Good afternoon. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Planet Fitness Second Quarter 2017 Earnings Call. Brendan Frey, Managing Director of ICR, you may
Thank you for joining us today to discuss Planet Fitness' Q2 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 at planetfitness.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 forward looking statements to be made in this conference call and webcast, we refer to you to the disclaimer regarding forward looking statements that is included in our Q2 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. We had a great second quarter as our business continues to perform very well. Comps increased 9%, marking our 42nd consecutive quarter of positive comparable sales growth. Revenues in each of our three segments were up meaningfully in this quarter. The franchise, our highest margin segment increased 28%.
This contributed to a 440 basis point increase in adjusted EBITDA margins and our ability to deliver adjusted earnings per share of $0.22 up 29% versus a year ago. I often get asked what the secret to Planet Fitness' success is and why other fitness operators haven't been able to replicate it on our scale. There are several key factors that contribute to our success and why we are so bullish on the future. First, we have a huge head start on competition. When we first introduced a $10 membership structure, no one in the industry thought it would work.
In fact, they pretty much wrote us off. This allowed us to operate under the radar for several years. It wasn't until 2010, we had approximately 400 stores that anyone really took notice to our success. And thanks to our franchise model, we've been able to scale very fast, doubling the number of stores over the past 4 years to over 1400 locations today. Obviously, any operator can sign a lease and sell memberships for $10 a month.
Piece of the puzzle that's difficult to replicate is attracting the right membership base and volume of members to make it work financially. And that is where Planet Fitness has significantly outpaced the rest of the industry. It starts with our judgmental zone. Unlike other gym malls, we're not about to fit getting fitter. We cater to the 80% of the population that doesn't have a gym membership, casual exercise or first time gym user that has never worked out before.
Our welcoming, non intimidating environment combined with our affordable $10 price point is the winning formula for attracting approximately 7,000 members per location. Our differentiated offering is clearly enticing people to get off the couch and improve their health, evidenced by the fact that over 40% of our recent joins indicate they have never belonged to a gym prior to joining Planet Fitness. On top of our welcoming non intimidating environment, we offer a high quality in store experience highlighted by Planet Fitness' branded cardio and strength equipment from White Fitness, one of the premier manufacturers in the industry. Our size and collective buying power provide us with the unique opportunity to source the latest top of the line cardiovascular and strength equipment for prices below what the competition can. And our stores have a consistent new feel to them regardless if they opened last week, last year or 10 years ago, as a result of the system wide commitment to replacing the equipment every 5 to 7 years, an issue that has long plagued the fitness industry.
Marmaris also enjoyed unparalleled customer service from our well trained store managers and staff. Our focus on providing a great in store experience was recently validated by the J. D. Power 2017 Health and Fitness Center Satisfaction Report, which ranked Planet Fitness highest in customer satisfaction for the first time, including performing particularly well in the areas of cleanliness, equipment conditions, price and safety. One of our biggest competitive advantages is marketing.
We realized in the early days that we needed to be bold and get creative to differentiate ourselves from other gyms as we were all competing over a small population in rural New Hampshire. This work eventually led to our highly recognizable purple and yellow branded colors and TV and digital market campaigns that run nationally throughout the year that do a great job reinforcing the differences between Planet Fitness and stereotypical gyms. In the past 2 years, our premier sponsorship of the Times Square New Year's Eve celebration. The timing of this global event is ideal for us, with health and wellness top of mind for consumers and the reach is incredible. Over 175,000,000 viewers in the U.
S. And over 1,000,000,000 worldwide. As a result, I'm excited to share that we have renewed our contract as the premier sponsor for 2 additional years beyond this year's New Year's Eve celebration. These programs are funded by the system wide commitment to contributing 2% of monthly dues to the National Ad Fund, while 7% goes towards more localized efforts. In total, approximately $100,000,000 was spent in 2016 marketing our brand and concepts.
A figure that grows with each new join. Bottom line, we have far more marketing goals to spend than anyone else in the industry. Moreover, we have a great group of well capitalized franchisees that are passionate about executing the brand into this business model and eager to grow their businesses. Their commitment to expanding our presence in the new and existing markets is what drives the roughly 200 new store openings per year the 1,000 we currently have in the pipeline over the next 5 years. While the vast majority of our pipeline is domestic stores, the number of international locations continues to grow driven by Canada and more recently Panama, where we just began the presale process ahead of the 1st Planet Fitness opening in the country later this year.
This reaffirms our confidence in our ability to increase our U. S. Footprint to 4,000 locations over time. To summarize, there are a few primary elements of our business model that have driven our success to date. From a high level, we define them as distinct store concept, strong unit economics, highly attractive franchise platform and a nationally recognized brand with a significant national and local marketing fund to drive new joints.
What's important to understand is that these elements are intertwined and fuel each other generate strong returns for our franchisees and deliver increased value for our shareholders. Trends we expect to continue for years to come, thanks to our well established industry leading position the multiple competitive advantages we enjoy as a company. Thank you. I'll now turn the call over to Gordon.
Thanks, Chris, and good afternoon, everyone. I'll begin by reviewing the details of our Q2 results and then discuss our full year 2017 outlook. For the Q2 of 2017, total revenue increased 17.3 percent to $107,300,000 from $91,500,000 in the prior year period. Total system wide same store sales increased 9%. From a segment perspective, franchisee same store sales increased 9.3% and our corporate store same store sales increased 4.3%.
