Good afternoon. My name is Tashan, I'll be your conference operator today. At this time, I'd like to welcome everyone to the Planet Fitness First Quarter 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question, simply press star, then the number 1 on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Brendon Frey, Managing Director of ICR. The floor is yours.
Thank you for joining us today to discuss Planet Fitness' first quarter 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. 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 you to the disclaimer regarding forward-looking statements that is included in our first quarter 2017 earnings release, which was furnished to the SEC today on Form 8-K, as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. In addition, the company may refer to certain adjusted non-GAAP metrics on this call. Explanation of these metrics can be found in 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, Brendon, and thank you, everyone, for joining us today. 2017 is off to a great start. During the first quarter, we added over 1.2 million net new members to surpass 10 million members system-wide and deliver adjusted earnings per share of $0.19. Our strong performance was a direct result of the hard work put in by our great group of well-capitalized franchisees and the passionate Planet Fitness staff that support them and manage our corporate-owned stores. It was a true team effort. As pleased as I am about our recent results, I'm even more excited about the trends our results show across our key growth drivers. Starting with store expansion, 54 new franchise stores opened in Q1, up from 48 in the same period last year. More importantly, the pipeline of new stores remains robust.
After opening 200 stores at this time last year, we continue to have over 1,000 committed stores in the pipeline based on current area development agreements. Specifically, we have approximately 1,000 stores scheduled to open over the next five years, including 500 in the next three years. At the same time, we continue to sell area development agreements throughout the country, as new franchisees are eager to expand their businesses to new markets and add to their growing portfolio of Planet Fitness locations. Q1 membership trends in stores were strong. System-wide same-store sales increased 11.1%, marking our 41st consecutive quarter of positive same-store sales and our third consecutive quarter of double-digit growth. There are a number of factors fueling our comp performance, including what we believe are some significant competitive advantages. It starts with our welcoming, non-intimidating environment featuring high-quality branded cardio and strength.
The fact that we are able to offer our differentiated, superior in-store experience for only $10 per month is incredibly compelling to our target audience of casual and first-time gym users. As we did in 2016, we continue to survey new members to determine if they've ever belonged to a gym prior to joining Planet Fitness. Based upon responses from approximately one million new members in Q1, over 40% are new gym users. We believe we are clearly growing the overall market by successfully targeting the approximately 80% of the U.S. population and Canada that currently does not belong to a gym. Another critical component to our success is the level of investment by the company and our franchisees to growing the brand awareness and educating consumers on the differences between Planet Fitness and stereotypical gyms.
Every month, 2% of members' dues are contributed to the national ad fund, which allows us to participate in high-profile events such as our sponsorship of the Times Square New Year's Eve celebration and TV and digital advertising that runs nationally during the year. On top of this, franchisees are required to spend another 7% on local and regional marketing programs aimed at driving awareness and member sign-ups. Between national and local programs, we estimate that almost $100 million was spent on marketing our brand and highlighting our welcoming, non-intimidating environment in 2016. We figure that as far outpaces the competition, it should continue to increase in 2017. An equally important point of differentiation is the capital spend of keeping Planet Fitness's stores fleet fresh and up to date.
This is anchored by a disciplined equipment replacement cycle that ensures a consistent store experience regardless if a member visits a store that opened this year or a decade ago. In 2016, replacement equipment sales represented approximately 30% of our total equipment revenue, underscoring the system-wide commitment to this important endeavor. Finally, we, along with much of the fitness industry, are benefiting from the current health and wellness trends. There is a growing awareness among all demographics about the importance of exercise, as it provides a variety of benefits from weight loss to stress relief and more. With healthcare costs continuing to rise, I expect commitments of living healthier lives will only get stronger among our target audience.
The growth in members at existing stores and from new stores opening is driving robust revenue and earnings gains in our high-margin franchise segment and contributing significantly to our company's strong cash flow generation. With approximately 190 to 200 franchise stores scheduled to open this year, and with each new joint adding incremental $ to our overall advertising budget, we are confident we will continue to attract large numbers of first-time and casual gym users to Planet Fitness and solidify our leadership position. Top of our growth prospects in the U.S. and Canada, there's significant untapped international opportunities for our brand. Later this year, we will open our first store in Panama, a market primed for Planet Fitness model, as more than 98% of the population does not currently belong to a health club, according to industry data.
We will leverage the learning in this market to inform our broader strategy for successfully penetrating Central and South America in the medium term, and potentially other regions of the world longer term. Another future growth driver is the increased royalty rate on monthly dues and annual fees, which we introduced in our recently filed franchise disclosure document. Dorvin will walk through the change in more detail, but we've taken the current royalty rate from 5% to 7%, while beginning to move away from commissions we have historically received on certain franchise purchases from our preferred vendors. The net effect of the royalty rate change is an increase over time of 41 basis points on royalties from new ADAs in the related franchise agreements, new franchise agreements that don't have a contractual right to a lower rate, and from renewals of expiring franchise agreements.
Finally, as noted in the press release, I'd like to congratulate Dorvin on his well-deserved promotion to President and CFO. In his newly created role, his expanded responsibilities will include overseeing technology and the real estate development functions, as well as our corporate stores, in addition to his ongoing oversight of all finance-related functions. Since joining the company in 2013, we have more than doubled the footprint and delivered strong financial results to our franchisees and shareholders. Dorvin has played an instrumental role in our continued success, and his promotion will allow me to increase my focus on brand growth, franchisee and shareholder returns, and our long-term strategy. My passion for the Planet Fitness brand and my commitment to bringing affordable and non-intimidating health and fitness to millions of people has never been stronger, and I look forward to our exciting future ahead.
