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 March 31, 2021
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
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 such files). ☒ Yes
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 | ☐ | ☒ | |||||||||
| Non-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 May 3, 2021:
Class A Common Stock: 118,252,146
Class B Common Stock: 269,272,682
| TABLE OF CONTENTS | ||||||||
| PART I | ||||||||
| Item 1 | Condensed Consolidated Balance Sheets at March 31, 2021 (Unaudited) and December 31, 2020 | |||||||
Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2021 and 2020 (Unaudited) | ||||||||
Condensed Consolidated Statements of Other Comprehensive Loss for the Three Months Ended March 31, 2021 and 2020 (Unaudited) | ||||||||
Condensed Consolidated Statements of Changes in Equity (Deficit) for the Three Months Ended March 31, 2021 and 2020 (Unaudited) | ||||||||
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2021 and 2020 (Unaudited) | ||||||||
| Item 2 | ||||||||
| Item 3 | ||||||||
| Item 4 | ||||||||
| PART II | ||||||||
| Item 1 | ||||||||
| Item 1A | ||||||||
| Item 6 | ||||||||
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q of SmileDirectClub, Inc. (“SmileDirectClub,” “Company,” “us,” “we,” or “our”) 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, 2020. 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 cyberattacks);
•the adequacy of our risk management framework;
•our cash needs and ability to raise additional capital, if needed;
•our intellectual property position;
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•our exposure to claims and legal proceedings;
•our ability to remain in compliance with our debt covenants;
•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.
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PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
SmileDirectClub, Inc.
Condensed Consolidated Balance Sheets (Unaudited)
(in thousands, except share and per share amounts)
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| ASSETS | ||||||||
| Cash | $ | $ | ||||||
| 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 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 | ||||||||
Equity | ||||||||
Class A common stock, par value $ | ||||||||
Class B common stock, par value $ | ||||||||
| Additional paid-in-capital | ||||||||
| Accumulated other comprehensive loss | ( | ( | ||||||
| Accumulated deficit | ( | ( | ||||||
| Noncontrolling interest | ( | ( | ||||||
| Warrants | ||||||||
Total equity | ||||||||
Total liabilities and equity | $ | $ | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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SmileDirectClub, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share amounts)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenue, net | $ | $ | ||||||
| Financing revenue | ||||||||
| Total revenues | ||||||||
| Cost of revenues | ||||||||
| Gross profit | ||||||||
| Marketing and selling expenses | ||||||||
| General and administrative expenses | ||||||||
| Other store closure and related costs | ||||||||
Loss from operations | ( | ( | ||||||
| Interest expense | ||||||||
Loss on extinguishment of debt | ||||||||
Other expense | ||||||||
Net loss before provision for income tax expense | ( | ( | ||||||
Provision for income tax expense | ||||||||
Net loss | ( | ( | ||||||
Net loss attributable to noncontrolling interest | ( | ( | ||||||
Net loss attributable to SmileDirectClub, Inc. | $ | ( | $ | ( | ||||
Earnings (loss) per share of Class A common stock: | ||||||||
Basic | $ | ( | $ | ( | ||||
Diluted | $ | ( | $ | ( | ||||
Weighted average shares outstanding: | ||||||||
Basic | ||||||||
Diluted | ||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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SmileDirectClub, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
Net loss | $ | ( | $ | ( | ||||
Other comprehensive income: | ||||||||
| 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 condensed consolidated financial statements.
