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May 6, 2019, 6:13 a.m. EDT

10-K: ONESPAWORLD HOLDINGS LTD

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(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

The following discussion and analysis of our audited financial condition and results of operations should be read in conjunction with the information presented in "Selected Historical Financial Information" and our combined financial statements and the notes thereto included elsewhere in this report. In addition to historical information, the following discussion contains forward-looking statements, such as statements regarding our expectation for future performance, liquidity and capital resources, that involve risks, uncertainties and assumptions that could cause actual results to differ materially from those contained in or implied by any forward-looking statements. Factors that could cause such differences include those identified below and those described in the sections entitled "Cautionary Note Regarding Forward-Looking Statements" and "Risk Factors." We assume no obligation to update any of these forward-looking statements.

The information for the years ended December 31, 2018, 2017 and 2016 are derived from OSW Predecessor's audited combined financial statements and the notes thereto included elsewhere in this report.

Any reference to "OneSpaWorld" refers to OneSpaWorld Holdings Limited and our consolidated subsidiaries on a forward-looking basis or, as the context requires, to the historical results of OSW Predecessor. Any reference to "OSW Predecessor" refers to the entities comprising the "OneSpaWorld" business prior to the consummation of the Business Combination.

Overview

We are the pre-eminent global operator of health and wellness centers onboard cruise ships and a leading operator of health and wellness centers at destination resorts worldwide. Our highly-trained and experienced staff offer guests a comprehensive suite of premium health, fitness, beauty and wellness services and products onboard 163 cruise ships and at 67 destination resorts globally as of December 31, 2018. With over 80% market share in the highly attractive outsourced maritime health and wellness market, we are the market leader at approximately 10x the size of our closest maritime competitor. Over the last 50 years, we have built our leading market position on our depth of staff expertise, broad and innovative service and product offerings, expansive global recruitment, training and logistics platform as well as decades-long relationships with cruise and destination resort partners. Throughout our history, our mission has been simple-helping guests look and feel their best during and after their stay.

At our core, we are a global services company. We serve a critical role for our cruise line and destination resort partners, operating a highly complex and increasingly important aspect of our cruise line and destination resort partners' overall guest experience. Decades of investment and know-how have allowed us to construct an unmatched global infrastructure to manage the complexity of our operations, which in 2018 included nearly 8,000 annual voyages with visits to over 1,100 ports of call around the world. We have consistently expanded our onboard offerings with innovative and leading-edge service and product introductions, and developed the powerful back-end recruiting, training and logistics platforms to manage our operational complexity, maintain our industry-leading quality standards, and maximize revenue per center. The combination of our renowned recruiting and training platform, deep labor pool, global logistics and supply chain infrastructure and proven revenue management capabilities represents a significant competitive advantage that we believe is not economically feasible to replicate.

Matters Affecting Comparability

Supply Agreement

We purchase beauty products for resale from an entity (the "Supplier Entity") that was, during the periods presented, a wholly-owned subsidiary of Steiner Leisure. OSW Predecessor and the Supplier Entity entered into an agreement, effective as of January 1, 2017 (subsequently amended in 2018), which established the prices at which beauty products will be purchased by us from the Supplier Entity for a term of 10 years (the "Supply Agreement"). The Supply Agreement has had a positive impact on our business as it has reduced the cost of products for retail goods and has lowered the cost of products used in services. The prices of beauty products purchased by OSW Predecessor from the Supplier Entity prior to 2017 were not comparable to those set forth under the Supply Agreement and applicable to future periods. As a result, our operations and financial condition in periods prior to January 1, 2017 differ materially from those ended after that date.

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The Supply Agreement was effective as of January 1, 2017, however, existing inventories of products purchased prior to the effectiveness of the Supply Agreement were not fully depleted until the end of the third quarter of 2017. Beginning October 1, 2017, the cost of products used in services and cost of products reflect the actual pricing under the Supply Agreement because, at that time, all inventory on hand was purchased under the terms of the Supply Agreement.

