NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except for share and per share data)

Note 1. General

Overview

On January 5, 2018, the Company changed its name to XpresSpa Group, Inc. (“XpresSpa Group” or the “Parent”) from FORM Holdings Corp. The Company rebranded to XpresSpa Group to align its corporate strategy to build a pure-play health and wellness services company, which commenced following its acquisition of XpresSpa Holdings, LLC (“Holdings” or “XpresSpa”) on December 23, 2016 (XpresSpa Group, Inc. and Holdings consolidated is referred to as the “Company”).

As a result of the transition to a pure-play health and wellness services company, the Company currently has one operating segment that is also its sole reporting unit, XpresSpa, the leading airport retailer of spa services. XpresSpa offers travelers premium spa services, including massage, nail and skin care, as well as spa and travel products. 

Basis of Presentation and Principals of Consolidation

The unaudited interim consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and the instructions to Article 8-03 of Regulation S-X, and should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2018. The unaudited interim consolidated condensed financial statements for all 2018 periods presented have been derived from the audited financial statements. The financial statements include the accounts of the Company, all entities that are wholly owned by the Company, and all entities in which the Company has a controlling financial interest. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected by the Company. Such adjustments are of a normal, recurring nature. The results of operations for the three and nine-month periods ended September 30, 2019 are not necessarily indicative of the results that may be expected for the entire fiscal year or for any other interim period. All significant intercompany balances and transactions have been eliminated in consolidation.

Recent Developments

Calm Private Placement

On July 8, 2019, the Company entered into a securities purchase agreement (the “Calm Purchase Agreement”) with Calm.com, Inc. (“Calm”) pursuant to which the Company agreed to sell (i) an aggregate principal amount of $2,500 in an unsecured convertible note due 2022 (the “Calm Note”), which is convertible into shares of Series E Convertible Preferred Stock (the “Series E Preferred Stock”) and (ii) warrants to purchase 937,500 shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), at an exercise price of $2.00 per share (the “Calm Warrants”) (collectively, the “Calm Private Placement”).

The Company received $2,500 in gross proceeds from the Calm Private Placement.

Convertible Notes and Warrants

The Calm Note is an unsecured subordinated obligation of the Company. Unless earlier converted or redeemed, the Calm Note will mature on May 31, 2022. The Calm Note bears interest at a rate of 5% per annum, subject to increase in the event of default to the lesser of 18% per annum or the maximum rate permitted under applicable law. The Calm Note is convertible at any time until the Calm Note is no longer outstanding, in whole or in part, at the option of Calm into shares of Series E Preferred Stock at a conversion price equal to $3.10 per share, except that no shares of Series E Preferred Stock could be issued as payment of interest or in connection with anti-dilution protection or voluntary reduction of the conversion price until receipt of shareholder approval, which approval was obtained on October 2, 2019. Interest on the Calm Note is payable in arrears beginning on the last day of each February, May, August and November during the period beginning on the original issuance date and ending on, and including, the maturity date, when all amounts outstanding under the Calm Note becomes due and payable in cash. The Company may elect to pay interest in cash, shares of Series E Preferred Stock or a combination thereof.

The Calm Warrants entitle Calm to purchase an aggregate of 937,500 shares of Common Stock. The Calm Warrants are exercisable beginning six months from the date of issuance, have a term of five years and feature an exercise price equal to $2.00 per share.

See Note 9. “Long-term Notes and Convertible Notes”, for discussion of the accounting for the Calm Private Placement. 

Calm Collaboration Agreement

On July 8, 2019, the Company entered into an Amended and Restated Product Sale and Marketing Agreement with Calm (the “Amended and Restated Collaboration Agreement”), which replaced the parties’ previous Product Sale and Marketing Agreement, dated as of November 12, 2018. The Amended and Restated Collaboration Agreement primarily relates to the display, marketing, promotion, offer for sale and sale of Calm’s products in each of the Company’s branded stores worldwide. The Amended and Restated Collaboration Agreement will remain in effect until July 31, 2021, unless terminated earlier in accordance with the Amended and Restated Collaboration Agreement, and automatically renews for successive terms of six months unless either party provides written notice of termination no later than thirty days prior to any such automatic renewal of the Amended and Restated Collaboration Agreement. On October 30, 2019, the Company and Calm entered into an amendment to the Amended and Restated Collaboration Agreement, which provides for the addition of certain Calm branded products, which amendment is attached as Exhibit 10.8 to this Quarterly Report on Form 10-Q and incorporated by reference herein.

Amendment to Certificate of Designation of Series E Convertible Preferred Stock

On July 8, 2019, the Company filed a certificate of amendment to the Certificate of Designation of Series E Convertible Preferred Stock (the “Series E COD Amendment”) with the State of Delaware to (i) increase the number of authorized shares of Series E Preferred Stock to 2,397,060 and (ii) upon receipt of Shareholder Approval, reduce the conversion price to $2.00. The Series E COD Amendment was approved by the Board of Directors of the Company and the Company obtained shareholder approval of the Series E COD Amendment on October 2, 2019. See Note 10. “Stockholders’ Equity”.

B3D Transaction and Senior Secured Note

On July 8, 2019, Holdings entered into the fourth amendment (the “Credit Agreement Amendment”) to its existing Credit Agreement with B3D, LLC (“B3D”) (the “Senior Secured Note” or the “B3D Note”) in order to, among other provisions, (i) extend the maturity date to May 31, 2021, (ii) reduce the applicable interest rate to 9.0%, and (iii) to amend and restate certain other provisions relating to its 11.24% Senior Secured Note. As consideration for these and other modifications the principal amount owed to B3D was increased to $7.0 million. Principal and any interest accrued thereon are convertible, at B3D’s option, into Common Stock subject to receipt of shareholder approval, which was obtained on October 2, 2019 ( the “B3D Transaction”).