In summary, membership and store growth trends remain very strong, and there are significant opportunities to take these numbers much higher. I'm very confident that we have the right leadership, franchisees, staff, and strategies in place to successfully achieve the long-term targets we have established for this business and return increased value to our shareholders consistently over the years ahead. I'll now turn the call over to Dorvin.
Thanks, Chris, and good afternoon, everyone. I'll begin by reviewing the details of our first quarter results and then discuss our full year 2017 outlook. For the first quarter of 2017, total revenue increased 9.3% to $91.1 million, from $83.3 million in the prior year period. Total system-wide same-store sales increased 11.1%. From a segment perspective, franchisee same-store sales increased 11.5%, and our corporate store same-store sales increased 4.5%. Over 90% of our Q1 comp increase was driven by an increase in members. At the same time, our Black Card membership penetration was 59%, up 140 basis points over Q1 last year. Our franchise segment revenue was $36.8 million, an increase of 33% from $27.7 million in the prior year period. Let me break down the drivers of our fastest-growing revenue segment. Royalty revenue was $20.9 million, which consists of royalties on monthly membership dues and annual membership fees.
This compares to royalty revenue of $14 million in the same quarter of last year, an increase of 49.1%. This year-over-year increase had three drivers. First, we opened 201 new franchise stores since the first quarter of last year. Second, as I mentioned, our franchisee-owned same-store sales increased by 11.5%. Third, a higher overall average royalty rate. For the first quarter, the average royalty rate was 3.9%, up from 3.58% in the same period last year, driven by more stores at the 5% royalty rate. Next, our franchise and other fees were $7.3 million, compared to $5.4 million in the same quarter a year ago, an increase of 34.7%. 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 agreements and area development agreements.
This increase is driven by additional stores and an increase in same-store sales as compared to the prior period. Also within franchise segment revenue is our placement revenue, which was $2.1 million, flat with the prior period. Finally, our commission income, which is made up of commissions from third-party preferred vendor arrangements and equipment commissions for international new stores, was $6.5 million, compared to $6.2 million a year ago. Our corporate-owned store segment revenue increased 5.2% to $27 million, from $25.7 million in the prior period. The $1.3 million increase was driven by the increase in corporate-owned same-store sales of 4.5% and increased annual fees. Turning to our equipment segment, revenue decreased by $2.7 million to $27.3 million, from $30 million.
The anticipated decrease was driven by a difference in timing of new store equipment placements versus a year ago, partially offset by an increase in replacement equipment sales to existing franchisee-owned stores. As we discussed at year-end, we had some stores that we placed equipment in Q4, but those stores did not open until Q1. Our replacement equipment sales as a percent of our total equipment sales was 37% in Q1, with strong purchases by our franchisees reequipping their clubs during the quarter. Looking ahead, we expect new store placements in Q2 to be higher versus the same period last year, and we continue to track towards our stated guidance of 190 to 200 new store placements for the full year.
Our cost of revenue, which primarily relates to direct cost of equipment sales to new and existing franchise-owned stores, amounted to $21.1 million compared to $23.6 million a year ago. A decrease of 10.6%, which was driven by the decrease in equipment sales I just mentioned. Store operation expenses, which is associated with our corporate-owned stores, increased slightly to $15.2 million compared to $14.7 million a year ago. SG&A for the quarter was $13.8 million compared to $11.8 million a year ago. Both periods include non-recurring expenses. Last year, these were severance-related costs, and this year they were primarily costs incurred in conjunction with the March secondary offering. Excluding these non-recurring expenses, total SG&A increased by $1.7 million or 15.2%. This increase was primarily to support our growing franchise operations.
Our operating income, inclusive of the aforementioned non-recurring expenses, increased 29.1% to $33.1 million for the quarter compared to operating income of $25.6 million in the prior period. On an adjusted basis, taking into account the one-time items I just mentioned, our adjusted operating margin was 37.8% this quarter versus 31.4% in the prior quarter, an increase of 640 basis points. This was primarily due to revenue growth and higher margins from our franchise segment, where we have leveraged the cost infrastructure in our fastest-growing segment. Our earnings before taxes, inclusive of the aforementioned non-recurring expenses, increased 27.2% to $25 million for the quarter compared to earnings before taxes of $19.6 million in the prior period.
As a result of our fourth quarter 2016 amended credit facility and increased terminal borrowing, the company incurred approximately $2.4 million in higher interest expense in the first quarter of 2017 compared to the prior year period, and will incur higher interest expense of approximately $10 million at today's LIBOR rate for full year 2017. Our GAAP effective income tax rate for the first quarter was 28.5% compared to 16.8% in the prior 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 first quarter of 2017, our net income was $17.9 million or $0.14 per diluted share, compared to net income of $16.3 million or $0.09 per diluted share in the prior period. On an adjusted basis, net income was $18.4 million or $0.19 per diluted share, an increase of 21.2% compared with $15.2 million or $0.15 per diluted share in the prior period. Keep in mind that Q1 included higher interest expense of $2.4 million as a result of the Q4 refinancing. Adjusted net income has been adjusted to exclude the impact of the March secondary offering and several other non-recurring costs, and to 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 23.3% to $42.3 million from $34.3 million in the prior 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 34.5% to $32 million, driven by higher royalties received from additional franchisee-owned stores not included in the same-store sales base and an increase in the franchise-owned same-store sales of 11.5%, as well as higher commissions and other fees. Our franchise segment adjusted EBITDA margins increased by approximately 200 basis points to 88%. Corporate-owned store segment EBITDA increased 5.2% to $10.7 million, driven primarily by a 4.5% increase in corporate same-store sales and higher annual fees.
