventories are comprised of the following:
| September 30, 2020 | December 31, 2019 | |||||||
| Raw materials | $ | $ | ||||||
Finished goods | ||||||||
Total inventories | $ | $ | ||||||
Note 4—Prepaid and other assets
Prepaid and other assets are comprised of the following:
| September 30, 2020 | December 31, 2019 | |||||||
| Prepaid expenses | $ | $ | ||||||
| Deposits to vendors | ||||||||
Other | ||||||||
Total prepaid and other current assets | $ | $ | ||||||
| Prepaid expenses, non-current | $ | $ | ||||||
| Deposits to vendors, non-current | ||||||||
| Indefinite-lived intangible assets | ||||||||
| Other intangible assets, net | ||||||||
Total other assets | $ | $ | ||||||
19
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Note 5—Lease Abandonment, Impairment of Long-lived Assets and Store Closure and Other Related Charges
Beginning in 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 one-time charges of $5,674 and $34,783 for the three and nine months ended September 30, 2020. These charges were primarily associated with the closure of the manufacturing facility in Kyle, Texas; the consolidation of several floors at the Company headquarters in Nashville, Tennessee; the closure and consolidation of a portion of SmileShops, which is an on-going evaluation; and the impairment of right of use assets and leasehold improvements at the closed manufacturing facility and 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. Additional future restructuring charges may result from the Company’s real estate repositioning and optimization initiatives.
The following table summarizes charges for the three and nine months ended September 30, 2020. There were no
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||
| Lease abandonment and impairment of long-lived assets and inventory: | ||||||||||||||
| Impairment of property, plant and equipment | $ | $ | $ | $ | ||||||||||
| Impairment of right of use asset | ||||||||||||||