SMILEDIRECTCLUB, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to historical 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 Annual Report on Form 10-K, particularly 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 years ended
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 customers
and our ability to maintain our pricing. Our ASP for the years ended December
31, 2022 and 2021 was $1,913 and $1,883 , respectively. Our ASP is less than our
standard $2,050 price as a result of discounts offered to select customers.
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.
Realignment of global workforce and strategic actions to increase profitability
OnJanuary 27, 2023 , we announced a realignment of our operating programs and global workforce to further hone focus on our core business and technology enabled innovation portfolio, and introduce additional cost savings to the Company's operating plan in order to enable growth, and sustainable positive cash flow. These actions to right-size the business are the natural next steps in the changes we introduced in 2022 to realign our operations in order to execute against our growth opportunities with efficiency and financial discipline. The opportunities we are in the process of launching include completing the launch of our artificial intelligence-enabled 3D mobile scanning technology, or SmileMaker Platform, which allows customers to scan their teeth using their mobile phone and receive a proposed aligner treatment plan in minutes, as well as our premium CarePlus offering, which allows customers to begin their treatment at a participating SmileDirectClub Partner Network office and receive an enhanced level of hybrid remote and in-person treatment. While we focus our resources on the successful deployment of these initiatives, we have paused expansion 67 --------------------------------------------------------------------------------
into new international markets while the global economy recovers from pandemic and macroeconomic pressures that have contributed to challenging operating environments.
Launch of new initiatives during 2023
OnNovember 18, 2022 , we announced the launch of our AI-powered 3D mobile imaging product, the SmileMaker Platform, inAustralia that is an industry first in leveraging AI to allow consumers to take a 3D image of their teeth using their mobile device. The platform will be introduced to the U.S. market in the first half of 2023 with the full rollout to all of the markets we operate in by the end of the year. This innovation not only introduces further-technology powered intelligence to our proprietary teledentistry and treatment planning platform, but may also increase customer conversion and decrease the path to purchase time by giving users an instant and initial view of their potential treatment plan and length of treatment. During the first quarter of 2023, we introduced the SmileDirectClub CarePlus initiative ("SDC Care+") which features a hybrid in-person or remote treatment approach and elevated service offering designed to appeal to those who want the assurance of beginning treatment at a dentist office with the added convenience of a teledentistry option. SDC Care+ will be priced at$3,900 or less than$115 per month with FlexPay, and includes two years of complementary retainers, a dedicated concierge team including licensed dental assistants and hygienists and remote or in-person check-ins with a Partner Network dentist. The program is now available in four majorU.S. markets (San Diego ,Sacramento ,Orlando andDenver ) and will soon expand to further Partner Network offices across theU.S.
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 49% of our clear aligner sales originating from impression kits during the fourth 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 customers, 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 68 -------------------------------------------------------------------------------- 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. 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. 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. During 2022, we received$8.0 million in insurance proceeds as final settlement related to reimbursement of expenses and business interruption as result of the Incident, which is included in Other expense (income) on the consolidated statement of operations.
Efficient acquisition of new customers
•Visits to our website: During the fourth 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 customer experience 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 fourth quarter of 2022, we remained strong on our member experience with referrals reaching 20% of all orders. We expect to continue to invest in our member journey to improve our member experience and increase our customer referrals. •Downloading our App: During the fourth quarter of 2022, we launched our AI-powered 3D mobile imaging product, the SmileMaker Platform, inAustralia that is an industry first in leveraging AI to allow consumers to take a 3D image of their teeth using their mobile device. The platform will be introduced to the U.S. market in the first half of 2023 with the full rollout to all of the markets we operate in by the end of the year. This innovation not only introduces further-technology powered intelligence to our proprietary teledentistry and treatment planning platform, but may also increase customer conversion and decrease the path to purchase time by giving users an instant and initial view of their potential treatment plan and length of treatment.
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 customer-specific circumstances, our efforts in member service and management, and the broader macroeconomic environment.
Investments in Transformative Innovation
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;
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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.
