UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2018

OR

For the transition period from ____  to ____

Commission File Number: 001-38151

YogaWorks, Inc.

(Exact Name of Registrant as Specified in its Charter)

5780 Uplander Way

Culver City, CA 90230

(Address of principal executive offices)

Registrant’s telephone number, including area code: (310) 664-6470

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☑    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☑    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☑

As of July 31, 2018, the registrant had 16,466,526 shares of common stock, $0.001 par value per share, outstanding.

Table of Contents

YogaWorks, Inc.

Condensed Consolidated Balance Sheets (Unaudited)

See accompanying notes to condensed consolidated financial statements.  

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YogaWorks, Inc.

Condensed Consolidated Statements of Operations (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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YogaWorks, Inc.

Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)

See accompanying notes to condensed consolidated financial statements.

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YogaWorks, Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

See accompanying notes to condensed consolidated financial statements.  

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YogaWorks, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

1.Organization and Basis of Presentation

General

YogaWorks, Inc., a Delaware corporation, and its wholly-owned subsidiary Yoga Works, Inc., a California corporation (together referred to as “we”, “us”, “our”, and the “Company”), are primarily engaged in operating yoga studios. YogaWorks, Inc. was formerly known as YWX Holdings, Inc. and we changed our name to YogaWorks, Inc. on April 10, 2017. We operate under the brand names YogaWorks, Yoga Tree and certain other local brands for a period of time following the acquisition of studios. We primarily offer yoga classes, workshops, teacher training programs and yoga-related retail merchandise across our studios. In addition to our studio locations, we offer online yoga instruction and programming through our MyYogaWorks.com web platform, which provides subscribers with a highly curated library of over 1,100 yoga classes.

Initial Public Offering

On August 16, 2017, we completed our initial public offering (“IPO”) whereby we sold 7,300,000 shares of our common stock (“Common Stock”) registered at a price of $5.50 per share. Our shares of our Common Stock are traded on the NASDAQ Global Market. We received proceeds from our IPO of $37.6 million after deducting underwriters' discounts and commissions of $2.5 million, but before deducting offering costs of $2.6 million. Certain IPO-related costs of $5.1 million were recorded as a reduction to additional paid-in capital in 2017.

Markets

We operate in regional markets across the United States (“U.S.”). As a result of the clustering of our studios in key geographic markets, and the flexibility offered to students to use different studios in a regional market, we do not report net revenues on an individual studio basis or report same studio sales. We prefer to analyze financial results on a regional market basis. Given the focus on acquisitions, we may acquire studios in an existing regional market to capture more regional market share, which may take some market share from our existing studios.

As of June 30, 2018, we owned and operated 71 yoga studios in nine regional markets. The following table illustrates the studio locations by regional market:

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We operate in a number of regional operating segments; however, we meet the aggregation criteria of Accounting Standards Codification (“ASC”) 280, Segment Reporting, and therefore report as one reportable segment. Our chief executive officer, who is our chief operating decision maker, determines our strategy and makes operating decisions for our regional operating segments, and assesses performance and allocates resources based on performance of our regional operating segments. We derive revenue from the sale of yoga classes, workshops, teacher training programs and yoga-related retail merchandise.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, normal recurring adjustments considered necessary for a fair presentation have been reflected in these condensed consolidated financial statements.

The consolidated balance sheet as of December 31, 2017 has been derived from the audited financial statements for the fiscal year then ended included in our Annual Report on Form 10-K filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended, on April 3, 2018 (the “10-K”), but does not include all of the information and notes required by GAAP for complete financial statements. The financial information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements as of and for the fiscal year ended December 31, 2017 and the related notes thereto included in the 10-K.

There have been no significant changes in our accounting policies from those disclosed in the 10-K.

2.Recent Accounting Pronouncements

Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have availed ourselves of this exemption from new or revised accounting standards. The effective dates of the recent accounting pronouncements noted below reflect the private company transition date.

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-07, Compensation – Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this ASU provide guidance on accounting for share-based payment transactions for acquiring goods and services from nonemployees. This ASU is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. We are evaluating the impact of implementing this update on our consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. The amendments in this ASU will provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This ASU was effective for fiscal years beginning after December 15, 2017. We adopted this ASU as of January 1, 2018 noting no material impact to the consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments in this ASU provide a robust framework to use in determining when a set of assets and activities is a business. This ASU is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted and the standard should be applied prospectively. We early adopted this ASU as of January 9, 2018 and this standard was applied on all acquisitions during the second quarter of 2018 (See Note 3).

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update provides guidance on classification for cash receipts and payments related to eight specific issues. The update is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We are evaluating the impact of implementing this update on our consolidated financial statements.

