SMILEDIRECTCLUB, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in any forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below, disclosed elsewhere in this Quarterly Report on Form 10-Q, and in our Annual Report on Form 10-K for the year endedDecember 31, 2021 under the heading "Risk Factors."
See "Cautionary Statement Regarding Forward-Looking Statements."
We are an oral care company and the creator of the firstMedTech platform for teeth straightening. Through our cutting-edge teledentistry technology and vertically integrated model, we are revolutionizing the oral care industry, from clear aligner therapy to our affordable, premium oral care product line. Our mission is to democratize access to a smile each and every person loves by making it affordable and convenient for everyone. We are headquartered inNashville, Tennessee and operate in theU.S. ,Costa Rica ,Puerto Rico ,Canada ,Australia ,United Kingdom ,France , andIreland .
Key Business Metrics
We review the following key business metrics to evaluate our business performance:
Unique aligner order shipments
For the three months endedSeptember 30, 2022 and 2021, we shipped 52,367 and 69,906 unique aligner orders, respectively. Each unique aligner order shipment represents a single contracted member.
Average aligner gross sales price
We define average gross sales price (''ASP") as gross revenue, before implicit
price concession and other variable considerations and exclusive of sales tax,
from aligner orders shipped divided by the number of unique aligner orders
shipped. We believe ASP is an indicator of the value we provide to our members
and our ability to maintain our pricing. Our ASP for the three months ended
September 30, 2022 and 2021 was $1,902 and $1,900 , respectively. Our ASP is less
than our standard $2,050 price as a result of discounts offered to select
members.
Key Factors Affecting Our Performance
We believe that our future performance will depend on many factors, including those described below and in the section titled "Risk Factors" included in Part I, Item 1A. in our Annual Report on Form 10-K for the year endedDecember 31, 2021 and in Part II, Item 1A. in this Quarterly Report on Form 10-Q.
Strategic actions to increase profitability
OnJanuary 24, 2022 , we announced a series of strategic actions to position us for improved business performance and future growth, including right-sizing our cost structure to better support core growth initiatives and allocating capital to countries with the greatest potential for near-term profitability. Following an evaluation of our business and the continuing macroeconomic factors impacting consumers, we implemented initiatives including the expansion of our professional channel, the SmileDirectClub Partner Network; innovations to our aligner products so as to allow us to capture greater market share of the teen and higher-household income demographics; focusing on our burgeoning oral care product business; and SmileShop growth in markets with strong 36 --------------------------------------------------------------------------------
consumer demand. Expansion into new international markets is paused while the global economy recovers from pandemic and macroeconomic pressures that have contributed to challenging operating environments.
In connection with these operational changes, we suspended operations inMexico ,Spain ,Germany ,Netherlands ,Austria ,Hong Kong ,Singapore andNew Zealand . We continue to operate in and scale our presence inthe United States ,Canada ,United Kingdom ,Ireland ,France andAustralia . As a result of these changes, we underwent a reduction in workforce to right-size our operating structure so it is tailored to the countries in which we continue to operate. During the first nine months of fiscal 2022, we incurred one-time charges of approximately$19.3 million , primarily associated with the right-sizing exercise and exiting the above markets. Beginning in the fourth quarter of 2021, we began an evaluation of our international operations as a result of the pandemic and the deteriorating economic environment. During the year endedDecember 31, 2021 , we incurred one-time charges of approximately$5.3 million primarily associated with lease abandonment and store closure costs including the costs to exit certain foreign markets,Germany ,Austria , andthe Netherlands , due to the uncertain operating environment and immaturity of those markets as well as regulatory challenges.
COVID-19 pandemic and macroeconomic environment
Although increasing rates of vaccinations across the globe and decreasing governmental restrictions have begun to lessen the impact of COVID-19, we continue to navigate the uncertain and unprecedented economic and operating conditions resulting from the COVID-19 pandemic and its protracted duration.
