Greetings and welcome to the Xponential Fitness, Inc. Third Quarter 2024 Earnings Conference Call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to Avery Wannemacher, Investor Relations. Please go ahead, Avery.

Thank you, operator. Good afternoon and thank you all for joining our conference call to discuss Xponential Fitness third quarter 2024 financial results. I am joined by Mark King, Chief Executive Officer; and John Meloun, Chief Financial Officer. Sarah Luna, President, will also be available for questions. A recording of this call will be posted in the Investors section of our website at investor.xponential.com. We remind you that during this conference call, we will make certain forward-looking statements, including discussions of our business outlook and financial projections. These forward-looking statements are based on management's current expectations and involve risks and uncertainties that could cause our actual results to differ materially from such expectations. For a more detailed description of these risks and uncertainties, please refer to our recent and subsequent filings with the SEC. We assume no obligation to update the information provided on today's call. In addition, we will be discussing certain non-GAAP financial measures in this conference call. We use non-GAAP measures because we believe they provide useful information about our operating performance that should be considered by investors in conjunction with the GAAP measures that we provide. A reconciliation of these non-GAAP measures to comparable GAAP measures is included in the earnings release that was issued earlier today prior to this call. Please note that all numbers reported in today's prepared remarks refer to global figures, unless otherwise noted. As a reminder, in order to ensure period-over-period comparability and consistent with our reporting methods since IPO, we present all KPIs on a fully pro forma basis, meaning for the full KPI history presented, we only include brands that are under our ownership as of the current reporting period. For the period ended September 30th, 2024, this includes AKT, BFT, Club Pilates, CycleBar, Lindora, Pure Barre, Rumble, StretchLab and YogaSix. I will now turn the call over to Mark King, CEO of Xponential Fitness.

Thank you, Avery, and good afternoon to all of you. I'm excited to speak with you today and share some updates from my first 100-plus days as CEO of Xponential. I want to start with what's great about Xponential, but I also want to talk about some of the challenges we're facing. So let's get started with what's going well. My 3 key takeaways are the following. First and perhaps most importantly, people really love what Xponential offers. On one level, that's self-evident from the growth in our membership base and total studio visits. But I'm beginning to appreciate just how integral our health and wellness experiences are to our members' weekly routines. Second, our domestic and international growth have been terrific. And as we'll discuss in more detail, I think I probably underestimated the extent of the future opportunity. Third, my feelings haven't changed at all about this 100 days in. This is just a great business model. Once we've worked through some of the challenges I'm going to discuss, I expect our business to become highly profitable and cash generative at scale. I pride myself on being candid, so let me be equally clear about some of the challenges we're facing, many of which are commonly faced by companies experiencing rapid growth. Challenge number one is infrastructure and processes. When companies grow very quickly, it's hard for these things to keep pace. In order to achieve sustainable, profitable growth, we must implement the infrastructure and processes needed to adequately support our franchisees and studios at scale. Challenge number 2 is fostering a culture that is conducive to long-term success. At Xponential, this means shifting from a sales-first to a marketing and operations-driven culture that places franchisees' success at the center. One of the main reasons we were so…

Thanks, Mark, and thank you to everyone for joining the call. I'll begin with an overview of our third quarter results. North America run rate average unit volumes of $631,000 in the third quarter increased 8% from $585,000 in the prior year period. As we'll discuss next quarter in more detail when we provide our annual brand level KPIs, the increase in AUVs was predominantly driven by the sales growth at our scaled brands. AUV growth has been driven by a higher number of actively paying members and the continued favorable trend of proportionate studio openings coming from our scaled brands. We ended the third quarter with 3,178 global open studios, opening 125 gross new studios during Q3 with 96 in North America and 29 internationally. There were 49 global studio closures in the period. On our previous call, we estimated closures in the range of 3% to 5% of the global system and are trending to come in at the higher end of the range for this year. In future years, we do expect a number of closures as a percentage of the global system to decrease from the current level. We sold 84 licenses globally in the third quarter, which trended lower due to lingering concerns in the franchise sales process around regulatory issues, personnel turnover in our franchise sales team and the culture shift that Mark spoke to earlier. Despite these hurdles, we still have over 1,700 licenses sold and contractually obligated to open in North America, plus an additional over 1,000 master franchise obligations internationally. This backlog of already sold licenses will provide a sufficient funnel of future new studio openings globally for the next few years. Third quarter North American system-wide sales of $431.2 million were up 21% year-over-year, with growth driven primarily by 5%…

[Operator Instructions] Our first question today is coming from Randy Konik from Jefferies.

