XpresSpa Group, Inc. (XSPA) Q2 2019 Results Earnings Conference Call August 14, 2019 4:30 PM ET

Company Participants

Doug Satzman - Chief Executive Officer

Conference Call Participants

Operator

Greetings and welcome to XpresSpa Group, Inc.'s second quarter 2019 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

Today's conference call is being hosted by Mr. Doug Satzman, CEO. Before I turn the call over to him, I need to advise you of the following. Comments made on today's call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current assumptions and opinions and involve a variety of known and unknown risks and uncertainties.

Actual results may differ materially from those contained in or suggested by such forward-looking statements. Important factors that might cause such differences include those set forth from time-to-time in the company's SEC filings, including the company's report on Form 10-K for the year ended December 31, 2018 and other current and periodic reports the company files with the SEC.

During today's call, the company will refer to certain non-GAAP financial measures, which it believes can be useful in evaluating its performance. The presentation of these measures or other information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. For reconciliations of these non-GAAP financial measures to GAAP measures and a discussion of why the company considers these measures useful, please refer to today's earnings release.

With that, I would like to turn the call over to Mr. Doug Satzman, CEO.

Doug Satzman

Thank you operator and thank you all for joining us today. I would like to begin by providing a business update before moving on to a review of our second quarter financial results and recent debt and equity transactions.

As you know in the six month since joining the company, I have been working diligently with the team to improve sales while enhancing the guest experience and identifying cost savings measures to improve our financial condition. I am pleased to report that many of the initiatives that I had laid out on prior two conference call are beginning to pay dividends for XpresSpa and we are only just beginning. These green shoots includes the following.

Five consecutive months of positive comparable store sales for March through July. Second quarter comparable store sales increased 3.8% and year-to-date, through the first half of the year, we are up 1.4%. There are two factors behind this momentum. First, we are getting better upselling services, including the length of massages through employee incentive. Notably in July we successful cycled over a massage price increase from last year and we were still able to grow our comparable store sales.

Second, our average retail ticket increased 8.6% in the second quarter compared to the prior year quarter as improved their supply chain and are now able to carry more relevant items in stock. The retail sales percent of our business continues to be restored although transactions fell 3.4% during the second quarter due to shifting enplanements from terminal to terminal.

Next, we experience a 4.5% increase in average sales per store as we closed one underperforming location compared to the prior year period. Subsequent to the quarter end, we closed two additional spas at the end of July and our single non-airport location in the World Trade Center in New York City. This location alone lost approximately $0.5 million at the store level over the last four quarters. So we are pleased to have exited this and other locations that were negatively impacting our business. We will continue to closely monitor all of our spa locations and when necessary close other locations for the health of our overall business.

Our store margin increased 14% to $3.1 million and rose to 23.7% of total revenue as we benefit from leverage on comparable store sales. Streamline processes reduced store level costs and the closure of underperforming stores. We reduced our G&A significantly by streamlining processes at the field and corporate level, along with a reduction in stock-based compensation versus the prior year. The totality of these efforts led to a substantial increase of our adjusted EBITDA to a positive $441,000 compared to an adjusted EBITDA loss of a negative $538,000 in second quarter 2018. This marks our first quarter of positive adjusted EBITDA since the fourth quarter of 2017. As you can see, the improvement in our sales momentum, margin and narrowing of our operating loss are validating our operating strategy. Of course, we are still early in the process and look forward to accomplishing more during the remainder of this transitional year and beyond.

In July, we took the much needed necessary steps to greatly improve our capital structure which was done through a series of debt and equity transactions that I will detail shortly. As a reminder, our senior secured lender B3D, LLC once again restructured our senior secured credit facility and we received our second investment from Calm.com, while extending and broadening our strategic partnership. We are confident this new round of funding will provide us with the necessary working capital for operations, new initiatives to improve the business and capital to continue to renovate existing spas and build new spas by the end of 2019.