In order to quantify the impact of the Supply Agreement on the comparability of our financial statements between periods, the following table sets forth the decrease in cost of products used in services and cost of products that would have been reflected in the financial statements of us for the periods presented if all inventory on hand during such periods was purchased under the terms of the Supply Agreement (i.e., as if no existing inventories of products purchased prior to the effectiveness of the Supply Agreement were sold during the periods presented):







              (in thousands)                                  2018       2017         2016
              Decrease in Cost of Products Used in Services   $  -      $ 4,170     $  7,824
              Decrease in Cost of Products                       -        5,214       10,589
              Total                                           $  -      $ 9,384     $ 18,413
        


In order to further quantify the impact of the Supply Agreement on the comparability of our financial statements between periods, the following table sets forth the increase in cost of products used in services and cost of products that would have been reflected in the financial statements of us for the periods presented if all inventory on hand during such periods was purchased prior to the effectiveness of the Supply Agreement:







                                                                 For the Year Ended
                                                                    December 31,
                                                                  2018          2017
               Increase in Cost of Products Used in Services   $     8,886     $ 3,282
               Increase in Cost of Products                         13,844       5,897
               Total                                           $    22,730     $ 9,179
        


timetospa.com Business Model

As a result of our planned separation from Steiner Leisure, we are no longer operating timetospa.com as a standalone e-commerce business with focused marketing efforts and paid search advertising through December 31, 2017. timetospa.com is now a post-cruise sales tool where guests may continue their wellness journey after disembarking. Revenue and net income in the years ended December 31, 2017 and 2016 are not directly comparable to revenue and net income in the year ended December 31, 2018 due to this change in the timetospa.com business model.

Key Performance Indicators

In assessing the performance of our business, we consider several key performance indicators used by management. These key indicators include:

Ship Count. The number of ships, both on average during the period and at period end, on which we operate health and wellness centers. This is a key metric that impacts revenue and profitability.

Average Weekly Revenue Per Ship. A key indicator of productivity per ship. Revenue per ship can be affected by the various sizes of health and wellness centers and categories of ships on which we serve.

Average Revenue Per Shipboard Staff Per Day. We utilize this performance metric to assist in determining the productivity of our onboard staff, which we believe is a critical element of our operations.

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Average Weekly Revenue Per Destination Resort Health and Wellness Center. A key indicator of productivity per destination resort health and wellness center. Revenue per destination resort health and wellness center in a period can be affected by the mix of North American and Asian centers for such period because North American centers are typically larger and produce substantially more revenues per center than Asian centers. Additionally, average weekly revenue can also be negatively impacted by renovations of our destination resort health and wellness centers. The following table sets forth the above key performance indicators for the periods presented:







                                                             As of and for the Year Ended
                                                                     December 31,
                                                            2018           2017         2016
           Average Ship Count                                 156.7         154.0        151.0
           Period End Ship Count                                163           157          156
           Average Weekly Revenue Per Ship               $   60,421      $ 56,999     $ 53,741
           Average Revenue Per Shipboard Staff Per Day   $      474      $    446     $    427
           Average Resort Count                                61.9          51.6         48.1
           Period End Resort Count                               67            54           50
           Average Weekly Revenue Per Resort             $   13,927      $ 16,400     $ 18,765
        


Key Financial Definitions

Revenues. Revenues consist primarily of sales of services and sales of products to cruise ship passengers and destination resort guests. The following is a brief description of the components of our revenues:

Service revenues. Service revenues consist primarily of sales of health and wellness services, including a full range of massage treatments, facial treatments, nutritional/weight management consultations, teeth whitening, mindfulness services and medi-spa services to cruise ship passengers and destination resort guests. We bill our services at rates which inherently include an immaterial charge for products used in the rendering of such services, if applicable.

Product revenues. Product revenues consist primarily of sales of health and wellness products, such as facial skincare, body care, orthotics and detox supplements to cruise ship passengers, destination resort guests and timetospa.com customers.

