Planet Fitness Inc (PLNT) 2016 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. And thank you for standing by. Welcome to the Planet Fitness third quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. Instructions will be provided at the time for you to queue up for questions. (Operator Instructions). I would like to remind everyone that this conference call is being recorded. I will now turn the call over to Brendon Frey, Managing Director of ICR.

Thank you for joining us today to discuss Planet Fitness's third quarter 2016 earnings results. On today's calling are Chris Rondeau, President and CEO, and Dorvin Lively, Chief Financial Officer. A copy of today's press release is available on the Investor Relations section of Planet Fitness's website at www.planetfitness.com. I would like to remind you that certain statements we will make in this presentation are forward-looking statements including statements relating to the proposed refinancing of the Company's senior secured indebtedness and potential use of proceeds to fund a special dividend and other equivalent payments.

These forward-looking statements reflect Planet Fitness's judgment and analysis only as of today and actual results may differ materially from current expectations based on a number of factors affecting Planet Fitness's business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made in this conference call and web cast we refer you to the disclaimer regarding forward-looking statements that is included in our third quarter 2016 earnings release which was furnished to the SEC today on Form 8-K as well as our filings with the SEC referenced in that disclaimer.

We do not undertake any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise. In addition the Company may refer to certain adjusted non-GAAP metrics on this call. Explanation of these metrics can be found in their earnings release filed earlier today. With that I will turn the call over to Chris Rondeau, President and Chief Executive Officer of Planet Fitness. Chris?

Thanks, Brendon. Thanks everybody for joining us today for our third quarter earnings call. Our business has continued to get stronger as the year has progressed. Third quarter system-wide same-store sales increased 10% compared with the comp gain of 6.8% and 7.6% in Q1 and Q2 respectively. At the same time we have expanded the opening of 37 new franchise locations during the quarter bringing the total system-wide store count to 1,242 at the end of September.

An increase of 19% compared to the same date a year-ago. The combination of 10% comp growth and the addition of nearly 200 Planet Fitness locations in the past twelve months to a total revenue growth of 26% and earnings per share of $0.16, $0.2 ahead of consensus. Our recent performance proves that our (inaudible) attracting new member both casual gym goes and first time gym members, seems to work. It starts with our welcoming non (inaudible) environment featured high-quality branded cardio and strength equipment and the fact that we are able to offer our differentiated superior in-store experience for $10 per month is incredibly compelling to our target audience and is a huge (inaudible) advantage for Planet Fitness in all markets.

Another critical component (inaudible) of success is a committed by the Company and our franchisees to continually reinvest in growing the business. This includes contributing 2% of monthly dues to the national ad fund which allows us to participate in rate brand building events such as our sponsorship of the Time Square New Year's Eve celebration and creative TV and digital advertising that runs nationally throughout the year. On top of this another 5% to 7% is spent on local and regional marketing programs and at driving awareness and member sign on's. We are extremely excited about this upcoming New Year's Eve event. This is our second year to be lead sponsor and whole team is excited to showcase our brand again to over 1 billion people around the world.

Equally important is the capital spend on keeping the Planet Fitness stores fresh and up to date. This is anchored by a disciplined equipment replacement cycle that ensure the consistent store experience regardless of the number of visits a store that opened this year or a decade ago. Our franchisees as well as our corporate stores have to continued invest in this endeavor throughout this year. While the membership experience is at the center of our differentiated fitness concept we would have not been able grow to our current size and reach as many people as we have without the superior business of our (inaudible) almost 25 years.

The financial returns we have been able to generate for our franchisees has fueled a rapid expansion of Planet Fitness evidenced by the fact over 9% of approximately 210 stores set to open this year are prior or existing operators. At the same time most of all (inaudible) development agreements were purchased by existing franchisees in order to further grow their businesses beyond their initial territories. This financial success extend to our shareholders as well.

With a higher margin recurrent revenue from our fastest growing franchise segment combined with our asset light model the Company has consistently achieved strong double-digit earnings growth and generates significant free cash flow. Based on past performance and more importantly longer away for growth ahead of us we are excited to announce that we are in the process of refinancing our existing debt in adding incremental debt to potentially declare a special cash dividend.

Our Board of Directors and Management Team are constantly evaluating the most prudent use of our strong balance sheet and free cash flow and believe increasing our leverage with the potential to use the proceeds to fund a special dividend is a great way to maximize our shareholder value. With that, I'll turn the call over to Dorvin.

Thanks, Chris. And good afternoon everyone. I'll begin by reviewing the details of our third quarter results and then discuss our full-year outlook as well as our proposed amendment to our credit facilities. For the third quarter of 2016 total revenue increased 26.4% to $87 million from $68.8 million in the prior period. Total system-wide same-store sales increased 10% from a segment perspective franchise same-store sales increased 10.3% and our corporate store same-store sales increased 5.4%. Over 90% of our Q3 comp increase was driven by an increase in members at the same time our black card membership penetration was 59%.

That's 180 basis points improvement over Q3 last year. Our franchise segment revenue was $27.2 million, an increase of 37.5% from $19.8 million in the prior-year period. Let me break down the drivers of our fastest growing revenue segment. Royalty revenue was $15.1 million, which consists of royalties on monthly membership dues and the annual membership fees.

