Xponential Fitness, Inc. (XPOF) Earnings Call Transcript & Summary

[Audio Gap] I'm very pleased to have Xponential Fitness with us here today, including John Meloun, Chief Financial Officer; and Andrea Mihic, VP of Corporate Development. Xponential Fitness is the largest provider of boutique fitness globally with 10 brands and over 3,000 studios open across multiple different modalities. I'm going to lead off with some questions and then open it up to Q&A for anyone that may have questions.

So, John and Andrea, thanks so much for joining us today. Just to start, it seems like at this point, the portfolio is pretty broad based with the recent Lindora acquisition. Can you just talk about how you're thinking about scaling your current brands versus another potential acquisition? And maybe talk to us about how you think the portfolio more broadly in potential divestitures as well?

Yes. So, when you think about the portfolio today, we have 10 brands. It's a mixture of different modalities. So they're very complementary brands like StretchLab, could be placed right next door to a CycleBar. Each of the brands was acquired at a different time. So they're kind of at a different scale as far as their maturity Club Pilates continues to grow. It was one of our fastest-growing brands. We opened the most amount of studios last year in 2023, a very similar kind of profile for 2024. That brand has still a healthy amount of domestic or North American growth lopped at it and has become more popular international. We mentioned a little bit, as a case study like Japan over the last couple of years is really starting to scale in Club Pilates. So when you look at each of the brands, they're each at kind of different spots of their growth profile. Brands like BFT and Rumble will make up a larger portions of our openings in 2024 than they did in '23 and even more in 2025. Lindora, recent acquisition. It's kind of our second time kind of more diversifying more into the wellness side from a portfolio perspective. That brand, you'll see very few openings this year because we're more in the sales kind of phase of that. So we typically, as we acquire a brand, you go into more of a sales kind of function for a while, selling licenses and then usually the following years when you start to see studios start to get open. So you kind of look at it in a staggering approach, and the intent of kind of the portfolio is to kind of continue to always extend your growth profile. So from our perspective, we have what we call scale brands, which we define as brands that have over 150 studios opened in North America, Club Pilates, StretchLab, Pure Barre, CycleBar and YogaSix fit that profile. Those are kind of at scale, but continuing to grow. And then we buy these younger brands with a much smaller sample of studios that are open, and those are intended to kind of seed future growth. And that's how we kind of look at the portfolio. Over time, if brands don't get the traction that they need just like a stock portfolio, we could divest them. And most recently, we announced the divestiture of Stride, just wasn't really resonating with consumers today. It doesn't mean it won't in the future, but at this point, we want to make sure we're very disciplined around our deploying capital. So [ reflective ]. You could think of us kind of acquiring about one brand every year. So obviously, Lindora was the beginning of this year, we're going to really focus on growing the assets we have [ or it can be next year ], potentially another brand if there's something that is of interest and fits the portfolio.

Yes. And that's a good segue. I just wanted to get you in and sort of accelerate you into that GLP-1 weight loss space. And then -- can you just maybe talk to us about the financial profile of Lindora, what are the AUV? We expect more wellness-focused concepts as the sort of next leg or growth for Xponential?

Yes, sure. I can take that. We were really excited about the health and wellness. Xponential, when they got started, it got incorporated as H&W Health and Wellness, right? So we always had that plan to do something in broader wellness and fitness because it's subject to corporate practice of medicine. So we wanted to make sure that we got that right. We spent probably about 18 months learning how to really get that set up. And so at the end of last year, we really felt ready to opportunistically act on Lindora. We really like Lindora, because even though, timing obviously was interesting, the latest development, medical developments in the weight loss space, but Lindora has been around since the 1970s, and it's done [ $900,000-plus ] AUVs well before the weight loss drugs came on the scene. So we view it as a broader distribution platform for that broader metabolic health. We think that, of course, today, there's going to be a lot of focus on weight loss drugs, but we think that it is that platform to service the consumer with whatever the latest technologies and developments are that people want to get exposed to. For Xponential, it's exciting because it really is a stronghold in that Wellness segment. And we think that off of that, we have lots more runway to add on more similar concepts.

It's really interesting. And you mentioned that [ registering $900,000 ] in AUVs before sort of the takeoff of the weight loss drugs. Maybe talk about how sort of the recent phenomenon and buzz around that sort of plays into Lindora and maybe what part of the offering of Lindora sort of fits that profile?