Cost of services. Cost of services consists primarily of an allocable portion of payments to cruise lines (which are derived as a percentage of service revenues or a minimum annual rent or a combination of both), an allocable portion of wages paid to shipboard employees, an allocable portion of staff-related shipboard expenses, costs related to recruitment and training of shipboard employees, wages paid directly to destination resort employees, payments to destination resort venue owners, the allocable cost of products consumed in the rendering of a service and health and wellness center depreciation. Cost of services has historically been highly variable; increases and decreases in cost of services are primarily attributable to a corresponding increase or decrease in service revenues. Cost of services has tended to remain consistent as a percentage of service revenues.

Cost of products. Cost of products consists primarily of the cost of products sold through our various methods of distribution, an allocable portion of wages paid to shipboard employees and an allocable portion of payments to cruise lines and destination resort partners (which are derived as a percentage of product revenues or a minimum annual rent or a combination of both). Cost of products has historically been highly variable, increases and decreases in cost of products are primarily attributable to a corresponding increase or decrease in product revenues. Cost of products has tended to remain consistent as a percentage of product revenues.

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Administrative. Administrative expenses are comprised of expenses associated with corporate and administrative functions that support our business, including fees for professional services, insurance, headquarter rent and other general corporate expenses. We expect administrative expenses to increase due to additional legal, accounting, insurance and other expenses related to becoming a public company.

Salary and payroll taxes. Salary and payroll taxes are comprised of employee expenses associated with corporate and administrative functions that support our business, including fees for employee salaries, bonuses, payroll taxes, pension/401K and other employee costs.

Amortization of intangible assets. Amortization of intangible assets are comprised of the amortization of intangible assets with definite useful lives (e.g. customer contracts, trade names, long-term leases) and amortization expenses associated with the 2015 Transaction.

Other income (expense), net. Other income (expense) consists of royalty income, interest income, interest expense and minority interest expense.

Provision for income taxes. Provision for income taxes includes current and deferred federal income tax expenses, as well as state and local income taxes. See "-Critical Accounting Policies-Income Taxes" included elsewhere in this Annual Report on Form 10-K.

Net income. Net income consists of income from operations less other income (expense) and provision for income taxes.

Revenue Drivers and Business Trends

Our revenues and financial performance are impacted by a multitude of factors, including, but not limited to:

The number of ships and destination resorts in which we operate health and wellness centers. Revenue is impacted by net new ship growth and the increase in the number of destination resort health and wellness centers in each period.

The size and offerings of new health and wellness centers. We have focused our attention on the innovation and provision of higher value added and price point services such as medi-spa and advanced facial techniques, which require treatment rooms equipped with specific equipment and staff trained to perform these services. As our cruise line partners continue to invest in new ships with enhanced health and wellness centers that allows for more advanced treatment rooms and larger staff sizes, we are able to increase the availability of these services, driving an overall shift towards a more attractive service mix.

Expansion of value-added services and products across modalities in existing health and wellness centers. We continue to expand our higher value added and price point offerings in existing health and wellness centers, including introducing premium medi-spa services, resulting in higher guest spending.

The mix of ship count across contemporary, premium, luxury and budget categories. Revenue generated per shipboard health and wellness center differs across contemporary, premium, luxury and budget ship categories due to the size of the health and wellness centers, services offered, guest demographics and guest spending patterns.

The mix of cruise geography and itinerary. Revenue generated per shipboard health and wellness center is influenced by each cruise itinerary including the number of sea versus port days, which impacts center utilization, as well as the geographic sailing region which may impact offerings of services and products to best address guest preferences.

Collaboration with cruise line partners including targeted marketing and promotion initiatives as well as implementation of proprietary technologies to increase center utilization via pre-booking and pre-payment. We are now directly marketing and distributing promotions to onboard passengers as a result of enhanced collaboration with select cruise line partners. We have also begun to implement proprietary pre-booking and pre-paymenttechnology platforms that interface with our cruise line partners' pre-cruise planning systems. These areas of increased collaboration with cruise line partners are resulting in higher revenue generation across our health and wellness centers.