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In March 2016, the FASB issued ASU 2016-04, Liabilities – Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products. This update addresses the current and potential future diversity in practice related to the derecognition of a prepaid stored-value product liability. This ASU was effective for fiscal years beginning after December 15, 2017. We adopted this ASU as of January 1, 2018 noting no material impact to the consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Although early adoption is permitted, we anticipate adopting these provisions in the first quarter of 2020. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We had $51.2 million of operating lease obligations as of December 31, 2017, and upon adoption of this standard we will record a ROU asset and lease liability equal to the present value of these leases, which will have a material impact on the consolidated balance sheet. However, the recognition of lease expense in the consolidated statement of operations is not expected to change from the current methodology.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU supersedes the revenue recognition requirements in ASU Topic 605, Revenue Recognition, and requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. Topic 606 is effective for our Company in fiscal years beginning after December 15, 2018, with early adoption permitted. The standard permits the use of either the retrospective or modified retrospective (cumulative effect) transition method. Our Company primarily generates revenues by selling yoga classes in the form of memberships or class packages. Our implementation efforts included the identification of revenue streams within the scope of the guidance, evaluation of the revenue contracts and existing revenue recognition policies. We anticipate that we will adopt the new standard on January 1, 2019 and our evaluation remains preliminary because we are still in the process of evaluating the impact.

3.Acquisitions

Our Company uses acquisitions as our primary strategy to grow our market share, quickly gain students and build on the operating momentum of the acquired businesses. We completed two acquisitions during the quarter ended June 30, 2018, paying total consideration of $721,930, excluding earnouts of $159,000. On April 30, 2018, we acquired Prana Power Yoga (three studios) and on May 24, 2018, we acquired Inner Strength Yoga Studios (two studios) all in the Boston area. The acquisitions were accounted for as a business acquisition in accordance with ASC 805, Business Combinations (“ASC 805”). Under the acquisition method of accounting, the total purchase price was allocated to the net tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values. Any excess amount paid over identifiable assets is recorded as goodwill. The associated goodwill is deductible for tax purposes. The process for estimating the fair values of the acquired studios involves the use of significant estimates and assumptions, including estimating average industry purchase price multiple and estimating future cash flows.

The condensed consolidated statement of operations since the date of each acquisition through June 30, 2018 and the condensed consolidated balance sheet as of June 30, 2018 include the results of operations and the acquired assets and assumed liabilities related to all 2018 acquisitions. For the three months ended June 30, 2018, these acquisitions contributed $150,166 to our Company’s revenues. Net income contributed by these acquisitions was not separately identifiable due to our integration activities and the impact of corporate-level expenses and is impracticable to provide. Acquisition-related costs, including legal fees and all related professional fees, were expensed. There were no acquisitions in six months ended June 30, 2017.

The total purchase price consideration was allocated to the acquired assets and liabilities as follows:

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The purchase price allocations are preliminary and are based on information existing at the acquisition dates. Accordingly, the purchase price allocations are subject to change. These acquisitions are not material to our Company's results of operations, individually or in the aggregate. As a result, no pro forma financial information is provided.

4.Property and Equipment

The major classes of property and equipment are as follows:

We incurred depreciation expense of $753,884 and $633,842 for the three months ended June 30, 2018 and 2017, respectively, and $1,576,005 and $1,294,644 for the six months ended June 30, 2018 and 2017, respectively, which is included in depreciation and amortization expense in the Statement of Operations.

5. Goodwill

The changes in the carrying amount of goodwill are as follows:

In the second quarter of 2018, our Company performed a goodwill impairment test which found goodwill to be impaired primarily due to the continued decrease in the Company’s market capitalization. We recorded an impairment to goodwill of $2.5 million and $7.5 million in the second quarter of 2018 and fourth quarter of 2017, respectively.

During the quarter ended June 30, 2018, we completed two acquisitions which resulted in the addition of $0.5 million in goodwill (See Note 3).

6.Deferred Revenue

The following is a reconciliation of the changes in deferred revenue for the three months and six months ended June 30, 2018 and 2017:

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7.Related Party

We paid expense reimbursement fees to an affiliate of Great Hill Equity Partners V, L.P. and Great Hill Investors, LLC (collectively, “Great Hill Partners” or “GHP”), the owners of a majority of our Common Stock, in the amount of $25,000 for the three months ended June 30, 2017 and $50,000 for the six months ended June 30, 2017. In connection with our IPO, the Expense Reimbursement Agreement that we entered into with Great Hill Partners was terminated.

On March 27, 2017, we issued new convertible notes (the “New Convertible Notes”) to Great Hill Partners, in the aggregate principal amount of $3.2 million, which were convertible, at the option of the holder, into shares of our Common Stock at a conversion price of $8.40 per share (see Note 8). In connection with the IPO, the New Convertible Notes were repaid in full.

