Company Quick10K Filing
SmileDirectClub
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$0.00 0 $0
10-Q 2019-11-14 Quarter: 2019-09-30
S-1 2019-08-16 Public Filing
8-K 2019-11-12 Earnings, Exhibits
8-K 2019-09-13 Enter Agreement, Sale of Shares, Amend Bylaw, Exhibits
SDC 2019-09-30
Part I-Financial Information
Item 1. Financial Statements.
Note 1-Organization and Basis of Presentation Organization
Note 2-Summary of Significant Accounting Policies
Note 3-Inventories
Note 4-Prepaid and Other Assets
Note 5-Property, Plant and Equipment, Net
Note 6-Accrued Liabilities
Note 7-Income Taxes
Note 8-Long-Term Debt
Note 9-Temporary Equity
Note 10-Noncontrolling Interests
Note 11-Variable Interest Entities
Note 12-Incentive Compensation Plans
Note 13-Earnings per Share
Note 14-Employee Benefit Plans
Note 15-Related Party Transactions
Note 16-Commitments and Contingencies Lease Commitments
Note 17-Segment Reporting
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures.
Part Ii-Other Information
Item 1. Legal Proceedings.
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
EX-31.1 a09302019sdcexhibit311.htm
EX-31.2 a09302019sdcexhibit312.htm
EX-32.1 a09302019sdcexhibit321.htm

SmileDirectClub Earnings 2019-09-30

SDC 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

Comparables ($MM TTM)
Ticker M Cap Assets Liab Rev G Profit Net Inc EBITDA EV G Margin EV/EBITDA ROA
WORK
TRWH
UGRO
VIR
XTEG
VERY
VIE
BLPG 0 2 5 3 1 -4 -4 -0 32% 0.0 -282%
DGTW 0 0 3 -0 -0 -6 -4 -0 12,618% 0.0 -16,557%
BHAT

Document
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 

 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019
or
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to________
Commission File Number: 001-39037
 
SMILEDIRECTCLUB, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
83-4505317
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
414 Union Street
 
37219
Nashville,
TN
 
(Address of principal executive offices)
 
(Zip Code)
(800) 848-7566
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Class A common stock, par value $0.0001 per share
SDC
The NASDAQ Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes      No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       Yes      No



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
 

Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  No
The registrant has the following number of shares outstanding of each of the registrant’s classes of common stock as of September 30, 2019:
Class A Common stock: 102,807,291
Class B Common Stock: 279,474,505

 
 
 
 
 




 
 
TABLE OF CONTENTS
 
 
Cautionary Statement Regarding Forward-Looking Statements
PART I
 
Item 1
 


 


 
 
 
Condensed Consolidated Statements of Changes in Equity (Deficit) for the Three and Nine Months Ended September 30, 2019 and 2018 (Unaudited)


 


 
Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2
 
Item 3
 
Item 4
 
PART II
 
Item 1
 
Item 1A
 
Item 2
 
Item 3
 
Item 4
 
Item 5
 
Item 6
 




CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions, or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipates,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends,” and similar words or phrases. Although we believe that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors, some of which are beyond our control. For more information regarding these risks and uncertainties as well as certain additional risks that we face, refer to “Risk Factors” as well as the factors more fully described in “Management’s Discussion and Analysis of Financial Conditions and Results of Operations.” Among the factors that could cause our financial performance to differ materially from that suggested by the forward-looking statements are:

our ability to effectively manage our growth; 

our ability to effectively execute our business strategies, implement new initiatives, and improve efficiency; 

our sales and marketing efforts; 

our manufacturing capacity and performance and our ability to reduce the per unit production cost of our clear aligners; 

our ability to obtain regulatory approvals for any new or enhanced products; 

our estimates regarding revenues, expenses, capital requirements, and needs for additional financing; 

our ability to effectively market and sell, consumer acceptance of, and competition for our clear aligners in new markets; 

our relationships with retail partners and insurance carriers; 

our research, development, commercialization, and other activities and projected expenditures; 

changes or errors in the methodologies, models, assumptions, and estimates we use to prepare our financial statements, make business decisions, and manage risks; 

our current business model is dependent, in part, on current laws and regulations governing remote healthcare and the practice of dentistry, and changes in those laws, regulations, or interpretations that are inconsistent with our current business model could have a material adverse effect on our business; 

our relationships with our freight carriers, suppliers, and other vendors; 

our ability to maintain the security of our operating systems and infrastructure (e.g., against cyber-attacks); 

the adequacy of our risk management framework; 

our cash needs and ability to raise additional capital, if needed; 

our intellectual property position; 

our exposure to claims and legal proceedings; and

other factors and assumptions described in this Quarterly Report on Form 10-Q.

1



If one or more of the factors affecting our forward-looking information and statements proves incorrect, our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements. Therefore, we caution not to place undue reliance on any forward-looking information or statements. The effect of these factors is difficult to predict. Factors other than these also could adversely affect our results, and the reader should not consider these factors to be a complete set of all potential risks or uncertainties. New factors emerge from time to time, and management cannot assess the impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statements only speak as of the date of this document, and we undertake no obligation to update any forward-looking information or statements, whether written or oral, to reflect any change, except as required by law. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the Securities and Exchange Commission (“SEC”) as exhibits to this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance, and events and circumstances may be materially different from what we expect.

PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.