Now, I would like to provide updates on our near-term priorities including what we have accomplished recently and what we hope to accomplish over the next few months. One, staffing up through recruiting, training and retention. A, because of our improved capital structure and sales improvements, we are now able to attract better talent across our organization. In July 20, we appointed our first Chief People Officer, Scott Milford. Scott is responsible for attracting top talent across the organization, developing employees through training and retention, fostering a people-first culture and elevating the customer experience. Having worked with Scott at a prior company, I know Scott is an excellent fit within the XpresSpa team and culture and will play an important part in our strategic plan. We look forward to continuing this positive momentum with future recruitment as we upgrade our talent at all levels of the organization.

B, we are shifting the mindset of some of our staff from highly skilled independent contractors to a unified XpresSpa team at each spa. This is ongoing and critical to enhancing their job satisfaction and strengthening retention in a very competitive environment for skilled labor and also critical to attracting the very best people to our brand. C, we are planning a more robust employee stock plan that will extend deeper down the organization and further incent behaviors aligned with shareholder interests as well as attract and retain the strongest talent. D, we continue to gain momentum in the retooled leadership team that was put in place last fall.

Number two, building transactions through improved scheduling, loyalty and launching an XpresSpa app to fill in the gaps within the overall customer experience. Under this, we have A, we have rolled out Phase 1 of our new in store app across all domestic spas, capturing more customer data and enabling us to better schedule services including the creation of a digital queue and texting customers when we are ready for them. This is leading to greater customer satisfaction and higher retention as we minimize walkaways.

B, in the fourth quarter we intend to rollout an XpresSpa consumer facing app at Phase 2 which will enable customers at the airport to schedule services before they get through security and reach the spa. We will also better track loyalty so that we can increase the frequency of our best highest spend customers. C, we have launched a new online training tool that incorporates a gaming methodology which increases participation, effectiveness and retention of the training material. We have started with our concierge population as our first investment to improving our guest experience and further supporting upselling behaviors.

Three, increasing our average ticket by fixing our own retail supply chain and upselling services. As I mentioned earlier, we have improved our product assortment issues and have been able to increase our average ticket by offering our customers an array of quality retail items that they are interested in purchasing.

And four, selectively opening high performing new spas and renovating existing spas. A, we have several high visibility new store openings planned for 2019. These include Atlanta, Philadelphia and Las Vegas, where we already operate one or more profitable spas and Austin, where we will be opening our first airport franchise-owned spa and a company-owned spa. Our focus remains on thoughtful regimented capital allocation so that we can maximize our return on investment for shareholders. We expect about half of stores opened in the third quarter and half to open in the fourth quarter. C, we will also refreshen our brand with three to four renovation projects in addition to three already completed. This is both an offensive and defensive move to elevate perceptions of XpresSpa.

As I referenced on our prior conference call, we also view activating partnerships with like-minded wellness brands a critical opportunity for us as well. We are exploring conversations with several companies to this end. This is why I am so excited when we are able to extend and broaden our strategic partnership with Calm.com, world's number one app for sleep, meditation and relaxation. The relationship now encompasses XpresSpa's international portfolio, all future spas and the brands will collaborate on testing an expanded Calm brick-and-mortar experience at select domestic XpresSpa locations. For example, this fall we intend to begin selling a Calm branded waiting eye mask and weighted travel blanket as we expand our Calm product line with high-end items relative to our customer.

Finally, we are going to begin testing cashless payment in five spas and after a period of time, we will assess customer feedback before considering next steps. Collecting cash and depositing it in the bank from the airport is actually more expensive than credit card fees, so we are eager to see if the test proves beneficial as cost saving initiative.

Now let me move to the second quarter itself. Revenue was $12.9 million, representing a slight decrease of 1% or $130,000 compared to the prior three month period of $13.0 million. Revenue decrease was due to net three less stores versus the prior year second quarter, including one spa closure during the second quarter 2019 itself. This decrease was partially offset by a 3.8% increase in comparable store sales. As I said earlier, comparable store sales have been positive every month since March through to July and rose 1.4% through the first half of the year.