Over 90% of our Q2 comp increase was driven by an increase in members. At the same time, our Black Card membership penetration was 60%, up 150 basis points over Q2 last year. Our franchise segment revenue was $37,800,000 an increase of 28.2 percent from $29,500,000 in the prior year period. Let me break down the drivers of our fastest growing revenue segment. Royalty revenue was $23,600,000 which consists of royalties on monthly membership dues and annual membership fees.
This compares to royalty revenue of $18,000,000 in the same quarter of last year, an increase of 31.3 percent. This year over year increase had 3 drivers. First, we opened 2 0 2 new franchise stores since the Q2 of last year. 2nd, as I mentioned, our franchisee owned same store sales increased by 9.3% and then 3rd, a higher overall average royalty rate. For the 2nd quarter, the average royalty rate was 3.93%, up from 3.43% in the same period last year, driven by more stores at the 5% royalty rate.
Next, our franchise and other fees were $6,300,000 compared to $4,900,000
in the
same quarter a year ago, an increase of 29.6%. 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 agreements and area development agreements. This increase was driven by additional stores and an increase in same store sales as compared to the prior period. Also within the franchise segment revenue is our placement revenue, which was $2,900,000 compared to $2,700,000 last year. And then finally, our commission income, which is made up of commissions from 3rd party preferred vendor arrangements and equipment commissions for international new store openings, was $5,000,000 compared to $4,000,000 a year ago.
This $1,000,000 increase 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 7.2 percent to $28,300,000 from $26,400,000 in the prior year period. The $1,900,000 increase was driven by the increase in corporate owned same store sales of 4.3% and increased annual fees as a result of a higher average annual dues. Regarding our corporate store segment, we recently finalized plans to open 3 to 4 new corporate owned stores late this year. These are primarily in our existing markets where we see opportunities to increase our total market penetration in markets that we own versus selling those markets to franchisees.
Turning to our Equipment segment. Revenue increased by $5,600,000 or 15.8 percent to $41,200,000 from $35,600,000 The increase was driven by an increase in replacement equipment sales to existing franchisee owned stores and higher new store equipment placements versus a year ago. Our cost of revenue, which primarily relates to direct cost of equipment sales to new and existing franchise owned stores, amounted to $31,500,000 compared to $27,800,000 a year ago, an increase of 13.1 percent, which was driven by the increase in equipment sales I just mentioned. Store operations expense, which is associated with our corporate owned stores, decreased to $14,600,000 compared to $15,800,000 a year ago. This decrease was threefold.
1st, in the prior year, we had some unusual large expense items like CAM and real estate taxes. Secondly, our corporate store operations team continues to focus on expense management and efficiencies. And then third, some timing of expenses. SG and A for the quarter was $14,800,000 compared to $12,400,000 a year ago. Both periods include non recurring expenses.
Last year, these were severance and secondary offering related costs. And this year, they were primarily costs incurred in conjunction with the May secondary offering and the amendment of our credit facility. Excluding these non recurring expenses, total SG and A increased by $3,100,000 or 27.2 percent. This increase was primarily to support our growing operations and infrastructure, including higher payroll and related costs as well as higher public company expenses. Our operating income, inclusive of the aforementioned non recurring expenses, increased 37.4 percent to $38,300,000 for the quarter, compared to operating income of $27,800,000 in the prior year period.
On an adjusted basis, taking into account the non recurring expenses I just mentioned, our adjusted operating margin was 37.4% this quarter versus 31.9% in the prior quarter, an increase of 550 basis points. This was primarily due to revenue growth and higher margins from all three of our operating segments, where we have leveraged our cost infrastructure. Our earnings before taxes inclusive of the aforementioned non recurring expenses increased 31.5 percent to $28,300,000 for the quarter compared to earnings before taxes of $21,500,000 in the prior year period. As a result of our Q4 2016 amended credit facility and the increased term loan borrowings, we incurred approximately $2,900,000 in higher interest expense in the Q2 of 2017 compared to the prior period. Our GAAP effective income tax rate for the 2nd quarter was 36.4% compared to 15.9% in the prior year period.
As we've 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% if all the earnings of the company were taxed at the Planet Fitness Inc. Level. On a GAAP basis, for the Q2 of 20 17, our net income attributable to Planet Fitness Inc. Was $12,400,000 or $0.16 per diluted this year, compared to $4,100,000 or $0.11 per diluted share in the prior year period.
Net income was $18,000,000 compared to $18,100,000 in the prior year period. On an adjusted basis, net income was 21,700,000 or $0.22 per diluted share, an increase of 28.9 percent compared with 16,800,000 dollars or $0.17 per diluted share in the prior year period. Keep in mind that Q2 included higher interest expense of $2,900,000 as a result of the Q4 refinancing. Adjusted net income has been adjusted to exclude the impact of the May secondary offering, the amendment of our credit facility 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 30.3 percent to $47,900,000 from $36,800,000 in the prior year period. A reconciliation of adjusted EBITDA to GAAP net income can also be found in the earnings release. By segment, our franchise segment EBITDA increased 31.6 percent to $32,500,000 driven by higher royalties received from additional franchise owned stores not included in the same store sales base, an increase in franchise owned same store sales of 9.3% as well as higher commissions and other fees. Our franchise segment adjusted EBITDA margins increased by approximately 330 basis points to 87.1%. Corporate Owned Store segment EBITDA increased 34.5% to $12,800,000 driven primarily by a 4.3% increase in corporate same store sales, higher annual fees and a decrease in store operating expenses.