2

SmileDirectClub, Inc.
Condensed Consolidated Balance Sheets (Unaudited)
September 30, 2019 and December 31, 2018
(in thousands)


 
September 30,
2019
December 31,
2018
ASSETS
 
 
Cash
$
547,563

$
313,929

Accounts receivable
224,360

113,934

Inventories
14,633

8,781

Prepaid and other current assets
11,987

5,782

Total current assets
798,543

442,426

Accounts receivable, non-current
87,299

60,217

Property, plant and equipment, net
119,130

52,551

Other assets
6,269


Total assets
$
1,011,241

$
555,194

LIABILITIES, TEMPORARY AND PERMANENT EQUITY (DEFICIT)
 
 
Accounts payable
$
40,561

$
25,250

Accrued liabilities
129,434

34,939

Due to related parties
1,128

20,305

Deferred revenue
24,893

19,059

Current portion of related party debt

16,054

Current portion of long-term debt
29,737

1,866

Total current liabilities
225,753

117,473

Long-term debt, net of current portion
189,648

137,123

Long-term related party debt

1,799

Other long-term liabilities
45,230

602

Total liabilities
460,631

256,997

Commitment and contingencies




Temporary Equity (Note 9)
 
 
Preferred Units

388,634

Permanent Equity (Deficit)
 
 
Class A common stock, par value $0.0001 and 102,807,291 shares issued and outstanding at September 30, 2019 and 0 shares issued and outstanding at December 31, 2018
10


Class B common stock, par value $0.0001 and 279,474,505 shares issued and outstanding at September 30, 2019 and 0 shares issued and outstanding at December 31, 2018
28


Additional paid-in-capital
441,855

57,677

Accumulated deficit
(88,296
)
(148,429
)
Noncontrolling interest
197,013


Warrants

315

Total permanent equity (deficit)
550,610

(90,437
)
Total liabilities, temporary and permanent equity (deficit)
$
1,011,241

$
555,194


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.

3

SmileDirectClub, Inc.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share amounts)


 
Three months ended
September 30,
Nine months ended
September 30,
2019
2018
2019
2018
Revenue, net
$
168,663

$
112,508

$
522,529

$
278,024

Financing revenue
11,522

7,158

31,185

16,706

Total revenues
180,185

119,666

553,714

294,730

Cost of revenues
39,125

25,837

111,363

67,704

Cost of revenues—related parties
2,310

10,098

13,652

28,608

Total cost of revenues
41,435

35,935

125,015

96,312

Gross profit
138,750

83,731

428,699

198,418

Marketing and selling expenses
131,263

57,210

340,409

143,667

General and administrative expenses
389,828

30,249

486,319

77,550

Loss from operations
(382,341
)
(3,728
)
(398,029
)
(22,799
)
Interest expense
4,291

4,352

11,607

9,283

Interest expense—related parties

293

75

1,246

Loss on extinguishment of debt
32


29,672


Other expense
421

6,493

500

15,135

Net loss before provision for income tax expense
(387,085
)
(14,866
)
(439,883
)
(48,463
)
Provision for income tax expense
479

85

596

294

Net loss
(387,564
)
(14,951
)
(440,479
)
(48,757
)
Net loss attributable to noncontrolling interest
(299,268
)

(352,183
)

Net loss attributable to SmileDirectClub, Inc.
$
(88,296
)
$
(14,951
)
$
(88,296
)
$
(48,757
)
 
 
 
 
 
Earnings per share of Class A common stock:
 
 
 
 
Basic
$
(0.89
)
N/A

$
(0.89
)
N/A

Diluted
$
(0.89
)
N/A

$
(0.89
)
N/A

 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
Basic
99,533,877

N/A

99,533,877

N/A

Diluted
379,008,382

N/A

379,008,382

N/A


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.


4

SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)


 
 
SDC Financial (Prior to Reorganization Transactions)
 
Additional Paid in Capital
Warrants
Accumulated Deficit
Permanent Equity (Deficit)
Temporary Equity (Deficit)
Three Months Ended
Units
Amount
Units
Amount
Balance at June 30, 2018
108,878
 
$
45,710
 
369
 
$
315
 
$
(107,464
)
$
(61,439
)
$

Issuance of Preferred Units
 
 
 
 


298,549

Equity-based compensation
 
5,754
 
 
 

5,754


Net loss
 
 
 
 
(14,951
)
(14,951
)

Other
 
88
 
 
 

88


Balance at September 30, 2018
108,878
 
$
51,552
 
369
 
$
315
 
$
(122,415
)
$
(70,548
)
$
298,549

Balance at June 30, 2019
88,168
 
$
(24,976
)
369
 
$
315
 
$
(201,344
)
$
(226,005
)
$
425,395

Net income prior to Reorganization Transactions
 
 
 
 
(51,330
)
(51,330
)

Preferred Unit redemption accretion
 
(21,746
)
 
 

(21,746
)
21,746

Share-based compensation prior to Reorganization Transactions
 
299
 
 
 

299


Distribution payable
 
(43,400
)
 
 

(43,400
)

Effect of Reorganization Transactions
(88,168
)
89,823
 
(369
)
(315
)
252,674

342,182

(447,141
)
Balance at September 30, 2019
 
$
 
 
$
 
$

$

$


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.



5

SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)


 
SmileDirectClub, Inc. Stockholders Equity
 
 
 
 
 
 
 
 
 
Three Months Ended
Class A Shares
Class B Shares
Class A Amount
Class B Amount
Additional Paid-in Capital
Accumulated Deficit
Noncontrolling Interest
Total
Balance at June 30, 2018







(61,439
)
Issuance of Preferred Units







298,549

Equity-based compensation







5,754

Net loss







(14,951
)
Other







88

Balance at September 30, 2018


$

$

$

$

$

$
228,001

Balance at June 30, 2019


$

$

$

$

$

$
199,390

Net loss prior to Reorganization Transactions







(51,330
)
Preferred Unit redemption accretion








Equity-based compensation prior to Reorganization Transactions







299

Distribution payable







(43,400
)
Effect of Reorganization Transactions
70,238,188

279,474,505

7

28

104,609


315


Issuance of Class A common stock in IPO, net of costs
58,537,000


5


1,278,848



1,278,853

Repurchases of Class A shares and LLC Units from Pre-IPO investors
(31,621,975
)

(3
)

(696,486
)


(696,489
)
Issuance of Class A shares in connection with IBA vesting
5,654,078


1

 
(1
)



Initial effect of the Reorganization Transactions and IPO on noncontrolling interests




(444,636
)
 
444,636


Net loss subsequent to Reorganization Transactions





(88,296
)
(247,938
)
(336,234
)
Equity-based compensation subsequent to Reorganization Transactions




283,124



283,124

Equity-based payments subsequent to Reorganization Transactions




(83,603
)


(83,603
)
Balance at September 30, 2019
102,807,291

279,474,505

$
10

$
28

$
441,855

$
(88,296
)
$
197,013

$
550,610


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.