We bolstered our business continuity plans to address the evolving and on-going operational challenges associated with COVID-19. Specifically, we have a crisis management team that meets regularly with the heads of all functional areas to monitor the regulatory environment and health and safety guidelines and to manage the corresponding changes and impacts to our business. Our technology platforms continue to support a majority work from home environment. Our demand forecasting process is integrated with our suppliers to allow us to maintain target inventory levels. This collaborative relationship also allows us to monitor the impact of COVID-19 on our suppliers, review their related action plans and confirm they meet our standards as well as public health guidelines. We believe that our teledentistry platform is well suited for the current operating environment. Our impression kit offers the ability to begin treatment or obtain any necessary touch-ups (mid-course corrections or refinements) remotely from home. During the COVID-19 pandemic, we experienced a customer shift towards impression kits, with approximately 60% of our clear aligner sales originating from impression kits during the second half of 2020 and first quarter of 2021. As governmental restrictions began to ease during the second quarter of 2021, we began to see a shift towards a more normalized mix of clear aligner sales originating from impressions kits versus scans in our SmileShops, Partner Network, and popup locations, with approximately 47% of our clear aligner sales originating from impression kits during the third quarter of fiscal 2022. Although we cannot know or control the duration and severity of COVID-19 and its impact on our business, we will continue to focus on efficient acquisition of new members, including higher income customers, and controlled growth, each as more specifically discussed below. We will also continue to evaluate our business due to the negative macroeconomic environment impacting our core demographic, including lower discretionary spending and a challenging economic environment impacted by increased inflation.
Cybersecurity Incident
OnMay 3, 2021 , the Company announced that it experienced a systems outage that was caused by a cybersecurity incident onApril 14, 2021 (the "Incident"). We promptly implemented a series of containment and remediation measures to address the Incident, including temporarily isolating and shutting down affected systems and related manufacturing operations. We immediately mobilized our internal engineering security team and engaged leading forensic information technology firms to assist our investigation into the Incident. As a result of these efforts, we were able to successfully block the attack, no ransom was paid, and our systems and operations are back online and performing normally. 37 -------------------------------------------------------------------------------- We had no data loss from, or other loss of assets as a result of, the Incident, including any exposure of customer or team member information. The Incident, however, caused delays and disruptions to parts of our business, including treatment planning, manufacturing operations, and product delivery. We maintain insurance coverage for certain expenses and potential liabilities that may be associated with the Incident, and we are pursuing coverage for all applicable expense and liabilities. The Incident had a material impact on business operations and financial results in the second quarter of fiscal 2021, including a delay in fulfilling customer orders. As a result, we experienced a decrease to revenue and increase to certain costs associated with our response to the Incident.
Efficient acquisition of new members
•Visits to our website: During the third quarter of 2022, we averaged approximately 2-3 million unique visitors to our website each month, and we expect to continue to invest in sales and marketing to spread awareness and increase the number of individuals visiting our website.
•Conversions from visits to aligner orders: From our website, individuals can either sign up for a SmileShop appointment, order a doctor prescribed impression kit or book an appointment at an affiliated dentist or orthodontist office, which we refer to as our "Partner Network," to evaluate and ultimately purchase our clear aligner treatment. We expect to continue to invest heavily in our proprietary technology platform, operations, and other processes to improve member conversion from website visit through SmileShop and Partner Network appointment booking, appointment attendance, and aligners ordered; and a similar process for our impression kits. •Referrals: During the third quarter of 2022, we remained strong on our member experience with referrals reaching 21% of all orders. We expect to continue to invest in our member journey to improve our member experience and increase our member referrals. SmilePay We offer SmilePay, a convenient monthly payment plan, to maximize accessibility and provide an affordable option for all of our members. The$250 down payment for SmilePay covers our cost of manufacturing the aligners, and the interest income generated by SmilePay more than offsets the negative impact of delinquencies and cancellations. A number of factors affect delinquency and cancellation rates, including member-specific circumstances, our efforts in member service and management, and the broader macroeconomic environment.
Continued investment in controlled growth
We intend to continue investing in our business to support future growth by
focusing on strategies that best address our large market opportunity, both
domestically and internationally, and focus on cost discipline across the
business. These investments include technological advancements that allow us to
serve more customers, improve the customer experience and create efficiencies
across our organization. Our key growth initiatives include enhancing our
existing product platform; including to improve conversion rate; introducing new
products to further differentiate our offerings; expanding our customer
acquisition channels; expanding our reach through the professional channel; and
expanding our market share with more traditional, higher income customers of
clear aligner therapy. Additionally, we are focused on continued advancement in
automating and streamlining our manufacturing and treatment planning operations
to allow us to stay ahead of consumer demand; continued discipline around
marketing and selling investments, including a focus on pushing more demand
through our existing SmileShop network and Partner Network, comprised of
affiliated dentist offices, and leveraging our referrals, aided awareness, and
customer acquisition strategies. We also intend to continue to develop a suite
of ancillary products for our members' oral care needs, lengthening our
relationship with our members and enhancing our recurring revenue base. As part
of these key investment initiatives, we will also continue to explore
collaborations with retailers and other third-party partnerships as a component
of our strategy.