B3D Note

The B3D Note is a senior secured and guaranteed obligation of Holdings, secured by the personal property of the parent company of Holdings (XpresSpa Group, Inc.) and Holdings’ wholly owned subsidiaries. Unless earlier converted or redeemed, the B3D Note will mature on May 31, 2021. The B3D Note bears interest at a rate of 9.00% per annum, calculated on a monthly basis. Interest only is payable in arrears on the last business date of each month (the "Monthly Interest"). Notwithstanding the foregoing, until the earlier of (i) ninety days from the date of the Credit Agreement Amendment or (ii) the date upon which shareholder approval is received, which approval was obtained on October 2, 2019 (the "Interest Deferment Date"), the Monthly Interest continued to accrue, compounded monthly, and all unpaid amounts thereof became due and payable on the Interest Deferment Date. At the option of Holdings, all or any portion of the Monthly Interest that is payable (i) on the Interest Deferment Date or (ii) after the Interest Deferment Date, but not more than twenty-one days and not less than five trading days prior to the date on which each payment of Monthly Interest is due, may be paid in shares of XpresSpa Group, Inc.’s Common Stock. At any time after receipt of shareholder approval until the B3D Note is no longer outstanding, at the option of B3D, all or any portion of the outstanding principal amount of the B3D Note, plus any accrued and unpaid interest thereon, shall be convertible into XpresSpa Group, Inc.’s Common Stock at a conversion price equal to $2.00 per share.

See Note 9. "Long-term Notes and Convertible Notes", for discussion of the accounting for the B3D Transaction and B3D Note.

On August 22, 2019, the Company entered into an amendment to the B3D Note. Among other provisions, the amendment provided that B3D shall not have the right to convert the B3D Note into shares of Common Stock to the extent that such conversion would cause B3D to beneficially own in excess of the Beneficial Ownership Limitation, initially defined as 4.99% of the number of shares of Common Stock outstanding immediately after giving effect to the issuance of shares of Common Stock issuable upon conversion of the B3D Note.

Series D Convertible Preferred Stock Amendment and December 2016 Warrant Amendment

Series D Convertible Preferred Stock Amendment

On July 8, 2019, the Company filed a certificate of amendment to the Certificate of Designation of Series D Convertible Preferred Stock (the “Series D COD Amendment”) with the State of Delaware to, upon receipt of shareholder approval, reduce the conversion price to $2.00 and provide for automatic conversion of the Series D Convertible Preferred Stock (the “Series D Preferred Stock”) into shares of Common Stock. The Series D COD Amendment was approved by the Company’s Board and the Company obtained shareholder approval on October 2, 2019.

December 2016 Warrant Amendment

On July 8, 2019, the Company entered into an amendment to certain outstanding warrants issued in December 2016 (the “December 2016 Warrants”) to the holders of its Series D Preferred Stock (the “December 2016 Warrant Amendment”) to provide for (i) a reduction in the price to convert to Common Stock to $2.00, (ii) certain anti-dilution price protection and (iii) voluntary reduction of the conversion price by the Company in its discretion. The Company obtained shareholder approval in connection with the December 2016 Warrant Amendment on October 2, 2019. The December 2016 Warrants were recorded as an equity instrument at December 31, 2016. As such, no adjustment to the consolidated condensed financial statements was made as a result of the change in the conversion price.

May 2018 SPA Amendment, Series F Preferred Stock and Series B Preferred Stock

May 2018 SPA Amendment

On May 15, 2018, in a private placement offering, the Company issued (i) 5% Secured Convertible Notes (the “5% Secured Convertible Notes”) convertible into Common Stock at $12.40 per share, due November 2019, (ii) May 2018 Class A Warrants to purchase 357,863 shares of Common Stock (the “May 2018 Class A Warrants”) and (iii) Class B Warrants to purchase 178,932 shares of Common Stock (the “May 2018 Class B Warrants”).

On July 8, 2019, the Company entered into an amendment (the “May 2018 SPA Amendment”) to its Securities Purchase Agreement, dated as of May 15, 2018, by and between the Company and the purchasers party thereto (the “May 2018 SPA”), to provide for, among other provisions, (i) an update to certain definitions, including the definition of an “Exempt Issuance,” (ii) the waiver of certain provisions regarding restrictions on subsequent equity sales and participation in subsequent financings, (iii) the removal of certain of such provisions upon receipt of shareholder approval (obtained on October 2, 2019), (iv) the amendment to certain provisions of the May 2018 Class A Warrants issued pursuant to the May 2018 SPA to modify certain provisions in connection with a Notice Failure (as such term is defined in the May 2018 Class A Warrants), and the reduction in the exercise price of the May 2018 Class A Warrants issuable pursuant to anti-dilution price protection contained in such May 2018 Class A Warrants to $2.00 per share following receipt of shareholder approval, which approval was obtained on October 2, 2019, (v) the cancellation of all outstanding May 2018 Class B Warrants and (vi) the establishment of a new class of preferred stock, designated Series F Convertible Preferred Stock, par value $0.01 per share (the “Series F Preferred Stock”) and the issuance of 8,996 shares of such Series F Preferred Stock to the parties to the May 2018 SPA Amendment, which are convertible into Common Stock upon receipt of shareholder approval, which approval was obtained on October 2, 2019.

Certificate of Designation of Series F Preferred Stock

In connection with the May 2018 SPA Amendment, on July 8, 2019, the Company filed with the Secretary of State of the State of Delaware a Certificate of Designation of Preferences, Rights and Limitations of Series F Convertible Preferred Stock (the “Series F Certificate of Designation”) establishing and designating the rights, powers and preferences of the Series F Preferred Stock. The Company designated 9,000 shares of Series F Preferred Stock. The Series F Convertible Preferred Stock was recorded at its fair value on July 8, 2019 of $1,154 (net of issuance costs of approximately $123) in the Company’s consolidated condensed balance sheet as of September 30, 2019. See Note 10. “Stockholders’ Equity” for further discussion.