6

SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)


 
SDC Financial (Prior to Reorganization Transactions)
 
Additional Paid in Capital
Warrants
Accumulated Deficit
Permanent Equity (Deficit)
Temporary Equity (Deficit)
Nine Months Ended
Units
Amount
Units
Amount
Balance at December 31, 2017
109,041
 
$
39,489
 
369
 
$
315
 
$
(73,658
)
$
(33,854
)
$

Redemption of member units
(271
)
(1,544
)
 
 

(1,544
)

Unitholder distribution
 
(19
)
 
 

(19
)

Grant of incentive member units
108
 
 
 
 



Issuance of Preferred Units
 
 
 
 


298,549

Equity-based compensation
 
13,626
 
 
 

13,626


Net loss
 
 
 
 
(48,757
)
(48,757
)

Balance at September 30, 2018
108,878
 
$
51,552
 
369
 
$
315
 
$
(122,415
)
$
(70,548
)
$
298,549

Balance at December 31, 2018
108,878
 
$
57,677
 
369
 
$
315
 
$
(148,429
)
$
(90,437
)
$
388,634

Net income prior to Reorganization Transactions
 
 
 
 
(104,245
)
(104,245
)
 
Preferred Unit redemption accretion
 
(58,507
)
 
 

(58,507
)
58,507

Redemptions prior to Reorganization Transactions
(20,710
)
(54,154
)
 
 

(54,154
)

Share-based compensation prior to Reorganization Transactions
 
8,561
 
 
 

8,561


Distribution payable
 
(43,400
)
 
 

(43,400
)

Effect of Reorganization Transactions
(88,168
)
89,823
 
(369
)
(315
)
252,674

342,182

(447,141
)
Balance at September 30, 2019
 
$
 
 
$
 
$

$

$


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.


7

SmileDirectClub, Inc.
Condensed Consolidated Statements of Changes in Equity (Deficit) (Unaudited)
(in thousands, except share/unit data and per share/unit amounts)


 
SmileDirectClub, Inc. Stockholders Equity
Nine Months Ended
Class A Shares
Class B Shares
Class A Amount
Class B Amount
Additional Paid-in Capital
Accumulated Deficit
Noncontrolling Interest
Total
Balance at December 31, 2017







(33,854
)
Redemption of member units







(1,544
)
Unitholder distribution







(19
)
Grant of incentive member units








Issuance of Preferred Units







298,549

Equity-based compensation







13,626

Net loss







(48,757
)
Balance at September 30, 2018


$

$

$

$

$

$
228,001

Balance at December 31, 2018


$

$

$

$

$

$
298,197

Net loss prior to Reorganization Transactions







(104,245
)
Preferred Unit redemption accretion








Redemptions prior to Reorganization Transactions







(54,154
)
Equity-based compensation prior to Reorganization Transactions







8,561

Distribution payable







(43,400
)
Effect of Reorganization Transactions
70,238,188

279,474,505

7

28

104,609


315


Issuance of Class A common stock in IPO, net of costs
58,537,000


5


1,278,848



1,278,853

Repurchases of Class A shares and LLC Units from Pre-IPO investors
(31,621,975
)

(3
)

(696,486
)


(696,489
)
Issuance of Class A shares in connection with IBA vesting
5,654,078


1



(1
)



Initial effect of the Reorganization Transactions and IPO on noncontrolling interests




(444,636
)


444,636


Net loss subsequent to Reorganization Transactions





(88,296
)
(247,938
)
(336,234
)
Equity-based compensation subsequent to Reorganization Transactions




283,124



283,124

Equity-based payments subsequent to Reorganization Transactions




(83,603
)


(83,603
)
Balance at September 30, 2019
102,807,291

279,474,505

$
10

$
28

$
441,855

$
(88,296
)
$
197,013

$
550,610


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.



8

SmileDirectClub, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2019 and 2018
(in thousands)


 
Nine months ended September 30,
2019
2018
Operating Activities
 
 
Net loss
$
(440,479
)
$
(48,757
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
Depreciation and amortization
16,237

4,966

Deferred loan cost amortization
1,496

461

Accrued interest to related parties

884

Fair value adjustment of warrant derivative

14,500

Equity-based compensation
332,759

13,626

Loss on extinguishment of debt
17,693


Other non-cash operating activities
1,783

3,305

Changes in operating assets and liabilities:
 
 
Accounts receivable
(137,509
)
(97,005
)
Inventories
(5,852
)
(3,963
)
Prepaid and other current assets
(6,205
)
(2,233
)
Accounts payable
(4,475
)
11,935

Accrued liabilities
45,880

9,926

Due to related parties
(19,177
)
306

Deferred revenue
5,834

8,869

Net cash used in operating activities
(192,015
)
(83,180
)
Investing Activities
 
 
Purchases of property and equipment—related party

(4,722
)
Purchases of property, equipment, and intangible assets
(66,355
)
(15,231
)
Net cash used in investing activities
(66,355
)
(19,953
)
Financing Activities
 
 
IPO proceeds, net of discount and related fees
1,285,759


Repurchase of Class A shares and LLC Units
(696,489
)

Repurchase of Class A shares to cover employee tax withholdings
(81,603
)

Settlement of canceled awards
(2,000
)

Issuance of Class A common stock
6


Proceeds from sale of Preferred Units, net

298,549

Borrowings on long-term debt
176,000

117,375

Payments of issuance costs
(6,127
)
(3,174
)
Principal payments on long-term debt
(159,047
)

Principal payments on related party debt
(24,581
)
(34,376
)
Other
86


Net cash provided by financing activities
492,004

378,374

Increase in cash
233,634

275,241

Cash at beginning of period
313,929

4,071

Cash at end of period
$
547,563

$
279,312


The accompanying notes are an integral part of these interim unaudited condensed consolidated financial statements.