This compares to royalty revenue of $10.9 million in the same quarter of last year, an increase of 39%. This year-over-year increase had three drivers. First, we opened 205 new franchise stores since the third quarter of last year. Second, as I mentioned our franchise owned same stores he sales increased by 10.3% which was primarily driven by higher members per comp store as well as a slightly higher dues per member. And then third, a higher overall average royalty rate.

For the third quarter our average royalty rate was 4.01%, up from 3.65% in the same period last year driven by more stores at our current royalty rate of 5%. Next our franchise and other fees were $5.8 million, an increase of 56.3% or $2.1 million over the prior-year period. These fees are fees we receive from processing dues through a point-of-sale system. Fees from online new member sign-ups as well as fees paid to us in association with new and amended franchise agreements and area development agreements.

Also within the franchise segment revenues are placement revenue. Which was $2.2 million versus $1.6 million in the prior-year period. That's an increase of 37%. These are fees we received for assembly and replacement of equipment for franchisee owned stores. The increase was driven by 9 additional new store equipment sales during the current year quarter.

And then finally, our commission income which are missions from third-party preferred vendor arrangements used by all stores. And equipment commissions for international new store openings was up $600,000 to $4.2 million compared to $3.6 million a year-ago, and that's an increase of 14.6%. This was driven by additional stores in the current year period over the prior year as well as additional purchases from these vendors by existing stores. Our corporate-owned store segment revenue increased 6.1% to $26.7 million from $25.2 million in the prior-year period.

This $1.5 million increase was driven by the increase in corporate owned same store sales up 5.4%. Our system-wide total membership increased from more than 8.6 million members at the end of our second quarter of this year to more than 8.7 million members at the end of Q3. Cumulatively year-to-date we have increased our net members by more than 1.4 million members. Turning to our equipment segment, revenue increased by $9.2 million or 38.7%, to $33.1 million from $23.9 million last year.

This was driven by equipment sales to new franchise owned stores related to more new equipment sales compared to the prior-year period and an increase in replacement equipment sales to existing franchisee owned stores. Our replacement sales as a percent of our total equipment sales was 37% in Q3 with strong purchases by our franchisees re-equipping their clubs during the quarter.

We expect replacement revenue as a percent of total equipment revenue to be in the 25% to 30% range on a full year basis. For our equipment revenue segment year-to-date this year we have sold to US franchisees 111 new equipment sales compared to 113 last year. These revenues are recognized when our services are rendered and completed from the assembly and placement process.

Stores may open shortly thereafter but can be held up at times until the franchisees receive their certificate of occupancy from local municipalities. I'll address our full year guidance on new equipment placements in a few minutes. Cost of revenue which primarily relates to direct cost of equipment sales and to new and existing franchise owned stores amounted to $25.9 million compared to $18.9 million a year-ago an increase of 37.5%, which was driven by the increase in equipment sales I mentioned during this quarter.

Store operation expenses which are associated with our corporate owned stores was $15.2 million compared to $14.3 million a year-ago. This $900,000 increase was driven by a combination of factors including some incremental store labor at several of our corporate stores as we increased staffing levels to provide a better member experience along with some additional planned repairs and maintenance experiences for certain of our corporate stores.

SG&A for the quarter was $12.2 million compared to $17.3 million a year-ago. Both periods include non-recurring expenses. Last year they were primarily associated with our initial public offering and this year they were in conjunction with the secondary offerings. Excluding these non-recurring expenses our total SG&A increased by $2 million or 22.2%. This increase is due to supporting our growing franchise operations as well as incremental ongoing public company expenses.

Our operating income inclusive of the aforementioned non-recurring expenses increased to $26.2 million for the quarter compared to operating income of $10.3 million in the prior-year period. On an adjusted basis taking into account the one-time items and expenses related to our offerings our adjusted operating margin was 32% in this quarter versus 27.6% in the prior-year quarter, an increase of 440 basis points.

This was primarily due to revenue growth and higher margins from our franchise segment where we have leveraged the cost infrastructure in this fastest growing segment. Our effective income tax rate for the quarter was 24.4% compared to 62.5% in the prior-year period.

However, as I have stated before, an appropriate adjusted income tax rate would be approximately 39.5% if all of the earnings of our Company were taxed at the Planet Fitness, Inc. level. On a GAAP basis for the third quarter of 2016 our net income was $14.9 million compared to net income of $0.7 million in the prior-year period. On an adjusted basis net income was $15.9 million or $0.16 per diluted share, an increase of 51.7% and up from $10.5 million or $0.11 per diluted share in the prior-year period.

Adjusted net income has been adjusted to exclude the impact of the public offerings reflect a normalized federal income tax rate of 39.5% as if we were a public company for the current year and the comparable prior periods and excludes several non-recurring costs. We have provided a reconciliation of the adjusted net income to GAAP net income in today's earnings release. Adjusted EBITDA which is defined as net income before interest taxes, depreciation and amortization adjusted for the impact of certain non cash and other items that are not considered in the evaluation of ongoing operating performance increased 33.5% to $35.4 million from $26.5 million in the prior period.