Yes, for sure. So consumers, we always think that health is a much broader conversation than, for example, just taking drugs, right? And that was part of Lindora's ethos from the very beginning. Some of the recent medical developments are very interesting because they can help the consumer get along that journey faster. But even today, right, it's early days, there's certainly research around how people thinking these drugs might have loss in muscle mass, right. So Lindora is very much focused on working with the consumer to have a broader conversation about health. Now of course, Lindora helps provide access to some of these like medical developments, but then at the same time, they -- it works on a membership model, so people come in, they get like, they can put on a broader plan, they get put on a broader weight loss plan, then there are also offers access to things like IV hydration therapy and hormone replacement therapy. So it's a lot broader than just taking drugs.

That's really helpful. And then maybe talk to us about how you're thinking more broadly, I think at the time of the IPO, you sort of mentioned the 6,900 total club opportunity in the U.S. You've sort of curated the portfolio a bit over the past few years. You acquired Lindora. Maybe talk to us about how you're thinking about that total store opportunity now? And then maybe if we isolate Lindora on the total studio opportunity for that brand?

Yes. So when we bought BFT and Rumble, and I think in the last Investor Day, we estimated that the TAM to be close to around 8,000 studios in North America or clinics, I guess we could call them studios and clinics in North America. But we swapped out Stride and put in Lindora. So we haven't got the TAM analysis back from Buxton Technologies. That kind of estimates it. One of the things that's very interesting about Lindora, though is it has a very similar overlap to Club Pilates and StretchLab from a core consumer perspective. So we do believe that the TAM with Lindora will be pretty healthy. So if you kind of take -- if [ we're at 8,000 ] with Stride, you take out Stride and you kind of swap in Lindora, it will probably end up somewhere in the same kind of general area as far as total potential. But given that Lindora and we're kind of nationally scaling that and there really isn't a lot of national competitors. I think when you look at that specific brand, there's a lot of more kind of regional marketed or DMAs where you have 10, 20, maybe of some sort of, call it, competitor, the fact that we'll be able to scale this nationally and provide more of a national brand. And I think you'll see a lot more potential from Lindora than some of these more regional ones. So 8,000 seems like kind of the right area today, but once we get that official analysis back from Buxton, we'll be able to provide that. And most likely, on the Q1 earnings call, we'll have that number.

Perfect. That's really helpful. And then can we just talk about AUVs for the broader portfolio a little bit. I think last quarter, run rate AUVs reached $590,000, where do you think that could ultimately go over time? And will you continue to see mixed benefits as you shift towards higher AUV concepts like Club Pilates, like Lindora?

Yes. I mean, AUVs when you look at it kind of last year and the year before, we're really pulled up by the success of brands like Club Pilates and StretchLab. Over time, Club Pilates will continue to grow. As I mentioned, Club Pilates and StretchLab will be the #1 and #2 openers in 2024. But you have brands like BFT and Rumble, who have greater than the average current AUV. So you have BFTs and Rumble [ $600,000, $700,000 ] kind of AUVs. As we get more and more of those open, they'll continue to keep dragging up the portfolio. Lindora is another one, as we open more Lindora's today, small sample set, there's 31 locations, but they're doing [ $900 to $1 million ]. So, if you fast forward 2 years and we start to see a real good volume of those opening, could that help pull it up? Yes, that's the expectation. Over time, what's the question around -- or what's the answer around how high these can go? It's really tough to say. I mean when you look at just the portfolio and kind of the histogram of where studios are performing, you're seeing in certain brands, studios get well over $1 million in AUVs and across like 5 or 6 of our brands. So you're seeing more and more increases in AUVs. I think you'll see in the near term, and in 2024 you'll definitely see AUVs crossed the [ $600,000 ] mark. As you start looking out to like 2026, a couple of years out, should they be pushing closer to [ $700,000 ] yes. You do have brands when you look at the portfolio, there's a mix of brands that performed very well. There's kind of your mid performers and then you have kind of your -- the lower performing brands. But you're seeing most of the openings coming from your higher performing brands. That's where the license sales are coming from. That's where the growth is really coming from. So it gives us a lot of optimism that AUVs will continue to climb over the coming years.

Perfect. And I wanted to talk about Club Pilates, specifically. So I think you gave sort of a deeper dive into the financial profile of some of the individual brands on the last earnings call, which is really helpful. I think Club Pilates accounted for 52% of system-wide sales, which sort of implies like 800-ish AUV per studio, including new studios that were open. Can you talk about the trends that you're seeing there? Do you continue to expect Club Pilates to generate positive same-store sales, including the cohorts of openings that were opened a longer time ago?