Pace of adoption for teledentistry
The rate of adoption of teledentistry will impact our ability to acquire new customers 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 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.
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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.
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 9 to our consolidated financial statements.
Adjusted EBITDA
To supplement our consolidated financial statements presented in accordance with
accounting principles generally accepted in
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.
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--------------------------------------------------------------------------------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. You should read this discussion of our
results of operations in conjunction with our consolidated financial statements
and related notes thereto included elsewhere in this Form 10-K.
Years Ended December
31,
2022 2021
(in thousands)
Statements of Operations Data:
Total revenues $ 470,743 $ 637,611
Cost of revenues 142,890 177,597
Gross profit 327,853 460,014
Marketing and selling expenses 290,231 388,450
General and administrative expenses 278,778 325,569
Lease abandonment and impairment of long-lived assets 1,289 1,481
Restructuring and other related costs 19,668 3,798
Loss from operations (262,113) (259,284)
Total interest expense 17,961 23,154
Loss on extinguishment of debt - 47,631
Other expense (income) (1,579) 4,313
Net loss before provision for income tax expense
(benefit) (278,495) (334,382)
Provision for income tax expense (benefit) (642) 1,268
Net loss (277,853) (335,650)
Net loss attributable to non-controlling interest (191,449) (233,208)
Net loss attributable to SDC Inc. $ (86,404) $ (102,442)
Other Data:
Adjusted EBITDA $ (134,613) $ (133,204) The following table reconciles Adjusted EBITDA to net loss, the most directly comparable GAAP financial measure.
Years Ended December
31,
2022 2021
(in thousands)
Net loss $ (277,853) $ (335,650)
Depreciation and amortization 74,395 70,113
Total interest expense 17,961 23,154
Income tax expense (benefit) (642) 1,268
Lease abandonment and impairment of long-lived assets 1,289 1,481
Restructuring and other related costs 19,668 3,798
Loss on extinguishment of debt - 47,631
Equity-based compensation 26,608 44,628
Other non-operating general and administrative losses 3,961 10,373
Adjusted EBITDA $ (134,613) $ (133,204)
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Comparison of the years ended
Revenues
Revenues decreased$166.9 million , or 26.2%, to$470.7 million in the year endedDecember 31, 2022 from$637.6 million in the year endedDecember 31, 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 year endedDecember 31, 2022 and 2021, revenues for theU.S. andCanada were$395.1 million and$525.4 million , or 83.9% and 82.4% of total revenues, respectively, and revenues for the rest of world were$75.7 million and$112.2 million , or 16.1% and 17.6%, respectively.
Cost of revenues
Cost of revenues decreased$34.7 million , or 19.5%, to$142.9 million in the year endedDecember 31, 2022 from$177.6 million in the year endedDecember 31, 2021 . Cost of revenues increased as a percentage of revenues from 27.9% in the year endedDecember 31, 2021 to 30.4% in the year endedDecember 31, 2022 , primarily due to the effect of the deleveraging of fixed costs in our manufacturing process as a result of the lower aligner sales for the current year when compared to the prior year. The decrease in overall cost of revenues in the current year as compared to the prior year is primarily due to producing a lower number of aligners in the current year.
Gross margin decreased to 69.6% in the year ended
Marketing and selling expenses
Marketing and selling expenses as a percentage of revenues increased to 61.7% in the year endedDecember 31, 2022 from 60.9% in the year endedDecember 31, 2021 , and decreased to$290.2 million in the year endedDecember 31, 2022 from$388.5 million in the year endedDecember 31, 2021 . The increase in marketing and selling expense as a percentage of sales was primarily due to lower sales 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. Total marketing and selling expenses decreased$98.3 million compared to the prior year due to the Company's increased focus on efficiency and leveraging our 60% aided awareness in the marketplace.