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SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit)
(in thousands, except per share 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 December 31, 2019 | $ | $ | $ | $ | $ | ( | $ | $ | ( | $ | ||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||
| Issuance of Class A shares in connection with equity-based awards | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Issuance of Class B shares in connection with warrant exercise | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Exchange of Class B common stock for Class A common stock | ( | ( | — | — | ( | — | ||||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based payments | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Other | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
Balance at March 31, 2020 | $ | $ | $ | $ | $ | ( | $ | $ | $ | |||||||||||||||||||||||
Balance at December 31, 2020 | $ | $ | $ | $ | $ | ( | $ | ( | $ | ( | $ | |||||||||||||||||||||
| Net loss | — | — | — | — | — | — | ( | ( | — | ( | ||||||||||||||||||||||
| Issuance of Class A shares in connection with equity-based awards | — | — | ( | — | — | — | — | |||||||||||||||||||||||||
| Exchange of Class B common stock for Class A common stock | ( | — | — | ( | — | — | — | |||||||||||||||||||||||||
| Equity-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Equity-based payments | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | — | — | |||||||||||||||||||||||||
| Capped call instruments | ( | ( | ||||||||||||||||||||||||||||||
| Other | — | — | — | — | ( | — | — | — | — | ( | ||||||||||||||||||||||
| Balance at March 31, 2021 | $ | $ | $ | $ | $ | ( | $ | ( | $ | ( | $ | |||||||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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SmileDirectClub, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| 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 | ||||||||
| 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 | ( | |||||||
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 | ||||||||
| IPO proceeds, net of discount and related fees | ( | |||||||
| Proceeds from warrant exercise | ||||||||
| Repurchase of Class A shares to cover employee tax withholdings | ( | ( | ||||||
| Repayment of HPS Credit Facility | ( | |||||||
| Payment of extinguishment costs | ( | |||||||
| Borrowings of long-term debt | ||||||||
| Payments of issuance costs | ( | |||||||
| Purchase of capped call transactions | ( | |||||||
| Final settlement of Align arbitration | ( | |||||||
| Principal payments on long-term debt | ( | ( | ||||||
| Payments of finance leases | ( | ( | ||||||
Other | ||||||||
Net cash provided by financing activities | ||||||||
| Effect of exchange rates change on cash and cash equivalents | ||||||||
Increase (decrease) in cash | ( | |||||||
Cash at beginning of period | ||||||||
Cash at end of period | $ | $ | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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. For purposes of these notes to 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, the Netherlands, Mexico, 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;
•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
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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.
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 March 31, 2021, the variable interest entities include 55 dentist owned PCs, and at December 31, 2020 the variable interest entities included 54 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
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and orthodontists through a suite of agreements, including but not 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 condensed 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 beginning in the second quarter of 2020 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 and popup locations 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 beginning in the second quarter of 2020 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 long-term financing; and initiated a real estate repositioning program.
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
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 interim condensed consolidated balance sheets using the Black-Scholes option pricing model (see Note 9). 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 SSP. 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, touch-up aligners, and retainers for international sales only which can occur at any time
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
throughout the treatment plan (which is typically between five months 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 interim condensed 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, popup locations, 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 or retail partner.
The following table summarizes revenue recognized for each product sold by the Company:
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| 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 | $ | $ | ||||||
13
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Activity in the allowance for credit losses of receivables was as follows:
| Accounts Receivable Allowance for Credit Losses | |||||
| Balance at January 1, 2021 | $ | ||||
| Current period provision for expected credit losses | |||||
| Write-offs and other adjustments charged against the allowance, net of recoveries | ( | ||||
| Balance at March 31, 2021 | $ | ||||
Shipping and Handling Costs
Shipping and handling charges are recorded in cost of revenues in the condensed consolidated statements of operations upon shipment. The Company incurred approximately $6,909 and $5,391 in outsourced shipping expenses for the three months ended March 31, 2021 and 2020, 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.
General and Administrative Expenses
General and administrative expenses include payroll and benefit costs for corporate team members, equity-based compensation expenses, occupancy costs of corporate facilities, bank charges and costs associated with credit and debit card interchange fees, outside service fees, and other administrative costs, such as computer maintenance, supplies, travel, and lodging.
Depreciation and Amortization
Depreciation includes expenses related to the Company’s property, plant and equipment, including capital leases. Amortization includes expenses related to definite-lived intangible assets and capitalized software. Depreciation and amortization is calculated using the straight-line method over the useful lives of the related assets, ranging from to ten years . Leasehold improvements are amortized using the straight-line method over the shorter of the related lease terms or their useful lives. Depreciation and amortization is included in cost of revenues, selling expenses, and general and administrative expenses depending on the purpose of the related asset.
14
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| 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.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with applicable accounting standards for such instruments and hedging activities, which require that all derivatives are recorded on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability. The Company had no outstanding derivatives at March 31, 2021 or December 31, 2020; however, the Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards.
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 March 31, 2021 or December 31, 2020, or net revenue for the three months ended March 31, 2021 and 2020.
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.
Cash
Cash consists of all highly liquid investments with original maturities of less than three months. Cash is held in various financial institutions in the U.S. and internationally.
Inventories
Inventories are stated at the lower of cost or net realizable value using the first-in, first-out method of inventory accounting. Inventory consists of raw materials for producing impression kits and aligners and finished goods. Inventory is net of shrinkage and obsolescence.