Yes. So on our last earnings call, we kind of double clicked a little bit on our brands, on our scale brands to kind of give an idea of where AUVs and how they performed over '23 our same store sales did. Club Pilates actually, their average AUV is in the 900,000 range. So it's actually performing very well. It was our best-performing brand when you look at it over the last couple of years since COVID. The brand is starting to normalize with the same-store sales. They were doing 20%-ish kind of range early on in 2023 and normalizing down into the mid-teens. I think Club Pilates and all our brands as they mature, I think getting to somewhere between mid- to high single-digit same-store sales is the right way to think about it. Club Pilates still is in the mid-teens as it kind of finished Q4. I think you'll see healthy same-store sales out of that brand. It's hard because when you deal with -- we just crossed over 1,000 openings in North America with Club Pilates. And as the base of studios continues to mature, you're not opening as much every year. So therefore, I think you'll see the maturing of Club Pilates get to that mid- to high single digits. So that's kind of where the portfolio was in general prior to COVID. So that's why I see it getting back to.

Yes. And if we take a brand like a Club Pilates that's more scale than as a sort of denser network, can you maybe talk to us about your sort of store opening strategy for a brand like Club Pilates when you put newer studios in existing markets, how do you see that affecting the current base? Or is that intentional because due to the demand that you have at those studios, you feel like it's prudent to open another store in that market?

Yes. So how we determine where to put a studio is really driven by data. So Buxton Technologies is the third-party data provider we use. And what they pretty much do is they look at a Club Pilates core customer. It's kind of like a credit check that they do on the core customer. They put it into their database, and they really extrapolate across the U.S. where they could -- where we could put flags in the ground based off of a certain concentration of that core customer. So today, it's probably -- when you look actually go back prior to when we first kind of created Xponential, the TAM for Club Pilates was much smaller. And as we've continued to open more studios and grow the brand, we continue to keep refreshing where we could put Club Pilates. We always want the studios to perform at least at a $500,000 design average unit volume. They're doing almost twice that today. So what that tells us is we can add more studios in certain markets. Now when you become a franchisee, you get a protected territory. So I can't come back to you later and put another Club Pilates in your projected territory. But what you start doing is a lot more infilling. And what we're able to see is even when we go back to Buxton Technologies and lower what they believe the expected AUV to be, so let's just say we go down to like [ 475 or 450 versus a design 500 ], we're still seeing those studios get open and are perform outperformed the $500,000. So every year, we'll continue to look at Club Pilates as a brand and continue to add or infill in various markets. One of the things that we're feeling very comfortable is we're not cannibalizing the other studios because you continue to see AUVs continue to grow. So we're not seeing a retreat in AUVs as we add more and more studios. So we just did that a couple of years ago where we went back and we looked at our market. We added another couple of hundred Club Pilates locations and put that off to the broker network, and they sell really quick because we offer them to our existing franchisees who are performing very well. They have good returns on their money. So they come and buy those up pretty quickly.

Yes. And can we maybe just talk about sort of the health of your core customer right now? I think there is some worry in the broader fitness industry about the consumer slowing in the sort of 1Q period, which I think is a pretty high-volume join period. Maybe just talk about how you're viewing the health of your customer and what you're sort of seeing?

Yes. We've been hearing about the macro headwinds and inflation and the impacts on health and wellness in headlines, but we've proven with our 2023 performance that it's just not showing up. I think there is a normalization post-COVID. I think when you look back to when gyms were closed and a lot of people went to either Peloton or in-home fitness for a year. So once gym started opening back up, you just saw this tied away with people that had just got reeducated on why it's important to be healthy. And you saw that show up in our numbers pretty quick. So you're seeing a little bit of normalization is what I think people are reacting to is getting back to what it was like pre-COVID. So typically, Q1 is where a lot of people kind of have their New Year's resolutions and they want to get healthy for the new year. And this year was a little bit lighter than last year and a little bit lighter than the year before. And really again, that's just a normalization from people kind of coming back from COVID, who are more timid or scared to want to get back into health and wellness. We're really not seeing any change in the way our consumers are using us. We typically sell -- 50% of the memberships that we sell are unlimited. 25% is on an 8x a month and 25% is on 4x a month. That kind of profile has stayed very much the same. So we're not seeing consumers use this any differently. We did see good same-store sales, good growth in Q4. It varies across our brands where we saw some brands kind of resurging. Q1 looks very much in line with what we expected, but it is just more of a normalization of COVID, not having anything to do with consumers getting weaker.