A reconciliation of adjusted EBITDA to GAAP net income can also be found in the press release. By segment our franchise segment EBITDA increased 47.2% to $22.8 million driven by higher royalties received from additional franchisee owned stores not included is the same-store sales base, an increase in franchise owned same-store sales of 10.3% that I mentioned earlier as well as higher implications and other fees.

The prior year included certain non-recurring expenses associated with the initial public offering that I mentioned earlier as well. After adjusting for these non-recurring items franchise segment EBITDA margins increased by approximately 335 basis points to 85.5%. Corporate owned store segment EBITDA increased 14% to $10.6 million driven primarily by a 5.4% increase in corporate same-store sales as I stated a few minutes ago.

Our corporate store segment adjusted EBITDA margins increased by 185 basis points. Our equipment segment EBITDA increased 45.7% to $7.2 million driven by higher equipment sales. For the quarter, equipment adjusted EBITDA margins decreased slightly by 100 basis points to 21.6% but is in line with our stated equipment margin range of 21% to 22%. Let me summarize real quickly the highlights of another very strong quarter. Revenue rose by 26.4%.

Same-store sales were up 10%. Our fastest growing franchise segment grew revenue by approximately 37.5% with adjusted EBITDA margins up 185 basis points. Our average royalty rate for the quarter increased to 4.01%. Our corporate store segment revenue grew 6.1% driven by the 5.4% comp gain. Equipment segment revenue increased 38.7%.

We sold to our franchisees 37 new equipment sales this quarter compared to 28 new equipment sales last year bringing us to 111 new equipment sales in the US year-to-date. Our adjusted EBITDA margins were up approximately 215 basis points and then we grew our adjusted net income by 51.7%.

Now let me turn to the balance sheet. As of September 30, 2016 we had cash and cash equivalents of $66 million and borrowing capacity of $40 million under our revolving credit facility. Our total bank debt at the end of September was $488.4 million excluding the deferred financing costs consisting solely of our senior term loans which bears interest at LIBOR plus 350.

As Chris mentioned we are seeking to amend our existing credit facility to increase our term loan borrowings by approximately $230 million. The total borrowings under this amended credit facility-based upon the calculation of EBITDA in accordance with our credit agreement which includes incremental adjustments of approximately $12.5 million that are in addition to our trailing twelve month adjusted EBITDA as of September 30, 2016 puts the Company at a gross leverage ratio of approximately 4.6 times.

In connection with this potential amendment the Company is considering paying a special cash dividend of up to approximately $280 million with the proceeds from the additional borrowings as well as available cash. The specific timing and amount of the dividend has not been determined.

Should the refinancing and special dividend be completed we would feel very comfortable with our debt to credit agreement adjusted EBITDA leverage ratio given the anticipated leverage ratio would be only slightly higher than our two previous credit facility amendments at March 31, 2014 and March 31, 2015, combined with the strong free cash flow that this business consistently generated and our confidence in our business model. Should this refinancing occur we would incur approximately $2 million of additional interest expense in Q4, a reduction in our adjusted net income per diluted share of approximately $0.01.

Now to our outlook. Based on our third quarter performance we are raising our full year guidance. We now expect revenue to be in the range of $373 million to $378 million, up from our previous guidance range of $366 million to $372 million. We still expect 2016 system-wide comparable sales to increase in the high single digit range. With respect to new stores we think it's more helpful to guide on the number of new store equipment sales and placements versus new store openings.

As I explained earlier in the call, we recognize equipment revenue for new stores when our services are rendered and completed from the assembly and placement of equipment in new stores. The date a store actually opens has very little bearing on our top line performance. For 2016 we expect to sell and place equipment in approximately 195 to 200 new domestic stores which is consistent with our projections earlier this year.

Also, as a reminder we recognize our revenues on equipment purchases by our international franchisees differently compared to when we sell equipment to franchisees here in the US. Domestically we take title to the equipment from the equipment manufacturer, we ship the equipment to the franchisee location and then we generally assist the franchisee with the assembly and placement process of this equipment where by we also recognize a placement fee for those services.

In other words, we have got gross revenue, cost of goods sold and a gross profit. Internationally we do not take title to the equipment from the manufacturer but rather the manufacturer sells its equipment directly to the international franchisee and then pace us a commission on the sale that's equal to the gross profit that we would have recognized as if that transaction had occurred similar to here in the US.

Another way to think about it is that we have lower revenues for these new stores sales outside the US but it generates about the same gross profit dollars. For the full year we're expecting to receive commissions on international new store equipment sales of approximately 8 to 9 new stores.

Adjusted net income is now projected to range from $65 million to $66 million with adjusted EPS between $0.66 and $0.67, up from our previous adjusted EPS guidance of $0.63 to $0.66. Our new EPS guidance reflects the $0.02 upside we delivered in Q3 partially offset by a $0.01 of additional interest expense in the fourth quarter associated with this proposed financing that I just mentioned. And now with that we would like to turn the call back to the Operator for questions.