9

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)



Note 1—Organization and Basis of Presentation
Organization
SmileDirectClub, Inc. was formed on April 11, 2019 with no operating assets or operations as a Delaware corporation for the purpose of facilitating an initial public offering and other related transactions in order to carry on the business of SDC Financial LLC and its subsidiaries. Unless otherwise indicated or the context otherwise requires, references to “we,” “us,” “our,” the “Company,” “SmileDirectClub,” and similar references refer to SmileDirectClub, Inc. and its consolidated subsidiaries, including SDC Financial LLC and its subsidiaries. “SDC Financial” refers to SDC Financial LLC and “SDC Inc.” refers to SmileDirectClub, Inc. The Company is engaged by its network of doctors to provide a suite of non-clinical administrative support services, including access to and use of its SmileCheck platform, as a dental support organization (“DSO”). For purposes of these Notes to Interim Condensed Consolidated Financial Statements, the Company’s affiliated network of dentists and orthodontists is included in the definition of “we,” “us,” “our,” and the “Company” as it relates to any clinical aspect of the member’s treatment. All of the Company’s manufacturing operations are directly or indirectly conducted by Access Dental Lab, LLC (“Access Dental”), one of its operating subsidiaries.

The Company’s direct-to-consumer model provides customers with a customized clear aligner therapy treatment delivered through its teledentistry platform. The Company integrates the marketing, aligner manufacturing, and fulfillment, and provides a proprietary web-based teledentistry platform for the monitoring of treatment by licensed dentists and orthodontists through the completion of a member’s treatment. The Company is headquartered in Nashville, Tennessee and has locations throughout the U.S, Puerto Rico, Canada, Australia, New Zealand, the U.K., Ireland, and Costa Rica.

SDC Inc. is a holding company. Its sole material asset is its equity interest in SDC Financial which, through its direct and indirect subsidiaries, conducts all of the Company’s operations. SDC Financial is a Delaware limited liability company and wholly owns SmileDirectClub, LLC (“SDC LLC”) (a Tennessee limited liability company) and Access Dental (a Tennessee limited liability company). Because SDC Inc. is the managing member of SDC Financial, SDC Inc. indirectly operates and controls all of the business and affairs of SDC Financial and its subsidiaries.

Initial Public Offering

On September 16, 2019, SDC Inc. completed an initial public offering (“IPO”) of 58,537,000 shares of its Class A common stock at a public offering price of $23.00 per share. SDC Inc. received $1,286 million in proceeds, net of underwriting discounts and commissions. SDC Inc. used substantially all of the net proceeds after expenses to purchase newly-issued membership interest units from SDC Financial.

Reorganization Transactions

In connection with the IPO, the Company completed the following transactions (the “Reorganization Transactions”):

the formation of SDC Inc. as a Delaware corporation to function as the ultimate parent of SmileDirectClub and a publicly traded entity;

SDC Inc.’s acquisition of the pre-IPO membership interest units in SDC Financial (“Pre-IPO Units”) held by certain pre-IPO investors that are taxable as corporations for U.S. federal income tax purposes (“Blockers”), pursuant to a series of mergers (the “Blocker Mergers”) of the Blockers with wholly owned

10

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)



subsidiaries of SDC Inc., and the issuance by SDC Inc. to the equityholders of the Blockers shares of Class A common stock as consideration in the Blocker Mergers;

the amendment and restatement of the SDC Financial’s limited liability company operating agreement (the “SDC Financial LLC Agreement”) to, among other things, modify the capital structure of SDC Financial by replacing the different classes of Pre-IPO Units (including restricted Pre-IPO Units held by certain employees) with a single new class of membership interests of SDC Financial (“LLC Units”);
 
the issuance to each of the pre-IPO investors previously holding Pre-IPO Units (including restricted Pre-IPO Units) of a number of shares of SDC Inc. Class B common stock equal to the number of LLC Units held by it;

the issuance to certain employees of cash and shares of Class A common stock pursuant to their Incentive Bonus Agreements (“IBAs”); and

the equitable adjustment, pursuant to their terms, of outstanding warrants to purchase Pre-IPO Units held by two service providers into warrants to acquire LLC Units (together with an equal number of shares of SDC Inc.’s Class B common stock).

Following the completion of the Reorganization Transactions and the IPO, SDC Inc. owns 26.9% of SDC Financial. Holders (other than SDC Inc.) of LLC Units following the consummation of the Reorganization Transactions and the IPO (“Continuing LLC Members”) own the remaining 73.1% of SDC Financial.

SDC Inc. is the sole managing member of SDC Financial and, although SDC Inc. has a minority economic interest in SDC Financial, it has the sole voting power in, and controls the management of, SDC Financial. Accordingly, SDC Inc. consolidated the financial results of SDC Financial and reported a noncontrolling interest in its condensed consolidated financial statements. As the Reorganization Transactions are considered transactions between entities under common control, the financial statements for periods prior to the IPO and Reorganization Transactions have been adjusted to combine the previously separate entities for presentation purposes.

In connection with the Reorganization Transactions and the IPO, the Company entered into a Tax Receivable Agreement (the “Tax Receivable Agreement”) with the Continuing LLC Members, pursuant to which SDC Inc. agreed to pay the Continuing LLC Members 85% of the amount of cash tax savings, if any, in U.S. federal, state, and local income tax or franchise tax that SDC Inc. actually realizes as a result of (a) the increases in tax basis attributable to exchanges of LLC Units by Continuing LLC Members and (b) tax benefits related to imputed interest deemed to be paid by SDC Inc. as a result of the Tax Receivable Agreement.
Basis of Presentation and Consolidation
The accompanying unaudited condensed financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01of Regulation S-X of the SEC and, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of results for the unaudited interim periods presented. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. The results of operations for the interim period are not necessarily indicative of the results to be obtained for the full fiscal year. All intercompany accounts and transactions have been eliminated in the unaudited condensed financial statements.