8.Debt

 Long-term Debt

In July 2015, we obtained a 5-year $20 million senior secured term loan facility with Deerpath Funding LP (the “Deerpath Facility”). We borrowed $5 million in July 2015 (the “Initial Term Loan”), and had the ability, upon meeting certain conditions, to borrow up to an additional $15 million. Borrowings under the Deerpath Facility carried an annual interest rate of LIBOR + 7%. The proceeds from the Initial Term Loan were used to pay all of the outstanding indebtedness under our credit facility with a previous lender.

In December 2015, we borrowed an additional $2 million under the Deerpath Facility for general corporate purposes, thereby increasing the principal amount of the loans and reducing the incremental borrowing availability under the Deerpath Facility, in each case, by an equivalent amount. As of June 30, 2017, there remained $13.1 million of incremental borrowing capacity under the Deerpath Facility. Interest expense for the three months and six months ended June 30, 2017 related to the aggregate amount of outstanding indebtedness under the Deerpath Facility was $156,183 and $347,995, respectively. On August 16, 2017, in connection with the consummation of our IPO, the Deerpath Facility was repaid in full and immediately cancelled thereafter.

Convertible Note Due to Related Party

On March 27, 2017, we issued the New Convertible Notes to Great Hill Partners, in the aggregate principal amount of $3.2 million, which were convertible, at the option of the holder, into shares of our Common Stock at a conversion rate of $8.40 per share. The New Convertible Notes consisted of a Subordinated Convertible Promissory Note, dated March 27, 2017, made by us in favor of Great Hill Equity Partners V, L.P., in the principal amount of $3,189,350, and a Subordinated Convertible Promissory Note, dated March 27, 2017, made by us in favor of Great Hill Investors, LLC, in the principal amount of $10,650. Each New Convertible Note had a maturity date of March 27, 2018 and bore interest at an annual rate of 8%. Interest expense for the three months and six months ended June 30, 2017 was $65,061 and $407,074, respectively. On August 16, 2017, in connection with the consummation of our IPO, the New Convertible Notes were repaid in full.

9.Common Stock

Initial Public Offering

On August 16, 2017, we completed our IPO whereby we sold 7,300,000 shares of our Common Stock registered at a price of $5.50 per share. We received proceeds from our IPO of $37.6 million after deducting underwriters' discounts and commissions of $2.5 million, but before deducting offering costs of $2.6 million.

Conversion of Amended and Restated 2015 GHP convertible promissory notes and redeemable preferred stock

On March 24, 2017, we engaged in a series of transactions to convert certain of our outstanding indebtedness and all of the Company’s outstanding redeemable preferred stock into shares of Common Stock.

The aggregate amount of principal and accrued interest under that certain Second Amended and Restated Subordinated Convertible Promissory Note made by us in favor of Great Hill Equity Partners V, L.P., dated March 24, 2017, and that certain Second Amended and Restated Subordinated Convertible Promissory Note made by us in favor of Great Hill Investors, LLC, dated March 24, 2017 (collectively, the “Amended and Restated 2015 GHP Convertible Promissory Notes”), was converted into 1,407,632 shares of Common Stock based on the conversion price per share of Common Stock as set forth in such notes of $8.40. Concurrently, all of the outstanding shares of redeemable preferred stock were converted into shares of Common Stock, with the number of shares of Common Stock issuable upon such conversion computed by dividing the Preferred Share Liquidation Preference (as defined in the Amended and Restated 2015 GHP Convertible Promissory Notes) per share by a conversion price per share of Common Stock of $8.40, resulting in 7,426,169 newly issued shares of Common Stock. Immediately after the conversion of the Amended and Restated 2015 GHP Convertible Promissory Notes and the redeemable preferred stock into shares of Common Stock, we effected a 1-for-10 reverse stock split of the Common Stock. Accordingly, except as otherwise indicated, all share and per share amounts have been

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adjusted to reflect the 1-for-10 reverse stock split as though it had occurred at the beginning of the initial period presented. In connection with the foregoing transactions, we also increased our total number of shares of authorized Common Stock to 14,131,017 shares.

Following the 1-for-10 reverse stock split, our Board of Directors (“Board”) amended our 2014 Stock Option and Grant Plan to increase the shares of Common Stock reserved for issuance thereunder to 1,695,484. In addition, our Board approved the grant of options to purchase 1,425,641 shares of Common Stock to certain employees and consultants.

On July 14, 2017, we effectuated a 1-for-1.333520 reverse stock split (the “1-for- 1.333520 Reverse Split”). Under the terms of the 1-for-1.333520 Reverse Split, each share of Common Stock, issued and outstanding as of such effective date, was automatically reclassified and split into 0.749895 shares of Common Stock, without any further action by the stockholders. Fractional shares were rounded down to the nearest whole share. Accordingly, except as otherwise indicated, all share and per share amounts have been adjusted to reflect the 1-for-1.333520 Reverse Split for all periods presented in this quarterly report.