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Pace of adoption for teledentistry
The rate of adoption of teledentistry will impact our ability to acquire new members and grow our revenue.
Components of Operating Results
Revenues
Our revenues are derived primarily from sales of aligners, impression kits, whitening gel, retainers, and other oral care products, as well as interest earned on SmilePay. Revenues are recorded based on the amount that is expected to be collected, which considers implicit price concessions, discounts, and cancellations and refunds from customer returns. Revenues include revenue recognized from orders shipped in the current period, as well as deferred revenue recognized from orders in prior periods. We offer our members the option of paying the entire cost of their clear aligner treatment upfront or enrolling in SmilePay, our convenient monthly payment plan requiring a down payment and a monthly payment for up to 26 months. Financing revenue includes interest earned on SmilePay aligner orders shipped in prior periods. Our average APR is approximately 21%, which is included in the monthly payment. 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 our facilities and from our facilities to our members, and adjustments for shrinkage (physical inventory losses), lower of cost or net realizable value, slow moving product, and excess inventory quantities. We manufacture all of our aligners and retainers in our manufacturing facilities. We continue to invest in automating our manufacturing and treatment planning operations, launching our second-generation manufacturing at the end of the third quarter of 2020, which has contributed to increased efficiencies in our manufacturing process and increased margins. We have built extensive supply chain mechanisms that allow us to quickly and accurately create treatment plans and manufacture aligners.
Marketing and selling expenses
Our marketing expenses include costs associated with an omni-channel approach
supported by mixed media marketing ("MMM"). These costs include online sources,
such as social media and paid search, and offline sources, such as television,
experiential events, local events, and business-to-business partnerships. We
also have comprehensive strategies across search engine optimization, customer
relationship management ("CRM") marketing, and earned and owned marketing. We
have invested significant resources into optimizing our member conversion
process.
Our selling costs include both labor and non-labor expenses associated with our
SmileShops, Partner Network, and popup locations and costs associated with our
sales and scheduling teams in our customer contact center. Non-labor costs
associated with our SmileShops and popup locations include rent, travel,
supplies, and depreciation costs associated with digital photography equipment,
furniture, and computers, among other costs.
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.
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--------------------------------------------------------------------------------Interest and other expenses
Interest expense includes interest from our financing agreements and other long-term indebtedness. Other expense includes unrealized gains and losses on currency translation adjustments related to certain intercompany loan agreements between legal entities, disposal of long-lived assets, and other non-operating gains and losses.
Provision for income tax expense (benefit)
We are subject toU.S. federal, state, and local income taxes with respect to our allocable share of any taxable income of SDC Financial, and we are taxed at the prevailing corporate tax rates. In addition to tax expenses, we also incur tax expenses related to our operations, as well as payments under the Tax Receivable Agreement. We receive a portion of any distributions made by SDC Financial. Any cash received from such distributions from our subsidiaries will first be used by us to satisfy any tax liability and then to make any payments required under the Tax Receivable Agreement. See Note 8.
Adjusted EBITDA
To supplement our interim condensed consolidated financial statements presented in accordance with GAAP, we also present Adjusted EBITDA, a financial measure which is not based on any standardized methodology prescribed by GAAP. We define Adjusted EBITDA as net loss, plus depreciation and amortization, interest expense, income tax expense (benefit), equity-based compensation, loss on extinguishment of debt, impairment of long-lived assets, abandonment and other related charges and certain other non-operating expenses, such as one-time store closure costs associated with our real estate repositioning strategy, severance, retention and other labor costs, certain one-time legal settlement costs, and unrealized foreign currency adjustments. Adjusted EBITDA does not have a definition under GAAP, and our definition of Adjusted EBITDA may not be the same as, or comparable to, similarly titled measures used by other companies. We use Adjusted EBITDA when evaluating our performance when we believe that certain items are not indicative of operating performance. Adjusted EBITDA provides useful supplemental information to management regarding our operating performance, and we believe it will provide the same to members/stockholders. We believe that Adjusted EBITDA will provide useful information to members/stockholders about our performance, financial condition, and results of operations for the following reasons: (i) Adjusted EBITDA is among the measures used by our management team to evaluate our operating performance and make day-to-day operating decisions and (ii) Adjusted EBITDA is frequently used by securities analysts, investors, lenders, and other interested parties as a common performance measure to compare results or estimate valuations across companies in our industry. Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. A reconciliation of Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure, is set forth below.