Our corporate store segment adjusted EBITDA margins decreased slightly by 20 basis points to 40.1%. Our equipment segment EBITDA decreased 3.5% to $6.1 million, driven by lower equipment sales. For the quarter, equipment segment adjusted EBITDA margins increased 130 basis points to 22.4% and is in our stated range of 21%-23%. Turning to the balance sheet. As of March 31, 2017, we had cash and cash equivalents of $60.2 million compared with cash and cash equivalents of $40.4 million as of December 31, 2016. Borrowing capacity under our revolving credit facility stood at $75 million as of March 31, 2017, while total bank debt was $714.9 million, excluding deferred financing cost, consisting solely of our senior term loan, which bears interest at LIBOR plus 350 basis points. During Q1, we purchased incremental interest rate caps to effectively hedge against changes in interest rates on 50% of our outstanding debt.
As of March 31, 2017, our term debt has a spread of 350 basis points plus the applicable LIBOR rate, and 27% of our debt is capped at a LIBOR rate of 1.5%, and 23% is capped at a LIBOR rate of 2.5%. Before I move to our outlook, I want to walk through the recent change in our royalty rate in more detail. As Chris stated, we announced in our franchise disclosure document filed last month that we've taken the royalty rate on monthly and annual dues from 5%-7%. It is important to understand that the increase in the royalty rate includes the shift from commissions to royalties, which represents approximately 1.59% of the 2% increase for an average store. The remaining 41 basis point change represents an incremental royalty rate increase.
We believe the shift from commissions to royalties better aligns our interest with our franchisees' interest, compared to the existing model, where we, as the franchisor, make commissions as a result of purchases made by our franchisees. This shift to an all-in 7% royalty rate applies to all new ADAs sold since filing our most recent FDD. Franchisees have the option, if they choose, to amend their existing ADAs and franchise agreements to increase their current royalty rate by this 1.59%. To our outlook. For the year ended December 31, 2017, we still expect revenue to be between $405 million and $415 million.
Based on our quarter one results, we now expect adjusted net income to range from $73 million to $76 million, up from our previous guidance of $71 million to $74 million, with an adjusted EPS between $0.74 and $0.77, up from our previous guidance of $0.72 and $0.75. Adjusted EBITDA is now expected to increase 15%-18% to a range of $173 million to $178 million for the year. We now expect system-wide same-store sales increase to be 7%-8%, up from our previous guidance of 6%-8%. We still anticipate selling and placing equipment into approximately 190-200 new stores.
As a reminder, our 2017 guidance now assumes approximately $37 million in interest expense, compared with $27 million in 2016, with the increase attributable to our Q4 credit facility amendment and the higher term loan borrowings associated with the Q4 special dividend. I'll now turn the call back to the operator for questions.
At this time, I'd like to remind everyone that in order to ask a question over the phone, you may press star one on your telephone keypad. Again, that is star one on your telephone keypad. If you'd like to withdraw your question from the queue, you may press the pound key. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of John Heinbockel from Guggenheim. Your line is open.
Chris, two related things. When you think about what you're going to spend more time on strategically, what are one or two of those items, right, that you think could have the most impact on the business? Kind of related to that, I think you've had some thoughts about potential clubs in different countries. When you think about Central and South America more broadly, have you guys yet penciled out what you think that potential is?
Sure. Yeah. I'd say the two things from a focus standpoint would be the brand evolution, which is something that I've been involved with for nearly 25 years today, and our blocks and our model today has changed over the years. I think the important thing is to be careful that we stay disciplined to where we came from so we don't stray and end up being just like everybody else. I think it's a disciplined approach to evolving the brand, which ultimately should drive revenue. My focus is about that, member growth and revenue. That's where my increased potential comes from. Central South America, still somewhat preliminary. Some findings have told us 300 in Mexico, there's been nothing concrete in any of those larger countries. Again, we just did that Panama deal. We're in Dominican Republic at this point.
Maybe as a follow-up, when you think about the opportunity, you talk about brand development, something we thought about for a while, right, is kind of a consumer products opportunity and putting the Planet Fitness brand on different products that are not out there today. Where does that rank in importance to you?
Yeah. We had mentioned in a previous call that we did look into a company that looks into licensing for us.
Nothing has transpired that was of substance that we'd like to bring the direction. Still investigating that. Nothing is concrete there either. I do believe, now with over 10 million members, that our brand is a brand outside our four walls, that there could be something there that we can capitalize on.
Okay. Thank you.
Thanks, John.
Your next question comes from the line of John Ivankoe with JPMorgan. Your line is open.
Thank you. Dorvin, just wanted to get some clarification on the change in the royalty rate. It goes from 5% to 7% for new stores and new agreements. Yet you lose the 1.59% for commissions, correct?
That's correct, John.
Is there any type of transition where the commissions fall off for existing stores before they sign up at the new 7%? I just wanted to see if this is going to be a seamless transition from one revenue form to another revenue form and still have it on a quarter-to-quarter basis, be at least neutral or really additive to the overall business model.
