Too Broke to Smile: SmileDirectClub Chapter 11 Deep Dive

Welcome to the 127th Pari Passu Newsletter. 

Over the last few weeks, we covered restructurings of solid businesses which found themself in tough situations. Today, we are studying a broken business model.

The COVID-19 pandemic engendered increased usage of telehealth services following the shutdown of physical locations. What was originally an involuntary change became a willing shift to virtual and hybrid care as patients discovered more affordable and convenient options [27]. 

Below, we’re going to dive into a case of DTC dental care and use SmileDirectClub as an opportunity to learn about regulatory challenges in healthcare, the effect of unresolved legal disputes, and insider DIP financing. We’ll see how its business model became the company’s downfall and how it never recovered from its failed IPO in 2019. 

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Company Overview

SmileDirectClub (“SmileDirect”) was the first omnichannel telehealth platform to sell dental aligners and other affordable oral health products and services directly to consumers (DTC) [15]. The company launched its website in May 2014 by friends Alex Fenkell and Jordan Katzman and went public in September 2019 [1]. SmileDirect soared to prominence with bold marketing and a promise to revolutionize affordable orthodontics [1]; the company’s flagship product, clear aligners, sold for a starting price of $1,850 [3], far less than the $3,000–$8,000 price tag for traditional metal braces and Invisalign [5] [6]. The company’s primary customer base was low-to-middle-class income patients [12]. 

Rather than a direct provider of dental services, the company functioned as a Dental Support Organization; the company offered a suite of dental-related products and services via a network of 49 independent, third-party professional corporations (PCs). These PCs, owned by licensed dentists, are responsible for delivering aligner treatments to SmileDirect customers, operating under various contractual agreements while leveraging the company’s telehealth platform [1]. SmileDirect served over two million customers in its nine years of operation [3]. 

Business Model 

SmileDirectClub's hybrid business model combined DTC teledentistry with in-person professional care. Customers could begin their treatment by either ordering an at-home impression kit or visiting a SmileShop (a SmileDirect-owned retail location) for an in-person scan. All aspects of the company’s patient journey were overseen by licensed dental professionals, ensuring that both remote and in-office services meet clinical standards. 

SmileDirect had a vertically integrated supply chain, controlling everything from a customer’s initial website visit to the final manufacturing and delivery of aligners. The company’s competitive advantage was a function of three main factors that spanned across both online and in-person offerings [1]: 

1. Robust Partner Network (PN) – Patients could visit partner locations (the 49 PCs mentioned above) owned by over 1,150 independent dentists and orthodontists to get their teeth scanned or take physical impressions. Treating Doctors (also in the PN) then assessed and prescribed aligners. The PN network regularly monitored progress remotely through virtual check-ins. 

2. Proprietary technology – The SmileDirect Mobile Application provided patients with custom progress tracking, notifications, and customer support. The app used SmileMaker AI Technology, which allowed customers to scan their teeth and create an interactive 3D model, generating a treatment plan within minutes of uploading. 

3. Continued product innovation – In addition to the aligners, SmileDirect offered an array of other products. Notable offerings included Nighttime Clear Aligners (aligners that only need to be worn for ten hours at night), Comfort Sense Technology (enabling a smoother fit using laser precision-cutting), SmileOS (a new planning system for dental professionals launched in 2021 to optimize efficiency and accuracy of treatments), and CarePlus (a hybrid initiative for customers who wanted in-person treatment in addition to the company’s telehealth services). In 2022, SmileDirect launched whitening kits and strips as part of a broader strategy to expand into the oral care market. 

DTC Teledentistry 

SmileDirect’s first customer channel was its DTC teledentistry service. Customers could either use the company’s mobile app (powered by proprietary SmileMaker technology) to take 3D scans of their teeth or request an at-home impression kit to mail back to one of SmileDirect’s partner labs. Scans only took around thirty minutes to complete, giving customers full temporal autonomy over the process. Once approved by one of SmileDirect’s licensed dentists / orthodontists, the company manufactured and shipped aligners directly to customers [1]. 

SmileShops and Physical Footprint

As SmileDirect’s reputation grew, the company opened its first SmileShop in-person treatment center in 2016 in New York. SmileShops were company-run locations, distinct from independent Partner Network locations. By 2019, the company had significantly scaled its footprint through partnerships with CVS and Walgreens, which more than doubled the number of SmileShops. At its peak, SmileDirect operated over 144 SmileShops globally, including multiple locations across Texas and major international markets such as Canada, the UK, and Australia [1]. 

Payment and Satisfaction Policies 

To ensure financial accessibility, SmileDirect introduced SmilePay in 2018, a flexible payment plan that allows customers to pay the cost of their treatment in installments. For example, a patient could make a $250 down payment along with $85 monthly payments to cover the cost of a $1,895 treatment. 60-70% of the company’s customers use this option, benefiting from a streamlined, in-house financing model that avoids the friction caused by third-party financiers. SmilePay played a critical role in retaining customers and driving conversions. 