(Operator Instructions). Your first question comes from the line of Sharon Zackfia, from William Blair. Your line is open.

Hi. A couple of questions. First, on the decision to do a cash dividend, that's pretty unusual. So can you talk through why you would want to take on more leverage to do a cash dividend particularly with private equities still owning so much of the shares?

Yes. Hi Sharon. This is Chris. Myself as well as the Board looked for many ways to improve uses of the cash and to leverage that we're currently down to. And at this point it seemed like it was the right way to maximize value back to the shareholders at this stage of the game.

Yes. Sharon, I think just to add to it briefly is that, and I have stated this all the way back to the time we went public, which is barely over a year ago, because of the asset like model and the significant free cash flow generation of this business we have de-levered on a net basis pretty significantly including the two financings that we did back in the Q1 2014 and 2015. And between each of those two times now we've basically de-levered about a turn.

So we're down to right-size around three, three times, and we stated that our goal is to be kind of between about 3 to 5 times. We think that that's an appropriate leverage ratio and when we look at our business and the confidence, and the comment I made a minute ago, we believe that the best use of that cash today is to return the cash to shareholders. And as you mentioned, our sponsor is still in although they've had now three transactions, but the rest of our shareholders will obviously benefit in this as well and we just believe that this is the best use of the cash at this time.

We will still, in connection with the proposed refinancing we're also increasing our revolver from the current $40 million to $75 million, which will also then give us additional liquidity available for other uses of cash down the road.

Did the Board consider doing an ongoing dividend in addition to a special?

We did consider that and have discussed that at Board meetings. And I believe the overriding factor frankly at this point is we're a brands new public company, we've barely been out now, this is our fifth quarter, I guess, as a public company, and there's not a lot of new minted public companies that have implemented a regular quarterly dividend. And frankly, once you do it, I think the right policy is you stick to it over time. And so at this stage of our Company as a public company we believe this was the right transaction, possible transaction to date (inaudible) as opposed to implementing a quarterly dividend right now.

Okay. And then my last question. The last couple of quarters the royalty rate has kind of been up more in the 35, 45 basis points range and I think Dorvin you have kind of talked about 25 to 35 being the right range longer-term. Just kind of curious what's happened the last few quarters where that's been up a little bit more than average?

Yes. I think it was up 36 bits this quarter and you're right. I have said that it should be in that 25 to 35 range and part of the reason that I have stated that is that, and you will recall, Sharon, that in our thousand plus stores that are in the pipeline that are committed under area development agreements, a number of those stores have the grandfather royalty rate at the time the ADA was sold. And so knowing exactly the mix of new stores that are going to be coming online when we go back to let's say Q1 and we're looking for guidance and the way we gave guidance this year, we felt that was the appropriate range. And it turned out to be pretty close. I mean as I said we're up 36 bps for this quarter. But anyway, that's how we got to the range that we have indicated.

Okay. Thank you.

Sure. Thanks.

Your next question comes from the line of John Ivankoe from JPMorgan. Your line is open.

Hi. A couple, if I may. Firstly on the new stores, Dorvin, you talked about 195 to 200 placements and then you have 8 to 9 new international, which I don't think is included is that as placements if I followed you correctly. Could you put that store count in the context of your openings? I think what you previously talked about lower end of 210 to 220. Obviously, I know it doesn't really matter to fourth quarter revenue but it does matter to recurring revenue as we think about 2017. So what are you thinking the overall number of stores that will be open as just consistent with previous guidance for 2016?

Yes. That's a good question because as I stated we felt like this was probably actually better information and ties to the way we ultimately recognize revenue. So if you take the two of those and if we just talk pure stores for a second, then those numbers I gave you would basically take you from 203 to 209.

When you add the domestic and the US. And you are you're right to the point that the international piece, you just don't get that revenue component as I mentioned before. But as I also stated, that 195 to 200 range was in line with basically our previous, you know, the way we gave guidance in the past. So here's the point, and I alluded to it briefly.

Stores can open up in a month or quarter, or I'm sorry, we can place the equipment in a month or a quarter and it can open up in a following month or quarter. And the way to process works is as the franchisee is working whether GC to get down to, you know, close to an opening date that they have been given, there's lots of things that have got to happen from inspections to getting the rubber flooring down, to et cetera, and one big piece of that is getting the equipment there.

So, for every franchisee in the US we get a delivery date that's usually eight to ten weeks out from that time period that they want that equipment delivered. And in an ideal state the equipment would be delivered and within two to three days the franchisee and their GC working with the local officials will get their CO and then, believe me the franchisee will open up as quick as they can. But I will give you a couple examples as to why it doesn't.

Our last Oakland store that we had scheduled to open on December the 26, 2014, we had the equipment in there around the 20th or 23rd of December and the local town official went on holiday, vacation for Christmas. And we were not able to open up that store until January the 7th. So last year, similar issues. And it varies between the amount and the particular cutoff period and that's why we kind of defaulted to this, but our store openings this year included a handful of stores that we actually sold the equipment into and recognized those revenues in December of last year, but then those stores opened up this year.

So, two points I will make. I believe our guidance of now in essence total stores of 203 to 209 is not inconsistent with the way we have been talking about guidance on pure openings the last call we said kind of the lower end of 210 to 220, so it's pretty close to that. And then second of all, we're raising our revenue guidance and we feel comfortable with the revenue guidance even with this store count of placements versus those store counts of openings that I just mentioned.

Thank you for that explanation. And as we think about 2017, how does the current pipeline look how are franchisees feeling? Do you have any sense of timing of openings or placements, however you want to talk about it, throughout the year?

Yes. I think that , you know, if you go back to all of the discussions that Chris and I have had with you guys as well as investors at conferences or any on the road shows we continually talk about the fact that our franchisees are 90% of all of our stores open up existing franchisees many of our franchisees now are opening a much higher number of stores on an annual basis and they're also buying the majority of new stores that we sell from a new (inaudible) perspective. And when you think of the thousand plus in the pipeline, that's in general to these existing franchisees are the ones that are growing.

With that said we have always said we felt comfortable with right around 200. And the reason we say that is because it's been close to where specific been now for the last two or three years. And we have a very disciplined process with how we approve stores. Every store that comes in we have to sign off on not only the location and that location can be considered (inaudible), et cetera, within an existing franchisee's territory. But certainly to an abutting territory that is another consideration we take into place. But we also really take into account the location. Is it an ideal size for a new Planet Fitness store?

And we end up rejecting a lot of sites throughout the year and so we would rather do it on a measured promotion than to try to just approve more and more sites that come in from a real estate perspective. So we still feel comfortable in that kind of 200 a year range. But we will give guidance specifically for 2017 when we announce our year-end results.

Thank you. And then really quick you did guide to kind of a soft interest expense number for fourth quarter assuming the refinancing. Do you have an idea or do you have a range what you think the fully loaded GAAP interest rate will be for 2017 as we think about the models?

No, I don't at this point. And I think I just have to wait and work that into when we give full year potential for next year.

Of course. I understand. Thank you so much.

Thanks.

Your next question comes from the line of John Heinbockle, from Guggenheim Securities. Your line is open.

So Chris let me start with how would you characterize sort of the seasonal performance of membership? Both gross adds and then also, kind of the normal summer time drop off's? Because it looks like we don't have a lot of historical data, but it looks like membership through the summer was stronger than it's been maybe in past summers. So, your thoughts on that? Is that right?

Yes. I mean I would think, you know, look at the 10% same-store sales comp. I would say it lended a lot to much more (inaudible) our disciplined marketing strategy this year. For example, we had a national mandatory July sale, also a national mandatory flash sale, one day flash sale in August. And also I think it all kind of lends itself to a tailwind from New Year's Eve, quite honestly. Now that we are (inaudible) number one over of Gold Gym's. The first time we have dethroned them. And the digital strategy this year that quite honestly didn't really exist a year-ago. So I think when you factor all that in its just the momentum that carries through summer here in a very good way.

And it was more gross adds, right? As opposed to, there were less, I know the summer time sometimes you get these people drop-off and then come back. It was really the gross adds, not the people giving up the membership? Fair?

Yes. I would say, John, that we and I think I have stated this in the past. We don't see any major change in kind of the cancellation rates. We talk about it obviously and those members have been here longer than 12 months, et cetera. But, no major change in that. I think it relates to what Chris was saying in terms of the branding and then, you know, the better focus marketing I think in Q3 this year than last year.

When you think about long term, you know, obviously you have got such a huge advantage you mentioned the unaided brand awareness. You know, not just versus Gold's but think about people in your own channel there. When you think long-term about both the national add fund and the local, at some point is there an opportunity for that to drop a little bit just because the absolute magnitude, the absolute dollars spent will be so big that can drop a little bit, and then could at that tie-in with maybe getting a 5%, a higher royalty rate than the 5% you're getting today at the upper end?

I guess the beauty of this franchise model and the way the world sees it when you add fund works is the fact that with every incremental member it constantly pushes more dollars even the older stores to get more members and penetrate the market more. So while that will that give us the ability to raise royalties in the future you know possibly. You know, we can continue to push more members per store make the unit economics more and more attractive I think there is an opportunity there. At the same token I kind of look at it a lot where the existing franchisees keep opening all these stores, 90% are opened by existing franchisees. So it's the fact that they're putting back to work in the system is also rewarding. So it's hard to, (inaudible) putting it back to work for us is a good thing, too.

Okay. Thank you.

Thanks, John.

Your next question comes from the line of Sean Naughton, from Piper Jaffray. Your line is open.

A question on the members per club. You know, very impressive numbers. Obviously now we're getting over 7,000 members and the members per club seems to be what's really driving the comp here. Can you just give us an idea or maybe just a range on what the maximum number of members per club that you guys can operate effectively? Or just an idea of how much higher that number can go understanding there's a lot of moving pieces on different sides? But how much higher can that number go, do you think?

Yes. That's a good question. So we get this a lot. On a typical 20,000 square foot box which is our average, we have many stores in that size club and equipment that have up to 10,000 members. So we can raise that average of 7,000 up without having to retool the box. I guess is an easy way to put it. Which gives us a lot of room to grow. I would say when we start get to go that maybe 13 plus is where it starts to get a little dicey but until we get to. I think 10,000 is a pretty easy number to get to without having to redo anything.

Okay. So across the chain 10,000 still feels, that feels like you could operate most of the boxes feels like that would be okay on the current footprint?

Yes. Yes. And it really lends itself to the member number we have is not a 7 day a week for two hour user.

And other thing is, and you know this from conversations in past that the fact that we go 24/7 what that does is it smoothes out the real rush and it also, because of the value position that are members that are more willing to be a little bit flexible with their schedule. And Monday night is the busiest night of the every week. It always is and it winds down from there to a lower usage when you get throughout the week. But because of that and the value and the fact that we're closer to more and more people all the time, people are willing to be a little bit more flexible with their schedule.

Understood. And I guess just looking forward it sounds like no change to kind of the 200 new units and the royalty rate with the opportunity to expand 25 to 30 basis points or 35 still seems like that's kind of a good way to think about the model. In terms of the addressable market, have you guys thought any more about international? I think domestically or maybe it's US and Canada is 4,000, but I think you have had some good success in some new international markets. Anything there we should think about kind of on the 2 to 3 year time horizon for the business?

Yes. We constantly look at strategy here. We are (inaudible) previous calls Latin America is interesting to us. When we think about how our stores on Puerto Rico, the recent store we opened here in the Dominican Republic. That (inaudible) way there and how we work in a lot of other hispanic markets here in the states Miami, El Paso, San Antonio, et cetera. So those are still probably the first priority that we're looking at this point. No signed or solid concrete deal at this point.

Okay. Thank you.

Thank you.

Thanks.

Your next question comes from the line of Oliver Chen, with Cowen and Company. Your line is open.

Hi. Congrats on great results. We had a question related to the increase in replacement to existing franchisees. Was that number in line with your expectations in terms of where you thought that would come out? And also Dorvin, related to that equipment sales margin down 100 basis points, what was the main driver behind that line item as well?

Yes. A couple things, Oliver. I think earlier in the year I said it would probably be in the low to mid 20s as a percent of our total equipment revenue. And I said a few minutes ago that it would be between 25% and 30% of our revenue. So a slight improvement there. So not significantly out of line of what we thought at all, frankly. I think what we're seeing going on and we have talked about this before, in fact Chris made it in some of his remarks a few minutes ago, is that our franchisees have built up a significant business in these markets where they're at with a significant amount of EBITDA for a small business. And they have seen the power of not only what they spend locally but what we spend nationally and being able to continue to drive more people to stores.

Now, what we don't want to do is we don't want to be out, we use this term around here called out nude. And, competition is competition and we talked about that there's generally a knock off in almost every market. But what you don't want to do is you don't want do have a 6 and 7 year store that looks like it's 12, 15 years old. And we preach that and preach that now for the last probably three years. Before that we didn't really push it at all. Including Q1 of last year getting an agreement with our franchise advisory counsel and our independent franchise association on the specifics around replacing equipment. And so I think what you're seeing is that these guys are protecting their investment, protecting their turf and believe that much of the house or car you have to continually invest in it to make it be the most attractive place in the market and so that's what we're seeing going on.

So maybe slightly better than where we would have thought back earlier in the year, but not significantly out of line.

And, how were you feeling about the margin profile? Was that margin in line with your expectation?

Yes, it can vary a little bit over time and that's why we have said 21% to 22%. I think it's been slightly higher than that a couple times. Sometimes it comes down, frankly, to just the mix of the equipment being sold particularly on the replacement side. Because, and I think we have mentioned this, Oliver, that a franchisee doesn't go in and just say okay, I got to replace all my cardio here in the next quarter.

And it's somewhat of a rolling effect of how they do that. And so the specific orders in a particular month or quarter for those specific pieces can vary a bit because we don't have the exact same margin on every single piece that goes into a store. You could have a hundred pieces of cardio in a store and then all the other. And so they can vary a bit on an overall basis our new equipment sales generally are going to be right between that 21%, 22%.

Okay. And on the incremental term loan borrowings of $20 million, why was that dimension the right number just as we evaluate risk and return in terms of that amount?

Go ahead.

On the competitive. When you look across your competition which I am sure continues to be intense and is rising, what are competitors doing whether it be marketing or product or in-store experiences that you're kind of monitoring just to make sure that you remain on the cutting-edge?

So yes, Oliver. I will start first. I would say it hasn't changed in the sense of more competition or more units or more operators entering the the market. And in some ways think it's just the opposite. As I mentioned in the last call, the new trends there year and I had another one recently of local low cost operators with 10, 20 stores that stay that they have tried to get in the market tried to come up against us that, you know, five years ago and here we are today they have 10, 20 stores and they are looking for a way out because they just can't compete against us in our space.

And a lot, if not all of our markets are local franchisees with their fellow franchisees are larger than any other local competitor. So they are the market leader even in their own right. So almost been the opposite. It's been a recent trend that's happened this year and there's been some acquisitions and mergers already within our system where our franchisees have taken out their local competitors which has been intriguing for us and something I think we'll see a lot more of it.

