Xponential Fitness, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto and the other financial information included elsewhere in this Quarterly Report on Form 10-Q. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in the section titled “Risk Factors.” Xponential Fitness LLC (the “Company”), the principal operating subsidiary of Xponential Fitness, Inc. (“XPO, Inc.”), is a curator of leading boutique fitness brands across multiple verticals. Our mission is to make highly specialized workouts in motivating, community-based environments accessible to everyone. Our diversified portfolio of brands spans a variety of popular fitness and wellness verticals, including Pilates, barre, cycling, rowing, yoga, running, stretch, dance and boxing. Collectively, our brands offer consumers engaging experiences that appeal to a broad range of ages, fitness levels and demographics. As of June 30, 2021, 1,824 studios were open, and franchisees were contractually committed to open an additional 1,509 studios in North America under existing franchise agreements on an adjusted basis to reflect historical information of the brands we have acquired. In addition, as of June 30, 2021, we had 15 studios open internationally, and our master franchisees were contractually obligated to sell licenses to franchisees to open an additional 738 new studios in nine countries. In 2020 and the six months ended June 30, 2021, we had no material revenue outside of the United States and no franchisee accounted for more than 5% of our revenue. We operate in one segment for financial reporting purposes. The COVID-19 Pandemic In March 2020, the World Health Organization declared COVID-19 a pandemic. By mid-March, the spread of COVID-19 significantly impacted the global economy, and prevented or restricted us and our employees, franchisees, members and suppliers from conducting business activities, as federal, state, local and foreign governments mandated stay-at-home orders, encouraged social distancing measures and implemented travel restrictions and prohibitions on non-essential activities and business. The COVID-19 pandemic adversely impacted our ability to generate revenue. A substantial portion of our revenue is derived from royalty fees, which were affected by the decline in system-wide sales as almost all of our franchised studios were temporarily closed beginning in mid-March 2020. New studio openings were also delayed. We also experienced a reduction in sales of new studio licenses and in installation of equipment in new studios. Additionally, we temporarily reduced our marketing fund fees from 2% to 1% of the sales of franchisees whose studios were closed due to the COVID-19 pandemic and related government mandates as part of our COVID-19 support response. In response to the COVID-19 outbreak, franchisees temporarily closed almost all studios system-wide in mid-March 2020, although substantially all of our franchised studios have resumed operations as of June 30, 2021. Certain studios have had to re-close or are operating subject to capacity restrictions, and additional studios may have to re-close or further reduce capacity, pursuant to local guidelines. We also experienced lower license sales and delays in new studios openings due to the COVID-19 pandemic. However, we have continued opening studios throughout the COVID-19 pandemic and franchisees have opened 310 studios from March 31, 2020 through June 30, 2021. Our proven operational model allowed us to provide robust support to franchisees during the COVID-19 pandemic and has led to no units permanently closed under our ownership. Even though studios were temporarily closed, franchisees maintained strong member loyalty, with many members maintaining actively paying accounts or putting their memberships “on hold.” Members who did not pay membership dues while “on hold” kept their agreements and maintained the ability to reactivate when studios reopened, mitigating high member cancellation rates. While studios were closed, we continued to generate revenue from franchise license and royalty payments as customers engaged with our digital platform services and purchased merchandise. We took significant action to support franchisees’ efforts to ensure they had access to resources that guided them on generating revenues and reducing operating costs, including a temporary reduction in marketing fund percentage collected. The adverse effects of the COVID-19 pandemic have gradually begun to decline in the first half of 2021, although, infection rates continue to fluctuate in various regions and new strains and variants of the virus, including the delta variant, remain a risk. In the second quarter of 2021 in particular, as vaccination rates have increased substantially in the United States and restrictions on indoor fitness classes in most states have either been reduced or eliminated, franchisees’ membership visits have increased. As of June 30, 2021, our franchisees recovered to approximately 103% of actively paying members, relative to January 31, 2020 membership levels and membership visits were at 98% relative to January 31, 2020 (excludes Rumble). As of June 30, 2021, run-rate Average Unit Volume (“AUV”) recovered to approximately 88% of January 31, 2020 levels (excludes Rumble). 21 As a result of the COVID-19 pandemic, we also took ownership of a number of studios. We are currently operating these studios while we actively seek to refranchise them, as operating company-owned studios is not a component of our business model. However, we may not be able to do so and we expect that if we have not been able to do so by December 31, 2021 we may choose to close most or all such studios to the extent they are not profitable at that time and would incur charges in connection therewith for asset impairment and lease termination, employee severance and related matters, which could adversely affect our business, results of operations, cash flows and financial condition . See Note 3 of Notes to Condensed Consolidated Financial Statements for additional information . The full extent of the future impact of the COVID-19 pandemic on our operational and financial performance is uncertain and will depend on many factors outside of our control, including, without limitation, the timing, extent, trajectory and duration of the pandemic; the availability, distribution and effectiveness of vaccines; the spread of new variants of COVID-19; the continued and renewed imposition of protective public safety measures; the impact of the pandemic on the fitness industry and responses from our franchisees to the pandemic. Although we have implemented measures to mitigate the impact of the COVID-19 pandemic on our business, we expect the pandemic to continue to adversely affect franchisees, at least through 2021, as well as our overall business, results of operations, cash flows and financial condition. Rumble