Our corporate store segment adjusted EBITDA margins increased by approximately 8.90 basis points to 46.1 percent. Our Equipment segment EBITDA increased 24.8 percent to $9,800,000 driven by higher equipment sales. For the quarter, equipment segment adjusted EBITDA margins increased approximately 170 basis points to 23.8%. Now turning to the balance sheet. As of June 30, 2017, we had cash and cash equivalents of $78,500,000 compared with cash and cash equivalents of $40,400,000 as of December 31, 2016.
Our borrowing capacity under our revolving credit facility stood at $75,000,000 as of June 30, 2017, while total bank debt, excluding deferred financing cost was $713,100,000 consisting solely of our senior term loan. During Q2, we took advantage of lower interest rates and repriced our senior term loan, lowering the interest rate by 50 basis points to LIBOR plus 300. We estimate this will reduce our projected interest expense for 2017 by approximately $2,000,000 from this reduced rate. Therefore, we now expect full year interest expense to increase $8,000,000 over 2016, down from our previous forecast of $10,000,000 One comment on our cash flow statement. During the Q2, we made a $7,900,000 payment to certain LLC members related to our TRA or the tax receivable agreement and expect to pay the remaining $3,500,000 owed based on our 2016 tax return in late Q3 or early Q4.
As a reminder, payment of these amounts are a direct result of the cash tax savings we are able to realize on deductions taken on our prior year's tax return and less cash taxes paid, which occurs as a result of Holdings LLC units being converted to Class A shares and Class B shares being canceled. Per the TRA, 85% of the cash tax savings is returned to the original LLC owners and 15% of the cash tax savings is retained by the company. It's important to understand that the tax receivable agreement is a benefit to our cash flow generation because without it, we would be paying a greater amount in the form of higher taxes than the TRA cash payment. The simplest way to think about the TRA is that the liability only occurs after the cash tax savings and at $0.85 on the dollar Payment of this liability is only required if and when the company actually utilizes the deduction to reduce taxable income. In summary, we had a really good quarter across all three of our business segments and our results were in line with our internal plan.
We are confident in our full year expectations and as a result, we now expect revenue for the year ended December 31, 2017 to be between $409,000,000 $415,000,000 up from our previous guidance of $405,000,000 to $415,000,000 Based on our quarter two results, we now expect adjusted net income to range from $75,000,000 to $77,000,000 up from our previous guidance of $73,000,000 to $76,000,000 with adjusted EPS between $0.76 to $0.78 up from our previous guidance of $0.74 to $0.77 Adjusted EBITDA is now expected to increase between 16% 18% to a range of $174,000,000 to $178,000,000 for the year. We now expect system wide same store sales to increase between 8% and 9%, up from our previous guidance of 7% to 8%. We still anticipate settling and placing equipment into approximately 190 to 200 new stores. As a reminder, our 2017 guidance now assumes approximately $35,000,000 in interest expense compared with $27,000,000 in 2016 with the increase attributable to our Q4 credit facility amendment and the higher term loan borrowings associated with the Q4 special dividend coupled with the recent repricing of our senior term loan in May. Finally, keep in mind that we are now planning to open approximately 3 to 4 new corporate stores late this year.
These are all very good locations, which we expect to provide strong returns over time. That said, it's important to note that we will have additional expenses associated with these locations with very little to minimal revenue in 2017 as they just began the ramp to maturity. I'll now turn the call back to the operator for questions.
And your first question comes from the line of John Heinbockel with Guggenheim Securities. John, your line is now open. Please go ahead.
Can you guys hear me?
We do. Yes.
Good. So two questions. First, what is the latest on the pricing test on Black Card? And what is the thought on rolling that out as we go through 2017 into 2018?
Yes, I would say, so we had about almost 50 clubs running it starting in about March and we added, I think on our last call, we added an additional almost 50 clubs, so about 100 running it as of today. The results continue to be very favorable, I'd say. So long as things continue this direction, we'd probably make our decision by the end of the year.
And just as a follow-up to that, the thought was you were going to grandfather people in. Will they still the idea that they'd be grandfathered in forever or for some period of time?
Yes, they'd be grandfathered forever. I think one side note that I'm thinking is that the grandfathered members, it may time will tell, it may have some retention benefit that they know that they canceled it, they'll never get it back. So it could be a side benefit byproduct of the move too.
And then just secondly, obviously, you're opening in Panama here. So when you think about the broader opportunity right across Latin America, I mean, you've talked about Mexico in the past. Where does that sit? And how quickly can you move in many of those countries?
Sure. It's a good question. So yes Panama is in presale mode. It will open later this year. So far the pre sale has been going great.
We're still looking at other countries like Mexico as we talked in the past. The bigger hurdle in these countries from what we've seen and we mentioned in the last call is this basically software and banking processing world is very different than it is here in the So that's probably the bigger thing that we've investigated and trying to figure out the dynamics around that. So still an opportunity, still looking at it. Panama is in the American dollar, it's a little bit easier. But we're still going down that road.
I think the more we learn about the states and the better we keep producing here and I think there's so much upside in leveraging our 10,000,000 members and our growth here that we're still definitely extremely focused on making sure we continue to drive the business and the comps and the clubs here in the States and
Canada. Okay. Thank you.
Thanks, Adam.
Your next question comes from the line of Sharon Zackfia with William Blair. Sharon, your line is now open. Please go ahead. Hi, good afternoon. A couple of questions, I guess.
The guidance for the comps kind of implies a 6% to 8% comp in the back half of the year. And I'm just curious, the higher end of that would certainly be an acceleration into your trends. So maybe if you could talk about your confidence in raising that comp guidance? And then secondarily, just on the equipment side, could you give us the breakout of replacement versus newbuild for the quarter?