11

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)



The interim condensed consolidated financial statements include the accounts of SDC Inc., which consolidates SDC Financial and its wholly-owned subsidiaries, as well as accounts of contractually affiliated professional corporations (“PCs”) managed by the Company.
The interim condensed consolidated financial statements include the accounts of variable interest entities in which the Company is the primary beneficiary under the provisions of Accounting Standards Codification (‘‘ASC”) Topic 810, Consolidation.” At September 30, 2019, the variable interest entities include 44 dentist owned PCs and at December 31, 2018 the variable interest entities included 31 dentist owned PCs. The Company is a dental service organization and does not engage in the practice of dentistry. All clinical services are provided by dentists and orthodontists who are engaged as independent contractors or otherwise engaged by the dentist-owned PCs. The Company contracts with the PCs and dentists and orthodontists through a suite of agreements, including but not limited to, management services agreements, supply agreements, and licensing agreements, pursuant to which the Company provides the administrative, non-clinical management services to the PCs and independent contractors. The Company has the contractual right to manage the activities that most significantly impact the variable interest entities’ economic performance through these agreements without engaging in the corporate practice of dentistry. Additionally, the Company would absorb substantially all of the expected losses of these entities should they occur. The accompanying consolidated statements of operations reflect the revenue earned and the expenses incurred by the PCs.
All significant intercompany balances and transactions are eliminated in consolidation.
Note 2—Summary of Significant Accounting Policies
Management Use of Estimates
The preparation of the interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that impact the reported amounts. On an ongoing basis, the Company evaluates its estimates, including those related to the fair values of financial instruments, useful lives of property, plant and equipment, revenue recognition, equity-based compensation, long-lived assets, and contingent liabilities, among others. Each of these estimates varies in regard to the level of judgment involved and its potential impact on the Company’s financial results. Estimates are considered critical either when a different estimate could have reasonably been used, or where changes in the estimate are reasonably likely to occur from period to period, and such use or change would materially impact the Company’s financial condition, results of operations, or cash flows. Actual results could differ from those estimates.
Revenue Recognition
The Company’s revenues are derived primarily from sales of aligners, impression kits, whitening gel, and retainers, and interest earned through its SmilePay financing program. Revenue is recorded for all customers based on the amount that is expected to be collected, which considers implicit price concessions, discounts and returns. The Company adopted ASC 606, “Revenue from Contracts with Customers which outlines a single comprehensive model for recognizing revenue as performance obligations are transferred to the customer in exchange for consideration. This standard also requires expanded disclosures regarding the Company’s revenue recognition policies and significant judgments employed in the determination of revenue. The Company adopted this standard effective January 1, 2017.
The Company identifies a performance obligation as distinct if both of the following criteria are met: the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer and the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. Determining the standalone selling price (“SSP”) and allocation of consideration from a contract to the individual performance obligations, and the appropriate timing of revenue recognition, is the result of significant qualitative and quantitative judgments. Management considers a variety of factors such as historical sales, usage rates (the number of times a customer is expected to order additional aligners),

12

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


costs, and expected margin, which may vary over time depending upon the unique facts and circumstances related to each performance obligation, in making these estimates. Further, the Company’s process for estimating usage rates requires significant judgment and evaluation of inputs, including historical data and forecasted usages. Changes in the allocation of the SSP between performance obligations will not affect the amount of total revenues recognized for a particular contract. The Company uses the expected cost plus a margin approach to determine the SSP for performance obligations, and discounts are allocated to each performance obligation based on the relative standalone selling price. However, any material changes in the allocation of the SSP could impact the timing of revenue recognition, which may have a material effect on the Company’s financial position and result of operations as the contract consideration is allocated to each performance obligation, delivered or undelivered, at the inception of the contract based on the SSP of each distinct performance obligation.
The Company estimates the amount expected to be collected based upon management’s assessment of historical write-offs and expected net collections, business and economic conditions, and other collection indicators. Management relies on the results of detailed reviews of historical write-offs and collections as a primary source of information in estimating the amount of contract consideration expected to be collected and implicit price concessions. The Company believes its analysis provides reasonable estimates of its revenues and valuations of its accounts receivable. For the three and nine months ended September 30, 2019 and 2018, estimated implicit price concessions reduced contractual revenues by $17,299, $13,329, $56,394 and $32,772, respectively.
A description of the revenue recognition for each product sold by the Company is detailed below.
Aligners and Impression Kits: The Company enters into contracts with customers for aligner sales that involve multiple future performance obligations. The Company determined that aligner sales comprise the following distinct performance obligations: initial aligners, modified aligners, and refinement aligners which can occur at any time throughout the treatment plan (which is typically between five to ten months) upon the direction of and prescription from the treating dentist or orthodontist. The Company recognized $162,173, $109,694, $508,875 and $273,514 of aligner sales, net of implicit price concessions and reserves, during the three and nine months ended September 30, 2019 and 2018, respectively.
The Company allocates revenues for each performance obligation based on its SSP and recognizes the revenues as control of the performance obligation is transferred upon shipment of the aligners. The Company recognizes aligner revenue on amounts expected to be collected during the course of the treatment plan.
The Company bills its customers either upfront for the full cost of aligners or monthly through its SmilePay financing program, which involves a down payment and a fixed amount per month for up to 24 months. The Company’s accounts receivable related to the SmilePay financing program are reported at the amount expected to be collected on the consolidated balance sheets, which considers implicit price concessions. Financing revenue from its accounts receivable is recognized based on the contractual market interest rate with the customer, net of implicit price concessions. The Company recognized $11,522, $7,158, $31,185 and $16,706 of financing revenue from its SmilePay program, net of implicit price concessions and other adjustments, during the three and nine months ended September 30, 2019 and 2018, respectively, which is included in the consolidated statements of operations. There are no fees or origination costs included in accounts receivable.
The Company sells impression kits to its customers as an alternative to an in-person visit at one of its retail locations where the customer receives a free oral digital imaging of their teeth. The Company combines the sales of its impression kits with aligner sales and recognizes the revenues as control of the performance obligation is transferred upon shipment of the aligners. The Company estimates the amount of impression kit sales that do not result in an aligner therapy treatment plan and recognizes such revenue when aligner conversion becomes remote.
Retainers and Other Products: The Company sells retainers and other products (such as whitening gel) to customers, which can be purchased on the Company’s website. The sales of these products are independent and separate from the customer’s decision to purchase aligner therapy. The Company determined that the transfer of control for these performance obligations occurs as the title of such products passes to the customer. The Company