10.Preferred Stock

Redeemable Preferred Stock

On March 24, 2017, we engaged in a series of transactions to convert certain of our outstanding indebtedness and all of the outstanding redeemable preferred stock into shares of Common Stock. Because Great Hill Equity Partners V, L.P. and Great Hill Investors, LLC held all of the redeemable preferred stock and owned a substantial majority of the Common Stock both before and after the conversion of the redeemable preferred stock on March 24, 2017, there is no impact on earnings per share as a result of this conversion.

11.Loss per Share Attributable to Common Stockholders

The components of basic and diluted loss per share attributable to common stockholders are as follows (in thousands, except share and per share data):

For the period ended June 30, 2018, and 2017, there were outstanding options to purchase 1,414,720 and 1,289,007 shares of Common Stock outstanding, respectively, which were excluded from the computation of diluted loss per share because it would be anti-dilutive.

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12.Accounting for Stock-Based Compensation

2014 Plan

In July 2014, our Company adopted the 2014 Stock Option and Grant Plan (the “2014 Plan”). Upon adoption of the 2014 Plan, the maximum aggregate number of shares issuable thereunder was 7,499 shares post-reverse split. In March 12, 2017, our Board amended the 2014 Plan to increase the shares of Common Stock reserved for issuance thereunder to 1,695,484. As of June 30, 2018, no shares were issuable under the 2014 Plan.

2017 Plan

In connection with our IPO, we adopted the 2017 Incentive Award Plan (the “2017 Plan”), effective as of August 9, 2017. The aggregate number of shares of Common Stock reserved for issuance pursuant to awards granted under the 2017 Plan equals: (i) 2,263,213, plus (ii) any shares which, as of the effective date of the 2017 Plan, subject to awards under the 2014 Plan which forfeited or lapsed unexercised following the effective date of the 2017 Plan, plus (iii) an annual increase on the first day of each calendar year beginning on January 1, 2018 and ending on and including January 1, 2027 equal to the lesser of (a) 5% of the shares outstanding (on an as-converted basis) on the final day of the immediately preceding calendar year, or (b) such smaller number of shares as determined by our Board.

The 2017 Plan permits the grant of incentive stock options, restricted stock, restricted stock units, stock appreciation rights, performance-based awards to our employees, directors and consultants. Shares issued pursuant to awards under the 2017 Plan that are settled for cash by our Company or that expire or are forfeited will become available for future grant or sale. Shares used to pay the exercise price of an award or to satisfy the minimum tax withholding obligations related to an award will not be available for future grants under the 2017 Plan. As of June 30, 2018, 2,107,421 shares remained available for issuance under the 2017 Plan.

With the exception of accelerated options, our typical options vest over four years from the grant date, with 25% of the award vesting on the first anniversary of the grant date and the remainder vesting over the next 36 months. Stock compensation expense related to these equity awards was recorded based upon the estimated fair value of the shares amortized over the vesting period.

Unamortized stock-based compensation expense relating to stock options was $1.0 million at June 30, 2018, which is expected to be recognized over a weighted-average period of 2.8 years.

Valuation

We use the Black-Scholes option pricing model to calculate the fair value of each option grant. The expected volatility is based on historical volatility of the stock price of comparable public companies. We estimate the expected term based upon the historical exercise behavior of employees. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a term equal to the expected term of the option assumed at the date of grant. We estimated a zero-forfeiture rate for these stock option grants as the awards have short vesting terms and have a low probability of forfeiture based on the recipients of the stock options.

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The fair values of stock options granted have been estimated utilizing the following assumptions:

Restricted Stock Units

Our Company granted 300,000 Restricted Stock Units (“RSU”) to our Company’s officers during the six months ended June 30, 2018. All RSU grants vest on the satisfaction of only a service-based condition. As of June 30, 2018, there were 445,873 shares of our Common Stock issuable upon the vesting of outstanding RSU. Unrecognized compensation expenses related to shares of our Common Stock subject to unvested RSU was $1.8 million at June 30, 2018, which is expected to be recognized as expense over the weighted-average period of 3.6 years. The service conditions are generally satisfied for the RSU granted to our officers and Board over four years starting from such person’s hiring date and the earlier to occur of the first anniversary of the grant date or the annual meeting of stockholders, respectively.

For the six months ended June 30, 2018, our Company withheld 32,542 shares of Common Stock (“Net Settlement”) and remitted $83,630 in cash to meet the related tax withholding requirements on behalf of our officers. We will continue to evaluate the Net Settlement of RSU that vest in the future.

Stock-Based Compensation Expense

Our Company recognized stock-based compensation expense related to stock options and RSU, included in general and administrative expenses as follows:

13.Income Taxes

Our effective income tax rate for the six months ended June 30, 2018 and 2017 was (0.22)% and (0.84)%, respectively. Our effective income tax rate is evaluated and adjusted at each interim period as facts and circumstances warrant. The difference between federal income taxes computed at the federal statutory rate and reported income taxes for the six months ended June 30, 2018 and 2017 was primarily related to the impact of the valuation allowance and state income taxes.