Sure, Sharon. I think the way we look at is we're halfway through the year. We've seen how our business has performed in terms of both the franchise side as well as the corporate side. Continue to feel very good about our comps. As I mentioned in my remarks a few minutes ago, about 90% of the comp was driven by member growth.
That's been pretty consistent now over the last couple of years. We added about 150 basis points from a mix perspective on the Black Card, Black Card. But I think with having kind of the 6 months behind us and looking at our current trends, we feel comfortable with a bit on the higher end as well as kind of narrowing the range. Keep in mind, we're up against both last year's back half, both quarters, double digit comps. So we have some headwinds against this that we're going up against, but we feel pretty good about it.
With respect to the equipment business, we had in the quarter, just a little bit north of 50% of our equipment sales were replacement sales, which is makes us feel really good about our business and the brand and our franchisees willingness and frankly, us at corporate as well and continuing to invest in that replacement cycle because as we said in the past, we believe that's a huge differentiator between us and the competition to keeping those stores fresh with equipment. So just a little north of 50 for replacement, a little under 50 on the new. I think one thing to keep in mind, the way the flow of our replacement business is happening this year, we probably had a higher percentage of our replacement sales in the back half of last year, and this year a bit in more so in the front half. And so as we look at our business, we feel real good about it, came in just I'd say slightly ahead of our internal plan, albeit about $0.03 ahead of the consensus. But one of the I'd say one of the levers where we probably got more of the replacement piece in the front half this year certainly versus the back half last year.
Great. Thank you.
Sure. Thanks, Aaron.
Your next question comes from the line of John Ivankoe with JPMorgan. John, your line is now open. Please go ahead.
Thank you. Firstly, just a housekeeping question and then a couple of others, if I may. Firstly, how many placements did you have in the Q2 and what might that cadence be for the Q3 and 4th?
Yes, we had 34 versus 32 last year, Don, in the quarter. And I think the if you kind of take the midpoint of our range, it's going to be very consistent with the prior year in the back half both Q3.
That's great. Thank you. Helpful. And then secondly, on the balance sheet, this is really just a point of education, I think. Deferred income tax assets has obviously had a pretty big leap here from the beginning of the year to around $738,000,000 almost entirely offset by that increase in the tax receivable arrangement that you so nicely kind of talked about just $703,000,000 over that same period of time.
Those are obviously 2 very significant components of both your asset and your liability and potentially influencing your cash flow if timing is different between those two categories. So as we kind of think about the model over the next couple of years, are both of those going to get drawn down at an equivalent rate? Or might one drop before the other where we might have some significant timing issues year to year?
Yes. The one thing to keep in mind, John, is that the benefit that we get on the tax return from that deduction is then payable in the following year. So for example, those cash flow numbers that I spoke to a few minutes ago that are hitting in the front half of this year already hit and then what will hit in late Q3 and Q4. All of that relates to the deduction from the 2016 return. So any deduction then I get this year that will reduce my deferred tax asset doesn't reduce the deferred tax liability then until the following year when the cash is paid.
So I think that's the only nuance. But you're right is we do have some other deferred tax assets and some other deferred tax liabilities as well. And some of those are actually netted into our deferred tax asset line. The brunt of the deferred tax assets as well as the deferred tax liabilities relates to the point that you raised.
Okay. Thanks for that technical answer. And then finally, the 3 to 4 company stores that you'll be opening, I think that was the number in 2017. Is that the beginning of a new company store development program? Is it just a one off thing isolated to that one market?
And I ask that question, of course, thinking about the out year CapEx 2018 2019, if we should expect some increases relative to the 2017 guide?
Yes. No, John, this is Chris. As I said in the past 2 or so a year, we didn't open any last year. So a lot of it is just timing on working on a lot of leases for a while and they finally all came to fruition at the same time, which is really why it's 3 to 4 now. But that's not a new trend, it's the same.
Okay. And then as you sat down with your banks and redone some of the credit agreements and everyone must be feeling very good about your EBITDA growth, What's the current thought of current long term leverage ratios assuming the business continues on the trajectory that it's on?
Yes. I think, John, we're still in what we've said in the past. We feel comfortable in that, call it, 3 to 5 times range. We levered up to back in Q4 last year, right around 4.5 times. We're just slightly under 4 times right now.
So we'll be under 4 times by the end of the year with continued generation of cash flow. But we feel comfortable in that. We've talked about in terms of the long term capital allocation strategy by our management team and our Board is looking at what's that right return of cash to shareholders. And I would say the 2 things that we're looking the most at are share repurchases and or quarterly dividends. But we're continuing that discussion with the Board and within that 3 to 5 range context.
Thank you.
Thanks, John. Thanks, John.
Your next question comes from the line of Oliver Chen with Cowen and Company. Oliver, your line is now open. Please go ahead.
On for Oliver today. We were wondering if you could provide us your thoughts on the real estate availability going forward and confidence in the 4,000 GM target. Also, could you comment on your demographic mix between higher income and lower income consumers? Is there any strength in any particular end of the spectrum? Thank you.
Sure. Thanks. I think we continue to benefit from the environment that we've been in now for a while. If you think about what's going on in the contraction of real estate, both in closings as well as a few of the retailers contracting in size and carving off a piece of the box, that benefits us. There's not a lot of retailers out there that's taking down a couple of 100, call it 20,000 square foot boxes a year.