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 condensed 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
16
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
liabilities, and long-term right-of-use operating lease obligations in the condensed consolidated balance sheets. 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 general economic and business conditions, and the structure that would yield the highest economic value, among other factors.
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 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 condensed consolidated financial statements reflects the income taxes for those states. Additionally, certain wholly-owned entities taxed as corporations are
17
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
subject to federal, state, and foreign income taxes, in the jurisdictions in which they operate, and accruals for such taxes are included in the condensed 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.
The Company computes the provision for income taxes using the liability method and recognizes deferred tax assets and liabilities for temporary differences between financial statement and income tax bases of assets and liabilities, as well as for operating loss and tax credit carryforwards. The Company measures deferred tax assets and liabilities using tax rates applicable to taxable income in effect for the years in which those tax assets are expected to be realized or settled and provides a valuation allowance against deferred tax assets when it cannot conclude that it is more likely than not that some or all deferred tax assets will be realized. In addition, the Company recognizes tax benefits from uncertain tax positions only if it expects that its tax positions are more likely than not that they will be sustained, based on the technical merits of the positions, on examination by the jurisdictional tax authority. The Company recognizes any accrued interest and penalties to unrecognized tax benefits as interest expense and income tax expense, respectively.
Tax Receivable Agreement
In connection with the Reorganization Transactions and the IPO, the Company entered into a 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 condensed consolidated financial statements when amounts become probable as to incurrence and estimable in amount.
Recently Adopted Accounting Pronouncements
In January 2021 the Company adopted FASB ASU 2016-13, “Financial Instruments—Credit Losses” (Topic 326). The FASB issued this update to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this update replace the existing guidance of incurred loss impairment methodology with an approach that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. In November 2018, the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” which clarifies the scope of guidance in the ASU 2016-13. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures.
In January 2021, the Company adopted FASB ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." This standard simplified the accounting for income taxes by eliminating certain exceptions to the guidance in Topic 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The guidance also simplified aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill and allocating consolidated income taxes to separate financial statements of entities not subject to income tax. The Company adopted the provisions of this guidance effective January 1, 2021 using the modified retrospective method of adoption which required no cumulative-effect adjustment to retained earnings as of the beginning of the period.
In January 2021, the Company adopted FASB ASU 2020-06, “Accounting for Convertible Instruments and Contracts in an Entity's Own Equity,” which eliminates most of the guidance in Subtopic 470-20 that requires separate accounting for embedded conversion features in convertible debt arrangements. Further, ASU 220-06 removes some of the conditions in Subtopic 815-40-25, "Contracts on an Entity's own Equity," that are required for equity classification, including the requirement for equity contracts to permit settlement in unregistered shares. The Company adopted the provisions of this
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:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Raw materials | $ | $ | ||||||
| Finished goods | ||||||||
| Total inventories | $ | $ | ||||||
Note 4—Prepaid and Other Assets
Prepaid and other assets are comprised of the following:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| 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 | ||||||||
| Investments | ||||||||
Total other assets | $ | $ | ||||||
Note 5—Lease Abandonment, Impairment of Long-lived Assets and Store Closure and Other Related Charges
19
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
The following table summarizes restructuring charges for the periods presented:
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Lease abandonment and impairment of long-lived assets: | ||||||||
| Impairment of property, plant and equipment | $ | $ | ||||||
| Impairment of right of use asset | ||||||||
| $ | $ | |||||||
| Store closure and other related charges: | ||||||||
| Impairment of inventory | $ | $ | ||||||
| Short-term lease termination fees | ||||||||
| Other expenses | ||||||||
| $ | $ | |||||||
The balance of the accruals for the restructuring programs recorded in accrued expenses in the condensed consolidated balance sheets as of March 31, 2021 was $400 .
Note 6—Property, Plant and Equipment, Net
Property, plant and equipment were comprised of the following:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Lab and SmileShop equipment | $ | $ | ||||||
| Computer equipment and software | ||||||||
| Leasehold improvements | ||||||||
| Furniture and fixtures | ||||||||
| Vehicles | ||||||||
Construction in progress | ||||||||
Less: accumulated depreciation | ( | ( | ||||||
Property, plant and equipment, net | $ | $ | ||||||
The carrying values of assets under finance leases were $18,058 and $20,484 as of March 31, 2021 and December 31, 2020, respectively, net of accumulated depreciation of $17,870 and $15,444 , respectively.