Certificate of Elimination of Series B Preferred Stock

On July 8, 2019, the Company filed a Certificate of Elimination of Shares of Series B Preferred Stock (the “Certificate of Elimination”) to the Company’s amended and restated certificate of incorporation. The Certificate of Elimination reduced, pursuant to Section 151(g) of the Delaware General Corporation Law, the number of authorized shares of Series B Convertible Preferred Stock of the Company, par value $0.01 per share (the “Series B Preferred Stock”) from 1,609,167 shares to zero shares. Pursuant to the provisions of Section 151(g) of the Delaware General Corporation Law, the 1,609,167 authorized shares of Series B Preferred Stock were eliminated pursuant to the reduction return to the available undesignated preferred stock of the Company and may be re-designated into another series of preferred stock.

CEO Transition

On February 8, 2019, Edward Jankowski resigned as Chief Executive Officer of the Company and as a director of the Company. Mr. Jankowski’s resignation was not as a result of any disagreement with the Company on any matters related to the Company’s operations, policies or practices. Mr. Jankowski is receiving termination benefits including $375 payable in equal installments over a twelve-month term which commenced on February 13, 2019 and COBRA continuation coverage paid in full by the Company for up to a maximum of twelve months.

Effective as of February 11, 2019, Douglas Satzman was appointed by the Company’s Board of Directors as the Chief Executive Officer of the Company and as a director of the Company to fill the position vacated by Mr. Jankowski.

Liquidity and Going Concern

As of September 30, 2019, the Company had cash and cash equivalents of $2,432, total current assets of $3,976, total current liabilities of $7,761, and a working capital deficiency of $3,785, compared to a working capital deficiency of $10,899 as of December 31, 2018.

The Company is exploring valuable strategic partnerships, right-sizing its corporate structure, and stream-lining spa operations. The Company expects that these actions will be executed in alignment with the anticipated timing of its long-term liquidity needs. There can be no assurance, however, that any such opportunities will materialize.

The Company has also reduced operating expenses with net cash used in operating activities decreasing from $6,129 for the nine months ended September 30, 2018 to $782 for the nine months ended September 30, 2019. While the Company continues to focus on its overall profitability; the Company expects to incur net losses in the foreseeable future.

The report of the Company’s independent registered public accounting firm on its financial statements for the year ended December 31, 2018 included an explanatory paragraph indicating that there is substantial doubt about the Company’s ability to continue as a going concern. In addition to the transactions that have already occurred, the Company believes it is probable that it will generate additional liquidity through other actions it expects to undertake in the near future. The Company’s management believes it will successfully mitigate the substantial doubt raised by its historical operating results and will satisfy its liquidity needs for at least twelve months from the issuance of these financial statements. However, the Company cannot reasonably predict with any certainty that the results of its actions will generate the liquidity required to satisfy its liquidity needs.

If the Company continues to experience operating losses, and the Company is not able to generate additional liquidity through the actions described above or through some combination of other actions, while not expected, the Company may not be able to access additional funds and the Company might need to secure additional sources of funds, which may or may not be available. Additionally, a failure to generate additional liquidity could negatively impact its access to inventory or services that are important to the continued operation of the business.

Note 2. Accounting and Reporting Policies

(a) Right of use asset and lease liability

The right of use asset on our consolidated condensed balance sheet represents a lessee's right to use an asset over the life of a lease. The asset is calculated as the initial amount of the lease liability, plus any lease payments made to the lessor before the lease commencement date, plus any initial direct costs incurred, minus any lease incentives received. The amortization period for the right of use asset is from the lease commencement date to the earlier of the end of the lease term or the end of the useful life of the asset.

The addition of these items on the balance sheet is in accordance with new lease accounting standard Topic 842-Leases issued by the FASB. This standard requires operating leases to be recorded on the balance sheet as assets and liabilities and requires disclosure of key information about leasing arrangements. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations and comprehensive loss.

(b) Revenue recognition

The Company recognizes revenue from the sale of XpresSpa products at the time the goods are purchased at our stores or online (usually by credit card) and services when they are rendered at our stores, net of discounts and applicable sales taxes. Revenues from the XpresSpa wholesale and e-commerce businesses are recorded at the time goods are shipped. Accordingly, the Company recognizes revenue for its single performance obligation related to both in-store and online sales at the point at which the service has been performed or the control of the merchandise has passed to the customer. The Company excludes all sales taxes assessed to its customers. Sales taxes assessed on revenues are included in accounts payable, accrued expenses and other current liabilities in the consolidated condensed balance sheets until remitted to the respective state agencies.

Other revenue relates to one-time intellectual property licenses as well as the sale of certain of the Company’s intellectual property. Revenue from patent licensing is recognized when the Company transfers promised intellectual property rights to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those intellectual property rights.

(c) Recently adopted accounting pronouncements

ASU No. 2016-02, Leases (Topic 842), as amended

This standard and its amendments provide new guidance related to accounting for leases and supersedes GAAP on lease accounting with the intent to increase transparency. This standard requires operating leases to be recorded on the balance sheet as assets and liabilities and requires disclosure of key information about leasing arrangements. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations and comprehensive loss.

On January 1, 2019, the Company adopted ASU 2016-02 on a prospective basis, beginning on January 1, 2019 using the optional transition method. The Company applied the transition options permitted by ASU 2018-11 and elected the package of practical expedients to alleviate certain operational and reporting complexities related to the adoption, one of which was not to recognize a right of use asset or lease liability for leases with a term of twelve months or less. See Note 8. “Leases” for further discussion. The Company recorded right of use assets and lease liabilities for its operating leases of $9,565 upon adoption of ASU 2016-02.

ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

This standard provides guidance on the reclassification of certain tax effects from accumulated other comprehensive income to retained earnings in the period in which the effects of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recorded. The new standard is effective for the fiscal year beginning after December 15, 2018. The Company adopted this standard on January 1, 2019. Adoption of this standard did not have a material impact on the Company’s consolidated condensed financial statements.