And I think one of the benefits we get is we're one of the first ones that you called now when something comes available. And the second piece of that is because of 1400 locations in almost every city out there today, we're a very respected brand from a leasee's perspective. So those conversations that maybe 4, 5 years ago or longer that were more difficult with our brand competing with some of the other ones is not the same kind of conversation today as it was then. So I'd say still very, very favorable. Our member mix, it doesn't change much.
And we've said this before, we gym intimidation is real regardless of ethnicity, income level. We're going after that 80% of the population. And we see our stores that are in, call it, the higher side of net income do very, very well. And then those that are in the lower end of the channel doing very well. A third of our members make over $100,000 a year and a third of our members make $150,000 a year.
So no real change on that. And again, I think the main point is that our brand and what we offer appeals to all demographics.
Next question comes from the line of Jonathan Komp with Robert W. Baird. Jonathan, your line is now open. Please go ahead.
Yes. Hi. Thank you. I wanted to first ask just the overall same store sales momentum over the last few quarters. Really the middle part of last year you saw a nice acceleration.
I'm just wondering as you look back to that trend line you've seen continue, any more thoughts on what's driving the strength? And relatedly, as you look forward, what can sustain the momentum?
Yes. Hi John, this is Chris. I think as we've talked a lot over the years, I think it's when we look at our marketing dollars and our marketing spend and we've introduced digital now probably about 2 years ago as we've talked in the past. And it's that if you look at what we would IPO now just barely 2 years ago, we've added 3,000,000 incremental members since then. And every incremental members and incremental spend.
So I think what we're really enjoying here is the just this constant penetration and pounding of the market and more and more people joining and that stat that we've been watching that just over 40% of our new joins are never going to a gym in their life. It's just showing that we're continuing to introduce fitness to people that have just never thought about it. And I think it's just we're constantly on the market and getting the word out there and people giving it a shot. And I think that coupled with just the general awareness and wellness and that's the acceleration between wearables and whole foods and healthy eating. I think it's just everything is in our warehouse, which is pushing a lot of that.
I think on a smaller part, what's driving it too is just we've talked to the efficiencies of our software, and our processing and a lot of data that we're using to refine our billing and our membership mix. So I think it's just a lot of things working in our favor.
Great. And maybe related to the in gym experience if you will or the experience in the box, Curious if you could talk a little bit more about some of the equipment initiatives you might be looking at adding some enhanced equipment in a number of different ways, including things like rowing machines and that type of thing. Just curious what initiatives you have in place there?
Yes. We're excited to look at adding some rollers as well as some sidefit ergometers, basically an upper people don't know it's an upper body basically bike but for your arms. So some equipment there. But I think more customer experience I would say is more enhancements in probably more the technology piece where the cardiovascular equipment we're looking at is going to be more interactive, give people a better experience than instead of just generally walking on a treadmill with a LED red light going on a track, it's actually going to be like you're walking through the Grand Canyon or through the streets of Paris. So and then also let you surf your Hulu account or your Netflix account for that matter.
And a lot of this we're also working on that will make it an enhanced experience if you're a Black Card member. So we're working on a lot of different avenues in that sense. So it's I think a lot of that enhancement stuff will be around technology.
Great. And last one for me. Just wanted to ask a clarification on the guidance update for the year. Just trying to reconcile, I know you raised the comps outlook a little bit for the year. The net income also up slightly and I think in proportion to the interest expense reduction.
So I'm just curious as you look at the moving parts how you formulated the updated net income guidance since most of that looks like it's interest expense. Maybe I know you mentioned Dorvin the company store openings carrying more expense in the short term, but if you could just reconcile the guidance update?
Sure. So when you think about kind of for the full year, we started the year with about an 8.5% to 9% kind of growth rate on an EPS basis. I think it was $0.75 versus $0.69 talking top end of the range now. With our current guidance we're putting out there, we're at about 13%. So I think the headline there is that we came in, as I said a minute ago, just slightly ahead of our internal plan.
So on a full year basis, we're higher than where we were when we started the year. 2nd point is, when we look at our business and how it's performed over the first half of the year, we're going to continue to make some investments in areas where we can really support our operations, not only the corporate stores, but franchise stores as well. And one of those is we expanded and moved into our headquarters back in late May. We've got some headcount positions that were not in the numbers last year and not in the first half this year either. So we're looking to do that.
We think that will help us to continue to really support the growth of our primarily our franchise segment of opening, call it, close to a couple of 100 stores a year. So we feel very good about that. But we also have 6 months to go. A big chunk of our equipment business is in the back half of the year, as you know, a lot of it in the last 6 weeks of the year. But based upon that, we feel very confident in our projections and the guidance we gave in today's release.
Okay. But just maybe a follow-up. It doesn't sound like you're changing factors like your equipment assumption for the second half. You're just I just want to clarify that piece.
No, we're not. I mean, as I said earlier, the original guidance was $190,000,000 to $200,000,000 a year. We still feel very comfortable we'll be within that range on total equipment sales. I'll go back to that one point I made a while ago. A bit more of the replacement hit in the second quarter and therefore the first half versus where we thought it would have been in the back half of the year.
So that's a little bit of a difference when you compare that. But otherwise, we're still comfortable with the equipment piece.
Okay. Thank you very much.
Thanks,
John. And your next question comes from the line of Randy Konik with Jefferies. Randy, your line is now open. Please go ahead.
Hi. This is Janine Sikdar on for Randy. Just had a couple of questions. Just wondering as your marketing spend builds and your brand awareness is obviously growing, anything you're seeing new change in terms of store productivity or the store maturity curve? And also as the marketing spend continues to build as you open more stores, any plans to augment the marketing you're already doing?
Any changes to the strategy there? Thank you.