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The effect of each of these factors on our revenues and financial performance varies from period to period. Results of Operations







        Comparison of Results for the Years Ended December 31, 2018 (audited) and
        December 31, 2017 (audited)
                                                            Year Ended December 31,
                                                               % of                         % of
                                                              Total                        Total                Change
        ($ in thousands)                        2018         Revenue         2017         Revenue           $             %
        Revenues
        Service Revenues                      $ 410,927          76.0 %    $ 383,686          75.7 %    $  27,241          7.1 %
        Product Revenues                        129,851          24.0 %      122,999          24.3 %        6,852          5.6 %
        Total Revenues                          540,778         100.0 %      506,685         100.0 %       34,093          6.7 %
        Cost of Revenues and Operating
        Expenses
        Cost of Services                        352,382          65.2 %      332,360          65.6 %       20,022          6.0 %
        Cost of Products                        110,793          20.5 %      107,990          21.3 %        2,803          2.6 %
        Administrative                            9,937           1.8 %        9,222           1.8 %          715          7.8 %
        Salary and Payroll Taxes                 15,624           2.9 %       15,294           3.0 %          330          2.2 %
        Amortization of Intangible Assets         3,521           0.7 %        3,521           0.7 %            0          0.0 %
        Total Cost of Revenues and
        Operating Expenses                      492,257          91.0 %      468,387          92.4 %       23,870          5.1 %
        Income from Operations                   48,521           9.0 %       38,298           7.6 %       10,223         26.7 %
        Other Income (Expense), net
        Interest Expense                        (34,099 )         6.3 %            0           0.0 %      (34,099 )         NM
        Interest Income                             238           0.0 %          408           0.1 %         (170 )      (41.4 %)
        Other (Expense)/Income                      171           0.0 %         (217 )         0.0 %          388           NM
        Total Other Income, net                 (33,690 )         6.2 %          191           0.0 %      (33,881 )         NM
        Income Before Provision for Income
        Taxes                                    14,831           2.7 %       38,489           7.6 %      (23,658 )      (61.5 %)
        Provision for Income Taxes                1,088           0.2 %        5,263           1.0 %       (4,175 )      (79.3 %)
        Net Income                            $  13,743           2.5 %    $  33,226           6.6 %    $ (19,483 )      (58.6 %)
        


Revenues. Revenues increased approximately 6.7%, or $34.1 million, to $540.8 million in 2018, from $506.7 million in 2017. The increase was driven by six incremental net new shipboard health and wellness centers added to the fleet, 14 incremental net new destination resort health and wellness centers opened, a continued trend towards larger and enhanced shipboard health and wellness centers as well as increased guest spending on higher-priced services, product innovation and improved collaboration with partners such as the continued rollout of new direct marketing initiatives onboard. The revenue increase was offset by one-time changes in the business model for the timetospa.com website.

For the year ended December 31, 2018, the 20 incremental net new health and wellness centers contributed $20.1 million, the increase in average price of services and products sold contributed $15.3 million and the increase in the volume of services sold at existing health and wellness centers contributed $1.0 million in increased revenue, respectively, offset by a decrease of $2.2 million due to the change in the timetospa.com website business model. The revenue growth over this time period was relatively proportional between service and product revenues:

Service revenues. Service revenues increased approximately 7.1%, or $27.2 million, to $410.9 million in 2018, from $383.7 million in 2017.

Product revenues. Product revenues increased approximately 5.6%, or $6.9 million, to $129.9 million in 2018, from $123.0 million in 2017.

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The productivity of shipboard health and wellness centers increased for 2018 compared to 2017 as evidenced by an increase in both average weekly revenues and revenues per shipboard staff per day. Average weekly revenues increased by 6.0% to $60,421 in 2018, from $56,999 in 2017, and revenues per shipboard staff per day increased by 6.3% over the same time period. We had an average of 2,852 shipboard staff members in service in 2018 compared to an average of 2,809 shipboard staff members in service in 2017. The productivity of destination resort health and wellness centers, measured by average weekly revenues, decreased 12.9% to $13,927 in 2018, from $16,400 in 2017. The decrease in productivity was primarily driven by one large destination resort health and wellness center being under renovation as well as the addition of smaller health and wellness centers in Asia that generate lower revenue and the closure of a large health and wellness center in Las Vegas.