Acquisition On March 24, 2021, H&W Franchise Holdings LLC entered into a contribution agreement with Rumble Holdings LLC, Rumble Parent LLC and Rumble Fitness LLC to acquire certain rights and intellectual property of Rumble Fitness LLC (“Rumble”), to be used by H&W Franchise Holdings LLC in connection with the franchise business under the “Rumble” trade name. Pursuant to this agreement, Rumble became a direct subsidiary of Rumble Parent LLC, which is owned by Rumble Holdings LLC, and H&W Franchise Holdings LLC acquired certain rights and intellectual property of Rumble Holdings LLC, which beneficially held all of the issued and outstanding membership interests of Rumble. As consideration, H&W Franchise Holdings, LLC (i) issued 39,540.5 Class A Units (equivalent to 1,300,033 shares of XPO, Inc. Class A common stock) to Rumble Holdings LLC, (ii) issued 61,573.5 Class A Units (equivalent to 2,024,446 shares of XPO, Inc. Class A common stock) to Rumble Holdings LLC, which are subject to vesting and forfeiture as provided in the contribution agreement and (iii) assumed and discharged any liabilities arising from and after the closing date under the assigned contracts and acquired assets. H&W Franchise Holdings, LLC then contributed the Rumble assets to H&W Intermediate Holdings, LLC, which then immediately contributed the Rumble assets to us. As a result of this transaction, Rumble became a holder of 5% or more of the equity interests of H&W Franchise Holdings LLC. Prior to the vesting and/or forfeiture of certain equity instruments issued to Rumble Holdings LLC, the instruments will be treated as a liability on our balance sheet instead of equity and will therefore be subject to a subsequent quarterly fair value remeasurement on a mark-to-market basis as a derivative liability. As a result, fluctuations in these quarterly liability valuations will impact our financial results following the initial public offering (“IPO”) in accordance with movements in our stock price, and the related valuation of the derivative liability that we will be required to make on a quarterly basis. Factors Affecting Our Results of Operations In addition to the impact of the COVID-19 pandemic as described above, we believe that the most significant factors affecting our results of operations include: • Licensing new qualified franchisees, selling additional licenses to existing franchisees and opening studios. Our growth depends upon our success in licensing new studios to new and existing franchisees. We believe our success in attracting new franchisees and attracting existing franchisees to invest in additional studios has resulted from our diverse offering of attractive brands, corporate level support, training provided to franchisees and the opportunity to realize attractive returns on their invested capital. We believe our significant investments in centralized systems and infrastructure help support new and existing franchisees. To continue to attract qualified new franchisees, sell additional studios to existing franchisees and assist franchisees in opening their studios, we plan to continue to invest in our brands to enable them to deliver positive consumer experiences and in our integrated services at the brand level to support franchisees. • Timing of studio openings. Our revenue growth depends to a significant extent on the number of studios that are open and operating. Many factors affect whether a new studio will be opened on time, if at all, including the availability and cost of financing, selection and availability of suitable studio locations, delays in hiring personnel as well as any delays in equipment delivery or installation. To the extent franchisees are unable to open new studios on the timeline we anticipate, or at all, we will not realize the revenue growth that we expect. We believe our investments in centralized systems and infrastructure, including real estate site selection, studio build-out and design assistance help enable franchisees to open studios in a timely manner, and we plan to continue to invest in our systems to continue to provide assistance during the opening process. 22 • Increasing same store sales. Our long-term revenue prospects are driven in part by franchisees’ ability to increase same store sales (discussed below) . Several factors affect our same store sales in any given period, including the number of stores that have been in operation for a significant period of time, growth in total memberships and marketing and promotional efforts. We expect to continue to seek to grow same store sales and AUVs by helping franchisees acquire new members, increase studio utilization and drive increased spend from consumers. We also intend to expand ancillary revenue streams, such as our digital platform offerings and retail merchandise. • International expansion. We continue to invest in increasing the number of franchisees outside of North America. We have developed strong relationships and executed committed development contracts with master franchisees to propel our international growth. We plan to continue to invest in these relationships and seek new relationships and opportunities in countries that we have targeted for expansion. • Consumer demand and competition for discretionary income . Our revenue and future success will depend in part on the attractiveness of our brands and the services provided by franchisees relative to other fitness and entertainment options available to consumers. Our franchisees’ AUVs are dependent upon the performance of studios and may be impacted by reduced capacity as a result of the COVID-19 pandemic. Macroeconomic factors generally, and economic factors affecting a particular geographic territory, may also increase competition for discretionary income, impact the returns generated by franchisees and therefore impact our operating results. Key Performance Indicators In addition to our financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), we regularly review the following key metrics to measure performance, identify trends, formulate financial projections, compensate our employees, and monitor our business. While we believe that these metrics are useful in evaluating our business, other companies may not use similar metrics or may not calculate similarly titled metrics in a consistent manner. The following table sets forth our key performance indicators for the three and six months ended June 30, 2021 and 2020: Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 ($ in thousands) System-wide sales $ 171,611 $ 61,492 $ 303,221 $ 221,515 Number of new studio openings in North America 59 56 112 112 Number of studios operating in North America (cumulative total as of period end) 1,824 1,583 1,824 1,583 Number of licenses sold in North America (cumulative total as of period end) 3,568 3,185 3,568 3,185 Number of licenses contractually obligated to be