Jordan can jump in here as well. The marketing spend, I haven't there's no more opening we're still opening stores with the same pace. The presales are still being opening with the 1400 or so members on day 1. So no not really accelerating there and not accelerating on the majority level either. I'd just say more of a constant or consistent trend we've seen in the past.
As far as anything different, no, I wouldn't say anything necessarily different. I'd say just the one thing with digital real time change and test things that we're able to fine tune our digital marketing programs, but the trends of the work in the past was staying pretty true to them.
Thank you. Thanks. Your next question comes from the line of Rafi Jatarosh with Bank of America Merrill Lynch. Your line is now open. Please go ahead.
Hi guys, it's Rafe. Thanks for taking my questions.
Hey, Rafe.
So you had really strong margin expansion in the first half of the year, especially in 2Q, but the guidance sort of implies a slower expansion in the back half of the year. Can you talk about what's driving that? Are there any shifts that are impacting that? Or is that just the lower comp outlook?
Yes. I think, Rafe, obviously, from my remarks I made earlier, all three of our segments had really great margin expansions in the quarter. And I would say a bit abnormal in a couple of ways. One is, our I'll take our corporate store segment. It came in at, call it, 46% or so margins.
That comparison to last year, last year was abnormally low and that's the reason I mentioned that I think we're at 37% last year. So we had some unusually large CAM and real estate taxes that hit last year. So that was part of the delta. The corporate store team has done a really good job of managing that expense structure and with same store sales, we're able to drive some really good comps. I don't think we'll be at that level at the end of the year.
I think we will certainly be if you look at last year's comps or last year's margins were right around 40%. We'll be ahead of that this year, but the back half should be a little bit lower that based on just frankly some timing of expenses between quarters. On the our fastest growing and the highest margin piece of our business is the franchise side of the business. That's one of the areas where we are investing in additional headcount That will hit us in the back half of the year a bit with some open heads that were not in the first half. Outside of that, nothing too significant would vary.
I think we can as you saw, we continue to leverage our SG and A structure and we will leverage our SG and A structure both through the SG and A side as well as operating expense side on a full year basis. We'll be ahead of last year's margins on both fronts, full year at the end of the year. And then just lastly, our equipment segment business had higher margins this quarter than it has had historically. And you guys will remember, Rafe, I've said that that is kind of 21%, 22% margin business came in, in the high 23% s this time. A little bit has to do with just the way our volume rebate structure works with our OEM.
And we'll see a slightly lower margin in the back half of this year than we had in Q2, but we'll still be in that 21% to 22% margin range that I have said in the past should be range that I have said in the past should be the way to plan that business in the life of this contract that we're in right now today. So I think those are the I guess the color I'd put on to this quarter versus what we expect to see in the back half of the year.
And as you look at the operating margins for the overall business longer term, do you think is there opportunity in each one of the segments Or will the operating margin expansion just continue to be driven by the mix shift to franchise?
I don't think there'll be a lot on the equipment side until we get to the point in time that we renegotiate our contract on that one. And we've talked about that, that contract, by the way, expires in at the end of June next year. So I in the certainly between now and in the middle of next year, I don't expect that to vary between that 21% to 22% or so margin, which we've talked about historically. With respect to our 2 operating segments, the store segments of our business, we will be able to continue to leverage our structure, if we can keep driving the same these kind of comps we have. In the guidance I gave of 8% to 9% comps, we can we will get leverage out of that even with continuing to invest.
And as I've said in the past, it's a little bit of a stair step approach. We are starting to put more people in the field from 3 different aspects of our business. 1 is in marketing, so that we can work with the local co ops out in those markets to really leverage this brand to some of the points that Chris made earlier. The second one is really critical on the real estate side. And one of the callers earlier asked about that and frankly, the do we still think we can get to the 4,000 stores?
Being really, really close to the brokers and close to the franchisees and working those markets and be able to get the site first before somebody else might be able to get it, that's really critical. So we're starting to and we will add during the back half of this year, some real estate folks out in the field to support that. And we think that is really, really important to help keep the pipeline fresh, not only on finding new sites, but then getting stores open as well. We've said in the past, we still have we had and still have over 1,000 locations in our pipeline that are committed to today and we need to find those the best sites, Maine and Maine and then get those approved and open. But I think the net of it is we are leveraging the structure, both individually by segment as well as including the corporate structure.
We will this year and we can leverage it even further next
year. And Jordan, one more quick one. Just to follow-up on the TRA for just a clarification. Is there any scenario where you'd be obligated to make payments without getting the cash savings benefits that are offsetting your taxable income? Or is there any scenario where the payments from that liability could be accelerated?
There is no chance that I would ever make a TRA payment if I did not get a tax savings on my federal and state tax returns.
Great. Thank you.
Your next question comes from the line of Dave King with Roth Capital. Dave, your line is now open. Please go ahead.
Thanks. Good afternoon, guys.
Hey, Dave. Good.
Looks like you had a nicer acceleration in the non comp or new store sign ups this quarter, Chris. I guess, can you talk a little bit about what's driving that? Any specific regions you can point to? I guess I'm most interested in sort of the underpenetrated markets like California. And then separately, is there anything you can share about the overall sign up versus cancellation trend?
Thanks.
Yes. I'd say the sign ups and the new joins are it's not necessarily any particular market. It's pretty much everywhere and it's every class year of clubs, new clubs, old clubs are all comping nicely. So it's I think it's just Vekka said earlier, I think it's just that compounding residual effect of just constantly marketing and getting better at it. And with our digital component and just some small upticks on just better processing, the secondary billing, which members have on file as a backup billing method and better collections through our software.
So I think we get a few cylinders that are all hit in the right way that's making it all work good for us. So nothing really that's driving it beside any particular market, it's everywhere at this point. Cancellation trends have been normal. I haven't seen anything different there. Except the only difference that saves that small uptick is a secondary billing is that this because there's a second billing on file, you're more likely to be collecting with more people than have it one billing.
So that does have some help there for sure.
Okay. That's good color. And then, Dorvin, it sounds like you may have said this already, but in terms of the franchise EBITDA margins this quarter, what were there any one time items that sort of drove that down? I got a good sense on the other 2 from some of your other answers to your questions. But in the franchise segment, anything to point to there on the EBITDA margin?
Not really. I mean, other than, as I mentioned, we keep investing in that and we think it's the appropriate thing to do. We'll have some additional headcount, not a significant amount, but some in the back half of the year. But we're in that we've said
historically, we think that margin
business is
kind of a mid-80s. Year. We think full year will be ahead of last year. So we'll be able to keep leveraging that business. But nothing no significant item in terms of one time type things this year versus last year.
Okay. Okay. That helps. And then lastly, any update on existing franchisees adopting the commission structure change? Any response to that they can share
since last quarter?
Sure. Obviously, just got announced to the system just a few weeks ago. The franchisees do have that option. It's too early to say right this minute, whether they will or will not. But keep in mind that 1.59% incremental royalty is equivalent to the same amount of commission and rebates that we have in the P and L today.
So for those franchisees that choose to do that, they'll be able to buy at cost. Therefore, we won't get that markup, that 1.59% in the form of rebates and commissions, we get it in the form of a royalty. So from a kind of a 4 wall store P and L basis neutral for us on a net P and Lbasis neutral, but still too early at this point.
Okay. All right. Thanks, guys.
Thank you. Thank you.
Your next question comes from the line of Christian Busch, Credit Suisse. Christian, your line is now open. Please go ahead.
Hi, congratulations on another nice quarter, first of all. I'm wondering if you could provide some perspective on what you're trying to do in the new stores that you're going to be opening. Are you going to be testing out any new initiatives in those locations as they open up?
The only we have the pilot club that we mentioned in the past that are doing the strength machines that are tracking workouts and stuff is only 5 clubs like that. We started that in the last call. And like the expanded enhanced experience with the cardio, which I mentioned that will be piloted in a few clubs as well to see if that helps the black card percentages and members seem to like the experience. Besides that, nothing necessarily new in the new stores besides those couple of things, which is again back to Black Card experience enhancement. But as far as the 20,000 square feet, the same box, the spas, the Black Card spas, which we've been doing now for a couple of years, those are the ones we continue to make sure they're enhanced like we've been building last couple of years as members seem to like the Blackheart spas better which drives the our Blackhawk percentage which is the massage beds and chairs and tanning with a little bit of a lounge area to sit and wait for your session.
So but that's been going on a couple of years now, a few years. If you think about it, it's
I mean, we're opening stores in virtually all markets where we already have stores. Now there's some smaller markets where you're getting outside of the major metropolitan area, where that market might only have one store as an example. But a lot of the stores are continuing to penetrate existing markets that we're already in and have stores open.
Your next question comes from the line of Matthew Brooks with Macquarie. Matthew, your line is now open. Please go ahead.
Good morning. I guess relating to the issue about industry competition you sort of started off the call with. In the last couple of quarters, you've mentioned that some of the other low cost gyms were struggling and even calling your franchisees. Can you give us an update on what's happening there? Are some of your competitors feeling the pressure from your competition?
Yes. We continue to see that same trend. There's a couple real time in process now that have called. So that trend is continuing to be the same. So I think we'll continue as we continue to open more stores and penetrate more markets.
And what's the sort of scenario there? Like if they call you and you're going to provide some sort of assistance, does it mean you want to take over some of their clubs? Or what is the potential option?
There's really 3 different scenarios where it plays out. It's either one that it's a good location, it's a good planet location and it can be convertible planet, or it's maybe even a better location than the current planet. So we move over and take it over and convert it over and bring our members over. And then the 3rd option, which is happens probably 50% of the time is actually they close the club and they just basically inherit the members at the existing Planet location, which is naturally the best because it's all bottom line.
Right. And as a follow-up to your early one on capital allocation, would you generally rule out special dividends?
Yes. I mean, I think that the Board today and Chris and I, the management team, we would say that's probably not the preferred way to return cash to shareholders today based upon our shareholder base. And as I said, I think we'd look at stock repurchases and or a quarterly dividend.
Right. I know we had a stage where you can say anything about how many units you think you might open next year?
Yes. No, we haven't given any guidance for 2018.
The last one on the TRA. With the cash flow cash outflow there, will that cash outflow increase as your earnings and profitable taxable income rise? Or will that cash outflow sort of amortize the liability sort of equally over the years?
Yes. So the it will increase. Obviously, we have to have taxable income to be able to offset taxable income with a deduction. So that's that comes back to the caller's question earlier about is there any way that you'd have to make any cash payments. So as long as we have taxable income, reduced income taxes, then we get this tax savings and we make that payment in the following year.
These tax deductions, which generated the deferred tax asset occurred each time primarily TSG sold their shares. So when these B shares got converted to A shares and because those were done in tranches, starting with the IPO in August of 2015 and then the first secondary in June of 2016 and then these follow on offerings. We haven't built up to the full kind of run rate yet because that deduction gets a straight line amortization over a period of time. We'll get to that in the next, call it, couple of years. So it will increase a bit over the next, call it, 6 to 8 quarters.