Yes. That's really helpful. And then on the last earnings call, you mentioned that 350 studios have crossed the [ $1 million mark at AUV ], just talk to us about which brands. I think you mentioned it a little bit already, but maybe just talk about which brands are seeing the heaviest concentration of 1 million-plus studios?

Yes. I mean it cost us a lot of our brands. Club Pilates is obviously -- it's just again, since COVID it's just performed exceptionally well. But you have it in StretchLab, you have it in CycleBar, you have it in Rumble's, BFT. So not just like one brand that's driving the entire top 10% performance across the brands that we continue to have more and more studios opening and the ones where we have plenty of white space to continue to grow. So going back to your AUV comment, where does this thing top off? Do I expect the entire portfolio to get to [ 1 million ]? Well, I hope so. But the reality is, it will continue to grow, but I don't expect all of our studios to perform at [ 1 million ]. But it is nice to see it showing up in a lot of the brands.

And maybe can you talk to us about the current health about the franchisee base in terms of profitability? What is sort of the average 4-wall margins for the franchisee base? What concepts are seeing the strongest profitability and what concepts are a bit more challenged?

Yes. So when I kind of touched on this a little bit earlier, when we design our studios and kind of what we would expect the 4-wall to be and where we kind of plant flags in the U.S., we wanted to be about a $500,000 AUV. That's the minimum kind of performance that we designed our studios for. And that should contribute around 25% to 30% margin. If you take a weighted average of all our brands, switch them together, that's kind of the expectation. So that provides a healthy amount of income to our franchisees to get a payback within a couple of years. So when you look at the 4-wall brands like Club Pilates, doing 900,000 are far exceeding that level of performance. Brands like StretchLab, very similar kind of above $590,000 AUV, different labor model, but for the most part, those brands are producing very high margins. The way to kind of think of what is the breakeven of the studio, it's very simple. This is kind of back of the napkin, but your rent is about $10,000 a month, your labor and these things is about $10,000 a month on average, and there's about $10,000 of other, which is like your royalty, your tech fee or marketing, all those kind of utilities, insurance, all that kind of stuff makes up the other [ $10,000 ], very rudimentary kind of way of blocking it. So it gets you to roughly $30,000 a month for a breakeven point. So we talked a lot about this in our Investor Day back in last September, kind of giving a breakdown. But it's about $30,000 a month. That's a semi-absentee model. A lot of our franchisees and brands like Pure Barre and CycleBar, they choose to be owner operator, which means they actually -- the franchisee works in their studio and that could actually reduce the breakeven point a little bit more because they take home their salary in the model -- or within the 4 walls. So you'll see brands with AUVs where franchisees run it more like a hobby versus a business. And you can see the breakeven point fall into like the mid- to high [ $200,000 ] kind of range. So a much lower breakeven point. And we see that in like brands like Pure Barre. That was kind of how the original franchisees were taught is like, hey, you're going to be a franchisee, and you're going to go work in your studio. So you could see the breakeven point on average [ 250 to kind of the 360 mark ]. If you're the semi-absentee is [ 360, the owner operator is 250 ]. Those are just very rough ranges. If you're in New York City, I could promise you, your breakeven point is not [ 250, because the rent ] cost is very expensive in New York City versus like Middle America, it's much cheaper. So you do get a little bit of a blend to the betting on the DMA. The brands that again have done really well from a profitability, obviously, Club Pilates, StretchLab. Rumble's had very early success. YogaSix, when you look at that brand, kind of the data we provided at our Investor Day, AUVs continue to grow, really strong same-store sales. Pure Barre same thing. The brands that are more challenged. CycleBar is one of the brands that post-COVID, it's at scale. I think cycling in general, became a little bit challenged. I think a lot of people went to cycling during COVID and got a got burnout from it. So we're looking to kind of do some more kind of rejuvenating that brand by adding some additional classes. AKT was -- it's a dance-based concept for us. That one's been a little bit challenged as far as getting AUVs where we want. A lot of people are probably more intimidated to be dancing in public. Stride was one of those brands where it kind of launched during COVID, really didn't get the traction. We gave it some time to kind of prevent and see if it got to the financial performance. We wanted, it didn't. We found a buyer for that brand. And just like any stock portfolio, you could sell off and buy and trade out brands as you see fit. So those are -- those are probably 3 that come to mind that are more challenged.