Mark, I really appreciate the thoughtfulness in the approach going forward. I guess you mentioned -- you talked a little bit about the potential to divest certain concepts or some concepts or whatever, if we're not meeting hurdles. Maybe give us some perspective on maybe some of the qualitative or quantitative factors you're thinking about in assessing that decision across those different -- across these concepts. And maybe give us a little bit more thought around potential timing of making a decision on that -- across those different concepts.

Thanks, Randy. First of all, I think having been here now just a little over 120 days, or right around 120 days, I'm getting really much more familiar with the brands. We like all of the brands. We like them strategically. We like the potential of those brands. I guess my comment was more around we're going to spend 2025 investing in different brands in different ways than we have in the past. We want to give every brand a chance to gain some momentum. And I think the way we evaluate that will be on a couple of fronts. Are the studios profitable for franchisees, which will result in us selling license and opening brands? If we start to see momentum in brands or continued momentum in brands, we wouldn't divest anything. So short term, there's no plan to divest any of our brands other than go into our planning process, which we're in right now, looking at next year, where we want to invest. And each year, we'll make that evaluation based on performance during the year.

Great. Last question would be around your focus on bringing up the country of Japan. Maybe kind of elaborate a little bit more on why you brought that up as an example for international expansion as a focus. Just what kind of makes it special from your perspective, obviously from the golf days, but as it relates to the fitness industry? And just maybe elaborate on other countries you may have in focus beyond Japan.

Well, thanks for the question. It's really based on the momentum that we have. So the biggest territory we have today is Australia. They have approximately 240 studios that are open. Japan would be #2 with 75 studios that are open. And the success there is really very positive. So there's a lot of positive momentum. We have good partners in those countries. And we just signed a deal recently in Mexico for Club Pilates for a master franchise deal for 50 locations. So I think there's a couple of keys to the expansion. One is the size of the potential market, and then the other is the strength of the franchisee, the potential master franchisee. They have to be well capitalized. They have to be in the local market. They have to have local talent. So we have others like Singapore is doing very well. New Zealand's doing very well. So it's really a combination of does the market have decent potential, and what would that be? I would say it's 100-plus studios. Does it have the potential for that? And if it does, then can we find the right franchise partner in those markets.

Next question is coming from John Heinbockel from Guggenheim Partners.

Mark, let me start with when you think about sort of execution, and I know it'll vary across brands, but when you look at that, because I know you sort of talked about the operational playbook. How would you assess the consistency of your execution? And do you have a view on franchisee consolidation, right, meaning -- I'm sure you're going to say that the guys that are operating 1 or 2 or 3 can do so well. Do you think the business would benefit from some consolidation over time or no?

I don't -- I actually don't know if it would benefit from consolidation. I'm still evaluating all of that and looking at it. I think the first thing that we need to do is really evolve the way we think about franchisees. And as we do that, we'll look at these different brands, and we'll evaluate how we make them grow. And also the starting point to your first question is, I think the execution across the brands is a little bit different. Some Club Pilates, for example, has excellent execution. Some of the smaller brands does not. I now have the 7 of the 8 brand presidents are reporting to me. I've spent countless hours this week already talking about standardizing some things across all of the platforms, all of the brands and creating this playbook that all the tabs will be the same in the playbooks, but the execution or the nuance will be dependent on the brand. I think we have to go through -- and the brand presidents are very excited about really standardizing best practices, so we have better execution. Because I don't think we can really evaluate the brands until we have consistent execution across them. So that's my focus right now. And I've jumped in myself to help drive that process.