sold internationally (cumulative total as of period end) 738 547 738 547 AUV (LTM as of period end) $ 312 $ 371 $ 312 $ 371 Same store sales 129 % -58 % 22 % -29 % Adjusted EBITDA* $ 8,334 $ (3,073 ) $ 11,891 $ 5,010 *The definition of “Adjusted EBITDA” and a detailed reconciliation of Adjusted EBITDA is set forth below under the section entitled “Non-GAAP Financial Measures”. All metrics above, other than adjusted EBITDA, are presented on an adjusted basis to include historical information of Rumble prior to the acquisition by the Company in March 2021. All references to these metrics in this Form 10-Q use this same basis of reporting. System-Wide Sales System-wide sales represent gross sales by all studios. System-wide sales includes sales by franchisees that are not revenue realized by us in accordance with GAAP. While we do not record sales by franchisees as revenue, and such sales are not included in our consolidated financial statements, this operating metric relates to our revenue because we receive approximately 7% and 2% of the sales by franchisees as royalty revenue and marketing fee revenue, respectively. We believe that this operating measure aids in understanding how we derive our royalty revenue and marketing fee revenue and is important in evaluating our performance. System-wide sales growth is driven by new studio openings and increases in same store sales. Management reviews system-wide sales 23 monthly, which enables us to assess changes in our franchise revenue, overall studio performance, the health of our brands and the strength of our market position relative to competitors. Number of New Studio Openings The number of new studio openings reflects the number of studios opened in North America during a particular reporting period. We consider a new studio to be open once the studio begins offering classes. Opening new studios is an important part of our growth strategy. New studios may not generate material revenue in the early period following an opening and their revenue may not follow historical patterns. Management reviews the number of new studio openings in order to help forecast operating results and to monitor studio opening processes. Number of Studios Operating In addition to the number of new studios opened during a period, we track the number of total studios operating in North America at the end of a reporting period. We view this metric on a net basis to take account of any studios that may have closed during the reporting period. While nearly all our franchised studios are licensed to franchisees, from time to time we own and operate a limited number of studios (typically as we take possession of a studio following a franchisee ceasing to operate it and as we prepare it to be licensed to a new franchisee). Management reviews the number of studios operating at a given point in time in order to help forecast system-wide sales, franchise revenue and other revenue streams. Licenses Sold The number of licenses sold in North America and globally reflect the cumulative number of licenses sold by us (or, outside of North America, by our master franchisees), since inception through the date indicated. Licenses contractually obligated to open refer to licenses sold net of opened studios and terminations. Licenses contractually obligated to be sold internationally reflect the number of licenses that master franchisees are contractually obligated to sell to franchisees outside of North America under master franchise agreements. The number of licenses sold is a useful indicator of the number of studios that have opened and that are expected to open in the future, which management reviews in order to monitor and forecast our revenue streams. Of the franchisees that opened their first studio in 2019, on average it took approximately 12.2 months from signing the franchise agreement to open. Of the franchisees that opened their first studio in 2020, on average it took approximately 14.6 months from signing the franchise agreement to open. The length of time increased during 2020 due to COVID-related opening restrictions. Management also reviews the number of licenses sold in North America and the number of licenses contractually obligated to be sold internationally in order to help forecast studio growth and system-wide sales. Average Unit Volume AUV consists of the average sales for the trailing 12 calendar months for all studios in North America that have been open for at least 13 calendar months as of the measurement date. AUV is calculated by dividing sales during the applicable period for all studios being measured by the number of studios being measured. AUV growth is primarily driven by changes in same store sales and is also influenced by new studio openings. Management reviews AUV to assess studio economics. Same Store Sales Same store sales refer to period-over-period sales comparisons for the base of studios. We define the same store sales base to include studios in North America that have been open for at least 13 calendar months as of the measurement date. Any transfer of ownership of a studio does not affect this metric. We measure same store sales based solely upon monthly sales as reported by franchisees. This measure highlights the performance of existing studios, while excluding the impact of new studio openings. Management reviews same store sales to assess the health of the franchised studios. Non-GAAP Financial Measures In addition to our results determined in accordance with GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We use the following non-GAAP financial information to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively, is helpful to investors because it provides consistency and comparability with past financial performance. However, non-GAAP financial information is presented for supplemental informational purposes only, has limitations as an analytical tool, and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. In addition, other companies, including companies in our industry, may calculate similarly titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measure as tools for comparison. A 24 reconciliation is provided below for the non-GAAP financial measures to the most directly comparable financial measures stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of the non-GAAP financial measures to their most directly comparable GAAP financial measures and not rely on any single financial measure to evaluate our business. We believe that the non-GAAP financial measures presented below, when taken together with the corresponding GAAP financial measures, provides meaningful supplemental information regarding our performance by excluding certain items that may not be indicative of our business, results of operations or outlook. Adjusted EBITDA We define adjusted EBITDA as EBITDA (net income/loss before interest, taxes, depreciation and