Yes. And so is it fair to say that as AUVs, if you're a current franchisee is AUV scale, your margin profile is just going to go up because it's a fairly fixed cost model. I guess that's the first part of the question. And then just within that labor component, $10,000 a month on average, are there certain brands where maybe like a StretchLab, for instance, that's a little bit higher and certain brands where maybe it's a little lower.

Yes. When you talk about -- answer the last question first, when you talk about kind of the 4-wall economic StretchLab is a different labor model because it is one-on-one stretching. So it does have a little bit more labor in the model. Lindora will likely be similar to that just because we have a higher priced labor inside the 4-wall because you're dealing with people who have to be certified in whatever medical practice that they'll be performing. So that will carry a little bit higher. But the other ones, the other -- most of the other brands that we have, like Club Pilates and YogaSix and Pure Barre, the labor model is cheaper. As brands scale, how it benefits the franchisee and the [ franchise or franchisee ] obviously, there's a fair amount of fixed cost with like rent and some of the marketing and some of the expenses as the AUVs continue to climb for the franchisee, they make more money. It's just the margins continue to expand. So when you see brands like Club Pilates at [ 900,000 ], they're doing far better than the 30%, kind of... So the [ franchisor ] one of the beautiful things about what we've done here is, so prior to coming over to Xponential, I was the CFO at The Joint Chiropractic and you had 1 brand, 1 back-office SG&A. So it was somewhat fixed. But when you kind of come over to Xponential, we have that same back-office SG&A, but we're doing it across 10 brands. So as AUVs continue to grow, they generate insist wide sales grows, you generate for royalties. You don't have to work harder for, say, system-wide sales that you generate. It just becomes virtually 100% margin flow-through line to the P&L. So when we talked on our Investor Day and kind of gave more of a longer-term view on the business, as our franchisees continue to become more profitable and seeing AUVs grow, the franchisor benefits from that. So you'll see -- and if you look back to kind of 2021 to 2023 and then where we're kind of going towards 2026, you'll see the margin expansion on the bottom line continue to grow. So when you sense in 2023, we guided the Street and you could see that, that margin profile gets us closer to [ 40% ]. I do believe that this business, by the time we get to 2026, you'll see adjusted EBITDA margins closer to 45%. We're on track to doing that. And as long as the -- we continue to open studios, continue to grow AUVs and control SG&A, the margin expansion will be there.

Perfect. That's a good segue into my next question where I wanted to talk a little bit sort of about that. And maybe just talk to us about what you're doing there. It seems like you're rightsizing the SG&A a bit. You're sort of winding down the transition studio model. Maybe talk to us about sort of the overall strategy there, how you see sort of the lease terminations playing out within SG&A low single-digit percent number as the right number of closures in a given year as we sort of move forward?