General and administrative expenses
General and administrative expenses decreased$46.8 million , or 14.4%, to$278.8 million in the year endedDecember 31, 2022 from$325.6 million in the year endedDecember 31, 2021 . The decrease was primarily due to lower personnel and support costs resulting from restructuring activities as well as decreased stock-based compensation costs as a result of forfeitures resulting from management team member changes. 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. General and administrative expenses as a percent of revenue increased from 51.1% in the year endedDecember 31, 2021 to 59.2% in the year endedDecember 31, 2022 , primarily due to the deleveraging of fixed costs associated with the decrease in sales.
Lease abandonment, impairment of long-lived assets and other store closure and related charges
Lease abandonment, impairment of long-lived assets and other store closure and related costs were$21.0 million for the year endedDecember 31, 2022 , compared to$5.3 million for the year endedDecember 31, 2021 . The charges in the current year are primarily associated with the strategic actions explained above that 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 year endedDecember 31, 2022 , lease abandonment and impairment of long-lived asset costs were$1.3 million and restructuring and other related costs were 73 --------------------------------------------------------------------------------$19.7 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 year endedDecember 31, 2021 , lease abandonment and impairment of long-lived asset costs were$1.5 million , primarily associated with the closure and consolidation of a portion of our SmileShops and restructuring and other related costs were$3.8 million . 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.
Interest expense
Interest expense decreased
Loss on extinguishment of debt
Loss on extinguishment of debt in the year endedDecember 31, 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 (income)
Other expense (income) increased$5.9 million to income of$1.6 million in the year endedDecember 31, 2022 from expense of$4.3 million in the year endedDecember 31, 2021 . The increase in income was primarily due to the impact of unrealized foreign currency translation adjustments.
Provision for income tax expense (income)
Our provision for income tax benefit was
Adjusted EBITDA
For the year endedDecember 31, 2022 , Adjusted EBITDA was negative$134.6 million compared to negative$133.2 million for the year endedDecember 31, 2021 . The decline in Adjusted EBITDA was primarily due to the decrease in aligner revenue as a result of the effects of the macroeconomic factors discussed previously offset by the cost control and restructuring initiatives instituted at the beginning of the year to reduce cash-burn. For the year endedDecember 31, 2022 , Adjusted EBITDA for theU.S. andCanada combined was a negative$92.7 million , and Adjusted EBITDA for the rest of world was negative$41.9 million .
Liquidity and Capital Resources
As ofDecember 31, 2022 ,SDC Inc. had cash on hand of$118.4 million including$25.3 million in restricted cash, an accumulated deficit of$381.7 million and working capital of$180.6 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 74 -------------------------------------------------------------------------------- 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 mirror 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 ofDecember 31, 2022 , the outstanding balance on the facility was$126.4 million . The permitted loan balance was$140.4 million based on the underlying accounts receivable balances. Amounts drawn, up to$255 million , but in excess of the permitted loan balance are required to be kept in the SDCU.S. SmilePay SPV and are restricted. The Company was in compliance with all covenants related to the 2022 HPS Credit Facility as ofDecember 31, 2022 . OnNovember 7, 2022 , we entered into a distribution agreement withUBS Securities LLC , with respect to an at -the-market offering program under which the Company may, from time to time, offer and sell shares of the Company's Class A common stock having an aggregate offering price of up to$100.0 million . The shares to be sold, if any, will be issued and sold pursuant to the Company's shelf registration statement on Form S-3 (File No. 333-267370), which was filed with theSecurities and Exchange Commission onSeptember 9, 2022 , and which was declared effective onOctober 4, 2022 . During fiscal year 2022, the Company sold$1.9 million of Class A common stock pursuant to the distribution agreement and has$98.1 million available. 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 Receivable Agreement." We currently anticipate that such restrictions will not impact our ability to meet our cash obligations. 75 --------------------------------------------------------------------------------
Cash flows
The following table sets forth a summary of our cash flows for the periods
indicated.