The FASB issued ASU 2018-05, Income Taxes (Topic 740): “Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (“SAB”) No. 118” to address the application of GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act (the “Act”).    

The Act was enacted on December 22, 2017. Among other changes for tax years beginning January 1, 2018, the Act reduces the U.S. federal corporate tax rate from 34% to 21%, the deductibility of entertainment expenses and fringe benefits, and the limitations on excessive employee remuneration under Internal Revenue Code (“IRC”) Section 162(m). At June 30, 2018, the Company has not completed its accounting for all of the tax effects of the Act and has not made an adjustment to the provisional tax benefit recorded under SAB 118 at December 31, 2017.  We have estimated our provision for income taxes in accordance with the Act and guidance available as of the date of this filing. Our estimated annual effective tax rate may be adjusted in subsequent interim periods, due to, among other things, additional analysis, changes in interpretations and assumptions we have made, and additional regulatory guidance that may be issued.

At June 30, 2018, we had no unrecognized tax benefits. We believe that there are no uncertain tax positions for which it is reasonably possible that will produce a material effect to the financial statements over the next 12 months. We recognize interest and penalties on taxes, if any, related to unrecognized tax benefits as income tax expense. As of June 30, 2018 and 2017, we had no material uncertain tax positions to be accounted for in the financial statements; accordingly, no interest or penalties on taxes were recognized for the six months ended June 30, 2018 and for the same period in 2017.

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Pursuant to IRC Sections 382 and 383, annual use of our net operating loss carryforwards may be limited in the event a cumulative change in ownership of more than 50% occurred within a three-year period. We have not completed an IRC Section 382 and 383 analysis regarding the limitation of net operating loss carryforwards. As there is a full valuation allowance applied to the deferred taxes, a Section 382 limitation will not have an effect on the deferred taxes or the income tax rate.

During the second quarter of 2018, the Company completed the examination of the federal income tax return filed for the 2015 tax year by the Internal Revenue Service, which resulted in no change. We are currently not under examination by federal, state and local tax authorities.

14.Commitments and Contingencies

Legal Matters

On June 5, 2017, a letter was sent to the California Labor & Workforce Development Agency alleging our itemized wage statements did not comply with the California Labor Code, which we refer to herein as the Wage Statement Claim. On August 7, 2017, we agreed to a class wide settlement for a maximum amount of $865,000 with respect to the Wage Statement Claim, which would include settlement of all penalties under the Private Attorneys General Act of 2004 and California Labor Code section 226, attorneys’ fees and costs, class representative enhancements and claims administration fees. The class wide settlement, including the maximum settlement amount of $865,000, remains subject to court approval. As of June 30, 2018, we have reserved for the entire amount under accrued expenses. 

In addition to the Wage Statement Claim, from time to time, we may become involved in legal proceedings arising in the ordinary course of business. There can be no assurance with respect to the outcome of any legal proceeding, and we could suffer monetary liability from the outcome of the Wage Statement Claim described above or other claims that may be made in the future that could be material to our results of operations.

Other than the Wage Statement Claim, we believe there are no pending lawsuits or claims that may have a material adverse effect on our business, capital resources or results of operations.

15.Subsequent Events

Piece-Rate Employee Claims

On July 2, 2018, a former California employee (“Plaintiff”) filed a complaint against us in the Superior Court of the State of California for the County of Los Angeles (the “Complaint”). Plaintiff’s Complaint is filed pursuant to the California Labor Code purportedly on behalf of all Pilates instructors, yoga instructors and other employees who worked for us in California on a piece-rate basis within the four years preceding the date of the Complaint. The Complaint alleges that certain of our payroll-related practices with respect to California-based employees paid on a piece-rate did not comply with the California Labor Code. The Complaint seeks penalties under the Private Attorneys General Act of 2004 and relevant sections of the California Labor Code on behalf of the State of California and allegedly aggrieved employees. Neither the outcome of the alleged claims, nor the amount and range of potential damages or exposure associated with the allegations can be assessed with certainty, and any damage award could be substantial.

Appointment of Sky Meltzer to the Board

On August 8, 2018, the Board appointed Sky Meltzer (“Mr. Meltzer”) as a director of the Company to fill a newly created seat on the Board. Pursuant to the Company’s Bylaws, Mr. Meltzer will serve as a Class III Director and shall hold office until the Company’s annual meeting of stockholders held in 2020. Mr. Meltzer was also appointed as a member of the Audit Committee and the Compensation Committee of the Board, serving as an independent Board member on each.