And then it would stay flattish for a period of time, again, as long as we have enough taxable income to offset those to be offset with these deferred tax asset deductions.
Okay. Thank you very much.
Thank you.
Your next question comes from the line of George Kelly with Imperial Capital. Your line is now open. Please go ahead.
Hi, guys. I have a couple
of questions for you. First on the technology improvements that you mentioned with your equipment, what are the sort of key features that the Black Card members will be able to utilize?
Yes. It basically will expand from the typical treadmill experience, which is basically calories, time, mileage, just a red LED track on the screen too. As I mentioned walking through the Grand Canyon, walking through streets of Paris, you can search your Netflix, your Hulu, shop Amazon, You can stream music, do any all kinds of stuff with it. And also on top of that, we'll be able to capture data on usage, who's using what for how long, so getting some data and how to better utilize that and farm that as well as long term hopefully be able to push data back to the member and give them a tracking of their exercises so that they get data to follow themselves. So it kind of works data in 3 different ways.
There's one from the treadmill, one to us and one to them. So it's kind of enhanced their experience. So a pretty unique feature. I'm looking forward to seeing how we can expand that and give them more value.
Very cool. Do you think that will lead to a sort of sped up replenishment of equipment across the base then in the next couple of years if tests go well?
I mean, I guess it's going to depend if we are able to drive higher Black Card acquisition through it then my inclination would be that I would for my corporate stores, I'd want to replace it sooner to drive the Blackheart percentage. So I would think, yes, but until we can prove that out, it's going to be hard.
Sure. And then one other technology question. Some of these at home streaming fitness services continue to really grow like crazy. Is that something you would explore offering as part of a Black Card membership or some other plan? At any point, have you looked much in-depth at that?
Not too in-depth, but we've had discussions on some sort of feature like that on our app or some of that they could get in for feature. So it's something we've thought about not in-depth but thinking about
it. Okay. And then last question for me is about the number of members. It's just it's fun to watch the growth there. Can you talk about the usage you're seeing on a per club level?
Like what does it look like? How has that grown in usage? And do you think you're nearing any kind of limit where the experience is starting to change? Is there any kind of deterioration that is worth commenting on?
Yes. No, I'd say the trend is about the same. I'd say we would do average about 5,000 workouts a week per store. I think the beauty with our model, one is open 20 fourseven. So that helps expand the busy hours that a lot of clubs experience in the evenings.
But one of the bigger features is because we don't have the certain classes like most clubs do where you're demanding that people your members have to come in at a specific time to work out. And you have these big giant balloon periods where class outs are 5 o'clock, you're spinning the dinner and also maybe a Group X class and you have 200 people try to take the same hour classes. You have these giant log jams that happen not only in the classrooms, but in the locker rooms and the parking lot, right? So because it's basically everybody coming on their own time schedule, it just spreads out these periods. You don't have this huge log jam.
Our clubs we have a lot of many clubs that have 10,000 members. When you get to about 12,000, when it tends to get a little bit dicey, which easily enough we just open another store and the right distance away to help alleviate some of that flow. But I wouldn't say any customer experience thing is anything that's being hindered at all.
Okay. Okay. Thank you.
You're welcome. Thank you.
Thank you.
Your next question comes from the line of John Ivankoe with JPMorgan. John, your line is now open. Please go ahead.
Hi. Thank you for the follow-up. The question was on the effective royalty rate in the quarter. I mean, if my math is right, I think we saw a 50 basis point or so step up year over year. I mean, is that what you guys see?
And what's the trajectory of that as we finished up 2017 into 2018 2019? It's always kind of hard to model it from the outside, but what are you kind of seeing as that rate continues to grow?
Sure, John. Yes, it was up 50 bps in Q2, a little bit higher than what we had had in the past. I think it's going to end up full year in that, call it, 35 to 40 basis points range
for this
year. I think earlier in the year, I'd said probably 30 to 35. So it's going to come in a little bit higher. I guess one thing that we'll see we won't see any impact this year. We should start to see some impact down the road as franchise agreements expire and renew.
That'd be that extra 41 basis points on our current royalty rate of 7%. So remember, as you from the last call, that 7% royalty rate we have now in the FDD includes that incremental 1.59%, reducing the rebates and commissions that get paid to us from the vendors and then the incremental 41 basis points. I don't think it will be a lot next year, But as we get into 2019, 2020, 2021, 2022, that's when we'll have a higher number of franchise agreements that expire and renew. So I'm not ready to give any guidance for next year. A significant number of our stores today are at the 5% rate.
Out of our 1,000 plus pipeline to be opened, a very high percentage of those will open at the 5% rate. There's still a few that will open at a lower rate, but the far majority at the 5%. So I think the way, I guess, I would think about it is, we've said that we ought to be able to do that, call it close to 200 stores a year. So if it's 200 stores next year, a majority of those would open at the 5% rate. Probably a small handful might open at the 7%, which would give you the incremental 41 basis points.
But we'll give clearly more guidance when we get our Q4 release as to what next year's royalty rate increase will look like.
Helpful. Thank you.
Thanks, John.
There are no further questions at this time. I'll turn the call back over to management for closing remarks.
Thank you. In closing, I'd just like to reiterate my happiness and the great quarter we had as well as marking our 42nd consecutive quarter in positive comps. I think it really just displays our confidence in this brand and the confidence in our model and the confidence of our marketing power and look forward to the future. So thank you for joining us today. Talk soon.
Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.