Results of Operations
The following table summarizes our historical results of operations. The
period-over-period comparison of results of operations is not necessarily
indicative of results for future periods, and the results for any interim period
are not necessarily indicative of the operating results to be expected for the
full fiscal year. You should read this discussion of our results of
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--------------------------------------------------------------------------------operations in conjunction with our interim condensed consolidated financial statements and related notes thereto included elsewhere in this Form 10-Q.
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
(in thousands)
Statements of Operations Data:
Total revenues $ 106,770 $ 137,683 $ 384,212 $ 511,325
Cost of revenues 31,995 39,412 109,136 133,233
Gross profit 74,775 98,271 275,076 378,092
Marketing and selling expenses 58,212 96,175 226,114 289,241
General and administrative expenses 75,507 85,658 218,620 251,778
Lease abandonment and impairment of long-lived
assets 197 1,378 1,429 1,378
Restructuring and other related costs 3,169 95 17,869 1,759
Loss from operations (62,310) (85,035) (188,956) (166,064)
Total interest expense 5,360 1,772 11,370 21,277
Loss on extinguishment of debt - - - 47,631
Other expense 1,323 2,695 8,564 3,737
Net loss before provision for income tax
expense (benefit) (68,993) (89,502) (208,890) (238,709)
Provision for income tax expense (benefit) 739 (119) (468) 1,576
Net loss (69,732) (89,383) (208,422) (240,285)
Net loss attributable to non-controlling
interest (48,058) (61,991) (143,862) (167,104)
Net loss attributable to SDC Inc. $ (21,674) $ (27,392) $ (64,560) $ (73,181)
Other Data:
Adjusted EBITDA $ (29,673) $ (54,015) $ (87,276) $ (71,573) The following table reconciles Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.
Three Months Ended September
30, Nine Months Ended
2022 2021 2022 2021
(in thousands)
Net loss $ (69,732) $ (89,383) $ (208,422) $ (240,285)
Depreciation and amortization 19,113 18,486 57,609 51,655
Total interest expense 5,360 1,772 11,370 21,277
Income tax expense (benefit) 739 (119) (468) 1,576
Lease abandonment and impairment of
long-lived assets 197 1,378 1,429 1,378
Restructuring and other related costs 3,169 95 17,869 1,759
Loss on extinguishment of debt - - - 47,631
Equity-based compensation 7,693 10,492 21,559 37,659
Other non-operating general and
administrative losses 3,788 3,264 11,778 5,777
Adjusted EBITDA $ (29,673) $ (54,015) $ (87,276) $ (71,573)
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Comparison of the three and nine months ended
Revenues
Revenues decreased$30.9 million , or 22.5%, to$106.8 million in the three months endedSeptember 30, 2022 from$137.7 million in the three months endedSeptember 30, 2021 . The decrease in revenues was primarily driven by decreased aligner shipments compared to the prior year period as a result of the negative macroeconomic factors impacting our core demographic, including lower discretionary spending and a challenging economic environment impacted by increased inflation. Revenues decreased$127.1 million , or 24.9%, to$384.2 million in the nine months endedSeptember 30, 2022 from$511.3 million in the nine months endedSeptember 30, 2021 . The decrease in revenues was primarily driven by decreased aligner shipments compared to the prior year period as a result of the negative macroeconomic factors impacting our core demographic, including lower discretionary spending and a challenging economic environment impacted by increased inflation. For the nine months endedSeptember 30, 2022 and 2021, revenues for theU.S. andCanada were approximately$323.2 million and$422.8 million , or 84.1% and 82.7% of total revenues, respectively, and revenues for the rest of world were approximately$61.0 million and$88.6 million , or 15.9% and 17.3%, respectively.