20
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Note 7—Accrued Liabilities
Accrued liabilities were comprised of the following:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| Accrued marketing and selling costs | $ | $ | ||||||
| Accrued payroll and payroll related expenses | ||||||||
| Accrued sales tax and related costs | ||||||||
| Other | ||||||||
| Total accrued liabilities | $ | $ | ||||||
Note 8—Income Taxes
SDC Inc. is the managing member of SDC Financial and, as a result, consolidates the financial results of SDC Financial. 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 and certain of its domestic and foreign subsidiaries, are taxed as corporations. The Company files income tax returns in the U.S. federal, various states and foreign jurisdictions. Any taxable income or loss generated by SDC Financial is passed through to and included in the taxable income or loss of its members, including SDC Inc., generally on a pro rata basis or otherwise under the terms of the SDC Financial LLC Agreement. The Company is subject to U.S. federal income taxes, in addition to state and local income taxes with respect to its allocable share of any taxable income or loss of SDC Financial, as well as any stand-alone income or loss generated by SDC Inc.
The Company’s U.S. federal and state income tax returns for the tax years 2017 and beyond remain subject to examination by the Internal Revenue Service. The Company also has operations in Costa Rica, Puerto Rico, Canada, Mexico, Australia, the U.K., Germany, Austria, the Netherlands, Spain, Ireland, Hong Kong, Singapore, Taiwan, and New Zealand with tax filings in each foreign jurisdiction. With respect to state and local jurisdictions, the Company and its subsidiaries are typically subject to examination for several years after the income tax returns have been filed. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, interest and penalties have been provided for in the accompanying condensed consolidated financial statements for any adjustments that may be incurred due to state or local audits and uncertain tax positions. The Company is also subject to withholding taxes in foreign jurisdictions. The Company’s income tax expense may vary from the expense that would be expected based on statutory rates due principally to its organizational structure and recognition of valuation allowances against deferred tax assets.
21
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
The income tax provision was as follows:
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| Current: | ||||||||
| Federal | $ | $ | ||||||
| State | ( | |||||||
Foreign | ||||||||
| Current income tax provision | $ | $ | ||||||
| Deferred: | ||||||||
| Federal | $ | $ | ||||||
| State | ||||||||
| Foreign | ||||||||
Deferred income tax provision | $ | $ | ||||||
Total income tax provision | $ | $ | ||||||
At March 31, 2021 the Company had unused federal net operating loss carryforwards (tax effected) for federal income tax purposes of approximately $45,911 , which can be carried forward indefinitely and may be used to offset future taxable income. In addition, the Company had unused net operating loss carryforwards (tax effected) for state income tax purposes of approximately $27,625 , which expire from 2029 through 2035. The Company also had unused net operating loss carryforwards (tax effected) for foreign income tax purposes of approximately $3,121 . Additionally, the Company has certain other deferred tax assets related to potential future tax benefits. All deferred tax assets are evaluated using positive and negative evidence as to their future realization. The Company considers recent historic losses to be significant negative evidence, and as such, records a valuation allowance against substantially all of its deferred tax assets.
As of March 31, 2021, the Company maintained a valuation allowance of approximately $280,944 against its deferred tax assets. If there is a change in the Company’s assessment of the amount of deferred income tax assets that is realizable, adjustments to the valuation allowance will be made in future periods.
Tax Receivable Agreement
The Company expects to obtain an increase in its share of the tax basis in the net assets of SDC Financial when LLC Units are redeemed from or exchanged by Continuing LLC Members. The Company intends to treat any redemptions and exchanges of LLC Units as direct purchases of LLC Units for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that it would otherwise pay in the future to various tax authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.
In connection with the Reorganization Transactions and the IPO, the Company entered into the Tax Receivable Agreement with the Continuing LLC Members. The Tax Receivable Agreement provides for the payment by SDC Inc. of 85 % of the amount of any tax benefits that SDC Inc. actually realizes, or in some cases is deemed to realize, as a result of (i) increases in SDC Inc.’s share of the tax basis in the net assets of SDC Financial resulting from any redemptions or exchanges of LLC Units, (ii) tax basis increases attributable to payments made under the Tax Receivable Agreement, and (iii) deductions attributable to imputed interest pursuant to the Tax Receivable Agreement (collectively, the “TRA Payments”). The Company expects to benefit from the remaining 15 % of any of cash savings, if any, that it realizes.