Mr. Meltzer has significant experience in the yoga industry. He most recently served as Chief Executive Officer of Manduka, a brand of premium yoga equipment and apparel, where he led the company’s global expansion from 2008 to 2016. From 2004 to 2007, he held the position of YogaWorks’ Vice President of Marketing and Business Development and was responsible for managing the creative direction of the brand, expanding the teacher training program and supporting studio operations. Prior to his time with YogaWorks and Manduka, Mr. Meltzer spent 10 years working in the finance, technology and media sectors where he held a variety of positions including investment banking analyst for Soundview Financial Group and brand manager for MGM Studios. Mr. Meltzer graduated from Stanford University with a B.A. in Economics. He currently serves on the Board of Directors of Manduka and Pear Sports and is an investor and advisor to several companies in the health and wellness sector.

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Mr. Meltzer will be granted restricted stock units with a value of $86,537 (representing the pro-rated 2018 stock grant awarded to non-employee directors), in accordance with our non-employee director compensation program as described in our definitive proxy statement filed with the Securities and Exchange Commission on April 30, 2018.

There are no arrangements or understandings between Mr. Meltzer and any other person pursuant to which Mr. Meltzer was selected as a director of the Company. Mr. Meltzer is not a participant in, nor is he to be a participant in, any related-person transaction or proposed related-person transaction required to be disclosed by Item 404(a) of Regulation S-K under the Securities Exchange Act of 1934, as amended. Other than the Company’s formal plan for compensating its independent directors for their services approved by the Board, there are no plans, contracts or arrangements or amendments to any plans, contracts or arrangements entered into with Mr. Meltzer, or any grants or awards made to Mr. Meltzer, in connection with his election to the Board.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q contains forward-looking statements, including statements based upon or relating to our expectations, estimates, and projections. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans or intentions. These statements are not guarantees of future performance; they reflect our current views with respect to future events and are based on assumptions and are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from expectations or results projected or implied by forward-looking statements.

These forward-looking statements represent our estimates and assumptions only as of the date of this quarterly report on Form 10-Q. Unless required by federal securities laws, we assume no obligation to update any of these forward-looking statements, or to update the reasons actual results could differ materially from those anticipated, to reflect circumstances or events that occur after the statements are made. Given these uncertainties, investors should not place undue reliance on these forward-looking statements.

Investors should read this quarterly report on Form 10-Q and the documents we reference in this report and have filed with the SEC, including our 10-K, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

The following discussion should be read in conjunction with our consolidated financial statements and the related notes, included elsewhere in this Form 10-Q. Unless otherwise indicated, all references in this Form 10-Q to YogaWorks, we, us, our, and our Company refer to YogaWorks, Inc. and our consolidated subsidiary, Yoga Works, Inc.

Company Overview

YogaWorks is a healthy lifestyle brand focused on enriching and transforming lives through yoga. We strive to honor and empower our students’ journey toward personal growth and well-being, no matter their age or physical ability, in an inclusive and community-oriented environment. We offer a broad range of yoga disciplines and levels from fast-paced flow to soothing restorative and integrated fitness classes in order to meet the needs of our broad student base. We operate in a number of regional operating segments with similar economic characteristics and report as one reportable segment.

Key Metrics

Our financial results are primarily driven by the number of yoga studios we operate, the number of student visits to our studios and the number of classes that we conduct at our studios. The following table sets forth our key operating metrics for the periods indicated.

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Components of Our Financial Performance

In assessing the financial performance of our business, we consider a variety of financial and operating metrics, including the following:

Net revenues. We derive revenues primarily from conducting yoga classes, both in our studios and through MyYogaWorks.com. We also derive additional revenues from teacher training programs, workshops and the sale of yoga-related retail merchandise. We expect net revenues from teacher training programs, workshops and the sale of yoga-related retail merchandise to generally be consistent as a percentage of our total net revenues year-to-year because net revenue from teacher trainings, workshops and retail sales are primarily driven by the same key metrics that drive our yoga class revenue, namely, the number of studios we operate, the number of student visits to our studios and the number of classes we conduct at our studios. Our students generally pay for their visits through membership fees (unlimited classes), multi-class packages (fixed number of classes) and drop-in (single class) purchases. Membership, class package, workshop and teacher training revenues are generally paid in advance. There are primarily two types of memberships, monthly memberships and paid-in-full memberships (for six or twelve months), and revenue is recognized over the membership period. Class package revenue is recognized based on aggregate usage patterns as required by GAAP. Workshop and teacher training revenue is deferred until the date of the event or is recognized over the period the event takes place.

Cost of revenues. Cost of revenues consists of direct costs associated with delivering our classes and services, which mainly includes teacher payroll and related expenses, and cost of physical goods sold, such as yoga clothing and accessories. We review our inventory levels of physical goods on an ongoing basis to identify slow-moving yoga merchandise and use retail product markdowns to efficiently sell those retail products. We expect that our newer studios will have higher cost of revenues as a percentage of net revenues as they ramp to maturity.