Cost of revenues
Cost of revenues decreased$7.4 million , or 18.8%, to$32.0 million in the three months endedSeptember 30, 2022 from$39.4 million in the three months endedSeptember 30, 2021 . Cost of revenues increased as a percentage of revenues from 28.6% in the three months endedSeptember 30, 2021 to 30.0% in the three months endedSeptember 30, 2022 . The increase in cost of revenues as a percentage of revenue is primarily due to the deleveraging of fixed costs in our manufacturing process as a result of the lower aligner sales for the current quarter when compared to the prior year. The decrease in overall costs of revenues in the current year period as compared to the prior year period is primarily due to producing a lower number of aligners in the current year period. Gross margin decreased to 70.0% in the three months endedSeptember 30, 2022 from 71.4% in the three months endedSeptember 30, 2021 , primarily as a result of the factors described above.
Cost of revenues decreased
Marketing and selling expenses
Marketing and selling expenses decreased$38.0 million to$58.2 million or 54.5% of revenue in the three months endedSeptember 30, 2022 compared to$96.2 million or 69.9% of revenue in the three months endedSeptember 30, 2021 . The decrease in marketing and selling expense in both dollars and as a percentage of revenue was primarily due to the exit of certain foreign markets at the beginning of the year and the foc us on marketing efficiency as a result of the negative macroeconomic factors impacting our core demographic, including lower discretionary spending and a challenging economic environment impacted by increased inflation. Marketing and selling expenses as a percentage of revenues increased to 58.9% in the nine months endedSeptember 30, 2022 from 56.6% in the nine months endedSeptember 30, 2021 primarily due to the lower sales recognized in the current year as a result of the negative macroeconomic factors impacting our core demographic, including lower discretionary spending and a challenging economic environment impacted by increased inflation.
General and administrative expenses
General and administrative expenses decreased$10.2 million , or 11.9%, to$75.5 million in the three months endedSeptember 30, 2022 from$85.7 million in the three months endedSeptember 30, 2021 . The decrease was primarily due to 42 -------------------------------------------------------------------------------- lower personnel and administrative costs as a result of cost control measures put in place at the beginning of the year and lower stock-based compensation costs as a result of forfeitures resulting from management team member and changes resulting from restructuring activities. This decrease was partially offset by higher depreciation and amortization costs as a result of the investments we have made in the business over the last year. As a percent of revenue, general and administrative expenses increased from 62.2% in the three months endedSeptember 30, 2021 to 70.7% in the three months endedSeptember 30, 2022 , primarily due to the deleveraging of fixed costs associated with the decrease in revenue compared to the prior year period. General and administrative expenses decreased$33.2 million , or 13.2%, to$218.6 million in the nine months endedSeptember 30, 2022 from$251.8 million in the nine months endedSeptember 30, 2021 due to the reasons discussed above.
Lease abandonment, impairment of long-lived assets and other store closure and related charges
Lease abandonment, impairment of long-lived assets and other related charges were$3.4 million and$19.3 million in the three and nine months endedSeptember 30, 2022 , respectively, compared to$1.5 million and$3.1 million in the three and nine months endedSeptember 30, 2021 . The charges in the current year are primarily associated with the strategic actions the Company undertook inJanuary 2022 , including right-sizing its operating structure as a result of suspending operations inMexico ,Spain ,Germany ,Netherlands ,Austria ,Hong Kong ,Singapore andNew Zealand to improve business performance. In the nine months endedSeptember 30, 2022 , lease abandonment and impairment of long-lived assets were$1.4 million and restructuring and other related charges were$17.9 million which include lease buyouts, regional operating center and SmileShop closure costs and employee related costs, including severance and retention payments associated with the organizational changes. In the nine months endedSeptember 30, 2021 , lease abandonment and impairment of right-of-use assets were$1.4 million and restructuring and other related charges were$1.8 million , primarily associated with the closure and consolidation of a portion of our SmileShops. We continue to evaluate our SmileShops and other properties to determine if we will further rationalize our footprint to better align with marketplace demand, including direct and indirect effects of the COVID-19 pandemic and increased inflation.
Interest expense
Interest expense increased
Loss on extinguishment of debt
Loss on extinguishment of debt in the nine months endedSeptember 30, 2021 was$47.6 million . The prior year expense was in conjunction with the payoff of the 2020 HPS Credit Facility onMarch 29, 2021 . The cost was primarily made up of fees paid in connection with the termination of the 2020 HPS Credit Facility and unamortized fees and warrant costs associated with the initiation of the transaction in fiscal 2020.