amortization), adjusted for the impact of certain non-cash and other items that we do not consider in our evaluation of ongoing operating performance. These items include equity-based compensation, acquisition and transaction expenses (income) (including change in contingent consideration), management fees and expenses (that will be discontinued after July 2021), integration and related expenses and litigation expenses (consisting of legal and related fees for specific proceedings that arise outside of the ordinary course of our business) that we do not believe reflect our underlying business performance and affect comparability. EBITDA and adjusted EBITDA are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We believe that adjusted EBITDA is an appropriate measure of operating performance because it eliminates the impact of expenses that we do not believe reflect our underlying business performance. We believe that adjusted EBITDA, viewed in addition to, and not in lieu of, our reported GAAP results, provides useful information to investors regarding our performance and overall results of operations because it eliminates the impact of other items that we believe reduce the comparability of our underlying core business performance from period to period and is therefore useful to our investors in comparing the core performance of our business from period to period. The following table presents a reconciliation of net loss, the most directly comparable financial measure calculated in accordance with GAAP, to adjusted EBITDA for the three and six months ended June 30, 2021 and 2020: Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 (in thousands) Net loss $ (8,001 ) $ (4,752 ) $ (12,751 ) $ (6,701 ) Interest expense, net 11,233 4,279 15,561 12,175 Income taxes 83 — 284 162 Depreciation and amortization 2,407 1,883 4,462 3,697 EBITDA 5,722 1,410 7,556 9,333 Equity-based compensation 449 447 671 865 Acquisition and transaction expenses (income) 297 (5,035 ) 647 (5,809 ) Management fees and expenses 207 194 399 414 Integration and related expenses — (89 ) — 207 Litigation expenses 1,659 — 2,618 — Adjusted EBITDA $ 8,334 $ (3,073 ) $ 11,891 $ 5,010 25 Results of Operations The following table presents our condensed consolidated results of operations for the three and six months ended June 30, 2021 and 2020. Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 (in thousands) Revenue, net: Franchise revenue $ 17,764 $ 8,984 $ 31,519 $ 23,831 Equipment revenue 4,755 5,159 8,821 11,894 Merchandise revenue 4,509 3,552 8,741 8,616 Franchise marketing fund revenue 3,314 737 5,797 3,434 Other service revenue 5,433 3,030 9,962 5,474 Total revenue, net 35,775 21,462 64,840 53,249 Operating costs and expenses: Costs of product revenue 6,274 6,781 11,618 14,879 Costs of franchise and service revenue 3,127 2,048 5,446 4,130 Selling, general and administrative expenses 21,202 15,437 37,804 27,310 Depreciation and amortization 2,407 1,883 4,462 3,697 Marketing fund expense 2,860 821 5,476 3,406 Acquisition and transaction expenses (income) 297 (5,035 ) 647 (5,809 ) Total operating costs and expenses 36,167 21,935 65,453 47,613 Operating income (loss) (392 ) (473 ) (613 ) 5,636 Other (income) expense: Interest income (358 ) (87 ) (453 ) (177 ) Interest expense 11,591 4,366 16,014 12,352 Gain on debt extinguishment (3,707 ) — (3,707 ) — Total other expense 7,526 4,279 11,854 12,175 Loss before income taxes (7,918 ) (4,752 ) (12,467 ) (6,539 ) Income taxes 83 — 284 162 Net loss $ (8,001 ) $ (4,752 ) $ (12,751 ) $ (6,701 ) 26 The following table presents our condensed consolidated results of operations for the three and six months ended June 30, 2021 and 2020 as a percentage of revenue: Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Revenue, net: Franchise revenue 50 % 42 % 49 % 45 % Equipment revenue 13 % 24 % 14 % 22 % Merchandise revenue 13 % 17 % 13 % 16 % Franchise marketing fund revenue 9 % 3 % 9 % 7 % Other service revenue 15 % 14 % 15 % 10 % Total revenue, net 100 % 100 % 100 % 100 % Operating costs and expenses: Costs of product revenue 18 % 32 % 18 % 28 % Costs of franchise and service revenue 9 % 10 % 8 % 8 % Selling, general and administrative expenses 59 % 72 % 58 % 51 % Depreciation and amortization 7 % 9 % 7 % 7 % Marketing fund expense 8 % 4 % 8 % 6 % Acquisition and transaction expenses (income) 1 % (23 )% 1 % (11 )% Total operating costs and expenses 101 % 102 % 101 % 89 % Operating income (loss) (1 )% (2 )% (1 )% 11 % Other (income) expense: Interest income (1 )% — % (1 )% — % Interest expense 32 % 20 % 25 % 23 % Gain on debt extinguishment (10 )% — % (6 )% — % Total other expense 21 % 20 % 18 % 23 % Loss before income taxes (22 )% (22 )% (19 )% (12 )% Income taxes — % — % — % — % Net loss (22 )% (22 )% (20 )% (13 )% Three Months Ended June 30, 2021 versus 2020 The following is a discussion of our consolidated results of operations for the three months ended June 30, 2021 versus the three months ended June 30, 2020. Revenue Three Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Franchise revenue $ 17,764 $ 8,984 $ 8,780 97.7 % Equipment revenue 4,755 5,159 (404 ) (7.8 )% Merchandise revenue 4,509 3,552 957 26.9 % Franchise marketing fund revenue 3,314 737 2,577 349.7 % Other service revenue 5,433 3,030 2,403 79.3 % Total revenue, net $ 35,775 $ 21,462 $ 14,313 66.7 % Total revenue. Total revenue was $35.8 million in the three months ended June 30, 2021, compared to $21.5 million in the three months ended June 30, 2020, an increase of $14.3 million, or 66.7%. The increase in total revenue was primarily due to an increase in franchise revenue, franchise marketing fund revenue and other service revenue attributable to reopening of studios that were temporarily closed in 2020 due to the COVID-19 pandemic and to opening of new studios in 2021. Franchise revenue. Franchise revenue was $17.8 million in the three months ended June 30, 2021, compared to $9.0 million in the three months ended June 30, 2020, an increase of $8.8 million, or 97.7%. Franchise revenue consisted of franchise royalty fees of $11.1 million, training fees of $1.7 million, franchise territory fees of $3.4 million and technology fees of $1.6 million in the three 27 months ended June 30, 2021, compared to franchise royalty fees of $ 4.1 million, training fees of $ 1.3 million, franchise territory fees of $ 2.6 million and technology fees of $ 1.0 million in the three months ended June 30, 2020. The in crease in franchise royalty fees , technology fees and training fees was primarily due to a 129 % in crease in same store sales due in large part to temporary studio closures as a result of the COVID-19 pandemic in the prior year period , and to 241 new studio openings in North America since June 30, 2020, which also contributed to the increase in franchise territory fees. Equipment revenue. Equipment revenue was $4.8 million in the three