Years Ended December 31,
(in thousands) 2022 2021
Net cash used in operating activities $ (158,174) $ (141,519)
Net cash used in investing activities (51,996) (106,567)
Net cash provided by financing activities 103,448 155,717
Effect of changes in exchange rates on cash and cash equivalents
260 505
Decrease in cash and restricted cash (106,462) (91,864)
Cash and restricted cash at beginning of period 224,860 316,724
Cash and restricted cash at end of period $
118,398
Comparison of the year ended
As of
Cash used in operating activities increased to$158.2 million during the year endedDecember 31, 2022 compared to$141.5 million in the year endedDecember 31, 2021 , or an increase of$16.7 million , primarily due to the change in working capital primarily due to the timing of payments and the decrease in overall spend in the current year when compared to the prior year. Cash used in investing activities decreased to$52.0 million during the year endedDecember 31, 2022 , compared to$106.6 million in the year endedDecember 31, 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 costs to develop technology innovation and software as well as purchases of manufacturing automation equipment and investments in technology equipment. Cash provided by financing activities was$103.4 million during the year endedDecember 31, 2022 , compared to cash provided by financing activities of$155.7 million in the year endedDecember 31, 2021 . Cash provided by financing activities during the year endedDecember 31, 2022 primarily consists of net borrowings under our long-term debt facility of$114.9 million and$1.9 million proceeds from the sale of Class A common stock under our ATM facility offset by the payment of issuance costs, share purchase activity and the payment of financed leases. Cash provided by financing activities in the year endedDecember 31, 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 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 theContinuing LLC 76 -------------------------------------------------------------------------------- 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 "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 . Outstanding loans under the 2022 HPS Credit Facility 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 2022 HPS Credit Facility 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 2022 HPS Credit Facility 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 2022 HPS Credit Facility 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 2022 HPS Credit Facility. As ofDecember 31, 2022 , the outstanding balance on the facility was$126.4 million . The permitted loan balance was$140.4 million based on the underlying accounts receivable balances. Amounts drawn, up to$255 million , but in excess of the permitted loan balance are required to be kept in the SDCU.S. SmilePay SPV and are restricted. The Company was in compliance with all covenants related to the 2022 HPS Credit Facility as ofDecember 31, 2022 .
2026 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. 77 -------------------------------------------------------------------------------- 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. 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 (the "2020 HPS Credit Facility") 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.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which we have prepared in accordance with GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that impact the reported amounts. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition and equity-based compensation, among others. Each of these estimates varies in regard to the level of judgment involved and its potential impact on our financial results. Estimates are considered critical either 1) when a different estimate could have reasonably been used, or 2) where changes in the estimate are reasonably likely to occur from period to period, and such use or change would materially impact our financial condition, results of operations, or cash flows. Actual results could differ from those estimates. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies and estimates are most critical to a full understanding and evaluation of our reported financial results.
Revenue recognition
Our revenue is generated through sales of aligners, retainers, and other oral
care products. Our aligner sales commitment contains multiple promises which may
include (i) initial aligners, and (ii) touch-up aligners. Our members are
eligible for modified or refinement aligners, which we refer to as "touch-up
aligners," at any point during their treatment plan or immediately following
their original treatment plan (which is typically between five and ten months),
in each case, upon the direction of, and pursuant to a prescription from, the
treating dentist or orthodontist. Under Accounting Standard Codification
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--------------------------------------------------------------------------------606, Revenue from Contracts with Customers ("ASC 606"), we evaluate whether the initial aligners and touch-up aligners represent separate or combined performance obligations. We have determined that these promises, within the aligner sales commitment, represent separate performance obligations.