Maybe as a follow-up to that, right. When you think about sort of operational performance, I mean, obviously the AUVs are good, but they're partly driven by a couple of brands. So when you think about member experience versus franchisee experience, right, where is -- so is there a good member experience in a lot of places, but it's not -- it should be, but it's not translating into ease of use or profitability for the franchisees? How do you look at that between the member experience and the franchisee experience?

Well, they're obviously both very, very important. And for me, the focus is on looking at the entire experience both for the franchisees starting out, opening up. My belief is we should give more support upfront so that they get out of the gates in a more positive way, because we can really track. If franchisees start in a bad way, it's very difficult for them to overcome that. So I want to put the emphasis on preselling, opening, having the right economics, looking at all the buildout costs, looking at our vendor selection. I think that's really, really important. On the member experience, I think when you get actually into the studio and you do your exercising, I think we do pretty well there. I think the improvement opportunity is in the entire member journey from the first time we make contact with them, leading up to when they come into the studio and when they leave the studio. And the more we get to know them, the more we know why they exercise, what other modalities are they interested in, can we really curate specific customized programs for our consumers. Now that's down the road a little bit, but that's the ambition. So I think it's a holistic look at both the franchisee experience and the member experiencee.

Next question is coming from Joe Altobello from Raymond James.

So I guess first question, Mark. Earlier you mentioned the need for infrastructure and processes to support growth. Does that require meaningful spending? And is the outlook still 45% or so EBITDA margins by 2026? Does that impact that?

Well, I'll let John comment on the EBITDA margin in 2026. I don't believe the infrastructure and processes is a very expensive evolution. I think it's around discipline. I think it's around people wanting to have an infrastructure that's efficient and effective. I think we do that internally by looking at -- so for example, I'm starting to have all of the job descriptions looked at. Like what exactly is your job and how do you perform it and how can we perform it in a more efficient way. I think the data warehouse is going to give us a lot of data that we don't have today in real time that will allow us to look at our efficiencies and how do we structure the infrastructure. Processes is around disciplined management. It's not really about money investment. So I'm really comfortable. I think people are asking for that because with this hyper focus on growth, which has been fantastic, a lot of the jobs are very chaotic. And it's really a lot of in the moment reaction to things that happen without really building the proper infrastructure. So I think the company is very -- they're embracing it, they're looking forward to it, and we'll engage everyone in helping us in that process.

Yes. And Joe, just to kind of add, irrespective of everything that's going on, it should be assumed that the performance in 2025 will be better than 2024. And the assumption around 2026 should be the same, that it will build off of 2025. Today, as we go through the AOP process, and as Mark addresses what investments are needed to execute on the 5 pillars, there are a lot of moving parts right now to optimize the future of the business, noting that all the work that we are going to do is really from the perspective of protecting and growing that underlying business. The investments that we do make in the short term, the expectation is that they will generate better than the status quo or improved ROI benefits. There will be probably some short-term investments that may cause the SG&A to increase slightly now, but the efficiencies that we gain should improve it over the long term, so into 2026. So I do think the 45% that we talked about is a very doable target still, but I want to be prudent about not completely committing to that right now until we go through this AOP process. So again, just going back to that, I do believe that the benefits of these investments will have better than today's return on investment, so it should get us relatively within those ballparks of a 45% adjusted EBITDA margin. I just can't commit to that until we finish the AOP process. And we'll have a lot more to talk about that on our Q4 earnings call.

Okay. Understood. And just a follow-up on that. In terms of the 500 or so openings you've got planned for this year, can you roughly break that down by brand? I mean how much are Pilates and StretchLab, for example?

Yes. I think as you saw, 2/3 of the openings in Q3 were Pilates and StretchLabs. That should be the same assumption for the fourth quarter. And as you look into 2025, that's where the growth is coming from. I mean you'll see roughly 2/3 of the growth really coming from those brands. Body Fit Training and YogaSix are the 2, I would say, next in line as far as volume of openings that will make up the lion's share of that last 1/3. So those are the 4. Now BFT is largely going to be an international growth story in the near term. YogaSix, Club Pilates and StretchLab will primarily be the domestic growth story. But that's -- those are the 4 areas that you'll see a lot of the growth in 2025.