Center operations. Center operations consists of costs for studio rent, utilities, compensation and benefits for studio staff, sales support staff and management, sales and marketing expenses and certain studio-level general and administrative expenses. We recognize these costs as an expense when incurred.

General and administrative expenses. General and administrative expenses include corporate rent, marketing, office expenses and compensation and benefits costs for regional management and other regional support staff, executive, finance and accounting, human resources, information technology, administration, business development, legal and other support-function personnel. General and administrative expenses also include fees for professional services, insurance and licenses, as well as acquisition-related costs. As we grow our studio operations, we expect our aggregate general and administrative expenses to increase as we hire additional personnel in finance and accounting, human resources and administration to help manage our larger operations.

In connection with studio acquisitions, we incur transaction costs. These transaction costs include expenses incurred prior to owning a new studio and primarily consist of legal fees, due diligence expenses, travel and consulting fees. The transaction costs are included in general and administrative expenses and are expensed as incurred.

Pre-Opening Costs. In connection with opening new yoga studios, we incur pre-opening costs. Pre-opening costs include expenses incurred prior to the opening of a new yoga studio and primarily consist of payroll, travel, marketing, teacher training, initial opening supplies and costs of transporting initial retail apparel inventory and fixtures for our studios, as well as occupancy costs incurred from the time of possession of a yoga studio site to the opening of that studio. These pre-opening costs are included in cost of revenues, center operations and general and administrative expenses and are expensed as incurred.

Depreciation and amortization. Depreciation and amortization includes the depreciation of property and equipment, and the amortization expense of leasehold improvements and intangible assets.

Asset impairments. Asset impairments includes an asset impairment of our long-lived assets, finite-lived intangible assets or goodwill recognized in the applicable year. We test for such impairments at least annually, or whenever events or changes in circumstances indicate that an impairment of the applicable asset has occurred.

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RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the dollar variance and percentages of certain items included in our Condensed Consolidated Statements of Operations:

Quarter Ended June 30, 2018 Compared to Quarter Ended June 30, 2017 (unaudited)

Net revenues

The $2.4 million or 19% increase in net revenues for the quarter ended June 30, 2018, as compared to the same period in 2017, was primarily due to an increase in the number of studios. Sales from multi-class packages increased by $1.9 million and memberships increased by $0.3 million for the quarter ended June 30, 2018, compared to the same period in 2017, due to revenue from acquired studios that have predominantly sold multi-class packages and our flexible pricing strategy. In addition, retail sales increased by $0.3 million due to an increase in the number of studios. These increases were offset by a $0.4 million decrease in net revenues from teacher trainings and workshops due to a lower number of teacher trainings and workshop events held in the quarter ended June 30, 2018, compared to the same period in 2017.

Cost of revenues

The $1.0 million or 20% increase in cost of revenues for the quarter ended June 30, 2018, as compared to the same period in 2017, was primarily due to $0.8 million higher payroll related costs from the acquired studios and $0.1 million higher retail sales costs.

Center operations

The $1.5 million or 26% increase in center operations for the quarter ended June 30, 2018, as compared to the same period in 2017, which included $0.6 million higher rent expense and $0.6 million higher payroll expenses, primarily due to the impact of acquired studios. In addition, other expenses increased by $0.2 million which included repairs and maintenance, utilities and credit card fees.

General and administrative

The slight decrease in general and administrative expenses for the quarter ended June 30, 2018, as compared to the same period in 2017, was primarily due to a $0.9 million decrease in professional fees for audit, legal, and consulting services related to becoming a public company in 2017. This decrease was offset due to (i) $0.5 million higher corporate payroll expense from an increase in stock-based compensation expense recognized on RSU and Options issued to Employees and Directors during the rolling 12 months ended June 30, 2018 and an increase in headcount and new regional managers in the acquired studio regions, and (ii) $0.2 million in other expenses which included insurance, acquisition related travel expenses and investor relations expenses.

Depreciation and amortization

The slight increase in depreciation and amortization expense between the quarters ended June 30, 2018 and June 30, 2017 was due to depreciation and amortization from the acquired studios offset by the lower depreciation and amortization from assets that were fully amortized during the period.

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Goodwill impairment

We recognized an impairment to goodwill of $2.5 million for the quarter ended June 30, 2018. The impairment was primarily due to the continued decrease in the Company’s market capitalization. We did not record any impairment losses related to goodwill for the quarter ended June 30, 2017.

Interest (income) expense, net

The $0.3 million or 118% decrease in interest (income) expense, net for the quarter ended June 30, 2018, as compared to the same period in 2017, was due to the income from depository accounts and lower interest expense related to the conversion of the convertible note due to GHP and pay-off of the New Convertible Notes and the Deerpath Facility.