To further instill confidence in its products, SmileDirect also provided a Lifetime Smile Guarantee, giving customers a full refund within thirty days if they are unsatisfied. Beyond that period, customers could receive a partial refund or free additional aligners for adjustments [1]. 

Regulatory Hurdles 

While DTC dental care provided an affordable alternative to otherwise costly treatments, orthodontists and dental professionals had been skeptical of DTC treatments since SmileDirect’s inception. Critics argued that because patients take their own dental impressions or scans without an in-person evaluation, underlying oral health issues, like gum disease, may go undetected and lead to complications [2].

These concerns were not entirely unique to SmileDirect, but the company’s rapid growth brought it into the spotlight. As we will see later, regulatory hurdles would end up being one of the key factors leading to the company’s filing. 

Pre-Distress Financials 

Prior to its IPO in 2019, SmileDirect raised $380mm through an institutional private placement of equity capital (selling private shares directly to institutional investors), yielding the company a $3.2bn valuation in 2018 [14]. In the fifth largest US IPO in 2019 [13], SmileDirect then raised $1.35bn, boosting the company’s valuation to $9bn [11]. We will analyze SmileDirect’s failed IPO despite its high initial valuation later, but for now let’s take a look at SmileDirect’s financials from before FY 2020 to provide a snapshot of what the company looked like pre-COVID and pre-stress: 

The vast majority of revenue came from sales of clear aligners. From FY 2017-2019, the company experienced high revenue growth, bringing in $146mm, $423mm, and $750mm, respectively [16]. This is consistent with how quickly the company’s customer base grew, as unique aligner shipments increased from 258,278 to 453,053 from FY 2018 to FY 2019 [17]. Gross profit saw a similar trend, surging from $82mm in 2017 to $289mm in 2018 to $572mm in 2019, with respective gross profit margins at 56%, 68%, and 76% [16]. 

The company had reported net losses since 2017 (negative $33mm in 2017, negative $75mm in 2018, negative $115mm in 2019) [16], which wasn’t that uncommon for fast-growing companies. However, the fact that EBITDA, operating income, and net income have all been negative since 2017 suggests that even with its focus on rapid expansion, SmileDirectClub had struggled to achieve profitability at any level.

Even so, we can try to contextualize SmileDirect’s losses. Like many other disruptive companies (e.g. Uber), SmileDirect likely focused on scaling first, then improving margins later. This is most evident through three factors, the first two of which each made up around half of the company’s revenue throughout 2017 – 2019, while the third contributed to delayed cash collection [19]: 

1. High Marketing and Selling Expenses – Marketing and selling expenses included omni-channel advertising campaigns and customer acquisition costs as well as sales team expenses and SmileShop operations. These expenses more than doubled each year, increasing from $64mm in 2017 to $481mm in 2019. In each year, marketing and selling expenses constituted around half of all revenues [19]; this aggressive spending underscores SmileDirect’s push for rapid expansion, prioritizing visibility and market share over profitability. 

2. High General and Administrative Expenses – General and Administrative Expenses totaled $48mm, $122mm, and $581mm from 2017-2019. The majority of this category comprised of the two primary forms of worker compensation: wages and equity-based compensation. From the beginning of 2017 to the end of 2019, the number of SmileDirect’s employees increased from around 200 to 6,000. Wages paid to workers made up 40% of the overall G&A expense increase ($30mm out of $74mm) from 2017 – 2018. This increase in wages was due to “the expansion of [the company’s] headcount” [19], reflecting SmileDirect’s short-term goal of expansion. Equity-based compensation (non-cash awards like stock or stock options given in lieu of cash salaries) also falls under this category and totaled $7mm, $20mm, and $350mm from 2017 – 2019; while equity-based compensation is not a linear function of headcount, we can assume the sharp rise in equity based compensation reflects the same hiring. surge that drove up wages. Throughout 2017 – 2019, wages and compensation made up over half of overall G&A expenses; G&A as a whole made up around half of revenues during this time period.

3. Increasing Days Sales Outstanding – Days Sales Outstanding (DSO) is a way to measure how long it takes, on average, for a company to collect payments from its accounts receivables after a sale. DSO is calculated by dividing accounts receivables by total revenue and then multiplying that by 365. In their FY 2019 10-K, the company attributeed the increase in accounts receivables to the introduction of SmilePay (introduced in 2018). Accounts receivables were $114mm in FY 2018 and $239mm in FY 2019, and revenues were $423mm in FY 2018 and $750mm in FY 2019. This translates to an increase in DSO from 98 days to 116 days from 2018 to 2019. While this is not a huge increase, it still highlights how SmileDirect’s installment model delayed cash collection and ultimately contributed to a strain in liquidity. 

However, unlike other high-growth companies, SmileDirect’s long-term profitability turnaround failed to materialize due to operational and legal setbacks, which we will discuss in the next section. 

Events Leading to Distress

Despite its early growth, SmileDirect faced significant challenges due to its failed IPO, the COVID-19 pandemic, and legal battles. With both categories of challenges draining financial resources concurrently, SmileDirect quickly fell into a severe liquidity crisis. 

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