Next question today is coming from Chris O'Cull from Stifel.

Mark, I know the company hasn't had many levers to drive comp sales in the past, and I'm glad to hear you're obviously planning to address that issue. But can you talk about what can be done in the near term to support sales trends at the concepts that may be experiencing decelerating trends?

Well, we'll be able to answer that a lot better in -- at the next call because we've challenged all the brand presidents to put together their plan for 2025 and how they want to drive business, drive same-store sales, drive profitability. But short of that, I would say it really needs to be a focus on the member. That's really the -- short term, that's the answer here. So we're looking at how we spend our money. For example, we spend $1,500 a month in the local market, and how are we spending that and how are we helping the franchisee maximize the benefit of that in their market. And we'll do that one franchisee at a time by the brand teams in the different brands. So to answer your question today, the best I can give you is it's a member-focused approach. The next earnings call, we could be more specific by brand, actually, and what are we going to do to drive business in 2025.

And then just, John, I apologize if I missed this, but can you provide some more information about the $10 million litigation expense and whether a portion or even all of it is going to be expected to be reimbursed?

Yes. So we have about a $7.5 million retainer on our D&O policy. We have cash outflowed that to date or through the third quarter. In the process of working with the carriers to get some of that reimbursed. Going forward, all the legal costs will be -- or I guess I'd say the legal costs related to this regulatory defense will come back in the return -- or in part related to our D&O, so the D&O will cover it. So the cash outflow should be pretty minimal. You'll see the expense show up in the P&L until we actually receive the cash in hand back from the carriers. But at this point, most of the legal costs should be capped from a cash outflow, and the P&L should show very little of this because it will be reimbursed to the company.

Next question is coming from Jonathan Komp from Baird.

Can I just follow up on the closures? Could I -- and maybe if you could clarify the expectation for the fourth quarter? And then just more broadly, what's your handle on the current state of the units that are open and the time line or sort of comfort that the closure rate will start to lessen here at some point?

Yes. The closures in Q3 were 49, so they were down from Q2. I think Q2 was the high point, given there was mostly a lot of backlog from the prior year shift in strategy, Jonathan. So from that perspective, Q4 I expect to be, I would say, in line to lower than Q3 as we kind of work through a little bit of the tennis ball and the snake on that shift in strategy from 2023. As you move into 2025, I want to make sure it's very clear. I said the estimated closure rate we would expect to see is around 3% to 5%. Really meant that was for 2024. As the system continues to grow and the effectiveness of the management and supporting franchisees and just kind of the tail of the strategy shift from 2023 plays through, you should see a much lower percent of total system closures in 2025 and beyond. So we expect to be at the high end of the range this year. In 2025, I expect that percent to decline to something much smaller. So ideally, we'd love to be in that 1% to 2% range. I think that's pretty normal for most franchisees. We got some work to do, but I do believe that in 2025, that'll be lower than the 5%.

Okay. Sorry, just to clarify, John. Do you think you could get to 1% to 2% in 2025, or is 3% to 5% still the range to expect in 2025?

Yes. Yes, I mean at the end of the day, I think 3% is a good aspirational goal to show progress there, but 1% to 2% is obviously what we ultimately want to get back to. So short answer, yes. I mean, 3% is probably a good, safe assumption.

Okay. Great. And then maybe a broader question just on appetite for new openings from franchisees, as you clearly are working on putting new processes and new programs in place here. Are there any gaps in sort of the short-term appetite for openings as we think forward to 2025? Or what sort of visibility do you have today?

Good vis -- I mean we've always had good visibility into our openings. I mean the key for us is we are very involved in the lease signing upfront with franchisees and supporting them through that process. So as the lease signing pipeline stays healthy, then it makes it really easy for us domestically to be able to predict approximately 6 months or so from the time they get their lease signed when they'll approximately get opened. So we do have good visibility into that. For us, even in 2024, we do want to be very careful about making sure franchisees are launching, as Mark mentioned earlier on his earlier comments, successfully. So making sure that prior to opening, they get up to the right pre-membership counts, they have the right training, the right staffing, everything is in place, so when they do launch, they start strong. And typically when you see that, that studio performs very well. So we will be very careful about 2025 and not overcommitting on openings and making sure that it's more about the franchisee launching successfully. So as part of our AOP process, we'll be doing that on a brand-by-brand basis and assessing which franchisees and when. But yes, I think the total openings for next year, right now we've talked about 500 a year. It's a doable number. But we'll provide more comments around that when we get to our Q4 earnings call as what we think is the right range based off of the studios or the brands that are performing and the volume openings, we have in regards to line of sight in 2025.