Sure, John. As you pointed out, it applies to new area development agreements that we sell as well as any new franchise agreement, single franchise agreement we would sell post our FDD filing. In those examples, the royalty rate would be 7%. These products and services that they purchase at a store level that we receive rebates or commissions on today would go away. That, for an average store, is about 1.59%. Existing franchise agreements, so say our 1,300-plus stores that are open, they have the option to be able to amend their agreements if they so choose, and would go from their existing royalty rate, whatever that rate is, up by that 1.59%, and then by a cost like a new franchise agreement would. It's too early.
Obviously, we just filed this, so it's too early to know whether a few or how many of those might do that. I think the way that we think about it internally and the way we've had conversation with franchisees now for a long time about this, in terms of that alignment, that we make revenue when we make profits when they grow their top line, and we don't make it just when they're purchasing something that's more of an operating expense in their store. In reality, it should equal and offset. As far as in terms of the transition of that, if they chose not to amend, then it would take some period of time, obviously, to see how that impact would start to offset each other.
If they chose not to amend, Dorvin, then they would continue to pay that 1.59% commission and whatever their legacy royalty rate was, correct?
That's correct.
Okay. I just wanted to make sure.
Yeah.
You kind of do bring up a symbolic issue, I guess I'll say, of you want to make money off of the franchisee's top line, and top line is going to be most indicative of their bottom line. Certainly, I understand you starting to disaggregate yourself a little bit from the commission side. Is there any thought to rethinking some of the equipment, not necessarily placements, but the equipment sales that you do? Is this kind of an issue that the franchisees are saying to you that they want you to be a pure franchisor and not be involved in either commission or equipment revenue?
As you know, we have talked about that on some previous calls. In the ideal state, I think that's what we'd love to have. The franchisees have clear transparency into exactly what our cost is. One, because they help us negotiate the three-year contract that we have with our primary supplier. We felt like that at this point in time, making this change, because these are just ordinary, normal operating expenses that hit a store level P&L month to month, as opposed to day zero, you go out and buy brand new equipment for a store, and then you don't start replacing that till year five and six, et cetera. Maybe over time, but I think at this point it was too big of a pill to kind of swallow to do all of that. That would be a more perfect alignment.
Thanks.
Sure. Thanks, John.
Your next question comes from the line of Sharon Zackfia with William Blair. Your line is open.
Hi, this is Tania Anderson for Sharon.
Hi.
Hi. This is a question. You talked about the development pipeline at the beginning, and it sounds like it's good. Can you just kind of discuss the decline in deferred revenue? It came out in your 10-K, there were some questions and concerns on it. How do we look at that and read through development pipeline there? Thanks.
Yeah, sure. There's a number of items that are in that deferred revenue. One of the things that was in there at year-end, we got some questions about comparing kind of the 12/31 financials, 2016 with 12/31/2015.
The majority of that change, that reduction, was really related to the equipment discount, which we had negotiated with the sellers of the eight Hudson Valley clubs that we acquired at the end of Q1 in 2014. That was about a $1.7 million of the change, and that was related to the fact that discount was expiring at the end of Q1. This Q1, we just ended. At the end of December, we looked at that and said, "They're not going to be able to use all that discount." We reduced that, and it flowed through income at the time. The balance of the others really relate to membership fees or annual fees, et cetera, that set up and get deferred over. They're not recognized immediately.
From year-end to now, so from December 31 to March of 2017, the balance went down slightly, about $200,000, no significant change.
Okay. Then on the new royalty rate, the new ADAs are switching to 7%. Not counting the existing ones that might amend their agreements, when do the new ADAs that, say if someone signed today at 7%, when does that start to flow through into your P&L, the royalty rate when they start opening clubs and you get that?
Sure. Let's say we sell a new ADA today, a 10-store ADA, $10,000 fees. We receive $100,000. We set that up as deferred revenue. The franchisee has a development schedule. It may be they have four years to develop 10 stores, as an example.
Okay.
They go out, they have a defined market, a very specific market that is the only place that they can open up stores. They submit sites. We get to approve all sites. Once we approve the site, they negotiate a lease, they sign a franchise agreement, typically simultaneous with signing that lease. There's a period of time, depending on if they're getting a plain vanilla box or if it's going to require a significant amount of construction costs to get that store open. That whole process I just outlined could take a period of three or four months to find a lease, or longer, and then it could take three to six months to get a store open. We don't expect the new dirt that we would sell this year under our franchise disclosure document to have any material impact this year.
As you stated, it's only those new stores under the ADAs. We might get a small handful open by the end of the year with the new ones that we've sold or that we sell here in the next 30, 60 days. Once we get past June or so, it's very difficult to sign an ADA and then get a store open in the current year.
Okay. That's kind of what I thought, but I just want to check. Thanks.
Sure. Thank you.
Thank you.
Your next question comes from the line of Jonathan Komp with Robert W. Baird. Your line is open.
Yeah. Hi, thank you. A couple of questions. Maybe the first one just on the same-store sales momentum that you're seeing. Looks like the franchise performance accelerated, even though the comparison was a little bit tougher sequentially. I'm just wondering if you could maybe give an update on what you think is driving the strength, and then also with more than 1.2 million members added, how much visibility does that give you to the full year?