(d) Recently issued accounting pronouncements

ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

This standard changes the impairment model for most financial assets that are measured at amortized cost and certain other instruments, including trade receivables, from an incurred loss model to an expected loss model and adds certain new required disclosures. Under the expected loss model, entities will recognize estimated credit losses to be incurred over the entire contractual term of the instrument rather than delaying recognition of credit losses until it is probable the loss has been incurred. The new standard is effective for the fiscal year beginning after December 15, 2019, with early adoption permitted. Based upon the outstanding balance of the Company’s trade receivables and its positive collection history, the Company’s management does not believe that the adoption of this standard will have a material impact on its consolidated financial position and results of operations.

ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement

This amendment provides updates to the disclosure requirements on fair value measures in Topic 820 which includes the changes in unrealized gains and losses in other comprehensive income for recurring Level 3 fair value measurements, the option of additional quantitative information surrounding unobservable inputs and the elimination of disclosures around the valuation processes for Level 3 measurements. The new standard is effective for the fiscal year beginning after December 15, 2019. The Company’s management does not believe that the adoption of this standard will have a material impact on its consolidated financial position and results of results of operations.

(e) Presentation

Certain items in the 2018 financial statements have been reclassified to conform to the presentation in the 2019 financial statements. Such reclassifications did not have a material impact on the presentation of the overall financial statements.

Note 3. Potentially Dilutive Securities

Loss per share attributable to common shareholders data for each period presented excludes from the calculation of diluted net loss the following potentially dilutive securities (reflecting the impact of the 1:20 reverse stock split that became effective on February 22, 2019) as they had an anti-dilutive impact:

The 5% Secured Convertible Notes were converted into Common Stock in June 2019. See Note 9. “Long-term Notes and Convertible Notes.”

On October 2, 2019, the Company obtained shareholder approval of the reduction in the conversion price of the Company’s Series D Preferred Stock to Common Stock. Effective October 2, 2019, the Series D Preferred Stock converted into 10,964,460 shares of Common Stock and 1,408,050 warrants to purchase Common Stock. As of November 12, 2019, 570,035 of the warrants have been exercised and converted into Common Stock.

Cash denominated in Unites States dollars decreased from December 31, 2018 primarily due to increased capital expenditures to renovate spas and to open new spas, distributions to the Company’s noncontrolling interest investees and payments made on the Senior Secured Notes.

Restricted cash represents balances at financial institutions to secure bonds and letters of credit as required by the Company’s various lease agreements. 

Cash in escrow is the amount the Company was required to put into escrow to fund the renovation of one of its spa locations. Prepaid expenses are predominantly comprised of prepaid insurance policies which have terms of one year or less. The balance decreased from December 31, 2018 due to the timing of payments and amortization of the year end prepaid insurance balance.

The Company recorded an impairment loss on its FLI Charge cost method investment of approximately $47 which is included in “Impairment of assets” on the Company’s consolidated condensed statements of operations and comprehensive loss for the three and nine months ended September 30, 2019. As of September 30, 2019, the Company’s cost method investments consist primarily of a $787 investment in InfoMedia Services Limited which the Company acquired in 2014 and the remaining investment in Route1 of $484, which it received as part of the disposition of Group Mobile in March 2018.

In the second quarter of 2019, the Company impaired its investment in Route1, due to an under performance of operating results. The Company recorded an impairment charge of $1,141 in the second quarter of 2019, which is included in “Other non-operating income (expense), net” on the consolidated condensed statement of operations and comprehensive loss for the nine months ended September 30, 2019.

The Company has not identified any other events or changes in circumstances that could have a significant adverse effect on the carrying value of its remaining cost method investments.

The Company’s trade name relates to the value of the XpresSpa trade name, customer relationships represent the value of loyalty customers, software relates to certain capitalized third-party costs related to a new point-of-sale system, and patents consist of intellectual property portfolios acquired from third parties.

The Company’s intangible assets are amortized over their expected useful lives. During the three and nine months ended September 30, 2019 and 2018, the Company recorded amortization expense of $583 and $510, respectively, and $1,727 and $1,901, respectively.

During the three months ended September 30, 2019, the Company wrote off the net book value of certain patents that were no longer generating cash flow totaling approximately $85, which is included in “Impairment of assets” for the three and nine months ended September 30, 2019  on the Company’s consolidated condensed statement of operations and comprehensive loss.

Based on the intangible assets balance as of September 30, 2019, the estimated amortization expense for the remainder of the calendar year and each of the succeeding calendar years is as follows:

There were no impairment indicators related to any of the Company’s amortizable intangible assets during the nine months ended September 30, 2019.

Goodwill Impairment

During the first quarter of fiscal year 2018, the Company’s stock price declined from an opening price of $1.36 on January 2, 2018 to $0.72 on March 29, 2018. Subsequently, on April 19, 2018, the Company entered into a separation agreement with its Chief Executive Officer regarding his resignation as Chief Executive Officer and Director. These events were identified by the Company’s management as triggering events requiring that goodwill be tested for impairment as of March 31, 2018.  As the stock price had not rebounded, the Company determined that there was an impairment of the goodwill. The Company performed a quantitative goodwill impairment test, in which the Company compared the carrying value of the reporting unit to its estimated fair value, which was calculated using an income approach. The key assumptions for this approach were projected future cash flows and a discount rate, which was based on a weighted average cost of capital adjusted for the relevant risk associated with the characteristics of the business and the projected future cash flows. As a result of the quantitative goodwill impairment test performed as of March 31, 2018, the Company determined that the fair value of the reporting unit was less than its’ carrying amount and, therefore, goodwill of the reporting unit was considered impaired. The Company recorded an impairment charge of $19,630 to reduce the carrying value of goodwill to its fair value, which was determined to be zero. The impairment to goodwill was a result of the structural changes to the Company, including completion of the transition from a holding company to a pure-play health and wellness company, the change in Chief Executive Officer and the reduction in the Company’s stock price. 

Note 8. Leases

The Company leases its retail space at various domestic and international airports. Additionally, the Company leases its corporate office in New York. Certain leases entered into by the Company fall under ASU No. 2016-02, Leases (“Topic 842”) discussed in Note 2 (b) “Recently adopted accounting pronouncements”. The Company determines if an arrangement is a lease at inception and if it qualifies under Topic 842. Some of the Company’s lease arrangements contain fixed payments throughout the term of the lease. Others involve a variable component to determine the lease obligation where a certain percentage of sales is used to calculate the lease payments. The Company enters into certain leases that expire and are then extended on a month-to-month basis. These leases are not included in the calculation of the total lease liability and the right of use asset after they convert to month-to-month.