During the year ended December 31, 2019, the Company acquired an aggregate of $635,690 in LLC Units in connection with the redemption of certain Continuing LLC Members, which resulted in an increase in the tax basis of the assets of SDC Financial subject to the provisions of the Tax Receivable Agreement. The Company has not recognized any additional liability under the Tax Receivable Agreement after concluding it was not probable that such TRA Payments would be paid
22
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
based on its estimates of future taxable income. No
The amounts payable under the Tax Receivable Agreement will vary depending upon a number of factors, including the amount, character, and timing of the taxable income of SDC Inc. in the future. If the valuation allowance recorded against the deferred tax assets applicable to the tax attributes referenced above is released in a future period, the Tax Receivable Agreement liability may be considered probable at that time and recorded within earnings.
Note 9—Long-Term Debt
The Company’s debt and capital lease obligations are comprised of the following:
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
2026 Convertible Senior Notes, net of unamortized financing costs $ | $ | $ | ||||||
HPS Credit Facility, net of unamortized financing costs of $ | ||||||||
| Align redemption promissory note | ||||||||
| Capital lease obligations | ||||||||
| Total debt | ||||||||
Less current portion | ( | ( | ||||||
Total long-term debt | $ | $ | ||||||
2026 Convertible Senior Notes
On February 9, 2021, the Company issued $650,000 principal amount of the Company’s 0.00 % Convertible Senior Notes due 2026 (the “Notes”). The Company also granted the initial purchasers of the Notes an option to purchase up to an additional $97,500 aggregate principal amount of the Notes (“Option Notes”). On February 9, 2021, the initial purchasers of the Notes exercised their option to purchase $70,000 aggregate principal amount of the Option Notes (the “First Greenshoe Exercise”). The sale of the Option Notes from the First Greenshoe Exercise closed on February 12, 2021. On February 11, 2021, the initial purchasers of the Notes exercised the remaining portion of their option to purchase $27,500 aggregate principal amount of the Option Notes (the “Second Greenshoe Exercise” and, the Option Notes issued in connection with the Second Greenshoe Exercise, the “Second Greenshoe Option Notes”). The sale of the Second Greenshoe Option Notes closed on February 16, 2021.
The Notes were issued and governed by an indenture, dated February 9, 2021, (the “Indenture”), between the Company and Wilmington Trust, National Association, as trustee. The Notes will mature on February 1, 2026, unless earlier repurchased, redeemed or converted. The Notes will not bear regular interest, and the principal amount of the Notes will not accrete.
The initial conversion rate for the Notes is 55.3710 shares of the Company's Class A Common Stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $18.06 per share of Class A Common Stock. The initial conversion price of the Notes represents a premium of approximately 40 % over the last reported sale of $12.90 per share of the Company's Class A Common Stock on February 4, 2021. The conversion rate and conversion price will be subject to customary adjustments upon the occurrence of certain events in accordance with the terms of the Indenture.
The Company recorded $21,979 related to deferred financing costs of the Notes. During the three months ended March 31, 2021, the Company amortized under the effective interest rate method $623 of deferred financing costs.
23
SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
The Notes are the Company’s senior, unsecured obligations and are (i) equal in right of payment with the Company’s existing and future senior, unsecured indebtedness; (ii) senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated to the Notes; (iii) effectively subordinated to the Company’s existing and future secured indebtedness, to the extent of the value of the collateral securing that indebtedness; and (iv) structurally subordinated to all existing and future indebtedness and other liabilities, including the Company’s trade payables, and (to the extent the Company is not a holder thereof) preferred equity, if any, of the Company’s subsidiaries.
The Company may, at its option, redeem some of the Notes, in whole or in part, at the applicable redemption price as set forth in the Indenture.
If certain corporate events that constitute a “Fundamental Change” (as defined in the Indenture) occur, then, noteholders may require the Company to repurchase their Notes at a cash repurchase price equal to the principal amount of the Notes to be repurchased, plus accrued and unpaid special interest, if any. The definition of Fundamental Change includes certain business combination transactions involving the Company and certain de-listing events with respect to the Company’s Class A common stock.