Provision for income taxes

There was no material change in the provision for income taxes between the three months ended June 30, 2018 and 2017. Our effective income tax rate was (0.01)% for the three months ended June 30, 2018 and (0.93)% for the three months ended June 30, 2017.

Six Months Ended June 30, 2018 Compared to Six Months Ended June 30, 2017

Net revenues

The $3.9 million or 15% increase in net revenues for the six months ended June 30, 2018, as compared to the same period in 2017, was primarily due to an increase in the number of studios. Sales from multi-class packages increased by $3.3 million and memberships decreased by $0.4 million for the six months ended June 30, 2018, compared to the same period in 2017, due to revenue from acquired studios that have predominantly sold multi-class packages and our flexible pricing strategy. In addition, retail sales increased by $0.6 million, online class sales increased by $0.3 million and teacher trainings and workshop events increased by $0.3 million due to a higher number of events held during the six months ended June 30, 2018, as compared to the same period in 2017.

Cost of revenues

The cost of revenues for the six months ended June 30, 2018, as compared to the same period in 2017, increased $1.7 million or 18% primarily due to $1.4 million higher payroll costs related to the acquired studios and $0.3 million higher retail sales costs.

Center operations

The $2.6 million or 23% increase in center operations for the six months ended June 30, 2018, as compared to the same period in 2017, which included $1.1 million higher rent expense and $1.0 million higher payroll expenses, primarily due to the impact of acquired studios. In addition, other expenses increased by $0.5 million which included repairs and maintenance, utilities and credit card fees.

General and administrative

General and administrative expenses for the six months ended June 30, 2018, as compared to the same period in 2017, increased by $1.4 million or 19% primarily due to (i) $1.0 million higher corporate payroll expense from an increase in stock-based compensation expense recognized on RSU and Options issued to Employees and Directors during the rolling 12 months ended June

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30, 2018 and higher headcount and new regional managers in the acquired studio regions, (ii) $0.3 million higher studio marketing expense for the new studios as well as more promotional campaigns and web advertisements, and (iii) $0.5 million in other expenses which included insurance, acquisition related travel expenses and investor relations expenses. These increases were offset by a decrease of $0.5 million in professional fees for audit, legal and consulting services.

Depreciation and amortization

The slight increase in depreciation and amortization expense for the six months ended June 30, 2018, as compared to the same period in 2017, was due to depreciation and amortization from the acquired studios offset by the lower depreciation and amortization from assets that were fully amortized during the period.

Goodwill impairment

We recognized an impairment to goodwill of $2.5 million for the six months ended June 30, 2018. The impairment was primarily due to the continued decrease in the Company’s market capitalization. We did not record any impairment losses related to goodwill for the six months ended June 30, 2017.

Interest (income) expense, net

The $0.9 million or 106% decrease in interest (income) expense, net for the six months ended June 30, 2018, as compared to the same period in 2017, was due to the income from depository accounts and lower interest expense related to the conversion of the convertible note due to GHP and pay-off of the New Convertible Notes and the Deerpath Facility.

Provision for income taxes

There was no material change in the provision for income taxes between the six months ended June 30, 2018 and 2017. Our effective income tax rate was (0.22)% for the six months ended June 30, 2018 and (0.84)% for the six months ended June 30, 2017.

Non-GAAP financial measures

In addition to our results determined in accordance with GAAP, we use Adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”), Studio-Level EBITDA, Adjusted free cash flow, Studio-Level free cash flow and Adjusted net loss which are not calculated in accordance with GAAP. We use these financial measures to understand and evaluate our business. Adjusted EBITDA is a supplemental measure of the operating performance of our core business operations. Studio-Level EBITDA is a supplemental measure of our operating performance of our studios. Adjusted free cash flow is a supplemental measure of the operating performance of our core business operations excluding deferred revenue. Studio-Level free cash flow is a supplemental measure of our operating performance of our studios excluding deferred revenue. Adjusted net loss is a supplemental measure of operating performance that is adjusted for certain non-recurring items that we do not believe directly reflect our core business operations. Accordingly, we believe Adjusted EBITDA, Studio-Level EBITDA, Adjusted free cash flow, Studio-Level free cash flow and Adjusted net loss provide useful information to investors and others in understanding and evaluating our Company’s operating results in the same manner as management and the Board. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP.

Our use of Adjusted EBITDA, Studio-Level EBITDA, Adjusted free cash flow, Studio-Level free cash flow and Adjusted net loss has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:

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Adjusted EBITDA, Studio-Level EBITDA, Adjusted free cash flow and Studio-Level free cash flow

The following table presents a reconciliation of Adjusted EBITDA and Studio-Level EBITDA to Net loss. In addition, Adjusted free cash flow and Studio-Level free cash flow are presented for each of the periods indicated:

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Adjusted net loss

The following table presents a reconciliation of Adjusted net loss to Net loss for each of the periods indicated: