Good afternoon. My name is Jesse, and I'll be your conference operator today.
At this time, I would like
to welcome everyone to the Planet Fitness Third Quarter 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. With that, I'll turn the call over to Brendan Frey from ICR.
Thank you for joining us today to discuss Planet Fitness' Q3 2017 earnings results. On today's call are Chris Rondeau, Chief Executive Officer and Dorvin Lively, President and Chief Financial Officer. A copy of today's press release is available on the Investor Relations section of Planet Fitness' website atplanetfitness.com. I would like to remind you that certain statements we will make in this presentation are forward looking statements. These forward looking statements reflect Planet Fitness' 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' 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 webcast, We refer to the disclaimer regarding forward looking statements that is included in our Q3 2017 earnings release, which was furnished to the SEC today on Form 8 ks, 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 the earnings release filed earlier today.
With that, I'll turn the call over to Chris Rondeau, Chief Executive Officer of Planet Fitness. Chris?
Thank you, Brandon, and thank you everyone for joining us for our Q3 earnings call. Building off our strong performance in the first half of the year, the business continues to perform very well. Same store sales were positive for the 43rd consecutive quarter increasing 9.3% on top of a 10% comp gain in the Q3 last year. Total revenue was up 12.1% and revenues in each of the 3 segments were up in the quarter, with franchise our highest margin segment increasing 30.6% and 31 new Planet Fitness stores opened during the period bringing system wide total stores to 1432. As discussed on previous calls, over the past year, we've been conducting price elasticity testing in several markets throughout the U.
S. And Canada to evaluate the impact of increasing our Black Card monthly dues. We are proud to have held our Black Card pricing flat at $19.99 for the past 15 years, while at the same time increasing its value to our members significantly. The value of our reciprocity benefit alone has increased dramatically as we've grown our store base from 20 stores when the black Card was first introduced to more than 1400 stores today across the U. S.
Our members truly appreciate this perk. And in 2016, 50% of Black Card members across the country used the club other than their home club at least once. Since first rolling out the Black Card membership, we have built designated Black Card spa areas in our stores, added total body enhancement, massage chairs and hydro massage beds. These numerous benefits combined with the ability to bring a friend for free continue to make the planet that is Black Card a great value for consumers. We are pleased to report that the price elasticity test results were overwhelmingly positive, naturally increasing the average blended rate of new joints.
As a result and with close collaboration with franchisee leadership, we decided to allow AllSource system wide to roll out the new $21.99 Black Card price beginning September 1st and required Alt Source to implement the new pricing as of October 1st, which is perfect timing ahead of our busy season. We remain as committed as ever to providing our members with an access to low cost, high quality fitness and are confident that this rate adjustment will allow us to continue to strengthen our member experience and provide increased value to our franchisees and shareholders. While franchisee growth continues to be the pillar of our store expansion strategy, we are on schedule to open 4 new corporate stores by the end of the year, including 1 each in Wilmington, Delaware in Berlin, Vermont and 2 stores in Erie, Pennsylvania. All of these stores started presale in the Q3 and are off to a solid start. As we had said at the time of the IPO, our plan is to open a handful of corporate stores per year in new and existing markets, where we have the ability to capitalize on advertising dollars or test varying population densities and alternative build outs.
For example, our Berlin, Vermont corporate store is approximately 15,000 square feet versus our typical 20,000 square foot store. Berlin has a population of only 40,000 people within a 20 minute drive time, roughly half the average of our typical location. With that in mind, we are extremely pleased with the number of new members sign ups during our presale thus far and encouraged by the demand for the brand in smaller markets. We have a long runway for growth ahead of us with a potential footprint of 4,000 stores in the U. S.
Over time. While the vast majority of our pipeline is domestic stores, our franchisees continue to open new stores in Canada and the demand for our first location in Panama remains strong with the official grand opening scheduled to open in the coming weeks. Speaking of our stores, our Que Maria had the impact on our stores in Puerto Rico as the entire island was affected by the largest storm hit the region in nearly 100 years. Of our 11 stores in the market, we have reopened 2 and 9 are temporarily closed with damage ranging from water to structural issues. Our franchisee is committed to the market and is working on a plan to reopen stores and service community as soon as possible.
Thankfully, our stores in Texas, Florida, Georgia and South Carolina in the past of Hurricane Harvey and Hurricane Irma were not significantly damaged and remain open and operating as usual. Having said that, Planet Fitness store employees in various regions, particularly in Puerto Rico were personally impacted. And I was truly inspired by the generosity of our franchisees and vendors who came together to raise approximately $300,000 to provide financial assistance to help with housing, transportation, clothing and other essential items for employees and their families. With these funds, we formalized the Planet Fitness Disaster Relief Fund, which is a non profit organization that will serve as a mechanism to provide relief to club staff moving forward. Coming together to support one another in times of need is what sets our franchise system apart from the rest.
Finally, I'm excited to share that we have enhanced our leadership team to include 2 new positions. First, Craig Miller, Chief Digital and Information Officer, joined Planet Fitness with more than 20 years of experience in major consumer brands like Sonic Drive In, Movie Gallery Hollywood Video, PepsiCo and Bank of America. Rob Sopkin also joined us as Chief Development Officer. Rob brings nearly 2 decades of national regional real estate experience, spending the majority of his career working at Starbucks, most recently leading U. S.
Store development and overseeing the integration of Starbucks' store development with licensed stores in Canada and internationally. In addition, Cammy Dunaway recently joined our Board of Directors, bringing more than 25 years of experience leading the marketing and general management of global brands like Yahoo! Nintendo, Ritalei and Kinsania. In summary, it was another terrific quarter highlighted by robust system wide sales growth and earnings that exceeds expectations. Looking ahead, we are anticipating a strong finish to the year, which is incorporated into our increased outlook for 2017.
While we just celebrated our 25 years in business, I believe we are just beginning to scratch the surface of Planet Fitness' full potential. I'm confident that we are well positioned to capitalize on the many opportunities that lie ahead and deliver increased shareholder value over the long term. I'll now turn the call over to Dorvin.
Thanks, Chris, and good afternoon, everyone. I'll begin by reviewing the details of our Q3 results and then discuss our full year 2017 outlook. For the Q3 of 2017, total revenue increased 12.1 percent to $97,500,000 from $87,000,000 in the prior year period. Total system wide same store sales increased 9.3%. From a segment perspective, franchiseesame store sales increased 9.6% and our corporate store same store sales increased 5.1%.
Over 90% of our Q3 comp increase was driven by member growth. At the same time, our Black Card membership penetration was 60%, up 130 basis points over Q3 last year. As Chris mentioned, following the successful test of the $21.99 pricing on the Black Card in approximately 100 stores, we made the decision to roll the price increase out system wide on October 1. The impact on October results from the price increase was positive and we expect Q4 comps to benefit from both volume and rate growth, and this has been factored into our upwardly revised guidance. Our franchisee segment revenue was $35,600,000 an increase of 30.6 percent from $27,200,000 in the prior year period.
Let me break down the drivers of our fastest growing revenue segment. Royalty revenue was $22,000,000 which consists of royalties on monthly membership dues and annual membership fees. This compares to royalty revenue of $15,100,000 in the same quarter of last year, an increase of 46.2%. This year over year increase had 3 drivers. 1st, we opened 196 new franchise stores since the Q3 of last year.
2nd, as I mentioned, our franchisee owned same store sales increased by 9.6% and then third, a higher overall average royalty rate. For the Q3, the average royalty rate was 4.33%, up from 4.01% in the same period last year, driven by more stores at more current royalty rates. Next, our franchise and other fees were $7,000,000 compared to 5 $800,000 in the same quarter a year ago, an increase of 20.7%. These fees are received from processing dues through our point of sale system, fees from online new member sign ups, as well as fees paid to us in association with franchise and transfer fees and area development agreement fees. This increase was primarily driven by additional stores and increase in same store sales and higher franchise and transfer fees as compared to the prior year period.
Also within franchise segment revenue is our placement revenue, which was $2,400,000 compared to $2,200,000 last year. Finally, our commission income, which is made up of commission from 3rd party vendors, arrangements and equipment commissions for international new store openings, was $4,100,000 compared to 4,200,000 in the prior year period. Our corporate owned store segment revenue increased 7.1% to $28,600,000 from $26,700,000 in the prior year period. The $1,900,000 increase was driven by the increase in corporate owned same store sales of 5.1 percent and increased annual fee revenue. Turning to our Equipment segment, revenue increased slightly to $33,400,000 from $33,100,000 The increase was driven by higher replacement equipment sales to existing franchisee owned stores, partially offset by lower new store equipment placements versus a year ago period.
As a number of new store openings originally planned for Q3 this year shifted into Q4. Year to date, our placement our replacement equipment revenue represented 48% of total equipment revenue. Our cost of revenue, which primarily relates to direct cost of equipment sales to new and existing franchise owned stores, amounted to $25,800,000 compared to $25,900,000 a year ago. Store operations expense, which is associated with our corporate owned stores, was $15,600,000 compared to $15,200,000 a year ago. SG and A for the quarter was $14,100,000 compared to $12,200,000 a year ago.
Both periods include non recurring expenses related to secondary offerings. Excluding these non recurring expenses, total SG and A increased by $2,900,000 or 25.6 percent. This increased expense was primarily to support our growing operations and infrastructure, including higher payroll and related costs, as well as cost of being a public company. Our operating income, inclusive of the aforementioned non recurring expenses, increased 29.8 percent to $34,000,000 for the quarter compared to operating income of $26,200,000 in the prior year period. On an adjusted basis, taking into account the non recurring expenses I just mentioned, our adjusted operating margin was 35.8% this quarter versus 32% in the prior year quarter, an increase of 3.80 basis points.
This was primarily due to revenue growth and higher margins as we have continued to leverage our cost infrastructure. Our earnings before taxes, inclusive of the aforementioned non recurring expenses, increased 29.4 percent to $25,400,000 for the quarter compared to earnings before taxes of $19,700,000 in the prior year period. As a result of our 4th quarter 2016 amended credit facility and increased term loan borrowings, we incurred approximately $2,600,000 in higher interest expense in the Q3 of 2017 compared to the prior year period. Our GAAP effective income tax rate for the Q3 was 25.7 percent compared to 24.4% in the prior year period. As we have stated before, because of the income attributable to the non controlling interest, which isn't taxed at the Planet Fitness Inc.
Level, an appropriate adjusted income tax rate would be approximately 39.5 percent if all earnings were taxed at the Planet Fitness Inc. Level. On a GAAP basis for the Q3 of 2017, our net income attributable to Planet Fitness Inc. Was $15,300,000 or $0.18 per diluted $8 per diluted share compared to $3,400,000 or 0 point 0 $8 per diluted share in the prior year period. Net income was $18,900,000 compared to 14 point $9,000,000 in the prior period.
On an adjusted basis, net income was $18,700,000 or $0.19 per diluted share, an increase of 17.9 percent compared with $15,900,000 or $0.16 per diluted share in the prior year period. Keep in mind that Q3 included higher interest expense of $2,600,000 as a result of the prior year Q4 refinancing. Adjusted net income has been adjusted to exclude non recurring expenses and reflect a normalized federal income tax rate of 39.5%. We have provided a reconciliation of 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 22.4% to $43,400,000 from $35,400,000 in the prior year period.
A reconciliation of adjusted EBITDA to GAAP net income can also be found in today's earnings release. By segment, our franchise segment EBITDA increased 31.2% to $29,900,000 driven by higher royalties received from additional franchisee owned stores not included in the same store sales base, an increase in franchise owned same store sales of 9.6%, more stores at higher royalty rates, as well as higher commissions and other fees, including higher franchise and transfer fees. Our franchise segment adjusted EBITDA margins were 85.1% compared to 85.5% in the prior period. Corporate owned store segment EBITDA increased 14 0.2% to $12,000,000 driven primarily by a 5.1% increase in corporate same store sales and higher annual fees. Our corporate store segment adjusted EBITDA margins increased by approximately 400 basis points to 44.3%.
Our Equipment segment EBITDA increased 7.4% to $7,700,000 driven by higher margins. Equipment segment adjusted EBITDA margins increased 110 basis points to 22.7%. Now turning to the balance sheet. As of September 30, 2017, we had cash and cash equivalents of $93,300,000 compared with cash and cash equivalents of $40,400,000 as of December 31, 2016. Borrowing capacity under our revolving credit facility stood at $75,000,000 as of September 30, 2017, while total bank debt excluding deferred financing costs was $711,300,000 consisting solely of our senior term loan.
In summary, we had a really good quarter highlighted by strong system wide same store sales growth and EPS that was ahead of projections. Based on our year to date results combined with the expected benefit to 4th quarter system wide same store sales from the higher Black Card pricing, we are raising our guidance. We now expect revenue for the year ended December 31, 2017 to be between $425,000,000 $430,000,000 up from our previous guidance of 409,000,000 dollars to $415,000,000 and adjusted net income to range from $79,000,000 to $81,000,000 up from our previous guidance of $75,000,000 to $77,000,000 This translates into adjusted EPS between $0.80 to $0.82 compared with our previous guidance of $0.76 to $0.78 Adjusted EBITDA is now expected to increase between 20% 22% to a range of $180,000,000 to $183,000,000 for the year. We now expect system wide same store sales to increase between 9.5% 10%, up from our previous guidance of 8% to 9%. We still anticipate selling and placing equipment into approximately 190 to 200 new stores.
But based on the current store opening schedule, we believe we'll be towards the high end of that range. And as Chris mentioned, we are on track to open 4 corporate stores in the Q4. The equipment related to these corporate stores is not in our placement guidance as we don't recognize equipment revenue on corporate store equipment placements. Finally, we expect the average royalty rate for 2017 to be approximately 4.2% compared to 3.7% in 2016. The 50 basis points increase is higher than the 30 basis points to 40 basis points we previously guided to based on the number of franchisees that have opted to amend their existing franchise agreements and increase their existing royalty rate by 1.59% and eliminate the commissions they pay on certain operational purchases.
It is important to note that the increased royalty revenue that we'll receive due to the plus 1.59% royalty rate change is being offset by the corresponding decline in commission income as we will no longer receive commission on purchases by these stores. Therefore, we do not expect an impact on our bottom line results from the acceleration in the royalty rate increase. As of the end of Q3, approximately 400 stores have amended their franchise agreements to plus 1.59 percent and we expect additional amendments in Q4. I'll now turn the call back to the operator for questions.
Your first question comes from Jonathan Komp with Baird. Your line is open.
Yes. Hi. Thank you. Chris, I want to start off. I mean, obviously, the Q3, you did not have any benefits from the pricing actions yet, and the comps still accelerated quarter over quarter despite a tougher comparison, cycling double digits last year.
So I'm just curious as you look at the business, if anything stands out in terms of drivers of that momentum and how you see that playing out going forward?
Yes. I think it's still as I've talked in the past, I can't underestimate the impact of this, I call it the marketing machine once in an interview that with each new join and each new club that opens, the fact that 9% gets put in the marketing is what's driving this the member growth as well as some rate growth, but mostly the member growth is what's driving these comps. So it's I think we just continue to see the benefits of that. Also coupled with, as we mentioned, some small benefits of our POS system that's gotten just more refined in how it processes. But majority of it is that marketing machine that continues to drive.
And I think site selection naturally, because we still approve every site, as we've said in the past, we just get better at what we do with each and every location we open. So we get better real estate and better site selection that drives better comps as well.
Great. And then when you look to the full year outlook for unit openings, I think the commentary you just gave implies pretty strong Q4 openings. And I'm just curious what you're seeing from franchisee demand there, maybe both domestically, but also internationally. I'd be curious if you had any insights, Panama, how that's faring up faring so far with the first opening and any other color there?
Yes. Panama is the plan is open in a couple of weeks here. Presale there has been very strong and that's a franchisee actually from the states that's down there. And the clubs here, with these comps, the franchisees continue to be bullish on the business and continue to parlay their earnings back in to open more stores. So I think that's what again why we keep doing that 200 stores a year.
Yes. I'd just add to John is that obviously in a development cycle, it's a long period
of time as you know, depending on when you take over a box. If it's a plain vanilla box, you might be able to get it open in 3 months or so. If it's more complicated or certainly a ground up, which we're doing a few more ground ups now, that could take up to a year and a half or so. So today, our franchisees are out there. They're working on Q2, Q3 of next year, Q4 of site selections, providing those potential sites into the company.
And we obviously have already reviewed sites for Q1 of next year. So as Chris said, the Francesi base continues to be very excited about the brand and continuing to build out. And there's a lot of action going on right now for the last 2 months of the year, which gets us up to that 190 to 200 that I mentioned in my comments.
Okay. Thank you. I'll pass it on.
Thanks, John. Thanks, John.
Your next question comes from Randy Konik with Jefferies. Your line is open. Yes.
Thanks a lot. So, I guess a question for Chris, not to digress, but when you think about another space like the tech space where you see like Netflix or Amazon, they get bigger. As they get bigger, they keep getting bigger still and they build this flywheel of momentum, they call it, right? So your business kind of feels like it is approaching the same or it has approached the same type of flywheel momentum. You partially touched on it with the marketing, how it just keeps feeding upon itself.
So when you see this kind of build and we're seeing accelerating comps, we're seeing stores do very well. You touched on the Burlington example. Do you think do you kind of think about as you kind of gain more market share and you're pushing out these competitors that you kind of think about changing or moving to a higher target level of density potential in the markets you want to serve? Like for example, New Hampshire is X percent, but it's lower in California, for example. So I'm just trying to get a sense of how you think about this flywheel momentum in the business, whether it be the marketing dollars received from a new member or the success factor of entering a small market like Burlington with a smaller box.
How do you kind of think about this as you see it in the tech space today?
Yes, it's a great question. I think what we've seen, I think the more close we have in a market, it's like when the more tide rises, the more ships rise. And I think it's what we're seeing. Like if you told me we'd have 17 stores in New Hampshire 10 years ago, I'd say you're crazy. And now we're in New Hampshire with 17 stores and one out of every 2 health club members is a member.
We have almost 10% of the population is a member of New Hampshire. And we realistically can probably open another 1 or 2 stores I think in New Hampshire, so we're still not there. And I think like you said, the more stores we open, the more we can open. Brand awareness is up. The market penetration is up.
It just goes on and on. Reciprocity becomes a bigger place. So the car becomes bigger. So it moves many different levers. To the Berlin, I think Vermont, you think about that.
So the 20 minute drive, as I mentioned, has only 40,000 people. The town of Berlin itself has only got 2,800 people, believe it or not. And it's a neighboring town to Montpelier, which only has 7,000. So it's very rural and that store is in presale is already over indexing the average. So it's but you're the only club around for miles.
And to them, it's like Disney World's coming to town and we've got more hype and more media, free press. I mean, it's like the landlord is national tenants coming in and filling my space. I mean, it gets everybody excited. So and that's not even in that 4,000 number that we say our potential is. So this is it's still a test.
We've got about 20 of these with our franchisees that we're working through, but this could open up the doors for a whole another level of opportunity for us.
So I think I've said
in the past, in some ways, we're in uncharted waters. This industry had never really seen value got to 500 or 600 stores and crumbled, gold's got to there and now it's down to like 600 or 400 in the states. 24 Hour Fitness in LA has been in that 500, 600 number for many years. And we blew through that in 2012 and then here we are now with 1400. And I think it's just we got the right model, the right business and the right marketing plan that continues to just drive comps and drive growth.
Yes. And maybe it will be helpful because something we always have gotten from the market is the question mark around that 4,000 number. So I guess it would be helpful is any kind of a process on what was considered in that 4,000 number because you kind of made a mention that the 4,000 doesn't even include something like that you're seeing succeed in this smaller type box. So I'm just curious on how you thought about that initially and what a smaller box could provide going forward?
Sure, Randy. We use a company called Buxton, as you know, and we've been using them now for the last 5 years or so. And we were really kind of a dream client for them, because if you think about us versus a QSR where you know who's walking in the door maybe if there's a loyalty program, we know where every member lives. And therefore, when we were able to give them back in that day, probably 500, 600 stores, So we could give them a very broad cross section of America from urban to rural to east to west, different ethnicities, etcetera. So what they were able to do then was to plot those members in and around, call it, 500 plus stores to see what kind of market penetration we were getting in that day and time on a store by store basis.
And then based upon those demographics, based upon those store sizes in terms of member counts, we were able then to plot out the rest
of the U. S. What I
would say today is that there's clearly markets where we over index in terms of a higher market penetration. As you mentioned and Chris was talking about a while ago, we're in New Hampshire, we have like 10% of the population. In the Northeast, we're about 4.5% to 5% of the population. And then you get out West, it's barely 1.5% or so in terms of market penetration. But there's very distinct markets in some of these different regions of the country where we already have 8%, 10%, 12% market penetration in a market.
And so the way we look at it then is now we can plot the 1400 stores and we can see where our market penetration is doing very well. Maybe we have a lot more stores there. We've been there longer. But then we go to other markets like in LA, which we haven't been in LA for a long time now. But as we put more and more stores, we see then those stores continue to perform to Chris' point earlier, which we believe is driven by the benefits of the Black Card, the value proposition that you get from a $10 membership for the 21.99 dollars and the reciprocity, etcetera.
So we still feel very confident in our ability to hit that 4,000 number.
Yes, very helpful. My last question is this, the beauty of your model is the simplicity of it, but not to bring up Amazon again, maybe I think I wish I was Jeff Bezos, but they kind of morphed their business into adding AWS, for example. So I'm just, I guess, back to Chris and thinking about Amazon started with this and a type of business moved into AWS. Do you think about, given that obviously the huge opportunity to grow more and more stores, the margins are high, etcetera, Are there any types of things you think about strategically from a tangential perspective business wise that you may want to explore given the strength of the brand and the industry, etcetera?
Yes, I
mean, I think you're right.
I mean, stores definitely a lot of growth there. As far as I think with 10,000,000 members and groans, there's definitely some leverage that we can take advantage of there. And I think with some of this technology stuff we're working on, which we'll probably talk about here with the cardio and so on is what we'll gain from that from knowledge standpoint, what we learn from what our members are doing and using standpoint. I mean, now we can actually see what their likes and dislikes are, how do we be advertising at that point. I mean, what should our partners be?
What are they what buttons are they clicking on? Are they clicking on Map My Run, are they clicking on Spotify or all it goes on and on and on. So the industry never had the opportunity to capture data like that. All we could ever tell us from the walk through the door. We had no idea what they were doing.
So I think that a lot from the opportunities with Craig, our new CDIO. He's full of guns ablaze and all over this that I think where we see our clubs today and what we're going to gain from a data standpoint and how we can increase the members' experience and better the members' experience, where we are in 3 years from today or 2 years from today will be light years ahead of them today.
Your next question comes from Dave King with Roth Capital. Your line is open.
Thanks. Good afternoon, guys.
Hi. How are you doing?
I guess maybe first sticking with Randy's line of thinking on the flywheel a bit, maybe switching gears also. How do you think or have you guys looked at all at the lifetime value of your average customer? How that compares to your acquisition costs? Is there anything you can share about how those metrics have trended over time? And then as you're touching on that, maybe you can talk about the trending cancellations and churn?
Thanks.
Sure, Dave. I mean one of the things that we have the benefit of is was the inside with all these members and particularly at all of our older stores. So the older stores are going to have a longer tenure of members. We talk about attrition and as you guys know, we talk about it in terms of looking at members that have been a member of Planet Fitness over 12 months and what happens after that. And that cancellation rate is 1.5% to 2.5% or so a month.
But I think that a lot of the things that we see happening in our clubs today, particularly in markets where we get more market penetration, we look at tenure, we look at the different sections, the different types of our members. I mean, 49% of our members are millennials. How do they react? And as Chris talked about earlier, using technology in the future is going to be huge, because we want to be able to cater to what they want and what are the things that they want when they come into the club. Are they going to act differently than members did 4 or 5 years ago?
And so with some of the technology that we are working on with our equipment partners that we'll be able to roll out, we'll be able to offer them more than they have today. And we believe that that will provide some stickiness as well. Some of the other things we're doing is just in the technology areas around our mobile app to be able to really enhance that app and to be able particularly as one example to have data on the on what members do and what they what their accomplishments to be able to give that back to them as they walk out the front door, give them a high five so that it encourages them to come back the next time. But those are the kinds of things that we're working on or that we have kind of on the radar to be able to continue to provide that stickiness factor.
Okay. And maybe along those lines on that last piece, where are you in terms of beginning to evaluate or test some of that enhanced equipment? Is that something we could see in the near term? I think in the past you guys have talked about or I guess there was a potential to maybe see that drive maybe some equipment installs. How far out is that opportunity?
Sure, Dave. This is Chris. We installed the 1st club in September in New Jersey. Between now and January, we have another 14 clubs going in. And it will be 5 of each of the 3 manufacturers that will be part of the RFP.
So as we talked about, our contract with Life Fitness ends at the end of June. We're starting our RFP process and it's with Matrix Pre Core, the 3 big ones, Matrix Pre Core and Life. So all three of the manufacturers will be in with that cardio by January and we'll start to trend to see how the equipment is used. Now we can actually see how it's used, which is really interesting. And then as we mentioned, it's actually because the way that's working is the Black Card memberships will have a heightened experience.
So hopefully that will drive higher Black Card sales and time will tell. And it's one of those things because it is technology And the beauty of this cardio is it can be updated overnight through the Wi Fi. So it's not like you bought a treadmill and it's 5 years old and you can't get an upgrade. You can do it on the fly. So Bill actually can be like 2.03.0 as we learn from what customers are doing, making it better.
So that's still in the process of learning as we roll this out and learn from the usability of it. But I think it can be pretty interesting what it can do for us in the future.
Okay. That's good color. And then I guess just one more on the guidance, Dorvin. How much of the increase was related to the Black Card pricing growth, I guess what sort of adoption of the $2,199 does that assume I think you may have said the number of the stores that are in that, but I guess what sort of adoption at those stores and should we be holding that 60% penetration constant, what's the grandfathering rules? Any color there would be helpful.
Sure. So existing members, they retain their membership. So before we raise the price, our Black Card is $19.99 Those Black Card members continue to pay $19.99 All new Black Card members pay the $21.99 So that's how the membership works. As I mentioned in my remarks earlier, with respect to our upward guidance on comps, we think that the $21.99 price impact for Q4 will be kind of in the neighborhood of 70, 75 bps. So that's embedded into the way we put forth our guidance.
With respect to kind of the Black Card percentage, we're at 60% at the end of Q3. During our pilot, we saw small to negligible decrease in bike card percentage. We don't expect that to be huge or to be very similar to the pilot. We'll see now as we go full with all the clubs here in Q4, but that's how we factored it into our Q4 comps or full year comps rather.
Yes. Thanks for taking my questions and good luck with the rest of the year. Thank you, Nate.
Your next question comes from John Heinbockel with UBS and Hammer. Your line is open.
So based on your sense of your franchisees uptake, right, of the swap right between the royalty rate and commission income. Could the royalty rate be well above 5% next year or no?
Yes. John, we're not going to talk about kind of guidance for next year yet. We'll do that when we release our year end results. I would say that obviously the clubs that have amended, you'll see a higher royalty rate. We don't know yet how many of all of those we'll adopt by the end of the year, so that we get a full year impact to that next year.
Again, as I mentioned, it's offset by commissions. We expect a lot of them will. But keep in mind, John, as you know, we still have a number of stores out there that are significantly under the 5%. So when you add the 1.59%, you may still not be at 5%.
Okay. And then when you think of you look at how much you're spending on marketing, how close are we to or do we ever get to a point where you can relax the local spending requirement in maybe as an offset to that is raising the royalty rate further. Is that something that could be done? And is that something that could be done sooner rather than later or no?
Yes. I'd say probably later rather than sooner. I mean, I think there's still so much money to penetrate these markets and really what is the true capacity of the clubs as far as is it 7,000 members or is it 9,000 members? And we haven't really really know if we get there. I think it's when we realize we're not selling any more member growth and we're not keep spending more dollars and we realize kind of maybe at the tipping point, which I think is quite a ways off before that happens.
I think it's as far as the royalty rate question, I think there's probably more can be raised. I think it's we continue to drive comps in a few years. We keep driving comps. So because we make more money and they're more profitable, I think, then we can probably share in that down the road. But I think for now, we're probably in a good spot.
I think the fact that the franchisees keep putting the money in to build more stores, so they're not just taking it home, put it to work for us. So we kind of win on the other end anyway.
And then lastly, you think about this RFP versus prior ones, Do we see and then the commentary on technology, do we see a quantum leap in what's available out there? And if there is a significant leap forward, would you see or could you see franchisees replacing equipment before they're required to, where they would still probably wait until
that's up. I mean, I believe if we can prove that it enhances customer experience and even more so increases Black Card percentage, that will be the true tail and that will get people to get excited about doing it early. And if we can start getting that to happen, that will be that's a no brainer really. Okay. Thank you.
Thanks, John. Thanks, John.
Your next question comes from John Ivankoe with JPMorgan. Your line is open.
A couple of questions if I may. Firstly, in terms of the grandfathering in of the change in the Black Card fee, is that grandfathered in until the end of their term? Is it multiple years? I mean, what exactly do you mean by grandfathering? And when do you expect all Black Card members to be on 2,199?
Yes. I mean, there'll be a point even in 3, 4, 5 years that not everybody will be at 2,199 because they are John truly grandfathered in where as long as they don't cancel their membership, they don't lose that rate, but they cancel and come back and then you lose it, which time will tell. But I think to that point I just mentioned is that we could see some benefit of some stickiness from them realizing that if they cancel this membership, people are not using it for a few months that you don't have to get this right back. So we could get some help from that down the road and that ended it too.
Yes. I mean, it's definitely an opportunity to communicate for sure. I think most people would assume that forever means forever. Okay. Now, I certainly haven't sensed that the franchise community was struggling for profitability, in fact, just the opposite.
And yet, this is a nice shot in the arm for franchise level. So is there anything that they're giving in order to get this? I mean whether it is to the previous question, more marketing dollars or equipment or higher store growth? In other words, that's you're also referencing previous question. What do they put back in the flywheel to basically give back some of the benefit that they're receiving?
Yes. I mean, I think it goes back to the extra $2 an extra 9% marketing between LAF and NAS. So I think seeing the marketing fund that drives drive more marketing they're putting back in. But I think as I mentioned to Don Heimbroch, I think the fact that they keep putting more money back into building more stores and hopefully with this extra sharp in the arm and you're right, the clubs are already really profitable. So now it's even more so that they continue to open more stores and keep them excited about the brand as long as they're excited.
And as I mentioned in the past, I feel like I have 2 sets of customers. 1 is our franchisees, one of our members. And if we can keep our franchisees super happy, they'll keep our members even happier. So I think we keep them excited for the brand and continue to grow.
That's great, Chris. And it certainly seems that there's a lot of things that are lining up right now for a meaningful step up, whether it's in 2018, 2019 or 2020 in terms of that 200 new clubs a year. I mean, what are you currently thinking about in the pipeline? And is this kind of what we've been waiting for in order for the penetration of the brand to expand even faster than it already has?
Yes. I'll do Urban add to it. But I think they're excited. And I think retail as we continue to see on TV, it's every day there's another group of chain of stores, closing stores that downsizing and we're right in the perfect warehouse for them and all the reason landlords want us. And with the model, the comps the way they are and with this new 2199 and what that's going to do for stores, I mean, it's system is excited.
I mean, there's no way else to put it besides that. I mean, people are ready to rock and roll.
Yes, I'd add to it John that we're very excited to have Rob Sotkin on board as well. And I mean obviously he comes from big brands, lots of locations, understanding retail, understanding what drives retail. And one of the things that we have ahead of us here is over the next 4 or 5 years, we're going to have a lot of locations that are going to come up for lease renewals. And if you go back 5, 6, 7 years ago, we were competing for Main and Main with a lot of names that are maybe not even in business anymore, but we weren't always getting Main and Main. And we've had examples just here in the last 12, 18 months where a franchisee was at their lease came up, they relocated in a couple of cases in the same shopping center, but they went from an elbow to an outparcel, etcetera and or an end cap and significant increase in revenue by just getting better visibility being in a better site.
So one of our mantras from our real estate perspective is not only to find couple of 100 stores a year of brand new sites, but we've got to continue to upgrade, if you will, some of the locations of our existing stores. So I think that's another opportunity for us in some of these markets to be better front and center and to be able to drive more members per store by better real estate locations.
And I promise last one. Relocations typically slow development, ground ups typically slow development. Seems like on the other hand you have a lot of opportunity to accelerate development. Obviously, this is a really important question. I understand if you don't want to guide specifically.
But as we think about the next couple of years, should we expect net adds similar to 'seventeen or do you think we can start to take you up to some extent?
No. I mean, I'm going to defer back to the same kind of guidance I've given in the past, and we did this at the IPO, as you'll remember. We said we thought we could do a couple of 100 stores a year. We thought that made sense. You probably heard us use the term, we call it thoughtful growth.
We still reject that today, John. I mean, we in our real estate committee, they'll be sized proposed by either our franchisees or their broker network that comes into our headquarters here because we approve every real estate location and we still reject some and we'll do it for a number of reasons, but some is wait till the better side comes along. Given the momentum we think we have in real estate world. So I think as of now, and we'll give guidance next year, early in the year for full year 2018, but I still think kind of that 200 stores a year or so is a good number to think about.
Thank you so much.
Thanks, John.
Your next question comes from James Hardiman with Wedbush Securities. Your line is open.
Hi, good afternoon. Thanks for taking my call. So a quick clarification. So
you talked a
little bit about some of the new technology pilots, I guess we could call it, with Matrix, PreCore and Life. You kind of talked about that hand in hand with the notion that your equipment, you're looking to re up your equipment contract come June. Is that sort of the new technology, is that what's going to largely drive how you think about your supplier agreement as we look to June or are those sort of 2 separate events?
No, it's June's happening regardless, but the pilot program with the technology is probably going to be the biggest part of the deciding factor. Price is important, but functionality is probably more so if the customer experience is better and you can get more Black Card sales from it. That's most important. If you can do that, then you might get some retention and stickiness and then drive higher black card percentages. So I think that's going to be more the deciding factor.
So that's why the pilot is truly important to once again be able to capture the data where we'll know what members are doing and what they're experiencing. So how do we tee up more of what they like and get rid of what they don't like and update the content real time. And then we have Black Card members more experienced and better experience so that the White Card members instead of having a typical treadmill experience opt up to upgrade. And we actually have a design, believe it or not, that you can literally upgrade your membership on the piece of cardio. So you can be on the treadmill, see the person next to you running through the Grand Canyon.
You say, I want to do that. I don't want to just run on a track. You press upgrade and you're running on Grand Canyon and you're upgrading to the new Black Card membership. So it's a truly dynamic technology stuff that we're working on. It's going to be really, really cool for us for the program for the business.
Wow, that's really helpful. And then, you've talked in the past about sort of the algorithm, how we should think about same store sales contributions from clubs of various ages. Clearly, some if not all of your clubs are outperforming those expectations. But should we think that some of the stores that are 1 to 2 years old are ramping more quickly? Or is it more that your mature stores are continuing to bring in more and more members and maybe the ceiling on member potential for a given club is just greater than it was in the past?
Yes. I think it's probably a bit more of the more mature clubs as opposed to a brand new store kind of ramping at a much faster rate than it did 2 or 3 years ago. And we believe, and Chris and I have talked about this a lot over the last couple of years or so, that the franchisees willingness to invest and re equipping their clubs, having fresh new equipment in, some of the remodels and renovations are taking place, building nice Black Card Spa areas. Those are the kinds of things that we believe are contributing to the fact that more and more of our mature stores are probably outperforming kind of the guidance metrics comps, 1% to 3% or so. And comps, 1% to 3% or so.
And we've seen certainly, let's just say this year, we've seen those stores performing a bit better than that. So I think it's a combination of a lot of it, but I think it literally has to do with the marketing dollars, more of it, more penetration in existing markets, more value of the Black Card, hence the Black Card continues to increase albeit slightly, but continues to increase and then a better member experience that's driving more members per store. I think that in essence is what's driving the model.
And I think
the only thing
I'd add James is that we've talked about that where 90% of our openings every year are by the existing franchisees. So one franchise group might have 20 stores in the market. So they have great brand new shiny stores and they have their original legacy stores that they see how great the new ones go and how the new finishes, the new equipment looks. So even though we can require, they're doing it on their own. Own.
So it's they want their portfolio of stores to be. So it's not a one detwenty system. They want their portfolio of stores to all look the same. So it's they're really into keeping their clubs looking fresh.
Really helpful. And then last one for me, sort of a state of the industry question. Obviously, your focus has been on doing what you do well. But I think you've had so much success that there's almost always a response or an attempted response by some of your competitors. And I think the way you've laid out the industry is that specialty clubs are doing well.
You guys are consolidating the value segment and the traditional clubs are getting squeezed. So I guess, two questions here. Are you seeing a response from other players in the value segment gain traction whatsoever? How would you characterize that? And then do you think the traditional clubs are ever going to figure this out?
What's their response going to be? Do you think they'll ever turn it around?
Yes, I think I don't think anything has really changed since the last couple of calls. I think there's somewhat more of a slowdown in the low cost growth
compared to how
it was like 2, 3 years ago when every single person you talk to was opening up a $10 club. And I think the beauty of it is they're all opening $10 the ones that opened $10 clubs, they're opening a $10 a month goals gym or LA fitness type club. So they're not really going after our culture and our judgment free zone and our first time gym user type atmosphere. So I think if anything, they're probably making the LA Fitness and 24 Hour Fitness is world's tough because they're offering Group X and spinning classes and everything else at $15 to $25 a month like a crunch or something. So I don't see I haven't seen anything really change other than what's been happening.
And then how about on the traditional side, you don't see any meaningful change to those guys?
Yes, like the LA Fitness is in the 24 hours and so on. I've seen they didn't probably have anything slow growth as well in the recent probably 18, 24 months compared to 3, 4 years ago.
Great. Thanks guys.
Thank you.
Your next question comes from Oliver Chen with Cowen and Company. Your line is open.
Hi, Chris and Dorvin, thanks. I was curious about your thoughts around partnerships in the longer term as you think about partnerships across healthcare or food or technology companies in health and wellness and what might make sense for your business as you think about alliances as we see so much happening across different aspects of this? And Chris, the digital technology, maybe you could contextualize, it's been really helpful, like what might be more actionable within your business model and what might be more just nice to know about, but not really practical in terms of how you balance what's appropriate for your brand and you maintain the right level of focus, which is aligned with the core competency of what you do best? Thanks.
Yes. I think with groups that partner with, I think, while the technology might be interesting with the what users are doing on the cardio and what kind of results or distance they're going and who's who to be able to now have that data to show to insurance companies might be a partnership. Right now, we've been reimbursing our insurance companies, name UnitedHealthcare, Blue Cross, Blue Shield goes down the list. But all we can ever tell them is that the person walks through the door, we have no idea what they did. So it will be interesting that what this data captures, can we have more opportunity to sell or tell the story to either insurance companies or big corporations of what their subscribers or employees are doing and gaining benefits.
Some might be part of part some of the partnership. With 10,000,000 members, as I said, I think there's ways maybe leverage the brand. I don't know if it's whether it's weight loss apps or some other type of connection that we can even have or maybe Black Card Plus to give us an opportunity to learn nutrition or something like that as a partnership. As far as the I think that's probably the partnership. I haven't think of Durbin, anything that you can add to that.
As far as the technology piece, how we can conceptualize that? I think when you think about technology and you look about wearables and all fitness apps, I think what's interesting is they all track and wearables track everything. But nobody nothing really recommends what you do next. And very few people can capture this data and know what to do with it. I think it's going to be especially for our members that 43% as I said in the past, the first time gym users, they just need to be told what to do.
They don't even know where to start, let alone what the data is telling them to do. So I think to be able to capture the data, create algorithm to then serve up your next workout should be this and help them start their fitness journey and bring them through their fitness journey for years, if we can. And we've never really had the opportunity to do that before unless you had one person training for every member you had and have it for free because they're not going to pay for it. So I think as you get down the road of how you learn, we don't know what people really like on cardio. Do they just press start?
Do they like the hill climb? Do they like just watch TV and that's it? Or what programs they like to watch? What do the Black Card members will be able to walk through the Grand Canyon and walk through the Paris, walk through Charles River in Boston. Well, if that's what they like, let's give them more experiences like that so that keeps them engaged, keeps them curious about their next workout.
Otherwise, every day you come to the gym, it's the exact same thing day in, day out. I mean, it gets boring, right? So how can we enhance that experience and get them curious about wanting to walk in the gym the next day?
And it sounds like you're hitting on all cylinders really across the awareness and the numbers you're seeing. What would you say candidly is what things you're more concerned about or just things you're monitoring or uncontrollable factors as we just assess risk and reward? And obviously, we're in a very good period with the numbers we're seeing. Thanks.
Dore, you can add to that. I mean, I think real estate is in perfect timing for us. That's good. I don't see interest rates going too crazy that slow growth down. And right now with our franchisees, because 90% of the growth is by the existing franchisees and they got a portfolio of 20, 30 stores, a lot of them are just paying cash for the equipment build out.
So it's not like that would really necessarily be a big slowdown either for us. I think the big thing is to stay disciplined and keep executing and look at what opportunities we have to understanding our customers better. And I think the data we capture today and will be captured in the future will be we didn't even really have data to really look at with the team we have here at the office today. We never really had this depth 5 years ago or 3 years ago. So I think it's every decision we've made in the last probably 24 months has still been so data driven and I think the results are as we've seen the results are showing it.
We'll be able to look through the business through a much more refined lens and make much sharper decisions, which is really driving this machine.
And just lastly a modeling question. Dorvin on the equipment line, what are the longer term parameters from which we should model that? Do you expect it to stay within a similar margin range? And are there any things we should know looking ahead on a multiyear basis? Will it be lumpy or will it be pretty smooth?
I think, obviously, as you know, our current contract expires next June. So our margins will be clearly flat between now and then from a margin perspective. And I think we've guided or given data that we expect this year, our replacement equipment as a percentage of total equipment to kind of be in the 30% to call it 37% range. So that's higher than last year. I think we're 28%, 29% last year or thereabouts.
More and more stores over the next 2 or 3 years will be coming up for the replacement cycle. So if we keep our new flat, you're going to continue to see that replacement, I think increase as a percentage. It just by nature tends to be lumpy, given that we, 1, we don't want stores replacing equipment and call it November, December, January, February, March kind of time period, albeit some do. But it tends to be fairly lumpy. More of more than half usually is in Qs 2 and 3, kind of more of a kind of a downtime period in terms of usage in the club, etcetera.
But I guess as I sit back and think about maybe a little bit longer term, I still say, as I said, I think it was to John Abengoa earlier, a couple of 100 stores a year, I think makes sense from a new openings perspective. I think replacement will probably grow a bit, as I mentioned a minute ago. And then the big unknown, which Chris talked about a little bit earlier would be as we negotiate under RFP for the next contract, it will all be about what technology is included in the equipment that we end up with, which brand we end up with. And is that still come with a price reduction? Is it all set by technology, etcetera, etcetera?
We're nowhere close to having that conversation yet. But I think that will be the factor that ultimately determines kind of what that margin rate is on a go forward basis.
Okay. That's super helpful. Thanks. I'm really excited about the digital innovation and congrats on a great quarter.
Thanks, Oliver.
Your next question comes from George Kelly with Imperial Capital. Your line is open.
Hi, guys. A couple of
questions for you. Just to start one more on the machine technology enhancements. You mentioned different settings walking through the Grand Canyon in different cities. Are there any other major enhancements that you think that you're excited about that could boost Black Card penetration? What else is exciting?
There's a lot of different things on it. I mean, there's going to be you got to see your own Spotify account, your own Netflix account and it remembers you. So the next time you swipe to get in, it remembers all your logins for you. So you don't have to re log in every time you want to watch it and you can finish up the show that you watched last night at home and watch on the treadmill to finish it up. So and the beauty of it though is, George, we can learn from that, right?
So if you like Spotify, well, maybe put Pandora, maybe put the Hi Hart Radio. You just kind of can follow people of what they're doing. And it might get to the point where you're actually learning people where each person's experience is independently different from each other. So I think as we get smarter on what people are doing, it's going to be it's going to evolve the product, which is going to be really interesting as opposed to just having a treadmill that sits there and does the same thing for 5 years.
Sure, sure. It makes sense. And then second question on pricing. When you were doing the test about the new black card pricing, what gave you comfort that you could put make that mandatory across the club base? What would you see?
Sure. Yes. So we reciprocity is by far the number one biggest used
perk, if you will, of
the Black Card. 50% of our Black Card members in 2016 took advantage of that perk and used the clubs at least once, other clubs in their home club. And 20% of every Black Card workout last year was not at their home club, was at a different club. So as we started at Black Card, we had 20 stores. Now we go to about 1400.
So that perk is a well utilized perk and there's tons of value for $2,000,000 you've got access to 13.80 most stores. So it's a great perk. Guest Privileges is a huge perk. We could bring our guests for free. And inside our stores, we used to just have a couple of tanning beds in the corner and that was about it.
And now we have what we call them Blackheart Spa, which is a little bit like the private Delta room in the airport. So it's a little lounge area. We have our tanning, the massage beds and massage chairs, TV to wait for your session. So it's a little bit of an exclusive sale when you get in there. So the value has just increased greatly from when we came up with the $19.99 price.
And the $21.99 for $2 is kind of such a great value is still a no brainer compared to the 10 is actually a better value than the 10, I think.
Okay. And when you were doing the test though, you didn't I mean it sounds like there weren't any kind of major changes to did you see any kind of difference in Black Card adoption?
Yes, with the club we were up to we did the test in almost 100 stores and it was 0 it was like 0 some clubs have none all the way to like maybe 2%, 3% max.
Okay. So that's an easy choice. Thank you.
Yes. You're welcome.
Thank you.
Your last question comes from Amanda Adamey with Macquarie. Your line is open.
Hi. Thank you for taking the question. Most of mine have been answered. I just wanted to make sure that I understood in terms of the shift from the new store openings that were scheduled in Q3 that shifted into Q4. I wanted to know if any of the scheduled openings in 2017 had been pushed into 2018 and if so, if any of these were an impact of the hurricane?
No stores impacted by the hurricane in terms of our openings. And we guided if you go back to our last quarter, we guided to 190 to 200. So we're still 190 to 200. Small shift and just timing of a handful, small 2 or 3 clubs that could have shifted from Q3 into Q4. But as I've said before on the call is that you get down to the last couple of weeks of trying to open a club and you run into or you can run into a number of issues to get your certificate of occupancy to get moved in.
And it can literally be the inspectors out of town for a couple of days to they come in and make you do additional work to get a store open. So we're not concerned with anything that moved out of Q3 into Q4. We're still
very comfortable. And as I
said, we expect to be at the
high end
of that rate. Comfortable. And as I said, we expect to be at the high end of that range of $190,000,000 to $200,000,000 Okay, great. Thank you so much. Thank you.
This concludes today's Q and A session. I would like to turn the call back to Chris Rondeau.
Thank you. I'm excited. Thanks for joining us. I'm excited to be able to show such a great Q3 and look forward to wrapping up Q4 here and speaking to you all early part of next year. As you can see, the momentum we've gathered, we're definitely capturing from this marketing and the opening of new stores and each new member is fueling this flywheel, if you will.
And I think you see with the horsepower that this company is capturing from this market penetration as well as brand awareness. So it's exciting to see that the business is where it is and I think look forward to the future for sure. So thanks for joining us and have a great night.
This concludes today's conference