Okay. And sorry, just last one for me. On the full year revenue guidance for 2024, the implied range for Q4 is pretty wide. And I guess I'm asking the low end of the implied range would imply a sequential revenue decline, which would be a bit unusual. So just any further color on the expectations in Q4 and any directional color within the range since you reiterated the annual guidance?

Yes, it is a wide range, but the expectation is sequentially, it will be an increase in Q4, because our visibility right now shows us within the goalpost there that we didn't move the guidance at all. But the expectation around Q4 will be that, one, Jonathan, we have a lot of openings coming in the fourth quarter. So you're going to benefit from a lot of equipment revenue in the fourth quarter. We do get additional revenue related to our franchisee conference that happens in the fourth quarter. So you get an extra $3 million there in rebates. Obviously, there's $5 million of additional costs, but you get the revenue benefit. So assumption fourth quarter should be sequentially growing revenue, but within the range of the guidance that we provided.

Next question is coming from J.P. Wollam from ROTH Capital Partners.

Maybe if we could just start first, I want to kind of touch on sort of customer and some of the purchasing patterns. It sounds like maybe the merchandise sell-through is still a challenge. But could you just share a little bit more in terms of the mix of class packs versus actual subscriptions and just if you're seeing any changes in terms of spending trends there? Or just anything else you might want to point out in terms of the customer.

Yes. In regards to what we sell to the end consumer, we haven't seen really any shift there. The majority of our members are on the unlimited with about 50%, and then the 8 packs and 4 packs are split 25% and 25%. We do sell single base, whether it's walk-in or classes, but the majority of our system is on a membership base. In regards to the sales within the studio and talking about retail, we have seen, as we mentioned on our Q2 call, a decline in retail sales. We do believe it's more of a function of what we had in the warehouse and what we were selling. There could be some elements around consumers just tightening their purchases within the studio, but it's too early to tell given kind of the inventory situation that we talked about in Q2. We do expect that to get better, obviously, with the processes and the improvements we're going to make around our retail and our supply chain. But for the fourth quarter, for Q3, I think they'll look largely the same as far as kind of the performance of retail sales in the studio.

Okay. That's very helpful. And then if I could, just in terms of new units, I don't know -- maybe I missed. But just the lower guide there, is there anything that we should be taking away about the current development environment and whether there's anything to read through in terms of 2025?

No, I don't think there's anything to read into the shift in the guidance. I mean the reason we pulled back guidance is exactly what we talk about in regards to the pillars is the franchisee first. We have the ability to pull in openings -- accelerate buildouts, pull in openings, but then what that means is the franchisee has less time to acquire members prior to opening. And we're not going to do that in the fourth quarter. We're going to let the organic opening of the studio happen the way it should. Therefore, given that, we said let's just be prudent and pull down the expectations around the full year openings now, and then we'll just continue to execute. So 500 openings is still in play for sure. It's just we're not going to put pressure on the system to try and pull in openings at the sacrifice of franchisees not being ready.

Next question is coming from Richard Magnusen from B. Riley Securities.

You mentioned that you weren't going to make any divestitures, I believe. But in the time that you've been there, what modalities or concepts do you feel strongest about? And are there any that you feel that might be weak or ultimately not such a good match for the company's goals going forward?

I think strategically they make sense, because if you look at how they all go together, even CycleBar, which has struggled post-COVID, still is a modality that I can't see us not being in as if we're a fitness company. The new openings of CycleBar are actually doing quite well. So we're going to look at each one all the time. We're going to make the proper investment. I like the lineup today. So today, we're not thinking about a divestiture. We're thinking about how do we get the brands that aren't really -- that don't have much momentum, how do we build that momentum. And that's really the plan at this point, Richard.