All qualifying leases held by the Company are classified as operating leases. Operating lease assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. The Company records its operating lease assets and liabilities based on required guaranteed payments under each lease agreement. The Company uses its incremental borrowing rate, which approximates the rate at which the Company can borrow funds on a secured basis, using the information available at commencement date of the lease in determining the present value of guaranteed lease payments. The interest rate implicit in the lease is generally not determinable in transactions where a company is the lessee.

The Company reviews all of its existing lease agreements on a quarterly basis to determine whether there were any modifications to existing lease agreements and to assess if any agreements should be accounted for pursuant to the guidance in Topic 842. The option to extend the term of one existing lease contract was exercised during the current period. The Company recalculated the right of use asset and lease liability based on the modified lease term and adjusted both balances. There were no other lease modifications during the period. The Company entered into two new lease arrangements that are included in the balances of its right of use asset and lease liability as of September 30, 2019.

The following is a summary of the activity in the Company’s operating lease liabilities for the nine months ended September 30, 2019:

In July 2019, as a result of an early termination of a lease for one of its locations that was closed, the Company assessed all assets at the closed location (primarily leasehold improvements) for impairment. This resulted in a charge of approximately $620 which was included in “Impairment of assets” in the consolidated condensed statements of operations and comprehensive loss that was recorded in June 30, 2019 and is reflected in the current period year to date results. The Company also reduced the remaining balance in the right of use assets and the lease liabilities by approximately $421 in June 2019 to write off the balances related to the leases for this location.

The Company expensed approximately $210 of costs capitalized in anticipation of opening new spas that the Company later determined would not be realized. This charge is included in the “Impairment of assets” line in the consolidated condensed statement of operations and comprehensive loss for the nine months ended September 30, 2019.

As of September 30, 2019, operating leases contain the following future minimum commitments: 

Other assumptions and pertinent information related to the Company’s accounting for operating leases are:

Variable lease payments calculated monthly as a percentage of a product and services revenue, was $794 and $2,291 for the three and nine months ended September 30, 2019.

B3D Note

On July 8, 2019, the Company entered into the fourth amendment to its existing credit agreement (the “Amendment to the Credit Agreement”) with B3D, to renegotiate the terms of its 11.24 %, $6,500 senior secured note as discussed in Note 1 “General” under Recent Developments. The Amendment to the Credit Agreement, among other provisions, (i) extended the maturity date to May 31, 2021, (ii) reduced the applicable interest rate to 9.0%, and (iii) amended and restated certain other provisions. As consideration for these and other modifications, the principal amount owed to B3D was increased to $7,000.

The Company engaged an independent third party to assess the fair value of each of the derivative instruments included in the B3D Note. The results of the appraisal were that the conversion feature and the B3D Note should be bifurcated, and that the conversion option should be treated as a separate derivative liability. A fair value of $2,774 was assigned to the conversion option, which is included in “Derivative Liabilities” on the consolidated condensed balance sheet and the B3D Note was assigned a fair value of $4,226 as of July 8, 2019. The conversion option was marked to market as of September 30, 2019 and as a result, the Company recorded a revaluation gain of approximately $479 that is included in “Other income (expense), net” for the three and nine months ended September 30, 2019. During the three and nine months ended September 30, 2019 the Company recorded $362 of accretion expense that increased the carrying value of the B3D Note.

The modification to the terms included in the Credit Agreement Amendment were accounted for as a troubled debt restructuring in the Company’s consolidated condensed financial statements as of September 30, 2019, in accordance with ASC 470-60 “Troubled Debt Restructurings by Debtors”. A debtor in a troubled debt restructuring involving only a modification of terms of a payable should account for the effects of the restructuring prospectively from the time of restructuring and not change the carrying amount of the payable at the time of the restructuring. The Company will pay interest monthly at the revised 9.0% rate over the life of the B3D Note. Since the future cash payments for principal and interest under the restructured B3D Note will be greater than the carrying value of the original note no gain was recorded.

As a result of the extension of the maturity date to May 31, 2021, the balance of the B3D Note was reclassified from current liabilities as of December 31, 2018 to long-term liabilities on the Company’s consolidated condensed balance sheet as of September 30, 2019.

The Company agreed upon a $500 increase in the principal amount of the B3D Note which will be amortized on a straight-line basis over the revised term of the B3D Note. The net balance of the deferred issuance costs was $435 as of September 30, 2019 and is presented as a reduction of the B3D Note balance in the Company’s consolidated condensed balance sheet. Amortization expense from July 8, 2019 through September 30, 2019 was $65 and is included in “Interest expense” in the consolidated condensed statements of operations and comprehensive loss. Amortization of debt issuance costs for the three and nine months ended September 30, 2018 was $394 and $589, respectively, also included in “Interest expense”.

The B3D Note is guaranteed on a full, unconditional, joint, and several basis, by the parent Company, XpresSpa Group, Inc., and all wholly owned subsidiaries of Holdings (the “Guarantor Subsidiaries”). Under the terms of a security and guarantee agreement dated July 8, 2019, XpresSpa Group, Inc. (the parent company) and the Guarantor Subsidiaries each fully and unconditionally, jointly and severally, guarantee the payment of interest and principal on the B3D Note. Holdings pledged and granted to B3D a first priority security interest in, among other things, all of its equity interests in Holdings and all of its rights to receive distributions, cash or other property in connection with Holdings. The Company has not presented separate consolidating financial statements of XpresSpa Group, Inc., Holdings and Holdings wholly owned subsidiaries as each entity has guaranteed the B3D Note, so each entity is responsible for the payment.