Other expense
Other expense was an expense of$1.3 million in the three months endedSeptember 30, 2022 compared to expense of$2.7 million in the three months endedSeptember 30, 2021 , primarily as a result of the impact of unrealized foreign currency translation adjustments on intercompany loan balances denominated in a foreign currency.
Provision for income tax expense (benefit)
Our provision for income tax expense was
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Our provision for income tax benefit was $0.5 million and income tax expense was
$1.6 million for the nine months ended September 30, 2022 and 2021,
respectively. The current year benefit is primarily associated with return to
provision adjustments.
Adjusted EBITDA
For the three months ended September 30, 2022 , Adjusted EBITDA was negative
$29.7 million compared to negative $54.0 million for the three months ended
September 30, 2021 . The improvement in Adjusted EBITDA was primarily due to cost
control and restructuring initiatives instituted at the beginning of the year to
reduce cash-burn and offset the decrease in aligner revenue as a result of the
effects of the macroeconomic factors discussed previously. For the three months
ended September 30, 2022 , Adjusted EBITDA for the U.S. and Canada combined was a
negative $21.9 million , and Adjusted EBITDA for the rest of world for the three
months ended September 30, 2022 was negative $7.7 million .
Liquidity and Capital Resources
As ofSeptember 30, 2022 ,SDC Inc. had cash on hand of$120.2 million , an accumulated deficit of$359.9 million and had working capital of$190.3 million . Our operations have been financed primarily through net proceeds from the sale of our equity securities and borrowings under our debt instruments. Our short-term liquidity needs primarily include working capital, innovation, and research and development. We believe that our current liquidity, including net proceeds received in connection with the financing transactions, will be sufficient to meet our projected operating, investing, and debt service requirements for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our levels of revenue, the expansion of sales and marketing activities, market acceptance of our clear aligners, the results of research and development and other business initiatives, the timing of new product introductions, and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of additional debt financing would result in debt service obligations, and any future instruments governing such debt could provide for operating and financing covenants that would restrict our operations. InFebruary 2021 , we issued approximately$650.0 million aggregate principal amount of convertible senior Notes in a private placement offering. We also issued an additional$97.5 million aggregate principal amount of the Notes to the initial purchasers under an option granted to the initial purchasers. The proceeds of this offering were used by us to enter into privately negotiated capped call transactions with certain of the initial purchasers, which are expected to reduce dilution to the Class A common stock upon any conversion of the Notes, and we used a portion of the remainder of the net proceeds to repay amounts owed under the HPS Credit Facility. In connection with the issuance of the Notes,SmileDirectClub, Inc. entered into an intercompany convertible promissory note ("Intercompany Convertible Note") withSDC Financial, LLC , wherebySmileDirectClub, Inc. provided the net proceeds from the issuance of the Notes toSDC Financial, LLC . The terms of the Intercompany Convertible Note mirrors the terms of the Notes issued bySmileDirectClub, Inc. The intent of the Intercompany Convertible Note is to maintain the parity of shares of Class A common stock with LLC Units as required by the SDC Financial LLC Agreement. OnApril 27, 2022 , SPV, a wholly-owned special purpose subsidiary of the Company, entered into a Loan Agreement ("the 2022 HPS Credit Facility") by and among SPV, as borrower,SmileDirectClub, LLC , as the seller and servicer, the lenders from time to time party thereto, andHPS Investment Partners, LLC , as administrative agent and collateral agent, providing a 42-month secured delayed-draw term loan facility to SPV in an aggregate maximum principal amount of up to$255 million . As ofApril 27, 2022 ,$65 million was outstanding under the 2022 HPS Credit Facility. We are a holding company with no operations of our own and, as such, we depend on our subsidiaries for cash to fund all of our operations and expenses. We depend on the payment of distributions by our subsidiaries, and such distributions may be restricted as a result of regulatory restrictions, state and international laws regarding distributions, or contractual agreements, including agreements governing indebtedness. For a discussion of those restrictions, see "Risk Factors-Risks Related to Our Organization and Structure-We are a holding company. Our sole material asset is our equity interest in SDC Financial, and as such, we depend on our subsidiaries for cash to fund all of our expenses, including taxes and payments under the Tax 44 -------------------------------------------------------------------------------- Receivable Agreement" included in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . We currently anticipate that such restrictions will not impact our ability to meet our cash obligations.