Cost of sales decreased to $9.9 million from $10.4 million in the prior-year. This was due primarily to a cost savings initiative which reduced labor costs by 420 basis points to 45.6% as a percentage of sales compared to the year ago period. We also incurred slightly lower occupancy costs related to the closure of underperforming stores.

Gross profit, therefore, increased 14.0% to $3.1 million from $2.7 million in the prior year period. And gross profit margin increased 320 basis points to 23.7% from 20.5% in the prior year. General and administrative expenses decreased 36.1%, $2.5 million compared to $3.9 million in the prior year three-month period as we made traction in reducing our administrative costs through streamlined processes at the corporate level coupled with a reduction in stock-based compensation. Adjusted EBITDA was $441,000, reflecting a $979,000 improvement compared to a negative $538,000 adjusted EBITDA in the prior-year.

As you know, in early July, we announced a series of debt and equity transactions that improved our capital structure and significantly strengthened its financial condition. Our Board had limited options to simplify and enhance our capital structure, address potential loan defaults and secure additional working capital to support operations, invest in new technology, attract top talent, renovate spas and build five new spas by year-end. This series of transactions dilute existing common shareholders in the short term but also benefits common shareholders through the removal of the liquidation preference for Series D preferred shareholders, which is a necessary positive step forward for XpresSpa. We have now substantially improved our balance sheet through the restructuring and refinancing of outstanding secured debt and conversion of preferred shares to common, both subject to shareholders' approval.

First, on June 27, 2019, we worked with our second lien lender to eliminate over $2.3 million of secured convertible notes that were due November 17, 2019 by converting the notes into 942,432 shares underlying common stock consisting of 585,660 shares of common stock that were immediately issued and 356,772 shares underlying warrants that were issued. All of those warrants have been exercised and 354,502 shares issued in connection with those warrant exercises. The conversion price of the notes was $2.48 per share. The conversion freed up cash and flows from operations have been directed to debt service while also creating more availability and flexibility under our $11 million debt ceiling.

Second, our senior secured lender, B3D, LLC, agreed to amend its $6.5 million senior secured notes. The amendments include extending its maturity by 17 months to May 31, 2021 reducing the interest rate from 11.24% to 9.00%, representing a saving of $145,000 per year and giving us the option to conserve cash while paying interest in common stock rather than in cash, subject to shareholder approval. In exchange, we agreed to increase the principal amount by 40.5 million. Equally as important, subject to shareholder approval, the entire principal amount of the senior secured note will be convertible into shares of common stock at the company's option at a conversion price of $2 per share. The lower interest rate and ability to service debt in shares saves $730,000 per year in cash while the repayment of principal and shares for nearly two years likely unshackles us from needing to raise $7 million in cash.

Third, the holders of a majority of the outstanding shares of Series D preferred stock agreed to convert approximately $24 million of the Series D 9% convertible preferred stock into shares of common stock at a price of $2 per share, again subject to shareholder approval. The conversion of the Series D preferred stock creates a more simplified capital structure, aligns the holders of the Series D preferred stock to common shareholders and importantly removes the dilutive uncertainty associated with the Series D preferred stock when it is automatically converted into common stock at maturity at the then current market price. Conversion to common also removes the liquidation preference of the Series D preferred shareholders in the event of the sale or liquidation of the company. This places these preferred shareholders now on equal footing to common stockholders, which is a necessary and positive step forward.

Fourth, based on this reengineering of the capital structure and liquidity, we received a second capital infusion from Calm.com, Inc. This new round of capital consists of $2.5 million in 5% unsecured convertible notes due May 31, 2022 with the outstanding principal balance convertible at Calm's option into shares of Series E preferred stock at a conversion price equal to $3.10 per share. Calm has also issued warrants to purchase 937,500 shares of common stock which are exercisable beginning six months from the time of issuance, have a term of five years and feature an exercise price of $2 per share, subject to shareholder approval.