Yes. So one of the decisions we made, actually pretty early last year was -- the company has always taken the position that we will step in front of a studio that is challenged. So in essence, when a franchisee is not performing to the design unit economics -- [ for whatever or ] if life gets in the way we've had franchisees that had -- that have passed away or had these life-changing moments to worse moved out of market where they kind of decide here or here's the keys, and we would step in front of those studios. We've had a strategy of doing that. And the problem when you're smaller, it's a very easy and manageable way to be like, okay, I have a handful of studios that I'm going to take back. I'm going to kind of get them back in line with the model and how it should be operating, and then you refranchise and back out. Typically, when you get these studios back, it's all like the profitable, right? Usually, they're challenged for some reason. Post-COVID, what we did see happen is franchisees ran out of money, believe it or not, like some landlords did not give reprieve on things like rent and franchisees just simply ran out of money as their top line dipped during the COVID period. So there's about, I would call it less than 100 studios that we ended up taking back right after COVID, I think it was totally the right decision for the company to do that because there was a lot of people that really didn't understand how long was COVID going to last. [ Pick up in 2 weeks and another ] month, and it's just like, "Oh, my God". So for us to show confidence that, hey, listen, we're going to get through this. We took these studios back and we refranchised them. The challenge we had is some of these studios for whatever reason, maybe the strip setter they were in or the retail center they were in, maybe the major anchor lend bankrupt or left and foot traffic as an example, was down in that mall. The next question who kind of took over that studio was left with that challenge. So a lot of these studios coming back to us in 2022. In early 2023, me and Anthony had a lot of conversation around listen, as the business continues to get to 3,000, 4,000, 5,000 openings, our opening studios, does this make sense? And we both kind of said, I said no, like the SG&A will continue to -- even if the percent of studios stay constant, it's going to continue to bloom. So we made the decision last year, like, listen, let's get out of transition studios once and for all. Let's be 100% pure franchise play. And we said we're either going to refranchise or close all the transition studios that we owned last year, successfully navigated that. I think we have maybe 3 or 4 as of the last earnings call that we are working through. So we were able to significantly reduce our SG&A for 2020 -- going into 2024. Now restructuring because we exited a lot of studios, now we got to get out of the leases with these landlords. So there will be some cash usage in primarily in the first half of this year and break leases with these landlords and just get out of them all together. We view that as onetime for restructuring, for adjusted EBITDA purposes. So we'll add those costs back this year just get out of those. But it's the right thing to do as far as getting the resources of the company focused on the core business, which is franchising and not operating studio. So going forward, we will not take back any transition studios, and we'll focus purely on kind of moving our resources upstream to help franchisees out the moment we see performance, then hopefully, that will mitigate closures down the line. We don't have a historical trend of closures because we never really did that. So last year is not a good trend because it was just -- it was a forced decision that we made. I've said on prior calls, I don't really know exactly what the normal trend will be. My guess is like all franchises. When you kind of do your research, they're somewhere in the low single digits. So that's the best answer I can give you guys right now. Obviously, as we perform through Q1, our normal trend is. But when you look at the portfolio and how healthy of the [ 3,000, 1,000 ] of Club Pilates are doing really well. StretchLab makes up a big chunk. Pure Barre does really well. So we'll continue to evaluate closures and what it looks like. But I think the best answer I can give you right now is probably that...

The transformation efforts at a few of your brands. So Pure Barre specifically, I think that branded 15% same-store sales in 2023. Maybe just talk about what you sort of did there to generate those sort of same-store sales? And if you're going to maybe use that playbook on any of your other brands like a CycleBar for instance?

Yes. So Pure Barre exceptional performance, I mean that was a brand that we bought and there was almost 400 studios opened when we bought it. We continue to see good openings in that brand. And last year -- early last year, we introduced a weight class. So it's still a bar-based class, but it's introducing weights to the class. And it's done really, really well. It really resonated with that consumer base. So when you look at how it did last year, you have mid-teen same-store sales. When you asked earlier, like what are some of your challenged brands and one of the ones I mentioned was CycleBar, that is exactly -- that's the benefit of -- the beautiful thing about doing a portfolio is what you learn in one brand, and you can apply it towards the other. So CycleBar is getting a number of enhancements this year, including some of the media content within the studio as far as the music that they're playing, but they're also introducing weights to the CycleBar workouts as well. So early innings on that one, but it is something that we started introducing to kind of help that brand get AUVs growing, get a new interest in the type of classes being offered at the brand. And then also kind of reintroduce that next generation of people who are consumers that are entering kind of their fitness journey to be like, Oh, okay, this is cycling. I enjoy cycling, but they also have weights, let me give it a shot. So kind of peaked some more interest with the new class offerings.

Perfect. And just shifting gears a bit, I think one of the areas that's generated a decent amount of revenue and profit for you guys has been some of the B2B partnerships. Maybe just talk about sort of which partnerships you're seeing the most success with? And ultimately, how you're thinking about some of those B2B partnerships longer term?