13

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


recognized $6,490, $2,814, $13,654 and $4,510 of retainer and other product sales during the three and nine months ended September 30, 2019 and 2018, respectively.
Deferred Revenue: Deferred revenue represents the Company’s contract liability for performance obligations associated with sales of aligners. During the three and nine months ended September 30, 2019 and 2018, the Company recognized $180,185, $119,666, $553,714 and $294,730 of revenue, respectively, of which $1,801, $1,095, $16,453 and $11,154 was previously included in deferred revenue on the consolidated balance sheets as of June 30, 2019 and 2018 and December 31, 2018 and 2017, respectively.
Shipping and Handling Costs
Shipping and handling charges are recorded in cost of revenues in the consolidated statements of operations upon shipment. The Company incurred approximately $4,481, $2,709, $12,082 and $7,518 in outsourced shipping expenses for the three and nine months ended September 30, 2019 and 2018, respectively.
Cost of Revenues
Cost of revenues includes the total cost of products produced and sold. Such costs include direct materials, direct labor, overhead costs (occupancy costs, indirect labor, and depreciation), fees retained by doctors, freight and duty expenses associated with moving materials from vendors to the Company’s facilities and from its facilities to the customers, and adjustments for shrinkage (physical inventory losses), lower of cost or net realizable value, slow moving product and excess inventory quantities.
Marketing and Selling Expenses
Marketing and selling expenses include direct online and offline marketing and advertising costs, costs associated with intraoral imaging services, selling labor, and occupancy costs of SmileShop locations. All marketing and selling expenses are expensed as incurred. For the three and nine months ended September 30, 2019 and 2018, the Company incurred marketing and selling costs of $131,263, $57,210, $340,409 and $143,667, respectively.
General and Administrative Expenses
General and administrative expenses include payroll and benefit costs for corporate team members, equity-based compensation expenses, occupancy costs of corporate facilities, bank charges and costs associated with credit and debit card interchange fees, outside service fees, and other administrative costs, such as computer maintenance, supplies, travel, and lodging.
Depreciation and Amortization
Depreciation includes expenses related to the Company’s property, plant and equipment, including capital leases. Amortization includes expenses related to definite-lived intangible assets and capitalized software. Depreciation and amortization is calculated using the straight-line method over the useful lives of the related assets, ranging from three to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the related lease terms or their useful lives. Depreciation and amortization is included in cost of revenues, selling expenses, and general and administrative expenses depending on the purpose of the related asset. Depreciation and amortization by financial statement line item for the three and nine months ended September 30, 2019 and 2018 were as follows:

14

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2019
2018
2019
2018
Cost of revenues
$
2,518

$
1,354

$
6,932

$
3,076

Marketing and selling expenses
1,257

385

3,318

908

General and administrative expenses
2,739

493

5,987

982

Total
$
6,514

$
2,232

$
16,237

$
4,966


Fair Value of Financial Instruments
The Company measures the fair value of financial instruments as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 — Quoted (unadjusted) prices in active markets for identical assets or liabilities.
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 — Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.
The Company’s financial instruments consist of cash, receivables, accounts payable, debt instruments, and derivative financial instruments. Due to their short-term nature, the carrying values of cash, current receivables, trade payables, and debt instruments approximate current fair value at each balance sheet date. The derivative financial instruments are held at fair value, and the preferred units are recorded at the accreted redemption value. The Company had $176,000 and $144,400 in borrowings under its debt facilities (as discussed in Notes 8 and 15) as of September 30, 2019 and December 31, 2018, respectively. Based on current market interest rates (Level 2 inputs), the carrying value of the borrowings under its debt facilities approximates fair value for each period reported.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with applicable accounting standards for such instruments and hedging activities, which require that all derivatives are recorded on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company had no outstanding derivatives at September 30, 2019 or December 31, 2018; however, the Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards.
Certain Risks and Uncertainties