Okay. And then kind of related to that, I think you may have addressed a little bit about potential acquisitions, but do you see some opportunities to change like modalities or even adjacencies that are a little different that you may want to acquire and move into? For example, StretchLabs is a little bit different, but it seems to fit very well. Do you have -- what can you say about that type of concept?

I would say this, Richard. I think one of the things I really want to embed here is innovation, new ideas and different thinking. And I think everything is on the table. And I've challenged all the brand presidents and their teams to be thinking differently. Is there a way to put 2 brands together? Is there a way to cross-sell? Just I want everything on the table to be thinking about how do we continue to grow each of these brands and Xponential. And if it benefits the franchisee and the model -- the result of the model, is you have franchisees that are making money, there's going to be organic growth and people are going to want to do it. So I'm not ruling anything out. I think we have a great starting point from the 8 brands that we have today, and I think the future is really bright for all of them. That's where I sit today.

Next question today is coming from Korinne Wolfmeyer from Piper Sandler.

Could you provide a little bit of color on general membership and visitation trends as the quarter progressed, and then into the early parts of Q4, what you saw, just to give us a little bit more comfort around the general macro state of the business? And then separately, as we think about some of the unit openings heading into the, I guess, next couple of quarters and years, obviously Club Pilates and StretchLab are very heavy. But what are you doing to encourage franchisees to try and open or want to open some of the smaller brands? What kind of processes and motivations do you have in place for that?

Do you want me to take the member one first? Korinne, I'll do the member one first. As far as the macro, yes, not seeing any variation there. When you look at the total members through Q3 on the average per studio, it's actually in line and slightly growing. So the macro hasn't had an impact on our system. I think, again, when you look at fitness, it's one of these things that people just don't trade off as part of their daily lifestyles due to the cost of other things in their life. So the membership growth has remained constant on the average per studio. Now obviously brands like Club Pilates, they have an oversized impact on that given their size. But across the board, you are seeing growth in members for the most part. The total member count is a function of the fact that we just continue to open more studios, Therefore, you get the volume impact, as we talked on the call, 94% of the -- or excuse me, 96% of the growth in system-wide sales came from volume. So we are bringing more members into the system. We are seeing overall higher member counts per studio through the third quarter. Briefly got a view of that for the fourth quarter, and October results look relatively consistent with what I just kind of talked about in Q3. So not seeing the macro impacts in our business, and that aligns with what we said on previous quarters as well.

Korinne, I'll comment on franchisees by brand. We've -- we're changing the license sales team, and we're bringing in new people. But we're also going to make a nuanced shift there, which is I want the brand presidents to own their own development. Because rather than just have a licensed sales team that's going to sell the hottest brands, we really need to be putting together plans by brand that help drive development for their brands. And that's a different way of doing it than we have in the past. And I do think that will really be able to have brands speak specifically to a potential franchisee on why he or she might want to be in that brand. So I think it will help all of the smaller brands sell more licenses and open. It's all contingent on profitability in the model, which is part of this. So we're looking at all of the elements from the brands on how can we reduce cost, find members, more effective marketing spend. Because my experience is this in the franchise world. If franchisees are making money that they expected, they are going to organically grow. And that is the long-term vision for this is franchisee profitability, a lot of help to get up and started and along the way, and see more organic growth. We'll always be selling through the open market. That's not something we're going to stop. But that's really going to be the focus.

We have reached the end of our question-and-answer session. I'd like to turn the floor back over to Mark for any further or closing comments.

Thank you. Hey, everyone, I want to thank you again for joining the call today. We look forward to seeing many of you and franchises -- franchisees at our annual convention in Las Vegas in December. This will be a great opportunity to get everyone in the same place and continue building our vision together. This will be my first convention with the group, and I'm really looking forward to it. We also plan to meet with many of you at upcoming investor meetings and conferences, and we are planning to host an Investor Day sometime mid-2025. We'll continue to communicate more details on this event as we get closer to the date. And again, thank you for joining.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.