And lastly, we entered into an amendment with the investors to our May 2018 securities purchase agreement that, among other things, lays certain provisions regarding restrictions on subsequent equity sales by the company, raised participation in subsequent financings by the company and ultimately the removal of certain such provisions upon subject to shareholder approval. These investors are the formal holders of the secured note that was converted in late June and this amendment removes their influence for future financings by the company. In exchange, it also meant certain other provisions of the Alpha Class A warrants including one, following receipt of shareholder approval it cancels all outstanding Class B warrants. Finally, it establishes a new class of preferred stock to be designated Series F convertible preferred stock and the issuance of 9,000 shares of such Series F preferred stock to the parties to the May 2018 SPA amendment that will be convertible to common stock upon receipt of shareholder approval.

To conclude, we are now in better financial shape than we were just two months ago and eager to execute on our business priorities. We are already seeing signs of traction with respect to strengthening comparable store sales trends and a substantial narrowing of our operating losses which supports my belief that we have a lot of potential and keeps me bullish on our future. We intend to achieve positive EBITDA and positive operating cash flow in due time. And if we can enhance the result of our existing spas, continue to identify strategic opportunities and expand wisely, I am confident that we will get there. Our 700 team members are providing great hospitality and holistic wellness experiences to our guests. And in doing so, strengthening their perception of our brand, which we expect over time yields greater loyalty and frequency.

Before we take your questions, I would like to remind you that we are holding our 2019 Annual Meeting of stockholders at 11:00 AM Eastern Standard Time on Monday, September 9, 2019 in New York City. At this meeting, we are asking our shareholders to consider numerous proposals, many of which I have referenced a few moments ago. While I will not list all of them here now, I urge you to read and consider them carefully and then vote accordingly.

Thank you for your time and interest in XpresSpa and now we will turn to Q&A portion of our call.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question comes from Ryan Lupin [ph]. Please go ahead.

Unidentified Analyst

Hi. How's it going? You mentioned your Series D preferred shareholders are planning to convert to common. Isn't that just shifting one problem to another?

Doug Satzman

Thanks Ryan. I don't think so. I think anytime you can align shareholder interests with as many parties as possible, it's a good thing for the business. A way of background, the Series D holders represents former shareholders of XpresSpa on the merger of XpresSpa by Form Holdings in 2016. Converting to common simplifies our equity structure by eliminating a class of stock that would have preferred liquidation or that would have preferred liquidation and conversion rights. And once converted, the former Series D holders will now be perfectly aligned with the common shareholders, as I mentioned, allowing the market to clearly assess the proper capitalization of XpresSpa and allowing for what some already believe that the dilution is already priced into our stock price.

Unidentified Analyst

Great. Thanks. I will hop back into queue.

Operator

The next question comes from Steven Nelson [ph]. Please go ahead.

Unidentified Analyst

Hi. Thanks for taking my question. I have several actually. Can you discuss the reason for shelf filing and also do you plan on raising equity in the future? Also, lastly if I may ask one more question related to your extension. Why not limit further expansion until the company has a stronger financial footing from the transaction already completed and improved your operations? Thank you.

Doug Satzman

Okay. Let me see if I get these. So one, reason for filing the shelf is just good governance. A shelf filing allows the Board to take advantage of opportunities to refinance the debt and working capital of the company.

I think your second question was, do we plan on raising equity in the near future. I don't expect to use this device in the near future. But it's an important tool to have, for management to have, should our stock move in a positive direction that rewards everyone.

And then why not wait until we are on stronger financial footing? Again, there is no immediate plans to use a shelf. Step one is getting the business self-funding, back on its own two feet and we have made a lot of progress in a very short amount of time. And that will remain the priority. But as the numbers continue to improve, I will be looking for money to grow in investing more spas next year and the following year. So as many tools will only serve the company better. Thank you.

Unidentified Analyst

Great. Thanks. I appreciate the color.

Operator

The next question comes from Michelle Steele. Please go ahead.