months ended June 30, 2021, compared to $5.2 million in the three months ended June 30, 2020, a decrease of $0.4 million, or 7.8%. Most equipment revenue is recognized in the period that the equipment is installed. Equipment installations in the three months ended June 30, 2021 totaled 53 compared to 63 in the prior year period. In the three months ended June 30, 2020, a larger number of equipment installations occurred than studio openings, as studio openings for which equipment installations occurred in March were delayed due to the impact of COVID-19. Merchandise revenue. Merchandise revenue was $4.5 million in the three months ended June 30, 2021, compared to $3.6 million in the three months ended June 30, 2020, an increase of $0.9 million, or 27.0%. The increase was due primarily to a higher number of operating studios in the current year period and temporary closures of studios in the prior year period. Franchise marketing fund revenue. Franchise marketing fund revenue was $3.3 million in the three months ended June 30, 2021, compared to $0.7 million in the three months ended June 30, 2020, an increase of $2.6 million, or 349.9%. The increase was primarily due to an increase in same store sales, 241 new studio openings in North America since June 30, 2020 and a temporary reduction in the marketing fund percentage collected from 2% to 1% of the sales of franchisees whose studios were closed due to the COVID-19 pandemic in 2020. Other service revenue. Other service revenue was $5.4 million in the three months ended June 30, 2021, compared to $3.0 million in the three months ended June 30, 2020, an increase of $2.4 million, or 79.3%. The increase was primarily due to a $1.9 million increase in revenue from company-owned studios and a $1.1 million increase in other preferred vendor commission revenue, partially offset by a $0.7 million decrease in our digital platform revenue. Operating Costs and Expenses Three Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Costs of product revenue $ 6,274 $ 6,781 $ (507 ) (7.5 )% Costs of franchise and service revenue 3,127 2,048 1,079 52.7 % Selling, general and administrative expenses 21,202 15,437 5,765 37.3 % Depreciation and amortization 2,407 1,883 524 27.8 % Marketing fund expense 2,860 821 2,039 248.4 % Acquisition and transaction expenses (income) 297 (5,035 ) 5,332 (105.9 )% Total operating costs and expenses $ 36,167 $ 21,935 $ 14,232 64.9 % Costs of product revenue. Costs of product revenue was $6.3 million in the three months ended June 30, 2021, compared to $6.8 million in the three months ended June 30, 2020, a decrease of $0.5 million, or 7.5%. The decrease was due to a decrease in equipment revenue in 2021 and to a higher percentage of non-branded merchandise revenue in 2021 for which the company earns a commission with no corresponding cost of revenue. Costs of franchise and service revenue. Costs of franchise and service revenue was $3.1 million in the three months ended June 30, 2021, compared to $2.0 million in the three months ended June 30, 2020, an increase of $1.1 million, or 52.7%. The increase was primarily due to an increase in costs related to technology fee revenue, consistent with the related revenue increase. Selling, general and administrative expenses. Selling, general and administrative expenses were $21.2 million in the three months ended June 30, 2021, compared to $15.4 million in the three months ended June 30, 2020, an increase of $5.8 million, or 37.3%. The increase was primarily attributable to an increase in salaries and wages and occupancy expenses of $4.0 million and $1.1 million, respectively, primarily related to the increase in number of company-owned studios; $1.9 million increase in legal expenses, primarily related to litigation with the seller of AKT Franchise, LLC (“AKT”); and net increases in other variable expenses of $2.2 million; partially offset by a reduction in bad debt expense of $3.4 million. 28 Depreciation and amortization. Depreciation and amortization expense was $ 2.4 million in the three months ended June 30, 2021, compared to $ 1.9 million in the three months ended June 30, 2020, an increase of $ 0.5 million, or 27.8 %. The increase was due primarily to an increase in assets related to company-owned studios and intangibles related to the Rumble acquisition in March 2021 . Marketing fund expense. Marketing fund expense was $2.9 million in the three months ended June 30, 2021 compared to $0.8 million in the three months ended June 30, 2020, an increase of $2.0 million, or 248.4% and is consistent with the increase in franchise marketing fund revenue. Acquisition and transaction expenses (income). Acquisition and transaction expenses (income) were $0.3 million in the three months ended June 30, 2021, compared to ($5.0) million in the three months ended June 30, 2020, a change of $5.3 million, or 105.9%. These expenses (income) represent the non-cash change in contingent consideration related to 2017 and 2018 business acquisitions and $0.1 million of expense in 2021 related to the acquisition of Rumble. Other (Income) Expense, net Three Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Interest income $ (358 ) $ (87 ) $ (271 ) 311.5 % Interest expense 11,591 4,366 7,225 165.5 % Gain on debt extinguishment (3,707 ) — (3,707 ) NA Total other expense, net $ 7,526 $ 4,279 $ 3,247 75.9 % Interest income. Interest income primarily consists of interest on notes receivable and was insignificant in each of the three-month periods ended June 30, 2021 and 2020. Interest expense . Interest expense was $11.6 million in the three months ended June 30, 2021, compared to $4.4 million in the three months ended June 30, 2020, an increase of $7.2 million, or 165.5%. Interest expense consists of interest on notes payable and long-term debt, accretion of earn-out liabilities and amortization of deferred loan costs. The increase was due primarily to write off of $5.0 million of deferred loan costs and $1.9 million prepayment penalty incurred in the three months ended June 30, 2021, related to our credit agreement with Cerberus Business Finance Agency, LLC, which was replaced with a new credit facility in April 2021. Gain on debt extinguishment. Gain on debt extinguishment of $3.7 million in the three months ended June 30, 2021 represents the forgiveness of principal and interest on our Paycheck Protection Program loan (described herein). Income Taxes Three Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Income taxes $ 83 $ — $ 83 NA Income taxes . Income taxes were insignificant in each of the three-month periods ended June 30, 2021 and 2020. Six Months Ended June 30, 2021 versus 2020 The following is a discussion of our consolidated results of operations for the six months ended June 30, 2021 versus the six months ended June 30, 2020. 