Cost of services. Cost of services increased $20.0 million in 2018 compared to 2017. The increase was primarily attributable to an increase in service revenues which accounted for an increase of $23.6 million, offset by the effect of reduced costs under the Supply Agreement which decreased cost of services by $4.2 million. Cost of services as a percentage of service revenues decreased to 85.8% in 2018, from 86.6% in 2017. The decrease was primarily attributable to the effect of the Supply Agreement.

Cost of products. Cost of products increased $2.8 million in 2018 compared to 2017. The increase was primarily attributable to an increase in product revenues which accounted for an increase of $6.1 million and an increase in payments to cruise and destination resort partners of $3.0 million, offset by the effect of the Supply Agreement which decreased cost of products by $5.2 million. Cost of products as a percentage of product revenues decreased to 85.3% in 2018, from 87.8% in 2017. The decrease was attributable to the effect of reduced costs under the Supply Agreement.

Administrative. Administrative expenses increased $0.7 million in 2018 compared to 2017. The increase in administrative expenses was driven primarily by expenses incurred in connection with the Business Combination.

Salary and payroll taxes. Salary and payroll taxes increased $0.3 million in 2018 compared to 2017. The increase was primarily related to additional merit-based compensation.

Amortization of intangible assets. Amortization of intangible assets remained flat at $3.5 million in 2018 and 2017.

Other income (expense), net. Other income (expense), net decreased $33.9 million in 2018 compared to 2017. This decrease was primarily attributable to an increase in interest expense related to internal restructuring, which resulted in debt previously held at the parent level being assigned to us in anticipation of the Business Combination.

Provision for income taxes. Provision for income taxes decreased $4.2 million in 2018 compared to 2017. This decrease was primarily due to a favorable impact of the Act which resulted in a lower U.S. federal tax rate effective January 1, 2018. Cash taxes as a percentage of income before provision for income taxes for the years ended December 31, 2018 and 2017 were 4.9% and 1.2%, respectively.

Net income. Net income was $13.7 million in 2018 compared to net income of $33.2 million in 2017. This decrease in net income was due to all of the factors described above.

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        Comparison of Results for the Years Ended December 31, 2017 (audited) and
        December 31, 2016 (audited)
                                                             Year Ended December 31,
                                                                % of                         % of
                                                               Total                        Total               Change
        ($ in thousands)                         2017         Revenue         2016         Revenue          $             %
        Revenues
        Service Revenues                       $ 383,686          75.7 %    $ 362,698          76.2 %    $ 20,988          5.8 %
        Product Revenues                         122,999          24.3 %      113,586          23.9 %       9,413          8.3 %
        Total Revenues                           506,685         100.0 %      476,284         100.0 %      30,401          6.4 %
        Cost of Revenues and Operating
        Expenses
        Cost of Services                         332,360          65.6 %      318,001          66.8 %      14,359          4.5 %
        Cost of Products                         107,990          21.3 %      106,259          22.3 %       1,731          1.6 %
        Administrative                             9,222           1.8 %       10,432           2.2 %      (1,210 )      (11.6 %)
        Salary and Payroll Taxes                  15,294           3.0 %       14,454           3.0 %         840          5.8 %
        Amortization of Intangible Assets          3,521           0.7 %        3,521           0.7 %           0          0.0 %
        Total Cost of Revenues and Operating
        Expenses                                 468,387          92.4 %      452,667          95.0 %      15,720          3.5 %
        Income from Operations                    38,298           7.6 %       23,617           5.0 %      14,681         62.2 %
        Other Income (Expense), net
        Interest Income                              408           0.1 %          340           0.1 %          68         20.0 %
        Other (Expense)/Income                      (217 )         0.0 %         (178 )         0.0 %         (39 )       21.9 %
        Total Other Income, net                      191           0.0 %          162           0.0 %          29         17.9 %
        Income Before Provision for Income
        Taxes                                     38,489           7.6 %       23,779           5.0 %      14,710         61.9 %
        Provision for Income Taxes                 5,263           1.0 %        5,615           1.2 %        (352 )       (6.3 %)
        . . .
        


May 06, 2019

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