Unidentified Analyst

Hi. Two questions from me. Besides Calm, can you give examples of other partnerships that you are seeking?

Doug Satzman

Hi Michelle. Thank you for asking. I can't really answer that until I have something to announce. I am sure you can appreciate, but what I will say is, we are talking with different groups, some may be services related in health and wellness, some may be products that they what to place. But the consistent theme is there are a number of emerging and big players that see the same value in the real estate that we have within some of the best airports in the world, certainly in the U.S. and the exposure that we have. There is not a lot of health and wellness players in the airport. So we draw a lot of very desirable segment of customers right into our spas. So hopefully, I will have more things to share in the future. But it's very squarely with our strategic partnership platform that I am trying to build.

Operator

The next question comes from Marissa [indiscernible]. Please go ahead.

Unidentified Analyst

Hi. Good afternoon. Do you have any update on your franchising efforts beyond the Austin store which I understand will be opening in the next month or so? And maybe can you explain why opened a company-operated spa and a franchise spa in the same airport? Wouldn't that seem counterproductive to you? Thanks.

Doug Satzman

Yes. As you know, I have been asked that question before. It's a nontraditional move we have taken. First, let me get to your first question. We are just starting to entertain other franchisees in our system but nothing in the immediate future. Our focus right now is getting our first franchisee off the ground. So Austin airport, we are opening a company-owned store and a franchise store in the same venue. That is unusual.

Our intent though is to ensure that this first franchisee has a really great foundation and hopefully succeeds, we believe he and she will. With that, we are also in the organization in franchising and I have some franchising expense in my background, but most of the company and most of the team members at XpresSpa do not. So we have learning to make sure we start developing best of-class tools that other franchising organizations have built over the years. Fortunately with our first franchisee, he is a really strong experience operator that's teaching us along the way while we are getting he and his partner off the ground.

Long term, our goal is not to operate, have two different operators under the same roof. Typically it will be either all company-owned stores if there is more than one or supporting a franchisee to have more than one operation in the airport. But more to come.

Unidentified Analyst

Thank you.

Operator

The next question comes from Ryan Lupin [ph]. Please go ahead.

Unidentified Analyst

Hi. Thanks for letting me ask one more. So what other services are you looking to add here at existing spas? Or what services would you consider eliminating? And are you comfortable now with your current product assortment?

Doug Satzman

So I think we are trying to do too many things and less is more, in my view. And the spa business is by far the biggest piece of our business, followed by nail service and facial. But we are doing care in a few spas. There is several one-off tests that are very common with a founder-led company for a long time, which XpresSpa was for most of its life as you test things and you get them going and then sometimes somebody never ends the tests. And you just have these legacy one-off things.

So part of what I am doing is cleaning up some of these one-off things that aren't scalable, aren't replicable or maybe even successful. At the same time, we are looking at bringing in innovation into the spas. So some of it might be very traditional things. Our facial business is growing. So, are there any up-and-coming cosmetic companies that can bring some new protocols and we can further accelerate my facial business.

The nail business is constantly innovating with new products and services. So we capitalized on the gel trend last year. Now a dip trend, which is another application process, is quite popular. So we are going to test our ability to execute that in a timely manner. So we are watching the nail business.

But more importantly, I am looking for innovation that will help me better leverage my labor. So I can have one technician supporting two, three desks at a time, that's much better. Right now, I have a very labor-intensive, somebody wants a service, I have somebody there to provide that service one-on-one. But as we find new products having more flexibility, being able to increase our throughput without adding more people every time we add another customer is hopefully something I will give it a test and then go live over time.

Thank you for that question.

Unidentified Analyst

Great. Thanks so much.

Operator

This concludes the question-and-answer session. I would now like to turn the conference back over to Mr. Doug Satzman for any closing remarks.

Doug Satzman

Okay. Well, I think we are done. Thank you very much for calling in and your interest in XpresSpa. I look forward to presenting again in one quarter from now. Have a great day.

Operator

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.