Convertible Notes

5% Secured Convertible Notes

On May 15, 2018, in a private placement offering, the Company issued (i) 5% Secured Convertible Notes (the “5% Secured Convertible Notes”) convertible into Common Stock at $12.40 per share, originally due November 2019, (ii) May 2018 Class A Warrants to purchase 357,863 shares of Common Stock and (iii) May 2018 Class B Warrants to purchase 178,932 shares of Common Stock. The May 2018 Class A and May 2018 Class B Warrants were originally convertible into Common Stock at $12.40 per share. The Company received aggregate proceeds of $4,438 from the May 2018 private placement. Debt issuance costs that had been capitalized related to the 5% Secured Convertible Notes, were being amortized on a straight-line basis over their remaining term of the 5% Secured Convertible Notes. The Company did not record amortization expense of the debt issuance costs related to the 5% Secured Convertible Notes after June 30, 2019 as the notes were converted into Common Stock on June 27, 2019. The balance of debt issuance costs of $135 was written off in June 2019 and was included in “Interest expense” in the consolidated condensed financial statements for the nine months ended September 30, 2019.

During the second quarter of 2019, the Company failed to make minimum monthly payments as required pursuant to the 5% Secured Convertible Notes, which failure constituted an event of default. Pursuant to the terms of the 5% Secured Convertible Notes, upon an event of default, an investor may elect to accelerate payment of the outstanding principal amount of such investor’s 5% Secured Convertible Notes, liquidated damages and other amounts owing in respect thereof through the date of acceleration, which amounts become immediately due and payable in cash. No investor provided notice to the Company electing to exercise its right to accelerate payment.

On June 27, 2019, the Company entered into the Third Amendment Agreement to the 5% Secured Convertible Notes (the “Third Amendment”) whereby the holders of the 5% Convertible Notes agreed to convert their notes then held into Common Stock. The Third Amendment reduced the conversion price of the 5% Convertible Notes to Common Stock from $12.40 per share to $2.48 per share. As a result of the reduction in the conversion price, the Company recorded debt conversion expense of $1,547 to account for the additional consideration paid over what was agreed to in the original 5% Secured Convertible Notes agreement. The expense is reflected in “Other non-operating income (expense), net” in the consolidated condensed statement of operations and comprehensive loss. The 5% Secured Convertible Notes holders converted their remaining outstanding principal balances plus accrued interest into 586,389 shares of Common Stock and 356,772 Class A Warrants (the “June 2019 Class A Warrants”). The June 2019 Class A Warrants had an exercise price of $0.01 and are otherwise identical in form and substance to the Company's existing May 2018 Class A Warrants.

The Company had an independent third party perform an appraisal of the June 2019 Class A Warrants as of June 30, 2019. The June 2019 Class A Warrants were assigned an appraised value of $689. The value of these warrants was recorded as a derivative liability on the consolidated balance sheet and will be marked to market at the end of each reporting period. The expense of $689 is included in “Other non-operating income (expense), net” in the consolidated condensed statements of operations and comprehensive loss in the second quarter of 2019 and is included in our current period year to date results.

The June 2019 Class A Warrants were converted into 354,502 shares of Common Stock in July 2019.

Calm Note

The Calm Note is an unsecured subordinated obligation of the Company. The Calm Note will mature on May 31, 2022, and bears interest at a rate of 5% per annum, subject to increase in the event of default. The Calm Note is convertible at any time, in whole or in part, at the option of Calm into shares of Series E Preferred Stock at a conversion price equal to $3.10 per share. Interest on the Calm Note is payable in arrears and may be paid in cash, shares of Series E Preferred Stock or a combination thereof.

The Company engaged an independent third party to assess the fair value of each of the derivative instruments included in the Calm Note. The results of the appraisal were that the conversion feature and the Calm Warrants should be bifurcated, and both treated as derivative liabilities. A fair value of $351 was assigned to the conversion option, a fair value of $1,018 was assigned to the Calm Warrants and the Calm Note was assigned a fair value of $1,131 as of July 8, 2019. The conversion option and the Calm Warrants were marked to market as of September 30, 2019 and, as a result, the Company recorded a revaluation gain of approximately $185 that is included in “Other income (expense), net” in the consolidated condensed statements of operations and comprehensive loss for the three and nine months ended September 30, 2019.

The Company capitalized approximately $220 of costs related to the issuance of the Calm Note and recorded amortization expense of approximately $19 from the date the debt was issued on July 8, 2019 through September 30, 2019. The net balance of the deferred issuance costs is $201 as of September 30, 2019 and is presented as a reduction of the Calm Note balance in the Company’s consolidated condensed balance sheet. Amortization expense is included in “Interest expense” in the Company’s consolidated condensed statements of operations and comprehensive loss for the three- and nine-month periods ended September 30,2019. During the three and nine months ended September 30, 2019, the Company recorded $116 of accretion expense that increased the carrying value of the Calm Note.

Note 10. Stockholders’ Equity

Series D Convertible Preferred Stock Amendment and December 2016 Warrant Amendment

On July 8, 2019, the Company filed the Series D COD Amendment with the State of Delaware to reduce the conversion price of Series D Convertible Preferred Stock to Common Stock to $2.00 and to then provide for automatic conversion of the Series D Convertible Preferred Stock into shares of Common Stock.

When a reporting entity changes the terms of its preferred stock it must assess whether the changes should be accounted for as either a modification or extinguishment. The Company engaged an independent third party to perform an appraisal to determine the fair value of the Series D Preferred Stock before and after the changes were made. The results of the fair value assessment indicated that the fair values before and after the change in the provisions and characteristics of the Series D Preferred Shares were not substantially different (in practice, substantially different has been interpreted to be greater than ten percent). Therefore, the Company did not record an adjustment to the Series D Preferred Stock.

Also, on July 8, 2019, the Company entered into an amendment to the December 2016 Warrants to provide for (i) a reduction in the exercise price into Common Stock to $2.00, (ii) certain anti-dilution price protection and (iii) a voluntary reduction at a future date of the exercise price by the Company in its discretion.