The terms of the aligner and retainer sales include member rights to cancel the orders and return unopened aligner, impression kit, or retainer boxes for a refund of any consideration paid related to the returned products. The rights of return create variability in the amount of transaction consideration, and in turn, revenue we can recognize for fulfilling related performance obligations. We recognize revenue based on the amount of consideration to which we expect to be entitled, which excludes consideration received for products expected to be cancelled or refunded due to customer returns. Accordingly, we are required to make estimates of expected returns and related revenue adjustments. We estimate expected customer returns based upon our assessment of historical and expected cancellations. The estimated expected refunds are recorded as a refund liability. We offer our customers the option of paying for the entire cost of their aligners upfront or enrolling in SmilePay, a convenient monthly payment plan that requires a$250 down payment, with the remaining consideration due over a period up to 26 months. Approximately 60% of our customers elect to purchase our aligners using SmilePay. The amount of contract consideration we estimate to be collectible from our SmilePay customers results in an implicit price concession. We estimate the amount of implicit price concession based upon our assessment of historical write-offs and expected net collections, business and economic conditions, including the inflationary environment and the uncertainty of the lasting effects of the COVID-19 pandemic, and other collection indicators. We believe our analysis provides reasonable estimates of our revenues and valuations of our accounts receivable. Revenue is recognized for touch-up aligners when the promised goods are transferred to the customer. Touch-up aligners represent a promise to transfer goods to customers, and not all customers order touch-up aligners. We make our best estimate of touch-up aligner customer usage rates, which we use to determine the amount of revenue to allocate to those performance obligations at inception of our aligner sales commitment. Our process for estimating usage rates requires significant judgment and evaluation of inputs, including historical data and forecasted usages. Any material changes to usage rates could impact the timing of revenue recognition, which may have a material effect on our financial position and result of operations.
Amounts received prior to satisfying the above revenue recognition criteria are recorded as a contract liability in deferred revenue in our historical consolidated balance sheets. The deferred revenue balance is subject to fluctuation depending on the timing and fulfillment of aligner orders.
Equity-based compensation
We account for equity-based compensation for team members in accordance with ASC
718, "Compensation-Stock Compensation." In accordance with ASC 718, compensation
cost is measured at estimated fair value on grant date and is included as
compensation expense over the vesting period during which a team member provides
service in exchange for the award.
We used the Black-Scholes Option Pricing Method to allocate the total equity
fair value to outstanding Options. The Black-Scholes Option Pricing Method
includes various assumptions, including the expected life of Options, the
expected volatility, and the expected risk-free interest rate. These assumptions
reflect our best estimates, but they involve inherent uncertainties based on
market conditions generally outside our control. As a result, if other
assumptions had been used, equity-based compensation cost could have been
materially impacted. Furthermore, if we use different assumptions for future
grants, equity-based compensation cost could be materially impacted in future
periods.
The fair value of RSUs is determined by our stock price on the date of grant and
related compensation expense is generally recognized over the requisite service
period.
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Income tax expense (benefit)
We are the managing member of SDC Financial and, as a result, consolidate 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 , that is treated like a corporation. As such, SDC Financial does not pay any federal income taxes, as any income or loss will be included in the tax returns of the individual members. SDC Financial does pay state income tax in certain jurisdictions, and the Company's income tax provision in the consolidated financial statements reflects the income taxes for those states. Additionally, certain wholly-owned entities are required to be looked at on a stand-alone basis resulting in federal income taxes, and such federal income taxes are included in the consolidated financial statements. We use the asset and liability method to account for income taxes and apply the principles of ASC 740, "Income Taxes," in determining when our tax positions should be recognized. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If a net operating loss carryforward exists, we make a determination as to whether that net operating loss carryforward will be utilized in the future. A valuation allowance will be established for certain net operating loss carryforwards and other deferred tax assets where the recoverability is deemed to be uncertain. The carrying value of the net deferred tax assets is based upon estimates and assumptions related to our ability to generate sufficient future taxable income in certain tax jurisdictions. If these estimates and related assumptions change in the future, we will be required to adjust our deferred tax valuation allowances. In connection with the Reorganization Transactions and the IPO, we entered into the Tax Receivable Agreement with certain of the Continuing LLC Members that provides for the payment by us of 85% of the amount of any tax benefits that the Company actually realizes, or in some cases is deemed to realize, as a result of (i) increases in the Company'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 (the "TRA Payments"). We expect to benefit from the remaining 15% of any of cash savings, if any, that we realize. 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 the Company 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.
Recent Accounting Pronouncements
For a discussion of new accounting pronouncements recently adopted and not yet
adopted, see Note 2 to our consolidated financial statements included elsewhere
in this Annual Report on Form 10-K.
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