29 Revenue Six Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Franchise revenue $ 31,519 $ 23,831 $ 7,688 32.3 % Equipment revenue 8,821 11,894 (3,073 ) (25.8 )% Merchandise revenue 8,741 8,616 125 1.5 % Franchise marketing fund revenue 5,797 3,434 2,363 68.8 % Other service revenue 9,962 5,474 4,488 82.0 % Total revenue, net $ 64,840 $ 53,249 $ 11,591 21.8 % Total revenue. Total revenue was $64.8 million in the six months ended June 30, 2021, compared to $53.2 million in the six months ended June 30, 2020, an increase of $11.6 million, or 21.8%. The increase in total revenue was primarily due to an increase in franchise revenue, franchise marketing fund revenue and other service revenue attributable to reopening of studios that were temporarily closed in 2020 due to the COVID-19 pandemic, partially offset by a decrease in equipment revenue. Franchise revenue. Franchise revenue was $31.5 million in the six months ended June 30, 2021, compared to $23.8 million in the six months ended June 30, 2020, an increase of $7.7 million, or 32.3%. Franchise revenue consisted of franchise royalty fees of $19.6 million, training fees of $3.1 million, franchise territory fees of $6.0 million and technology fees of $2.8 million in the six months ended June 30, 2021, compared to franchise royalty fees of $14.1 million, training fees of $3.2 million, franchise territory fees of $4.9 million and technology fees of $1.7 million in the six months ended June 30, 2020. The increase in franchise royalty fees was primarily due to a 22% increase in same store sales due in large part to temporary studio closures as a result of the COVID-19 pandemic in the prior year period, and to 241 new studio openings in North America since June 30, 2020, which also contributed to the increase in franchise territory fees and technology fees. Equipment revenue. Equipment revenue was $8.8 million in the six months ended June 30, 2021, compared to $11.9 million in the six months ended June 30, 2020, a decrease of $3.1 million, or 25.8%. Most equipment revenue is recognized in the period that the equipment is installed. Equipment installations in the first half of 2021 totaled 100 compared to 136 in the first half of 2020. In the six months ended June 30, 2020, a larger number of equipment installations occurred than studio openings, as studio openings for which equipment installations occurred in the first half of 2020 were delayed due to the impact of COVID-19. Merchandise revenue. Merchandise revenue was $8.7 million in the six months ended June 30, 2021, compared to $8.6 million in the six months ended June 30, 2020, an increase of $0.1 million, or 1.5%. The increase was due primarily to a higher number of operating studios in the current year period and temporary closures of studios in the prior year period. Franchise marketing fund revenue. Franchise marketing fund revenue was $5.8 million in the six months ended June 30, 2021, compared to $3.4 million in the six months ended June 30, 2020, an increase of $2.4 million, or 68.8%. The increase was primarily due to an increase in same store sales, 241 new studio openings in North America since June 30, 2020 and to a temporary reduction in the marketing fund percentage collected from 2% to 1% of the sales of franchisees whose studios were closed due to the COVID-19 pandemic in 2020. Other service revenue. Other service revenue was $10.0 million in the six months ended June 30, 2021, compared to $5.5 million in the six months ended June 30, 2020, an increase of $4.5 million, or 82.0%. The increase was primarily due to a $3.2 million increase in revenue from company-owned studios and a $1.7 million increase in other preferred vendor commission revenue, partially offset by a $0.4 million decrease in our digital platform revenue. 30 Operating Costs and Expenses Six Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Costs of product revenue $ 11,618 $ 14,879 $ (3,261 ) (21.9 )% Costs of franchise and service revenue 5,446 4,130 1,316 31.9 % Selling, general and administrative expenses 37,804 27,310 10,494 38.4 % Depreciation and amortization 4,462 3,697 765 20.7 % Marketing fund expense 5,476 3,406 2,070 60.8 % Acquisition and transaction expenses (income) 647 (5,809 ) 6,456 (111.1 )% Total operating costs and expenses $ 65,453 $ 47,613 $ 17,840 37.5 % Costs of product revenue. Costs of product revenue was $11.6 million in the six months ended June 30, 2021, compared to $14.9 million in the six months ended June 30, 2020, a decrease of $3.3 million, or 21.9%. The decrease was due to a decrease in equipment revenue in 2021 and to a higher percentage of non-branded merchandise revenue in 2021 for which the company earns a commission with no corresponding cost of revenue Costs of franchise and service revenue. Costs of franchise and service revenue was $5.4 million in the six months ended June 30, 2021, compared to $4.1 million in the six months ended June 30, 2020, an increase of $1.3 million, or 31.9%. The increase was primarily due to an increase in costs related to technology fee revenue, consistent with the related revenue increase. Selling, general and administrative expenses. Selling, general and administrative expenses were $37.8 million in the six months ended June 30, 2021, compared to $27.3 million in the six months ended June 30, 2020, an increase of $10.5 million, or 38.4%. The increase was primarily attributable to an increase in salaries and wages and occupancy expenses of $5.9 million and $2.4 million, respectively, primarily related to the increase in number of company-owned studios; $2.7 million increase in legal expenses, primarily related to litigation with the AKT seller; $2.0 million reduction in settlement income recognized in 2020 and net increases of $1.0 million in other variable expenses in 2021, partially offset by a reduction in bad debt expense of $3.5 million. Depreciation and amortization. Depreciation and amortization expense was $4.5 million in the six months ended June 30, 2021, compared to $3.7 million in the six months ended June 30, 2020, an increase of $0.8 million, or 20.7%. The increase was due primarily to an increase in assets related to company-owned studios and intangibles related to the Rumble acquisition in March 2021. Marketing fund expense. Marketing fund expense was $5.5 million in the six months ended June 30, 2021, compared to $3.4 million in the six months ended June 30, 2020 and is consistent with the increase in franchise marketing fund revenue. Acquisition and transaction expenses (income). Acquisition and transaction expenses (income) were $0.6 million in the six months ended June 30, 2021, compared to ($5.8) million in the six months ended June 30, 2020, a change of $6.5 million, or 111.1%. These expenses (income) represent the non-cash change in contingent consideration related to 2017 and 2018 business acquisitions and $0.3 million of expense in 2021 related to the acquisition of Rumble. Other (Income) Expense, net Six Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Interest income $ (453 ) $ (177 ) $ (276 ) 155.9 % Interest expense 16,014 12,352 3,662 29.6 % Gain on debt extinguishment (3,707 ) — (3,707 ) NA Total other expense, net $ 11,854 $ 12,175 $ (321 ) (2.6 )% Interest income. Interest income primarily consists of interest on notes receivable and was insignificant in each of the six-month periods ended June 30, 2021 and 2020. 