Cash flows
The following table sets forth a summary of our cash flows for the periods
indicated.
Nine Months Ended September 30,
(in thousands) 2022 2021
Net cash used in operating activities $ (106,704) $ (98,067)
Net cash used in investing activities (40,168) (70,284)
Net cash provided by financing activities 42,006 158,811
Effect of changes in exchange rates on cash and cash
equivalents 187 464
Decrease in cash (104,679) (9,076)
Cash at beginning of period 224,860 316,724
Cash at end of period $ 120,181 $ 307,648 Comparison of the nine months ended
As of
Cash used in operating activities increased to$106.7 million during the nine months endedSeptember 30, 2022 compared to$98.1 million in the nine months endedSeptember 30, 2021 , or an increase of$8.6 million , primarily due to the increase in net loss during the period when adjusted for non-cash items, particularly the loss associated with the extinguishment of debt, partially offset by a reduction in uses of working capital when compared to the prior year. Cash used in investing activities decreased to$40.2 million during the nine months endedSeptember 30, 2022 , compared to$70.3 million in the nine months endedSeptember 30, 2021 . The decrease in cash used in investing was primarily due to cost reduction activities including a more focused investment portfolio on near-term profit projects. Cash used in investing activities primarily consists of purchases of manufacturing automation equipment and investments in technology equipment and software. Cash provided by financing activities was$42.0 million during the nine months endedSeptember 30, 2022 , compared to cash provided by financing activities of$158.8 million in the nine months endedSeptember 30, 2021 . Cash provided by financing activities during the nine months endedSeptember 30, 2022 primarily consists of net borrowings under our long-term debt facility of$54.9 million offset by the payment of issuance costs, share purchase activity and the payment of financed leases. Cash provided by financing activities in the nine months endedSeptember 30, 2021 primarily consists of the issuance of approximately$747.5 million principal amount of the 2026 Convertible Senior Notes in a private placement offering, including options. We incurred transaction costs associated with the issuance of the Notes of$21.2 million and entered into privately negotiated capped call transactions with certain of the initial purchasers in the amount of approximately$69.5 million , which are expected to reduce dilution to the Class A common stockholders upon any conversion of the Notes. Approximately$434.2 million of the proceeds from the Notes were used to repay the 2020 HPS Credit Facility in full, including certain prepayment and make-whole provisions. In addition, we paid Align Technology, Inc. the remaining$43.4 million of equity value previously accrued plus interest pursuant to an arbitration award. Tax Receivable Agreement Our purchase of LLC Units from SDC Financial, coupled with SDC Financial's purchase and cancellation of LLC Units from the Pre-IPO investors in connection with the IPO and any future exchanges of LLC Units for our Class A common stock or cash are expected to result in increases in our allocable tax basis in the assets of SDC Financial that otherwise would not have been available to us. These increases in tax basis are expected to provide us with certain tax benefits that can reduce the 45 -------------------------------------------------------------------------------- amount of cash tax that we otherwise would be required to pay in the future. We and SDC Financial are parties to the Tax Receivable Agreement with the Continuing LLC Members, pursuant to which we are obligated to pay the Continuing LLC Members 85% of the cash savings, if any, inU.S. federal, state, and local income tax or franchise tax that we actually realize 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 us as a result of the Tax Receivable Agreement. The amounts to be recorded for both the deferred tax assets and the liability for our obligations under the Tax Receivable Agreement will be estimated at the time of an exchange of LLC Units. All of the effects of changes in any of our estimates after the date of the exchange will be included in net loss. Similarly, the effect of subsequent changes in the enacted tax rates will be included in net loss. Because we are the managing member of SDC Financial, which is the managing member ofSDC LLC , which is the managing member ofSDC Holding , we have the ability to determine when distributions (other than tax distributions) will be made bySDC Holding toSDC LLC and bySDC LLC to SDC Financial and the amount of any such distributions, subject to limitations imposed by applicable law and contractual restrictions (including pursuant to our debt instruments). Any such distributions will then be distributed to all holders of LLC Units, including us, pro rata based on holdings of LLC Units. The cash received from such distributions will first be used by us to satisfy any tax liability and then to make any payments required under the Tax Receivable Agreement. We expect that such distributions will be sufficient to fund both our tax liability and the required payments under the Tax Receivable Agreement.