Yes. So the B2B partnerships are meant to do a couple of things. One, they're supposed to help us drive leads into studios ultimately. So brands like Optum and Princess Cruise Lines. We're really trying to drive more leads into the brick-and-mortar studio, but we also have the opportunity because we are an omnichannel with our [ XPLUS ] the opportunity to drive leads into our digital platform as well. It's really hard to measure when you have a bunch of different touch points with our consumers, which one ultimately is the most successful. But I think the key to the B2B thing for us is create brand awareness. And we want to make sure everywhere a consumer goes, there's Xponential in their face or an Xponential brand in their face. So some things like Princess Cruise Lines, where you're on a cruise ship, you're going to capture an audience, you're going to the gym. You'll see an Xponential brand as we have our studios on the ship, [ they will be recycling ] on the boat, they go get on the beach. They have [ XPLUS ] in the state rooms. It's meant to really educate consumers who we are, and where we're at. So when they go back home, they walk -- they go grocery shopping. They see Pure Barre for an example, deal. Hopefully, they walk in. Other B2B partnerships like [ Celsius ], we sell inside our studio. So it's meant to really enhance kind of the wallet share within the studio for franchisees to sell Celsius as an energy drink in some of ours. Optum, from an insurance perspective, provides our franchisees consumers who can leverage using Optum, more their insurance to be able to take classes. So I think when you holistically, you look at the B2B, it's really meant to cast as wide of a net as possible using as many different vehicles or funnels to capture these leads. So for us, we continue to -- we have a department within the company that's continued to engage with different companies and to really kind of just drive more brand awareness, but also a revenue stream for us lululemon on retail, because we've got 3,000 locations, they partner with us to sell their retail and their studios. They now have 3,000 more store fronts for which they're distributing their product. So it's a great deal for them. It's a great deal for us, because they [indiscernible] more retail for which they make margin as well.

Perfect. And maybe can you talk about the impact of joining Gympass -- it feels like the visitation in AUVs from joining Gympass?

Yes. So Gympass, it's early days still. But I think with Gympass just like with our other partnerships, I think the thought there really is to have that conversation about increased utilization with the franchisees. And when you're thinking about the broader growth conversation in AUV and like where that can go, I think a lot of it comes down to increasing utilization in the classes because you have your [ members not broken ], but then you have a large, especially with brands like CycleBar in brands like a Rumble, you would have a lot of spots that go unused, right. So with Gympass, it's very interesting because they capture a different kind of consumer from our day-to-day member. In particular, they capture that like last -- it's not [ sort of booking window]. So people walk in at the last minute to fill any spots that otherwise will go unused. So Gympass is really interesting in that context. And obviously, Gympass, like right now, almost the entire model is very much B2B driven versus Gympass introduces that B2C relationship. So that's -- that's another avenue of growth that we haven't even started tapping. So it's very interesting for us in that context.

Perfect. That's really helpful. And then maybe just talk a little bit about free cash flow conversion. I think it's like 60% to 70% of EBITDA sort of generated free cash flow. Can you just talk about sort of the reason behind that? Is that due to the license sales and sort of the revenue recognition there?

Yes. So call people have asked, how are you thinking about free cash flow? I mean the 60% to 70% is taking your adjusted EBITDA and then giving benefit to interest and taxes are accounting for that as well. We have really low tax cash outflow because we do have some NOLs, assets that we're burning through over the next couple of years. But 60% to 70% of adjusted EBITDA will generate will translate into cash. Lease or license sales does help, yes. But really, what you're seeing is we have a pretty low CapEx budget. Every year, it's only about [ $10 million ]. It's really coming from the overall profitability of the business. Royalties, as you look at the -- that portion of our revenue stream and the mix royalties becomes the larger and larger portion of our revenues. So being that it's 100% margin. The significant amount of cash we're generating is coming from really a juicier revenue streams as we continue to see that move in -- gross profits move up into the right. So license sales absolutely do help with free cash flow, but you -- it's really the higher gross profit and better mix of margins we're getting on our revenue streams. SG&A, controlling SG&A is key for us, as I mentioned earlier. So as we continue to control SG&A, grow top line with healthier margins, it falls to the bottom line.

Perfect. And then my last question, I just want to talk about sort of capital allocation. Can you just maybe talk about what are your top priorities for capital allocation going forward?

Yes. I mean we've always been focused on growth. So that is always -- is going to be kind of first and foremost is making sure that we have sufficient cash on the balance sheet for M&A. We did our M&A this year. We'll probably opportunistically continue to evaluate opportunities and nurture them. But primarily, you won't see much M&A in 2024. We did announce on our last earnings call that as the company continues to generate excess capital from operations that we will look to potentially buy back stock if the valuations are right. We have the opportunity to pay down debt if we want to, but we do have some make-whole provisions in our existing term loans. So probably not the best use of cash if we're paying the interest anyway. So probably you're going to see M&A first, buyback of stock second, paying down debt third. And then lastly, I think as the business gets more mature, could we return capital back to shareholders through dividends? Yes. But I think that's really down the road.

Perfect. Well, that is all the time we have for today. I want to thank the Xponential Fitness team for joining us. So thanks again, everyone.

Thank you, guys.