31 Interest expense . Interest expense was $ 16.0 million in the six months ended June 30, 2021, compared to $ 12.4 million in the six months ended June 30, 2020, a n in crease of $ 3.7 million, or 29.6 %. Interest expense consists of interest on notes payable and long-term debt, accretion of earn-out liabilities and amortization of deferred loan costs. The in crease was due primarily to write off of $ 5.0 million of deferred loan costs and $1.9 million prepayment penalty incurred in the three months ended June 30, 202 1, related to our credit agreement with Cerberus Business Finance Agency, LLC , which was replaced with a new credit facility in April 2021, compared to $1.5 million of prepayment and other penalties incurred in the six months ended June 30, 2020 and a write off of $ 1.8 million of deferred loan costs related to our credit agreement with Monroe Capital Management Advisors, LLC, which was replaced with a new credit facility in March 2020. Gain on debt extinguishment. Gain on debt extinguishment of $3.7 million in the six months ended June 30, 2021 represents the forgiveness of principal and interest on our PPP Loan. Income Taxes Six Months Ended June 30, 2021 2020 Change from Prior Year Percent Change from Prior Year ($ in thousands) Income taxes $ 284 $ 162 $ 122 75.3 % Income taxes . Income taxes were insignificant in each of the six-month periods ended June 30, 2021 and 2020. Liquidity and Capital Resources As of June 30, 2021, we had $18.9 million of cash and cash equivalents, excluding $1.3 million of restricted cash for marketing fund purposes. We require cash principally to fund day-to-day operations, finance capital investments, service our outstanding debt and address our working capital needs. Based on our current level of operations and anticipated growth, we believe that our available cash balance and the cash generated from our operations will be adequate to meet our anticipated debt service requirements and obligations under our tax receivable agreement, capital expenditures, payment of tax distributions and working capital needs for at least the next twelve months. Our ability to continue to fund these items and continue to reduce debt could be adversely affected by the occurrence of any of the events described under “Risk Factors.” There can be no assurance, however, that our business will generate sufficient cash flows from operations or that future borrowings will be available under our credit facility or otherwise to enable us to service our indebtedness, including our credit facility, or to make anticipated capital expenditures. Our future operating performance and our ability to service, extend or refinance the credit facility will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. Initial Public Offering On July 27, 2021, XPO, Inc. completed an initial public offering (“IPO”) of 10,000,000 shares of Class A common stock at a price to the public of $12.00 per share. After underwriter discounts and commissions, we received net proceeds from the IPO of approximately $111.9 million, before deduction of offering expenses. Also on July 27, 2021, we issued and sold 200,000 shares of Convertible Preferred for aggregate cash proceeds of $200 million, before deduction of offering costs. Holders of Convertible Preferred shares are entitled to quarterly coupon payments at the rate of 6.50% of the fixed liquidation preference per share, initially $1,000 per share. In the event the quarterly preferential coupon is not paid in cash, the fixed liquidation preference automatically increases at the PIK rate of 7.50%. The Convertible Preferred has an initial conversion price equal to $14.40 per share and is mandatorily convertible under certain circumstances and redeemable at the option of the holder beginning on the date that is eight years from the IPO or upon change of control. The issuance of Convertible Preferred shares and Class A common stock by us and the related net proceeds were recorded in the consolidated financial statements on July 27, 2021, the closing date of the IPO. In August 2021, XPO, Inc. sold 904,000 shares of Class A common stock to the underwriters pursuant to the underwriter’s option to purchase additional shares. After underwriter discounts and commissions, we received net proceeds of approximately $10.1 million on August 24, 2021, and we expect to use (i) $9.0 million to purchase 750,000 LLC Units from our Chief Executive Officer and (ii) $1.1 million for working capital. 32 Credit Facility On April 19, 2021, we entered into a Financing Agreement with Wilmington Trust, National Association, as administrative agent and collateral agent, and MSD XPO Partners, LLC, MSD PCOF Partners XXXIX, LLC and DESALKIV Cayman C-2, Ltd. (f/k/a DELALV Cayman C-2, Ltd.) as the lenders (the “Credit Agreement”), which consists of a $212 million senior secured term loan facility (the “Term Loan Facility”, and the loans thereunder, the “Term Loan”). Affiliates of MSD XPO Partners, LLC, MSD PCOF Partners XXXIX, LLC and DESALKIV Cayman C-2, Ltd. (f/k/a DELALV Cayman C-2, Ltd.) (collectively, the “Preferred Investors”) also separately purchased 200,000 shares of our 6.50% Series A Convertible Preferred Stock (the “Series A Convertible preferred stock”) for $200 million. Our obligations under the Credit Agreement are guaranteed by Xponential Intermediate Holdings, LLC and certain of our material subsidiaries, and are secured by substantially all of the assets of Xponential Intermediate Holdings, LLC and certain of our material subsidiaries. Under the Credit Agreement, we are required to make: (i) monthly payments of interest on the Term Loan and (ii) quarterly principal payments equal to 0.25% of the original principal amount of the Term Loan. Borrowings under the Term Loan Facility bear interest at a per annum rate of, at our option, either (a) the LIBOR Rate (as defined in the Credit Agreement) plus a margin of 6.50% or (b) the Reference Rate (as defined in the Credit Agreement) plus a margin of 5.50% (7.5% at June 30, 2021). The Credit Agreement also contains mandatory prepayments of the Term Loan with: (i) 50% of Xponential Intermediate Holdings, LLC and its subsidiaries’ Excess Cash Flow (as defined in the Credit Agreement), subject to certain exceptions; (ii) 100% of the net proceeds of certain asset sales and insurance/condemnation events, subject to reinvestment rights and certain other exceptions; (iii) 100% of the net proceeds of certain extraordinary