Yeah. I'd say we're hitting it from a few different angles, whether it's strong sales and then cancels, as well as involuntary cancels, which is more billing cancels. I think we're hitting it from all angles, which is driving the performance as well as just our ad budget just continues to grow, which is pushing what we're seeing today.
Yeah. I'd say, Jon, just to add to that. We certainly were pleased with our growth in the quarter. As we had stated back when we gave our guidance back in late February, I think it was, that our easiest comp would be earlier in the year, and then it gets harder sequentially. If you go back and look at our last year comp, kind of that two-year stacked comp, it would be easier, and therefore, that's why we said we'd be in that kind of low double-digit range for Q1. We're pleased with where we're at. As I said in my earlier remarks a few minutes ago, that the very high percentage, a little over 90% of that comp store growth came from member growth, which we like because I think it speaks to the health of the brand and to the effectiveness of our marketing.
We feel pretty good about our business.
Okay, great. If I could just clarify, Dorvin, did you give the number of placements during the quarter?
We did not. In total, I think we had 31 placements in Q1, down from last year. As I stated in my remarks also, that was planned, I think I had said our Q1 equipment revenue number would be down year-over-year. Then the cadence of that will be fairly similar to our cadence in Q2, three, and four last year, to get into that 190-200 range, which we're still comfortable with from a guidance perspective.
Okay. Was the timing shift, was that all backwards into Q4? Or was it some of that forward into Q2 on the placements?
Mostly Q4, yeah. Because we had about 20 store openings or so that got placed in Q4, that opened in Q1. We always have it from quarter-to-quarter, a bit higher last year than the year before.
Okay. Last one for me. I understand there's always various tests throughout the system, but a couple that look interesting, just on maybe testing some different pricing structure for the Black Card and also, some new rewards planned, kind of incentive-based, with a rewards card. I'm wondering if you could comment on either of those two.
Sure, yeah. Both of them are still in pilot or test phase, if you will. The test of the Black Card $21.99, I guess one good thing is we've never really referred to the Black Card as our $19.99 membership. It's always been our $10 membership in our Black Card, so we may have flexibility. I think as we've talked about many times in the past, is how we've changed the Black Card area into Black Card Spas, so they're much nicer. We're kind of testing to see what we can command for that number. It's too early to tell what we end with as far as, is it the right move, the wrong move, or can we get more or less? Early read is favorable, I'd say, at this point. Yeah, there's a PF Perks rewards.
Again, too early to tell on that if it's going to drive either I guess the two ways we're looking at now is does it drive just more referral leads for new joins and/or does it help retention? Still yet to be determined.
Okay. Thank you.
You're welcome.
Thank you.
Thank you.
Your next question comes from the line of Randy Konik with Jefferies. Your line is open.
Hi, guys. This is Jonathan Matuszewski on the line for Randy. Thanks for taking our question.
You're welcome.
I guess just to start off, could you give us an update just on what you and your franchisees are seeing on the real estate front? Obviously, there's been retail bankruptcies that have been accelerating over the last quarter even. Are you seeing kind of more quality real estate opportunities? Do you feel as if you have greater leverage in negotiations?
I would say, it's been good now for quite a while, this last year or two. I don't think it's any better or worse. I think it's probably still good for us. As I've said in the past, the REITs and landlords are generally calling us as one of the prime tenants to take these spaces, due to the fact is we can't be Amazoned, if you will. Also, our busiest days of the week, we have about 5,000 workouts per center, per week. Majority of those are Monday, Tuesday, Wednesday, which is driving traffic to the center when they're generally not as busy. It's a great traffic flow driver when the grocery stores are busy on the weekends.
Great. Thanks for taking the question.
Great. Thank you.
Thank you, John.
Your next question comes from the line of David King with Roth Capital. Your line is open.
Thanks. Afternoon, guys.
I guess first off, on the change in royalty rate, and assuming it may only impact the existing ADAs for now, I guess how should we think about the 190 to 200 stores planned for the year? I guess how many of those should be on existing ADAs?
Typically, every year, Dave, most of the store openings come under ADAs that you start the year with. I think I've said before on prior calls that we will this year, and have always historically, had a few one-offs franchise agreements that get signed. Somebody will say, "I want a Planet Fitness here in this town," and that market's available, and we'll do that. We like to do more ADAs, 5 to 10-type store ADAs, typically. Every year we do so. Those would be kind of self-generated, if you will, during the year, and we'll do some more this year.
The far majority of them, because if you got my comments a few minutes ago to the question that was posed, that timeline is, from start to finish, when you start out a brand new ADA, it's just that type of length of time to get that development schedule going. Because of that, most of our stores will come from our existing pipeline.
Okay. Not contribute that much this year in terms of revenue impact unless people do-
Correct
comp change and then, okay. It would help further out. Okay. Thanks for the color there. If I look at your comps, they continue to accelerate, which is impressive. I guess the pace of membership growth looks like it's sort of been holding in at similar levels. Is that more of a function of a slower pace of openings, or is it more due to initial sign-ups? Anything to point to there, and how that's been trending at new locations?
I would say that very similar to where we have been. We haven't seen, in Q1, whether it's stores opening in their first month or how they get ramped up in the earlier stages. We're four months into this year now, through April. No significant changes in the economic model, I would say. Just the last point I would say is that in addition to what we've seen in Q1, it was very similar to last year and even 2015, frankly, that the far majority of our comp is coming from member growth, which speaks to us and our franchisees to be able to drive with that marketing in these local markets to drive more and more people to the stores. We feel good about our business.
Okay, fantastic. I guess one more. Chris, any sort of high-level thoughts, understanding it's still early in terms of seeing the response to the royalty rate change. In terms of anecdotally from the franchisees, has there been any pushback at all? What have the conversations been like in terms of thoughts around-
Sure
the change?
Sure, Dave, yeah. I'd say, one thing, even whether it's this or equipment negotiations or so on and so forth , we're very transparent with our franchisees. To help them understand, I guess, the math behind it, we had three of the groups, and the three of the groups that are actually backed by private equity actually use their analytics to validate the math and make sure that they were all going to get comfortable. We involve them, so they understand the math and get their mind around the change in the 1.59. It's really truly an incremental 41 basis points. It's not a true 2%. That, we involve them and got them involved in it. It went over well.
That's great color. All right, thanks, guys. Good luck with the year.
Thank you.
Thank you.
Your next question comes from the line of Oliver Chen with Cowen and Company. Your line is open.
Hi, congrats. Thanks a lot. Regarding the royalty rate, with the 40 basis points, what was the main driver in terms of how you're thinking long term and why a 40 basis point was kind of the right methodology? Also, as we think about international, just what's your strategic framework for how you'd prioritize markets in terms of where you would think that the brand would make sense, just your filter as you work with franchisees and thinking about the right opportunities and how to sequence them with the right risk rewards. Thank you.
Yeah, I think the 41 basis points was more, going from five to seven, I think was a big move. Granted, most of it was in from one pocket to the other. It was more just what was a clean number that we could get franchisee approval and endorsement to be comfortable with the move. I think that's really where the increase came from, and I think with the 41 basis points, as you continue to have great same-store sales and drive more members per door, that I think it's warranted at this point to get an extra little more royalty, incremental royalty is good. As far as the priorities in the market, really it's all markets that are growing. I can't really say one that necessarily is a priority. Here domestically or Canada, like which one we should really focus on more than another.
I think also in the need to fire in all markets to continue to either open new stores or relocate older stores to continue to comp.
Okay, just finally, Dorvin, on the comp guidance, it was tweaked up slightly at the low end. What was the rationale for doing that in terms of what you're seeing and how you're feeling about the outlook?
Sure. Oliver. Obviously, when we put our guidance in place at the beginning of the year, we had the insight into a couple of months' worth of activity at the time, and saw what was going on, kind of the carryover effect from last year into January, February, and this recurring billing concept that we have. We obviously have good insight into that. You saw the member growth number that we had, on a net basis for the quarter. I guess it was, as we were thinking about this full year and reflecting back on my comments a minute ago of kind of what that two-year kind of stacked comp would look like, we wanted to make sure that we got into the year to see how mature stores were performing because it's getting to be obviously a bigger percentage of the base.
How new stores out of the gate were performing. I think what we ended up with then, sitting here now with three months past us looking into the balance of the year, is that we still see that increasing comp number on a year-over-year basis, as headwinds up against us, although albeit we feel good about our business. Tightening the range, we feel very comfortable with right now. We also have nine more months to go. I think it was really that, and seeing that the low end of our range was clearly achievable.
Okay, it sounds like the mature stores you're really pleased with. Are there methodologies or marketing programs or initiatives that are in place to kind of ensure that the glide path for mature stores continues to be robust? Just any thoughts along that line would be helpful. Thank you.
Yeah, I would say the one thing that we're real disciplined on with the mature stores, unlike some would think, is that once it gets to seven or 8,000 members, you can throttle back the marketing because you're there. That's the last thing you want to do is you want to continue to every month try to drive awareness and drive new members in and get them comfortable with coming in and giving it a shot, especially that 80% that doesn't have health club membership. It's, I think, disciplined approach to reequipping, remodeling, and constantly pounding the marketing.
Thank you, best regards.
Is there anything else?
Thanks, Oliver.
Your next question comes from the line of Rafe Jadrosich from Bank of America Merrill Lynch. Your line is open.
Hi, good afternoon. Thanks for taking my questions. Congratulations, gentlemen.
Thank you. Thank you, Rafe.
As you look at your comp growth, can you talk about how much of the growth you think is coming from you growing the market versus share gains? Then within share gains, who do you think you're taking share from? Is it the lower-priced players, higher-priced players, or are you seeing more members that are kind of signing up for multiple gyms?
This is Chris. I think still the same as Q1 2016 and Q1 of this year, the survey's showing that just over 40% are coming in as first-time gym members. I think that's showing what, finally, we are tapping into that segment of the population that has just never given fitness a try. That's the great news. There's industry data that show that people with two memberships, which is a growing trend, I think that's more based around the acceleration of all these boutique fitness outlets that are higher priced and you need an appointment to work out. If you can't get in for a cycling class, then you can't work out, period. You do need a backup option, and for $10 a month, we're the perfect option for that. If you can't get in, you have us.
I can't say really necessarily which competitors they're really coming from, if it's coming from another club.
All right. You spoke about the rising brand awareness. Have you seen any changes to your new store productivity? Are stores opening with more members initially now that your brand awareness is higher, or has it stayed pretty consistent?