(inaudible) I think a lot of what I see in the low cost operators doing is because I feel because it's probably not working competing with us because they're trying to gravitate back to the old model. They're adding the heavy weights in they're adding the day cares in and they're not doing that because they're they compete well they're doing it because they can't make it work. That's kind of what I have seen from my end.

From your question with respect to the amended loan facility; as I stated it'll take us to about 4.6 times leverage on a gross basis. And we generate a decent amount of cash flow even in the next three, four months here as we get two Q4, et cetera. So in that sense it gets us pretty much back to where we have been twice before and with de-levering it close to a turn a year or thereabouts it will continue. Within a four to six quarter time period we could be back down not too far from we are today. So the amount itself was somewhat predicated upon us being back pretty close to where we were leveraged before.

Okay. And just our last question we have done a lot of research on the election. What your thoughts on the election if it inter plays with the media posterior that you have or customer behavior, or not. Just curious if that's something that you have been seeing in terms of differences in your elasticity of the media or in the way your customers behave, or not?

Yes. I would say the only thing that really I kind of see is the marketing like marketing and disciplined and more planned approaches that marketing dollars don't go as far as in October because of the election. So we held off our October sale now into November with the media rate come down. So that's one thing we just had to move over which isn't really that big a deal. It's just one month but more strategic on our spend but other than that as far as the consumer is concerned we have people working out just as much as they ever did and no other changes there.

That's great. Thanks. Congrats. Best regards.

Thank you.

Your next question comes from the line of Dave King, with ROTH Capital Partners. Your line is open.

I guess first off on the strong comp store membership growth this quarter. Are there any, Chris, any specific regional call outs there in terms of what might be driving there whether that's urban versus tertiary markets or newer, call it, second or third year store markets versus kind of your more customer ones? Anything you could share there would be appreciated.

Yes. We haven't seen anything really from a regional perspective. We have really been across-the-board positive so nothing there even all different clubs as well, the clubs are performing well. I really think that it's the compounding promotion of the digital marketing media that we have been doing the tail winds of the New Year's Eve and brand awareness and then the (inaudible) promotion on our mandatory July sale and if you think about the health club industry the summer is kind of when they back off and being out there during the summer I think comes out well for us. I think everybody else has taken kind of a back seat and weathered the storm. So I think it worked out good for us.

Okay. That's helpful. Then maybe on the new store kind of sign-ups or sign-ups in some newly opened stores anything to share it there? Has that dropped off at all? You know obviously it seemed like the growth rate overall for memberships has accelerated a bit, but it seems like comp drove a lot of that anything to share on the new kind of stores and how the sign-ups have been going there initially?

Yes. Yes. Our new stores that we have opened this year have opened very similar to the stores for last year. No major change in kind of the number of members at kind of day one, month one, month two, et cetera. So I would say frankly it's very, very similar to as it's been in the last year or so.

Okay. That's good color. And then maybe Dorvin one more for you. In terms of interest expense, that $2 million that you called out, I assume that's been fees? That's not anything in terms of incremental rate because we don't know that yet? Did I understand that appropriately?

Yes. Yes. It's based on where we think we will, I mean the deal obviously just got announced today and we'll see where once we get it launched and where it end up at from a closing perspective and pricing, but based on what we know today we think that incremental amount will be about a penny in the quarter as I mentioned.

Okay. And lastly actually, Chris, one for you. In terms of churn rate I know that's been a subject in the past. If I sort of look at what the retention rate is at a substantial number of your clubs I think it's kind of 63% or so. That implies churn I think of towards kind of 3% on a monthly basis which I think he is a little bit higher than maybe some other gym concepts, but I know in the past you have talked about why that's not necessarily a great kind of metric. Can just remind us of that again and kind of talk us through that? Thank you.

Yes. It's Dorvin. As you know, we go after the 80% of the population that don't belong to a gym and we put a you know what they think is a great value position out there to get people off the couch. And because you're going to have people who are going try and they're not going to make it, and that's why we have always stated that the way we look at it is what happens after 12 months. Because frankly, there's no comp out there that you could even compare us to.

No one has the kind of members we have and et cetera, et cetera. So that math that we have talked about in the past is that the cancellation rate after you have been a member for greater than 12 months is low-ingle digits a month. It can be 1.5% to 2.5% a month and it has not changed as I have mentioned a few minutes ago certainly in you know the more recent time periods here.

That's great. Thanks for all the color and good luck the rest of the year.

Thank you.

Your next question comes from the line of Jonathan Comp, with Robert W. Baird. Your line is open.

Yes. Hi. Thanks. Chris, I want to follow up on some of the marketing plans going forward. First just on the digital piece some of the promotion it seems like there's a ton of low-hanging fruit there so I want to ask you how you maybe see some of those activities developing going forward? And then secondly, just more near-term with the second year of the New Year's Eve title sponsorship I'm wondering if you can talk about kind of how the plans look relative to the activities you had last year?