Series E Convertible Preferred Stock

On July 8, 2019, the Company filed the Series E COD Amendment with the State of Delaware to (i) increase the number of authorized shares of Series E Preferred Stock to 2,397,060 and (ii) reduce the conversion price to $2.00. The Series E COD Amendment was approved by the Board of Directors of the Company and the Company obtained shareholder approval of the Series E COD Amendment on October 2, 2019.

When a reporting entity changes the terms of its outstanding preferred stock it must assess whether the changes should be accounted for as either a modification or an extinguishment. The Company engaged an independent third party to perform an appraisal to determine the fair value of the Series E Preferred Stock before and after the changes were made. The results of the fair value assessment indicated that the fair values before and after the change in the provisions and characteristics of the Series E Preferred Stock were not substantially different (in practice, substantially different has been interpreted to be greater than ten percent). Therefore, the Company did not record an adjustment to the Series E Preferred Stock.

Series F Convertible Preferred Stock

In connection with the May 2018 SPA Amendment, the Company issued 8,996 shares of Series F Convertible Preferred Stock to the parties to the May 2018 SPA Amendment. The Company engaged an independent third party to perform an appraisal to determine the fair value of the Series F Preferred Stock. The Series F Preferred Stock has a par value of $0.01 per share and a stated value of $100 per share. The Series F Preferred Stock was appraised at a fair value of $1,254, which was recorded as a charge to “Other income (expense), net” in the Company’s consolidated condensed financial statements for the three and nine months ended September 30, 2019.

Reverse Stock Split

On February 22, 2019, the Company filed a certificate of amendment to its amended and restated certificate of incorporation with the Secretary of State of the State of Delaware to effect a 1-for-20 reverse stock split of the Company’s shares of Common Stock. Such amendment and ratio were previously approved by the Company’s stockholders and Board of Directors.

As a result of the reverse stock split, every twenty (20) shares of the Company’s pre-reverse split Common Stock were combined and reclassified into one (1) share of Common Stock. Proportionate voting rights and other rights of common stockholders were affected by the reverse stock split. Stockholders who would have otherwise held a fractional share of Common Stock received payment in cash in lieu of any such resulting fractional shares of Common Stock as the post-reverse split amounts of Common Stock were rounded down to the nearest full share. No fractional shares were issued in connection with the reverse stock split.

Note 11. Derivative Liabilities and Fair Value Measurements

Fair value measurements are determined based on assumptions that a market participant would use in pricing an asset or a liability. A three-tiered hierarchy distinguishes between market participant assumptions based on (i) observable inputs such as quoted prices in active markets (Level 1), (ii) inputs other than quoted prices in active markets that are observable either directly or indirectly (Level 2) and (iii) unobservable inputs that require us to use present value and other valuation techniques in the determination of fair value (Level 3).

The Company’s financial instruments as of September 30, 2019 and December 31, 2018 consisted of cash and cash equivalents, trade receivables, retail inventory, accounts payable, accrued expenses and other current liabilities. The carrying amounts of all the aforementioned financial instruments approximate fair value because of the short-term nature of these instruments.

Derivative Liabilities

In connection with the Calm Private Placement, the Company granted warrants to purchase 937,500 shares of the Company’s Common Stock, at an exercise price of $2.00 per share.

The Calm Warrants issued in connection with the Calm Private Placement entitle Calm to purchase an aggregate of 937,500 shares of Common Stock. The Calm Warrants are exercisable beginning six months from the date of issuance, have a term of five years and can be exercised for shares of Common Stock at an exercise price of $2.00 per share.

At September 30, 2019, the Company had outstanding its May 2018 Class A Warrants and the Calm Warrants which are classified as liabilities and are included in “Derivative liabilities” on the consolidated condensed balance sheet. Both the May 2018 Class A Warrants and the Calm Warrants were fair valued as of September 30, 2019 and market to market as of that date (see Note 9. Long-term Notes and Convertible Notes for further discussion).

The May 2018 Class B Warrants were cancelled in July 2019. Holders of these warrants were granted Class A Warrants and shares of the Company’s Series F Preferred Stock (see Note 10. “Stockholders’ Equity” for further discussion regarding the Series F Preferred Stock).

The fair value of the conversion options related to the issuance of the B3D Note of $2,295 and the Calm Note of $324 are included in “Derivative liabilities” on the consolidated condensed balance sheet as of September 30, 2019.

The following table presents the placement in the fair value hierarchy of the Company’s derivative liabilities measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018:

The Company measures its derivative liabilities at fair value. The derivative liabilities were classified within Level 3 because they were valued using the Monte-Carlo model, which utilizes significant inputs that are unobservable in the market. These derivative liabilities were initially measured at fair value and are marked to market at each balance sheet date. The derivative liabilities are recorded shown as “Derivative liabilities” in the consolidated condensed balance sheets and the revaluation of the derivative liabilities is included in “Other non-operating income (expense), net” in the consolidated condensed statements of operations and comprehensive loss.

The following table summarizes the changes in the Company’s derivative warrant liabilities measured at fair value using significant unobservable inputs (Level 3) during the nine months ended September 30, 2019:

Valuation Processes for Level 3 Fair Value Measurements

Fair value measurement of the derivative warrant liabilities falls within Level 3 of the fair value hierarchy. The fair value measurements are evaluated by management to ensure that changes are consistent with expectations of management based upon the sensitivity and nature of the inputs.

September 30, 2019:

December 31, 2018:

Sensitivity of Level 3 Measurements to Changes in Significant Unobservable Inputs

The inputs to estimate the fair value of the Company’s derivative liabilities were the current market price of the Company’s Common Stock, the exercise price of the derivative of the conversion options and the warrants, their remaining expected term, the volatility of the Company’s Common Stock price and the risk-free interest rate over the expected term. Significant changes in any of those inputs in isolation can result in a significant change in the fair value measurement.