receipts, subject to reinvestment rights and certain other exceptions; (iv) 100% of the net proceeds of any incurrence of debt, excluding certain permitted debt issuances; and (v) up to $60 million of net proceeds in connection with an initial public offering of at least $200 million, subject to certain exceptions. All voluntary prepayments and certain mandatory prepayments of the Term Loan made (i) on or prior to the first anniversary of the closing date are subject to a 2.00% premium on the principal amount of such prepayment and (ii) after the first anniversary of the closing date and on or prior to the second anniversary of the closing date are subject to a 0.50% premium on the principal amount of such prepayment. Otherwise, the Term Loan may be paid without premium or penalty, other than customary breakage costs with respect to LIBOR Rate Term Loan. The Credit Agreement contains customary affirmative and negative covenants, including, among other things: (i) to maintain certain total leverage ratios, liquidity levels and EBITDA levels (in each case, as discussed further in the Credit Agreement); (ii) to use the proceeds of borrowings only for certain specified purposes; (iii) to refrain from entering into certain agreements outside of the ordinary course of business, including with respect to consolidation or mergers; (iv) restricting further indebtedness or liens; (v) restricting certain transactions with our affiliates; (vi) restricting investments; (vii) restricting prepayments of subordinated indebtedness; (viii) restricting certain payments, including certain payments to our affiliates or equity holders and distributions to equity holders; and (ix) restricting the issuance of equity. As of June 30, 2021, we were in compliance with these covenants. The Credit Agreement also contains customary events of default, which could result in acceleration of amounts due under the Credit Agreement. Such events of default include, subject to the grace periods specified therein, our failure to pay principal or interest when due, our failure to satisfy or comply with covenants, a change of control, the imposition of certain judgments and the invalidation of liens we have granted. The proceeds of the Term Loan were used to repay principal, interest and fees outstanding under our prior financing agreement (including a prepayment penalty of approximately $1.9 million) and for working capital and other corporate purposes. Principal payments of the Term Loan of $0.53 million are due quarterly. Outstanding borrowings on the Term Loan were $211.5 million at June 30, 2021. Immediately following the IPO, on July 27, 2021 we paid off $115.0 million of the principal balance of the Term Loan, resulting in an outstanding balance of $96.5 million. PPP Loan In April 2020, we entered into a promissory note with Citizens Business Bank under the Paycheck Protection Program of the CARES Act pursuant to which Citizens Business Bank agreed to make a loan to us in the amount of approximately $3.7 million (the “PPP Loan”). The PPP Loan matures in April 2022, bears interest at a rate of 1.0% per annum and requires no payments during the first 16 months from the date of the loan. On June 10, 2021, we were notified that the U.S. Small Business Administration (the “SBA”) had forgiven the PPP Loan in full. 33 Contractual Obligations As a result of entering into the Credit Agreement and forgiveness of the PPP Loan our commitments for payment of debt principal have increased from $186.9 at March 31, 2021 to $211.5 million at June 30, 2021. Following partial pay off of term loans under the Credit Agreement using proceeds from the initial public offering of 10,000,000 shares of our Class A common stock in July 2021 (the “IPO”) and the sale of 200,000 shares of our Series A Convertible preferred stock in a private placement our commitments for payment of debt principal decreased to $98.1 million as of July 31, 2021. Cash Flows The following table presents summary audited cash flow information for the six months ended June 30, 2021 and 2020: Six Months Ended June 30, 2021 2020 (in thousands) Net cash provided by (used in) operating activities $ 510 $ (5,364 ) Net cash provided by (used in) investing activities (2,113 ) (2,221 ) Net cash provided by (used in) financing activities 10,507 11,137 Net increase in cash, cash equivalents and restricted cash $ 8,904 $ 3,552 Cash Flows from Operating Activities In the six months ended June 30, 2021, cash provided by operating activities was $0.5 million, compared to cash used of $5.4 million in the six months ended June 30, 2020, an increase in cash provided of $5.9 million. Of the change, ($2.7) million was due to a higher net loss adjusted for non-cash items. This amount was more than offset by the following changes in cash flows from operating assets and liabilities: • accounts payable, accrued expenses and other liabilities increased $3.9 million due to timing of payments; • deferred revenue increased $9.1 million due to an increase in sales of additional franchises; • current assets, excluding deferred costs, decreased $4.4 million due primarily to a decrease in accounts receivable and prepaid expenses and other current assets, partially offset by increases in inventories and notes receivable; and • deferred costs increased $0.2 million due to an increase in sales of additional franchises. Cash Flows from Investing Activities In the six months ended June 30, 2021, cash used in investing activities was $2.1 million, compared to $2.2 million in the six months ended June 30, 2020, a decrease of $0.1 million. The decrease was primarily attributable to an increase in cash received from collection of notes receivable, a decrease in cash used to purchase studios and a decrease in cash used to fund notes receivable, partially offset by an increase in cash used to purchase property and equipment. Cash Flows from Financing Activities In the six months ended June 30, 2021, cash provided by financing activities was $10.5 million, compared to $11.1 million in the six months ended June 30, 2020, a decrease in cash provided of $0.6 million. The decrease was primarily attributable to a decrease in net borrowings on our line of credit and long-term debt of $19.3 million, a decrease in member contributions of $17.3 million and a decrease in net receipts from member of $30.3 million, partially offset by decreases in distributions to member of $62.6 million and in payment of debt issuance costs of $4.1 million. Off-Balance Sheet Arrangements As of June 30, 2021, we did not have any off-balance sheet arrangements as defined in the rules and regulations of the Securities and Exchange Commission (the “SEC”). Critical Accounting Policies and Estimates There have been no significant changes to our critical accounting policies as disclosed in the final prospectus filed in connection with the IPO on July 26, 2021. 34