The Notes have customary provisions relating to the occurrence of an “Event of Default” (as defined in the Indenture), which include the following: (i) a default by the Company in the payment when due (whether at maturity, upon redemption or repurchase upon fundamental change or otherwise) of the principal of, or the redemption price or fundamental change repurchase price for, any Note (ii) a default by the Company for 30 days in the payment when due of special interest, if any, on any Note; (iii) the Company’s failure to send certain notices under the Indenture within specified periods of time; (iv) a default by the Company in its obligation to convert a Note in accordance with the Indenture upon the exercise of the conversion right with respect thereto, if such default is not cured within business days after its occurrence; (v) the Company’s failure to comply with certain covenants in the Indenture relating to the Company’s ability to consolidate with or merge with or into, or sell, lease or otherwise transfer, in one transaction or a series of transactions, all or substantially all of the assets of the Company and its subsidiaries, taken as a whole, to another person; (vi) a default by the Company in its other obligations or agreements under the Indenture or the Notes (other than a default set forth in clauses (i), (ii), (iii), (iv) or (v) above) if such default is not cured or waived within 60 days after written notice is given in accordance with the Indenture; (vii) certain defaults by the Company or any of its significant subsidiaries with respect to indebtedness for borrowed money of at least $50,000 ; and (viii) certain events of bankruptcy, insolvency and reorganization involving the Company or any of the Company’s significant subsidiaries.
If an Event of Default involving bankruptcy, insolvency or reorganization events with respect to the Company (and not solely with respect to a significant subsidiary of the Company) occurs, then the principal amount of, and all accrued and unpaid special interest, if any, on, all of the Notes then outstanding will immediately become due and payable without any further action or notice by any person. If any other Event of Default occurs and is continuing, then, the Trustee, by notice to the Company, or noteholders of at least 25 % of the aggregate principal amount of Notes then outstanding, by written notice to the Company and the Trustee, may declare the principal amount of, and all accrued and unpaid special interest, if any, on, all of the Notes then outstanding to become due and payable immediately. However, notwithstanding the foregoing, the Company may elect, at its option, that the sole remedy for an Event of Default relating to certain failures by the Company to comply with certain reporting covenants in the Indenture consists exclusively of the right of the noteholders to receive special interest on the Notes for up to 180 days at a specified rate per annum not exceeding 0.50 % on the principal amount of the Notes.
The Company used approximately $69,518 of the net proceeds from the Notes to fund the cost of entering into the capped call transactions described below. The Company used a portion of the remainder of the net proceeds from the offering to repay amounts owed under the HPS Credit Facility.
On February 4, 2021, in connection with the pricing of the Notes, the Company entered into privately negotiated capped call transactions (the “Base Capped Call Transactions”) with certain of the initial purchasers of the Notes and/or their respective affiliates and/or other financial institutions (the “Option Counterparties”). In addition, on February 9, 2021, in
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
connection with First Greenshoe Exercise and on February 11, 2021, in connection with the Second Greenshoe Exercise, the Company entered into additional privately negotiated capped call transactions (collectively, and together with the Base Capped Call Transactions, the “Capped Call Transactions”) with the Option Counterparties. The Capped Call Transactions cover, subject to anti-dilution adjustments substantially similar to those applicable to the Notes, the number of shares of Class A common stock initially underlying the Notes. The Capped Call Transactions are expected generally to reduce potential dilution to the Class A common stock upon any conversion of the Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of such converted Notes, as the case may be, with such reduction and/or offset subject to a cap.
The Capped Call Transactions are separate transactions entered into by the Company with each Option Counterparty, and are not part of the terms of the Notes and will not affect any noteholder’s rights under the Notes. Noteholders will not have any rights with respect to the Capped Call Transactions.
HPS Credit Facility
In May 2020, SDC U.S. SmilePay SPV (“SPV”), a wholly-owned special purpose subsidiary of the Company, entered into a Loan Agreement among SPV, as borrower, SmileDirectClub, LLC, as the seller and servicer, certain lenders, and HPS Investment Partners, LLC, as administrative agent and collateral agent, providing a five-year secured term loan facility to SPV in an initial aggregate maximum principal amount of $400,000 , net of original issue discount of $12,000 , with the ability to request incremental term loans of up to an additional aggregate principal amount of $100,000 with the consent of the lenders participating in such increase (the “HPS Credit Facility”).
The proceeds of the HPS Credit Facility were used to repay all outstanding amounts under the previous JPM Credit Facility and for working capital and other corporate purposes. In connection with the repayment, the Company paid $187 in fees and wrote-off the remaining unamortized loan costs of $1,594 , both of which were included in loss from extinguishment of debt in the period in which the HPS Credit Facility was entered.
The Company recorded $11,784 related to deferred financing costs of the HPS Credit Facility in the second quarter of 2020. During the three months ended March 31, 2021, the Company amortized under the effective interest rate method $536 of deferred financing costs. The original issue discount is included in loss from extinguishment of debt in the accompanying condensed consolidated statements of operations.