Indebtedness
2022 HPS Credit Facility
OnApril 27, 2022 , SPV, a wholly-owned special purpose subsidiary of the Company, entered into a Loan Agreement (the "Loan Agreement") by and among SPV, as borrower,SmileDirectClub, LLC , as the seller and servicer, the lenders from time to time party thereto, andHPS Investment Partners, LLC , as administrative agent and collateral agent, providing a 42-month secured delayed-draw term loan facility to SPV in an aggregate maximum principal amount of up to$255 million . Outstanding loans under the Loan Agreement bear interest at a variable rate equal to (i) subject to a 1.00% per annum floor, three-month LIBOR plus 10.75% per annum, of which interest accrued at up to 3.75% per annum may be payable in kind, or (ii) subject to a 2.00% per annum floor, an interest rate equal to the greater of (a) the prime rate in effect from time to time and (b) the federal funds rate in effect from time to time plus 0.5%, plus in each case 9.75% per annum, of which, in each of the foregoing cases, interest accrued at up to 3.75% per annum may be payable in kind. In addition to paying interest on the outstanding principal balance, the Company is required to pay lender's commitment fee of 2.75% per annum based on the unused facility amount. Subject to certain exceptions, the Loan Agreement is secured by first-priority security interests in SPV's assets, which consist of certain receivables, cash, intellectual property and related assets. SPV's obligations under the Loan Agreement are guaranteed on a limited basis bySmileDirectClub, LLC andSDC Financial LLC (collectively, the "Guarantors"). The Guarantors guarantee (i) on a full recourse basis, up to 10% of SPV's outstanding obligations under the Loan Agreement plus enforcement costs, and (ii) certain losses incurred by the lenders as a result of fraud, misrepresentation, legal and regulation violations and certain other actions and omissions by SPV and/or certain of its affiliates. The Guarantors do not pledge their assets to secure any obligations of SPV under the Loan Agreement. As ofSeptember 30, 2022 , the Company had$65.6 million outstanding and was in compliance with all covenants in the Loan Agreement.
Convertible Senior Notes
OnFebruary 9, 2021 we issued$650.0 million principal amount of Notes and also granted the initial purchasers of the Notes an option to purchase up to an additional$97.5 million aggregate principal amount of the Notes. The sale of the Notes concluded onFebruary 16, 2021 , with the initial purchasers exercising their options in full to buy the additional Notes. The Notes were issued and governed by an indenture, datedFebruary 9, 2021 (the "Indenture"), between us andWilmington Trust, National Association , as trustee. Overall, we incurred$747.5 million principal amount of indebtedness as a result of this offering. A portion of the proceeds of the offering of the Notes were used to fund the cost of privately negotiated capped call transactions with certain initial purchasers, and we used a portion of the remainder of the net proceeds to repay amounts owed under the 2020 HPS Credit Facility. 46 -------------------------------------------------------------------------------- The Notes will mature onFebruary 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. If certain corporate events that constitute a "Fundamental Change" (as defined in the Indenture) occur or "Events of Default" (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.
2020 HPS Credit Facility
OnMay 12, 2020 , we and a wholly-owned special purpose subsidiary, SDCU.S. SmilePay SPV ("SPV"), entered into a Loan Agreement among SPV, as borrower,SmileDirectClub, LLC , as the seller and servicer, certain lenders, andHPS 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 million , with the ability to request incremental term loans of up to an additional aggregate principal amount of$100 million with the consent of the lenders participating in such increase.
On
Tax Receivable Agreement
The payments that we may be required to make under the Tax Receivable Agreement to the Continuing LLC Members may be significant and are dependent upon future taxable income. See "Certain Relationships and Related Party Transactions-Tax Receivable Agreement."
Critical Accounting Policies and Estimates
We have adopted various accounting policies to prepare the interim condensed consolidated financial statements in accordance with GAAP. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. In our 2021 Annual Report on Form 10-K, we identified the critical accounting policies which affect our more significant estimates and assumptions used in preparing our consolidated financial statements.
There have been no material changes to our critical accounting policies and
estimates from those previously disclosed in our Annual Report on Form 10-K for
the year ended
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