It's pretty consistent, Rafe. I made that comment just a minute ago. We obviously have all of the EFT revenues that we draft every month. We look at how clubs are performing out of the gate. We think that ramp period is important, the first 12, 16 months of an operation. Even to Chris's point, as he said, mature stores continue to be able to comp, albeit at a lower rate as we've talked about in the past. There has been no real significant change in the model. When we go into newer markets, sometimes they perform a little bit different. When I say newer markets, less market penetration maybe just because of the reciprocity is not as valuable in some of those markets maybe. No significant change from that perspective.
Last question. As you look at the sequential comp acceleration over the last few quarters, what would you attribute that most to? Are you seeing that sequential improvement consistent across all maturity levels of your stores or of your gyms?
I would say there's not one single thing that's driving that, which I think it speaks to the power of the brand, both in our more higher market penetration markets, like here in the Northeast and maybe the Southeast, where we've had more stores and been there longer. Our new point-of-sale system, which we put in place back in early 2015. I think that we and our point-of-sale provider, third-party partner, have gotten smarter, with not only managing the data, but functionality of some things that we can do internally. I think our franchisees today are significantly smarter than they were three or four years ago. If you look at a number of our groups today, they have chief marketing officers and CFOs and head of store ops that they didn't have four or five years ago.
All the way from the investment that we make corporately, from a headquarters perspective, not corporate store perspective, but in putting people in the field closer to our franchisees, having marketing coordinators for the various markets where we form these marketing co-ops, looking at the way we're spending our money versus the way it was the prior years, all driving on that. It comes down to the power of the data. We didn't have this kind of data back under our previous point-of-sale systems. It's a combination of all of that, and franchisees today are holding their own training and coaching and mentoring, and it's all of that, I think, that when you think from an executional perspective, you could say, well, it's common sense things.
Keep in mind, if you go back three or four years ago, probably the average franchisee that hadn't gotten in just in the last 12, 18 months, probably only had three, four, five stores. Whereas today it's more like eight to 10 to 15 stores. They've got more money invested and got smarter with it. I think it's a combination of all those kinds of things.
That's really helpful. Thanks for all the color.
Thanks, Rafe.
Thanks.
Your next question comes from the line of George Kelly with Imperial Capital. Your line is open.
Hi, guys. A couple of questions for you. First, there's been a lot of growth in digital streaming subscription services. I'm wondering what your view is towards that market. Is that a place that you think within the next couple years you could be operating in?
Yes, this is Chris. I'd say it's interesting. I think one thing I must say is in that comment I made about just the general awareness of wellness. All of this I think helps the entire industry, whether it's this or quite honestly, even infomercials. I think the more it's in front of somebody's face, I think the more people have to give it a shot. I think being in whoever has that first time award definitely for it. Whether it's iPhones or apps or something like that, it might be something that'd be interesting or have it integrated in our app, for example. Again, those are some pretty strategic things that we're always looking at.
Okay. Then second question on the testing you've been conducting on the Black Card.
How long have those tests been going on? Can you share any more detail about what you've seen and how long you expect to continue the tests?
Yeah, it's only been, I don't even know if it's been barely two months yet, so it's still fairly new to really give any color on it, but so far it's been favorable.
Okay. Thanks.
Thanks, George.
Your next question comes from the line of James Hardiman with Wedbush Securities. Your line is open.
Hi. Good morning. Thanks for taking my call.
Thank you.
Thanks for taking my call.
Thank you.
Quick clarification. How you doing? Just wanted to make sure I understood this properly. The same-store sales guidance came up a bit, at least at the lower end. It doesn't look like the overall revenue number came up at all. Is that just sort of rounding or are you being a little bit more cautious maybe on the equipment front?
Yeah. On the same-store sales side, which is totally independent to the equipment side of the business, I think we've stated on some calls in the past that, like 100 basis points change or improvement on franchisee same-store sales is not a significant number. If you look at our overall average royalty rate, that we have today, it's in the long run, obviously month-by-month, it's all cumulative. It doesn't move the needle in a significant amount, to warrant basically doing an increase on the top-line revenue. The main reason that we did not move our top-line guidance of the $405 million-$415 million is that we still are, as I said earlier, within that 190-200 placement range. The real variable driver of revenue is that number because if it's significantly up or significantly down, typical average store's about around $600,000 in revenue.
Those are the more variable components. That's the reason that we didn't change the top line and then basically tightened the range on the same-store sales.
Got it. That's really helpful. I guess staying on the equipment side, maybe this is an unfair question, but your primary equipment supplier last week basically made a comment, they've seen some weaker equipment numbers, and they made a comment that clubs seem to be slowing investment as they evaluate changing exercise preferences. I guess my question is, was that maybe in reference to you and they didn't understand sort of the timing between 4Q and 1Q, or do you think maybe that was in reference to other club customers that they have and you're ultimately gaining share maybe as some of these other clubs are slowing their equipment investments?
Yeah. James, I think you're probably right. The back end of that, it's not necessarily us, it's the rest of the competitors are slowing down their growth and/or replacement. With replacement in this industry, unfortunately, it's kind of been a demon of this industry. No one's ever spent CapEx like we do. Also, I think new club growth is slow for everybody else but us, which is what they're seeing.
Okay. That's helpful. I guess lastly for me, on the royalty rate change. Can you explain why an existing franchisee would willingly increase their royalty rate by that 41 basis points? I guess if they do, or if any of the existing franchisees gets that step up, as you're having conversations with them and they're thinking about how to offset that incremental cost, I know it's not a big jump up, but are they thinking about it more in terms of increasing their memberships or maybe increasing the Black Card penetration? How are they thinking about offsetting that 41 basis points?