15

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


The Company’s operating results depend to a significant extent on the ability to market and develop its products. The life cycles of the Company’s products are difficult to estimate due, in part, to the effect of future product enhancements and competition. The inability to successfully develop and market the Company’s products as a result of competition or other factors would have a material adverse effect on its business, financial condition, and results of operations.
The Company provides credit to customers in the normal course of business. The Company maintains reserves for potential credit losses and such losses have been within management’s expectations. No individual customer accounted for 1% or more of the Company’s accounts receivable at September 30, 2019 or December 31, 2018, or net revenue for the three or nine months ended September 30, 2019 and 2018.
Some of the Company’s products are considered medical devices and are subject to extensive regulation in the U.S. and internationally. The regulations to which the Company is subject are complex. Regulatory changes could result in restrictions on the Company’s ability to carry on or expand its operations, higher than anticipated costs or lower than anticipated sales. The failure to comply with applicable regulatory requirements may have a material adverse impact on the Company.
The Company’s reliance on international operations exposes it to related risks and uncertainties, including difficulties in staffing and managing international operations, such as hiring and retaining qualified personnel; political, social and economic instability; interruptions and limitations in telecommunication services; product and material transportation delays or disruption; trade restrictions and changes in tariffs; import and export license requirements and restrictions; fluctuations in foreign currency exchange rates; and potential adverse tax consequences. If any of these risks materialize, operating results may be harmed.
The Company purchases certain inventory from sole suppliers, and the inability of any supplier or manufacturer to fulfill the supply requirements could materially and adversely impact its future operating results.
Cash
Cash consists of all highly-liquid investments with original maturities of less than three months. Cash is held in various financial institutions in the U.S. and internationally.
Inventories
Inventories are stated at the lower of cost or net realizable value using the first-in, first-out method of inventory accounting. Inventory consists of raw materials for producing impression kits and aligners and finished goods. Inventory is net of shrinkage and obsolescence.
Property, Plant and Equipment, net
Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Routine maintenance and repairs are charged to expense as incurred. At the time property, plant and equipment are retired from service, the cost and accumulated depreciation or amortization are removed from the respective accounts and the related gains or losses are reflected in the consolidated statements of operations.
Leases
Assets under capital leases are amortized in accordance with the Company’s normal depreciation policy for owned assets or over the lease term, if shorter, and the related charge to operations is included in depreciation expense in the consolidated statements of operations.
The Company leases office spaces and equipment under operating leases with original lease periods of up to 10 years. Certain of these leases have free or escalating rent payment provisions and lease incentives provided by the landlord. Rent expense is recognized under such leases on a straight-line basis over the term of the lease. The Company occasionally receives reimbursements from landlords to be used towards improving the related property

16

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


to be leased. Leasehold improvements are recorded at their gross costs, including items reimbursed by landlords. Related reimbursements are deferred and amortized on a straight-line basis as a reduction of rent expense over the applicable lease term.
Internally Developed Software Costs
The Company generally provides services to its customers using software developed for internal use. The costs that are incurred to develop such software are expensed as incurred during the preliminary project stage. Once certain criteria have been met, direct costs incurred in developing or obtaining computer software are capitalized. Training and maintenance costs are expensed as incurred. Capitalized software costs are included in property, plant and equipment in the consolidated balance sheets and are amortized over a three-year period. During the three and nine months ended September 30, 2019 and 2018, the Company capitalized $2,143, $1,707, $7,029 and $1,794, respectively, of internally developed software costs. Amortization expense for internally developed software was $810 and $1,547 for the three and nine months ended September 30, 2019, respectively and $0 for both the three and nine months ended September 30, 2018.
Impairment
The Company evaluates long-lived assets (including finite-lived intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the future undiscounted net cash flows that the asset or asset group is expected to generate. Factors the Company considers important which could trigger an impairment review include significant negative industry or economic trends, significant loss of customers and changes in the competitive environment. If an asset or asset group is considered to be impaired, the impairment to be recognized is calculated as the amount by which the carrying amount of the asset or asset group exceeds its fair market value. The Company’s estimates of future cash flows attributable to long-lived assets require significant judgment based on its historical and anticipated results and are subject to many assumptions. The estimation of fair value utilizing a discounted cash flow approach includes numerous uncertainties which require significant judgment when making assumptions of expected growth rates and the selection of discount rates, as well as assumptions regarding general economic and business conditions, and the structure that would yield the highest economic value, among other factors.
Debt Issuance Costs
The Company records debt issuance costs related to its term debt as direct deductions from the carrying amount of the debt. The costs are amortized to interest expense over the life of the debt using the effective interest method.
Redeemable Series A Preferred Units
SDC Financial classified its Redeemable Series A Preferred Units (‘‘Preferred Units”) as temporary equity on the consolidated balance sheet for periods prior to the Reorganization Transactions and IPO due to certain deemed liquidation events that are outside of its control. The Company evaluated the Preferred Units upon issuance in order to determine classification as to permanent or temporary equity and whether or not the instrument contained an embedded derivative that requires bifurcation. This analysis followed the whole instrument approach which compares an individual feature against the entire instrument that includes that feature. This analysis was based on a consideration of the economic characteristics and risk of the Preferred Units including: (i) redemption rights on the Preferred Units allowing the Preferred Unitholders the ability to redeem the Preferred Units six years from the anniversary of the Preferred Units original issuance, provided that a qualified public offering has not been consummated prior to such date; (ii) conversion rights that allowed the Preferred Unitholders the ability to convert into common member units at any time; (iii) the Preferred Unitholders could vote based on the combined membership percentage interest; and (iv) distributions of the preferred return on the Preferred Units were subject to the same

17

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


conditions as non-Preferred Unit distributions which required all distributions to be approved by SDC Financial’s board of directors.
The Company elected the accreted redemption value method in which it accreted changes in the redemption value, as defined in Note 9, over the period from the date of issuance of the Preferred Units to the earliest redemption date (six years from the date of issuance) using the effective interest method.
Income Taxes
SDC Inc. is the managing member of SDC Financial and, as a result, consolidates the financial results of SDC Financial in the unaudited condensed consolidated financial statements. SDC Financial and its subsidiaries are limited liability companies and have elected to be taxed as partnerships for income tax purposes except for a subsidiary, SDC Holding, LLC (‘‘SDC Holding”) and its domestic and foreign subsidiaries, which are taxed as corporations. As such, SDC Financial does not pay any federal income taxes, as any income or loss is included in the tax returns of the individual members. SDC Financial does pay state income tax in certain jurisdictions, and the Company’s income tax provision in the consolidated financial statements reflects the income taxes for those states. Additionally, certain wholly-owned entities taxed as corporations are subject to federal, state, and foreign income taxes, in the jurisdictions in which they operate, and accruals for such taxes are included in the consolidated financial statements. The Company further evaluates deferred tax assets in each jurisdiction and recognizes associated benefits when positive evidence of realization exceeds negative evidence, and otherwise records valuation allowances as necessary. 
Tax Receivable Agreement
In connection with the Reorganization Transactions and the IPO, the Company entered into a Tax Receivable Agreement (the “Tax Receivable Agreement”) with the Continuing LLC Members, pursuant to which SDC Inc. agreed to pay the Continuing LLC Members 85% of the amount of cash tax savings, if any, in U.S. federal, state, and local income tax or franchise tax that SDC Inc. actually realizes as a result of (a) the increases in tax basis attributable to exchanges by Continuing LLC Members and (b) tax benefits related to imputed interest deemed to be paid by SDC Inc. as a result of the Tax Receivable Agreement. The Company recognizes this contingent liability in its consolidated financial statements when amounts become probable as to incurrence and estimable in amount.
New Accounting Pronouncements Not Yet Adopted
In February 2016, the Financial Accounting Standards Board (‘‘FASB”) issued Accounting Standards Update (‘‘ASU”) 2016-02, ‘‘Leases (Topic 842).” This update requires a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. In July 2018, ASU 2018-10, ‘‘Codification Improvements to Topic 842, Leases,” was issued to provide more detailed guidance and additional clarification for implementing ASU 2016-02. Furthermore, in July 2018, the FASB issued ASU 2018-11, ‘‘Leases (Topic 842): Targeted Improvements,” which provides an optional transition method in addition to the existing modified retrospective transition method by allowing a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. These new leasing standards are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is continuing to evaluate the provisions of ASU 2016-02 (and related developments) to determine how the financial statements will be affected, and the Company believes the primary effect of adopting the new standard will be to record right-of-use assets and obligations for its leases currently classified as operating leases.
In September 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses” (Topic 326). The FASB issued this update to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this update replace the existing guidance of incurred loss impairment