Yes. The digital stuff you know about that (inaudible) capabilities there to streamline and make performance better each and every time we do it. And a lot of those I mentioned in the past calls is that for one instance is black card members are able to bring a free guest in to work out at no charge now we capture the emails and the market to those guests to see if we can get them to email marketing I guess so extremely cheap ROI is great.

Another example is the online Dropbox so if somebody join online which is about 20%, a little over 20% of our monthly joins are online. So people that are attempt tell me cold feet let's say halfway though it, we've now captured their email first so we're able to go after them and that's a really ripe prospect because they're all thinking of doing and got cold feet. So those are just two examples there are quite a few others that we are doing now that we didn't do before and we learned you a lot about that and getting better as times goes.

New Year's Eve it's exciting time for us. You know, naturally that first year so we learned a lot on stage presence, logo placements. So we have learned a lot of that and the hats will be released in December/more flash going on so I look forward to that. So I think we will get some good hype this New Year's Eve as well and I'm looking forward to attending actually.

Okay. Great. And then maybe switching topics just to ask about the unit development outlook again and I'm curious just following up on that kind of roughly 200 units target per year. I'm just asking I'm curious kind of how you think about that being the right rate. I imagine there's probably very few if any markets where you have hit saturation and now that you have a bigger unit base more franchisees , you know, probably a lot of real estate available, you might even argue that maybe you could go a little faster, but I want to just follow up on kind of why that's the right pace?

Yes. We're very (inaudible) on our openings now and I think the way retail is we are able to be more selective of our real estate. You know be five years ago we almost had to take anything we could find. And today I think it's important to make sure that we get the A site not settle for a B or C and be out placed in the future by somebody else coming in after the fact. So for every three sites we look at we'll turn down two.

So I think we really selective on making sure that we have the main A site. Could we go faster? Possibly. And could things turn out a little better for us? Possibly but think it's just making sure that we always have those A sites and success in the franchisees is important to us.

Okay. Got it thank you.

Your next question comes from the line of Rafe Jadrosich from Bank of America. Your line is open.

Hi, guys. It's Rafe. Thanks for take my questions. I just wanted to ask you about the initiative to add more store labor into some of the corporate stores. Can you just kind of talk about maybe the lift that you have gotten from that and then is that something that you would expect to expand?

Yes. I think it's still kind of early. I think it's more customer experience and as Jim Esposito who is our new leader in Corporate Store started really getting in same stores and putting the infrastructure around it so maybe some in the future but nothing I think just doing what's right for the customer to be sure that it continues.

And then can you give some color on maybe some of the black card initiatives? Maybe how you're partnering with third parties and then how the kind of remodel to support black card is going?

Yes. I think it's probably more around the model than it is third parties at this point. I think that's where we're seeing more of the lift a lot of franchisees the store making those black card what we call black card spas putting lounge areas in them and frosted glass doors and spa music in them a little bit more of that delta feel or club feel so I think that's probably what's driving or getting the franchisees to renovate and make the areas nice for third party.

And that 59% with good expansion year-over-year do you guys have an out look on how high that could go look longer-term or could you give some color on some of your clubs that have the highest black card penetration?

Yes. Some of those there were stores some are getting into that mid 60's. Mid-to-high 60's. 60%. So I think there's probably still some room to move although the closer gets to it the slower I think we will begin as opposed to five years ago was about 38%. So there's still some movement there, but I always looking for black card new amenity can we add to spike up those areas that are tracking more different people or more people in those areas. Nothing is set in stone yet as any new amenity right now.

Great. Thank you.

Your next question comes from the line of Christian Buss from Credit Suisse. Your line is open.

Yes. A follow-up on the bang card penetration. Wondering if you could talk a little bit about where you see the upper boundary for that and how much you want to move your customer up to that price point?

Yes. I think be (inaudible) plus range percent there's still some room to move there renovate stores put those black card we will continue to see it move. And I guess the other one key factor is reciprocity is a big one that happens to be the number one people choose it. So if you look at the penetration in the northeast we're about 4.5% of 4.5% of the population is a member of our stores (inaudible). Start franchiseesing here out west a little over 1% penetration so we're very (inaudible) some parts of the state so (inaudible) those could be driving more black card percentage in the future.

And then can I ask about the regional penetration? If you could talk a little bit about what you're seeing from a regional perspective in terms of comp stores sales and performance of the franchise concepts? Appreciate that.

Chris kind of talked about this a minute ago in terms of things we're seeing across the landscape, if you will. And I would say that there's nothing that really sticks out. We look at same-store sales by state, we look at it by we call it DMAs across the US. We have a decent size number of stores in a particular market and we haven't seen anything in terms of one really huge outlier that's something that alarms us. Within a group of 15 to 25 stores you're going to have some over achievers and under achievers in there in some cases. But nothing that we would say there is something going on in that region. So I say pretty consistent across the landscape.

That's very helpful. Thank you so much and best of luck.

Thank you.

Thank you.

There are no further questions in queue. I will now turn the call back to management.

Thank you everybody for joining us today. It was a great quarter for us. Thanks for the questions and I look forward to our next call at the end of the year call. Fourth quarter. So thank you everybody for joining us.

This concludes today's conference call. You may now disconnect.