Yeah. It's the 1.59%, it's not the 41% that is in essence, they have the option if they so chose to amend their franchise agreement and add the 1.59 to their existing rate. They would start buying those products and services at cost. From a P&L perspective, everything else being neutral, it's really no impact to the bottom line. Keep in mind, though, I want to make sure you understand it, is that the franchise agreement that you sign as a franchisee- That royalty rate is for the entire life of the franchise agreement, which is 10 years.
If you signed a franchise agreement two years ago and you were at a 5% royalty rate and that store is open, you are today paying 5%, you're also purchasing, for example, we give T-shirts away for free, our franchisees do, and we do in our corporate stores. Those volumes of T-shirts, as an example, that a franchisee purchases from a third-party vendor, we receive a rebate from that vendor. That would go away for that franchisee if he so choose to amend all of his franchise agreements and go up by that 1.59%. That's why we said that it really should be neutral to a store-level P&L.
The 41 basis points would not come into play until, in my hypothetical example, eight years from now, the franchise agreement would expire, he would renew at the then current rate, whether that's seven or something higher than that, or lower than that.
Okay. Just so I'm 1,000% clear here, if I'm an existing franchisee and I choose to go to the new, quote-unquote, "new deal," I'm not going to seven, I'm going to 6.59? Is that how I should think about that?
If you're at 5%, you would go to that. We have stores that we opened back years ago before the royalty rate went up to 5%, that they are paying a rate lower than that, their rate would go up by 1.59% as well.
Got it. Just to the question of, I guess, franchisees whose ADAs are expiring and are now rolling over to the new agreement, how are they thinking about recouping that cost? Or are they just assuming their profitability is going to go down?
Well, it would only be the 41 basis points, right? As we continue to show more same-store sales and more comp, it should more than offset it. Even one small thing we've talked about in the past, when we changed our Classic Card annual fee from $29 a year to $39 a year, just that by itself more than covers the 41 basis points. That was done in December of 2015. We've driven revenue all along.
Got it. Thanks, guys.
Your last question comes from the line of John Ivanko with JPMorgan. Your line is open.
Hi, thanks for the follow-up. Covering franchise systems over the years, you see some regions that do better than others, some markets that do better than others, and there can be a lot of reasons why a market doesn't do as particularly well. Wrong franchisee, or real estate, or growing too fast, or competition, what have you. As you've gone from being a regional company to multi-regional, to national over time, how good are you feeling about the entire system versus, whether it's percentage of markets or percentage of stores, what have you, when you guys are just really striving for 100% excellence. Do you think the system needs work or maybe needs a new franchisee or needs a new kind of strategy in any given market? Is it possible that you're kind of happy with everything that's out there?
I think I'm happy with everything that's out there. New markets are doing as good as old markets. The one that I'm real thrilled with is the same store sales comps with even the mature stores, the older generation stores. I give that a lot of credit to the franchisees that are remodeling and reinvesting in their system. A lot of it, honestly, John, is if they have 10 or 20 stores in a market, they take pride in their market. They themselves don't want a couple ugly stores amongst their 20 because they're giving themselves a bad rep. Outside of us even having to police it, they themselves take their business very serious. I think that's really pushing it on all fronts, all cylinders are firing today.
Even in some of the new market expansion, your franchise hitting their business plans, basically at 100% level. Again, I ask this just because it's very normal, especially when coming into new markets, that things don't really go as smoothly as initially planned. If the answer is everything is good, everything's good, I guess.
I would say, you never bat 1,000, John, we feel from conversations with franchisees that are really growing and expanding into some of these newer markets where there's less market penetration. You could argue, on the one hand, you don't have as much data on your existing members in that market and know exactly how those older, mature stores are doing, maybe the stores opened up in the last year or two. You got a lot of information in the market. You've been pounding that market in marketing, et cetera. On that, I would say that even in a market like that, a franchisee would be willing to even open up a store knowing that potentially, everybody wants it to be a home run, grand slam, and perform exactly like the others would be.
keeping out the competition is also an important point that our sophisticated franchisees think about when they look at that market or markets that they own. The flip side of that is when you go to newer markets, so primarily out west, because as you know, that's where we have less market penetration, et cetera. Again, it's not going to be 1,000%, but arguably, California is one of the markets which has got a huge opportunity. We're opening a lot of stores. We haven't been there for a long time. We have stores in a market like that where operating costs can be very high, whether it's rent or labor, et cetera, compared to maybe some other markets. You still see some of those stores still perform very similar to other markets.
I guess just the third I would say is that, there's more and more smaller geographical areas, or more and more cities, smaller, that we're moving into, just because that's where as you build out further around your markets. There you have the benefit of maybe you can't get to 6,000 or 7,000 members. Typically, you're going to have cheaper rent for sure, and probably cheaper labor a bit. The combination of those two things can offset the kind of same member volume that you might not get there as you would get in a more populated area. We see as we talk to franchisees, going out to markets to visit them or if they're coming in to buy new dirt, et cetera, we see a combination of all of those factors as things that they think about in growing their markets.
Thanks.
Thanks, John.
This concludes today's question and answer session. I'll turn the call back over to the presenters for closing remarks.
Well, thank you everybody for joining us today, it was great sharing our Q1 numbers with you. We look forward to Q2 call in August. Thanks for joining us this evening.
Thanks, everybody.
This concludes today's conference call. You may now disconnect.