18

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


methodology with an approach that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. In November 2018, the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” which clarifies the scope of guidance in the ASU 2016-13. The updated guidance is effective for annual periods beginning after December 15, 2020. Early adoption of the update is permitted in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of this guidance on its consolidated financial statements and related disclosures.
In September 2018, the FASB issued ASU 2018-07, “Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting,” which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees. This guidance is effective for years beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement,” which amends the disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This guidance is effective for years beginning after December 15, 2020, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU 2018-15, “Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This update clarifies the accounting treatment for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. This guidance is effective for years beginning after December 15, 2020, with early adoption permitted. The amendments may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements and related disclosures.
Note 3—Inventories
Inventories are comprised of the following:
 
September 30, 2019
December 31, 2018
Raw materials
$
7,767


$3,486

Finished goods
6,866

5,295

Total inventories
$
14,633


$8,781


Note 4—Prepaid and other assets
Prepaid and other assets are comprised of the following:

19

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


 
September 30,
2019
December 31,
2018
Prepaid expenses
$
7,418


$2,642

Deposits to vendors
3,129

2,822

Other
1,440

318

Total prepaid and other current assets
$
11,987


$5,782

Indefinite-lived intangible assets
$
6,269

$

Total other assets
$
6,269

$



In March 2019, the Company purchased an intangible asset related to manufacturing. The Company evaluates the remaining useful life and carrying value of this indefinite-lived intangible asset at least annually or when events and circumstances warrant such a review, to determine whether significant events or changes in circumstances indicate that a change in the useful life or impairment in value may have occurred. There were no impairment charges during the nine months ended September 30, 2019.

Note 5—Property, plant and equipment, net
Property, plant and equipment were comprised of the following at September 30, 2019 and December 31, 2018:
 
September 30,
2019
December 31,
2018
Lab and SmileShop equipment
$
58,650

$
30,627

Computer equipment and software
38,293

14,748

Leasehold improvements
12,476

7,208

Furniture and fixtures
9,462

5,174

Vehicles
2,551

721

Construction in progress
25,906

6,031

 
147,338

64,509

Less: accumulated depreciation
(28,208
)
(11,958
)
Property, plant and equipment, net
$
119,130

$
52,551



The carrying values of assets under capital leases were $7,284 and $6,285 as of September 30, 2019 and December 31, 2018, respectively, net of accumulated depreciation of $2,563 and $582, respectively.

Note 6—Accrued liabilities
Accrued liabilities were comprised of the following at September 30, 2019 and December 31, 2018:
 
September 30,
2019
December 31,
2018
Accrued marketing costs
$
45,893

$
11,760

Accrued payroll and payroll related expenses
19,191

10,469

Obligations related to equity-based compensation
41,509


Other
22,841

12,710

Total accrued liabilities
$
129,434

$
34,939



Note 7—Income taxes

SDC Inc. is the managing member of SDC Financial and, as a result, consolidates the financial results of SDC Financial. SDC Financial and its subsidiaries are limited liability companies and have elected to be taxed as partnerships for income tax purposes except for a subsidiary, SDC Holding and certain of its domestic and foreign subsidiaries, are taxed as corporations. The Company files income tax returns in the U.S. federal, various states and foreign jurisdictions. Any taxable income or loss generated by SDC Financial is passed through to and included in the taxable income or loss of its members, including SDC Inc., generally on a pro rata basis or otherwise under the terms of the SDC Financial LLC Agreement. The Company is subject to U.S. federal income taxes, in addition to state and local income taxes with respect to its allocable share of any taxable income or loss of SDC Financial, as well as any stand-alone income or loss generated by SDC Inc.

The Company’s U.S. federal and state income tax returns for the tax years 2015 and beyond remain subject to examination by the Internal Revenue Service. The Company also has operations in Costa Rica, Puerto Rico, Canada, Australia, the U.K., the E.U., Ireland and New Zealand with tax filings in each foreign jurisdiction. With respect to state and local jurisdictions, the Company and its subsidiaries are typically subject to examination for several years after the income tax returns have been filed. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, interest and penalties have been provided for in the accompanying consolidated financial statements for any adjustments that may be incurred due to state or local audits and uncertain tax positions. The Company is also subject to withholding taxes in foreign jurisdictions. The Company’s income tax expense may

20

SmileDirectClub, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)
September 30, 2019
(in thousands, except share/unit data and per share/unit amounts)


vary from the expense that would be expected based on statutory rates due principally to its organizational structure and recognition of valuation allowances against deferred tax assets.

The income tax provision was as follows:
 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2019