Generally, an increase in the market price of the Company’s shares of Common Stock, an increase in the volatility of the Company’s shares of Common Stock, and an increase in the remaining term of the derivative liabilities would each result in a directionally similar change in their estimated fair values Such changes would increase the associated liabilities while decreases in these assumptions would decrease the associated liabilities. An increase in the risk-free interest rate or a decrease in the differential between the derivative liabilities’ exercise price and the market price of the Company’s shares of Common Stock would result in a decrease in the estimated fair value measurement and thus a decrease in the associated liability. The Company has not declared, and does not plan to declare, dividends on its Common Stock, and as such, there is no change in the estimated fair value of the derivative liabilities due to the dividend assumption.

Note 12. Stock-based Compensation

The Company has a stock-based compensation plan available to grant stock options and RSUs to the Company’s directors, employees and consultants. Under the 2012 Employee, Director and Consultant Equity Incentive Plan (the “Plan”) a maximum of 355,000 shares of Common Stock may be awarded. In February 2019, the Company granted a total of 32,500 stock options to members of its Board of Directors and 75,000 stock options to the Company’s newly elected Chief Executive Officer at an exercise price of $4.20 per share. The options vest over a period of one year. The Company also granted 37,500 RSUs to its newly elected Chief Executive Officer at an exercise price of $4.20 per share.

Total stock-based compensation expense for the three and nine months ended September 30, 2019 was $35 and $266, respectively, and for the three and nine months ended September 30, 2018, stock-based compensation expense was $194 and $570, respectively.

Note 13. Related Party Transactions

On April 14, 2018, the Company entered into a consulting agreement with an employee of Mistral Equity Partners, which is a significant shareholder of the Company and whose Chief Executive Officer is a member of the Board of Directors of the Company, to consult on certain business-related matters. The total consideration was $10 per month through April 30, 2019, when it was terminated. The Company recorded consulting expense of $40 up through the termination date of the agreement.

Note 14. Discontinued Operations

FLI Charge

On October 20, 2017 (the “Closing Date”), the Company sold FLI Charge, a wholly owned subsidiary included in its discontinued technology operating segment, to a group of private investors and FLI Charge management. As part of the sale, the Company received a perpetual royalty agreement (the “Royalty Agreement”). The Company also received a warrant exercisable in shares of FLI Charge or an affiliate of FLI Charge upon an initial public offering or certain defined events in connection with a change of control. The warrant has a five-year life and is based on a valuation of the lesser of $30,000 or the financing valuation of FLI Charge preceding the initial public offering or certain defined events.

In June 2019, the Company received a buyout from the Royalty Agreement and warrants in the amount of $1,100. This is reflected in “Other” revenue on the consolidated condensed statement of operations and comprehensive loss.

Group Mobile

On March 7, 2018, the Company entered into a membership purchase agreement (the “Purchase Agreement”) with Route1 Security Corporation, a Delaware corporation (the “Buyer”), and Route1 Inc., an Ontario corporation (“Route1”), pursuant to which the Buyer agreed to acquire Group Mobile, a wholly-owned subsidiary included in the Company’s discontinued technology operating segment, (the “Disposition”). The transaction closed on March 22, 2018 (the “Closing Date”), after which the Company no longer had any involvement with Group Mobile.

In consideration for the Disposition, the Buyer issued to the Company:

Post-closing, the Company owned approximately 6.7% of Route1 common stock. The Route1 common stock is not tradable until a date no earlier than 12 months after the Closing Date; 50%, or 12,500,000 shares of Route1 common stock are tradeable after 12 months plus an additional 2,083,333 shares of Route1 common stock are tradeable each month until 18 months after the Closing Date, subject to a change of control provision. The Company has the ability to sell the Route1 common stock and warrants to qualified institutional investors. The Group Mobile Purchase Agreement also contains representations, warranties, and covenants customary for transactions of this type.

The total consideration of the Disposition was recognized as a cost method investment and, as such, was measured at cost on the date of acquisition, which, as of the Closing Date, approximated fair value. The fair value of the total consideration as of the Closing Date was determined to be $1,625, which was less than the carrying value of the asset. This resulted in a loss on disposal which is included in consolidated net loss from discontinued operations in the consolidated condensed statement of operations and comprehensive loss that was recorded in the nine-month period ended September 30, 2018 of $1,115.

The value of the total consideration for the Group Mobile disposition was determined using a combination of valuation methods including:

Due to the underperformance of operating results by Group Mobile in the first period for which results were required to be reported to the Company, we determined that the asset was impaired as of June 30, 2019 and recorded an impairment charge of $1,141, which is included in “Other non-operating income (expense), net” on the consolidated condensed statement of operations and comprehensive loss for the nine months ended September 30, 2019 (See Note 6. “Other Assets”).

Operating Results of Discontinued Operations

The following table presents the components of the consolidated net loss from discontinued operations, as presented in the consolidated condensed statements of operations and comprehensive loss for the nine-month period ended September 30, 2018:

Note 15. Income Taxes

The Company’s provision for income taxes consists of federal, state, local, and foreign taxes in amounts necessary to align the Company’s year-to-date provision for income taxes with the effective tax rate that the Company expects to achieve for the full year. Each quarter, the Company updates its estimate of the annual effective tax rate and records cumulative adjustments as deemed necessary. The income tax provisions for the nine-month period ended September 30, 2019 reflect an estimated global annual effective tax benefit at the rate of approximately 1%.

As of September 30, 2019, deferred tax assets generated from the Company’s activities in the United States were offset by a valuation allowance because realization depends on generating future taxable income, which, in the Company’s estimation, is not more likely than not to be generated before such net operating loss carryforwards expire. The Company expects its effective tax rate for its current fiscal year to be significantly lower than the statutory rate as a result of a full valuation allowance; therefore, any loss before income taxes does not generate a corresponding income tax benefit.

The Company recorded an income tax benefit during the three and nine months ended September 30, 2019, which is comprised primarily of the release of a liability for an uncertain tax position for which the statute of limitations expired in the third quarter of 2019 of $132, partially offset by earnings generated by foreign subsidiaries. The final annual tax rate cannot be determined until the end of the fiscal year therefore, the actual tax rate could differ from current estimates. The Company has an immaterial amount of remaining liabilities for uncertain tax positions and does not expect to record any additional material provisions for unrecognized tax benefits in the next year.