Outstanding loans under the HPS Credit Facility bore interest at a variable rate equal to three-month LIBOR (subject to a 1.75 % per annum floor), plus 7.50 % per annum payable in cash, plus 3.25 % per annum payable in kind or, at the Company’s election, wholly or partially in cash.
Subject to certain exceptions, the HPS Credit Facility was secured by first-priority security interests in SPV’s assets, which consisted of certain receivables, cash governed by a control agreement with HPS, intellectual property and related assets. SPV’s obligations under the Loan Agreement were guaranteed on a limited basis by SmileDirectClub, LLC and SDC Financial LLC. As of March 31, 2021, the Company had $0 of its receivables collateralized as part of the HPS Credit Facility.
The HPS Credit Facility contained various restrictions, covenants, ratios and events of default, including:
•SPV had limitations on consolidations, creation of liens, incurring additional indebtedness, dispositions of assets, investments and paying dividends or other distributions.
•SDC Financial LLC, its consolidated subsidiaries and certain originator entities had to maintain minimum monthly liquidity of $100,000 and are subject to additional leverage ratios upon the occurrence of additional debt.
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
•SDC Financial LLC was subject to a consolidated leverage ratio measured as of the end of each fiscal quarter beginning March 31, 2022, to be calculated based on annualized EBITDA for the first three quarters of 2022, and thereafter, to be calculated based on EBITDA during the trailing four fiscal quarters for the relevant period.
The HPS Credit Facility could have been refinanced during the first year, provided that SPV would be required to pay the amount of interest that would have accrued during the remainder of the first year, plus 4 % of the principal amount prepaid; and after the first year, for a fee of 4 % of the principal amount prepaid, with the prepayment fee decreasing each year to 3 % in the third year, 2 % in the fourth year and 1 % in the fifth year.
On March 29, 2021, the HPS Credit Facility was paid in full and terminated. In connection with the repayment, the unamortized loan costs, the unaccreted warrant value, and the prepayment fee described above are recorded as a loss on extinguishment of debt in the accompanying condensed consolidated statements of operations.
HPS Warrants
In connection with the HPS Credit Facility, the Company issued warrants (“HPS Warrants”) to affiliates of HPS Investment Partners, LLC exercisable at any time into an aggregate of 3,889,575 shares of the Company’s Class A common stock, which amounted to 1 % of the Company’s total outstanding Class A and Class B common stock, including the HPS Warrants, as of the closing date of the HPS Credit Facility, at an exercise price of $7.11 per share, payable in cash or pursuant to a cashless exercise. The HPS Warrants were recorded at their initial fair value of $17,620 and included within stockholders’ equity. The termination and payoff of the HPS Credit Facility did not impact the HPS Warrants.
Align Redemption Promissory Note
In connection with the required redemption of Align’s 20,710 Pre-IPO Units described in Note 15, the Company entered into a promissory note with Align Technology, Inc. (“Align”). Under the terms of the promissory note, the Company was scheduled to make monthly payments of $2,311 to Align through March 2021. The promissory note bore annual interest of 2.52 % which is included in the condensed consolidated statement of operations. As of March 31, 2021, the Company has $0 outstanding under this promissory note.
Future Maturities
Annual future maturities of long-term debt, excluding finance lease obligations, and unamortized financing costs, are as follows:
| 2026 Convertible Senior Notes | |||||
2021 (remaining) | $ | ||||
| 2022 | |||||
| 2023 | |||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| Total | $ | ||||
Note 10—Noncontrolling Interests
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Note 11—Variable Interest Entities
Upon completion of the IPO, SDC Inc. became the managing member of SDC Financial with 100 % of the management and voting power in SDC Financial. In its capacity as managing member, SDC Inc. has the sole authority to make decisions on behalf of SDC Financial and bind SDC Financial to signed agreements. Further, SDC Financial maintains separate capital accounts for its investors as a mechanism for tracking earnings and subsequent distribution rights. Accordingly, management concluded that SDC Financial is determined to be a limited partnership or similar legal entity as contemplated in ASC 810.
Furthermore, management concluded that SDC Inc. is SDC Financials’ primary beneficiary. As the primary beneficiary, SDC Inc. consolidates the results of SDC Financial for financial reporting purposes under the variable interest consolidation model guidance in ASC 810.
SDC Inc.’s relationship with SDC Financial results in no recourse to the general credit of SDC Inc. SDC Financial and its consolidated subsidiaries represents SDC Inc.’s sole investment. SDC Inc. shares in the income and losses of SDC Financial in direct proportion to SDC Inc.’s ownership percentage. Further, SDC Inc. has no contractual requirement to provide financial support to SDC Financial.
SDC Inc.’s financial position, performance and cash flows effectively represent those of SDC Financial as of and for the three months ended March 31, 2021 and 2020. Prior to the IPO and Reorganization Transactions, SDC Inc. was not impacted by SDC Financial.
Note 12—Incentive Compensation Plans
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
Class A Common Stock Options
Options activity was as follows during the three months ended March 31, 2021:
| Number of Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||||
Outstanding at December 31, 2020 | $ | $ | ||||||||||||
| Granted | — | |||||||||||||
| Exercised | — | — | ||||||||||||
| Expired | — | — | ||||||||||||
| Forfeited | — | — | ||||||||||||
Outstanding at March 31, 2021 | $ | $ | ||||||||||||
Exercisable at March 31, 2021 | $ | $ | ||||||||||||
The Company estimates fair value of the Options using the Black-Scholes option pricing model. Inputs to the Black-Scholes option pricing model for awards issued during the three months ended March 31, 2021, include an expected dividend yield of 0.0 %, expected volatility of 65.6 %, risk-free interest rate of 0.8 % and an expected term of 6.3 years, pursuant to vesting terms, resulting in a weighted average fair value of $8.17 per Option pursuant to vesting terms. As of March 31, 2021, unrecognized compensation expense related to the Options was $8,867 . This expense is expected to be recognized over a weighted average period of 1.6 years.
Expected dividend yield - An increase in the expected dividend yield would decrease compensation expense.
Expected volatility - This is a measure of the amount by which the price of the equity instrument has fluctuated or is expected to fluctuate. The expected volatility was based on the historical volatility of a group of guideline companies. An increase in expected volatility would increase compensation expense.
Risk-free interest rate - This is the U.S. Treasury rate as of the measurement date having a term approximating the expected life of the award. An increase in the risk-free interest rate would increase compensation expense.
Expected term - The period of time over which the awards are expected to remain outstanding. The Company estimates the expected term as the mid-point between actual or expected vesting date and the contractual term. An increase in the expected term would increase compensation expense.
Restricted Stock Units
Incentive Bonus Awards
The Company has IBA agreements with several key employees to provide a bonus payment in the event of a liquidation event as defined in each agreement. The bonus amounts are calculated based on the value of the Company at the time of the liquidation event, less an amount determined upon the employee entering into the agreement. The right to the payment generally vests annually over a five-year period, with certain liquidation events resulting in an acceleration of the vesting period. As the vesting of these awards was contingent on a liquidation event, no amounts were required to be recorded prior to a liquidation event. The IBA agreements were modified in August 2019 to accelerate certain vesting conditions upon a liquidation event and to modify the settlement terms, whereby the Company settled the vested portion of each IBA in 50 % shares of Class A common stock and/or vested RSUs and 50 % cash, of which approximately 80 % of the cash (40 % of the total vested portion of the award) that the IBA holders would have otherwise received was withheld by the Company to fulfill tax withholding obligations and the remainder was paid out to IBA holders upon the occurrence of a liquidation event. As a
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SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
(in thousands, except share/unit data and per share/unit amounts)
result of the modification and the occurrence of a liquidation event through the IPO, the Company recorded equity-based compensation expense of $316,959 , equivalent to the amount of IBAs vested at the time of the IPO, in the form of cash, 5,654,078 shares of Class A common stock and 2,199,453 vested RSUs to be released over a period of to twenty-four months following the date of the IPO. The unvested portion of the IBAs are represented in the form of unvested RSUs that will vest, subject to the holders’ continued employment, over a period generally ranging from 2 years to 4 years.
Non-IBA Restricted Stock Units
The Company granted RSUs to certain team members that generally vest annually over to three years or after three years from the date of grant, subject to the recipient’s continued employment or service to the Company through each vesting date.
A summary of activity related to these RSUs is as follows:
| IBA RSUs | Non-IBA RSUs | Total RSUs | Weighted Average Grant Date Fair Value | |||||||||||
RSUs outstanding, December 31, 2020 | $ | |||||||||||||
| Granted | $ | |||||||||||||
| Vested | ( | ( | ||||||||||||