Planet Fitness, Inc. (PLNT) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Planet Fitness’ Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. [Operator Instructions] I would like to remind everyone that this conference call is being recorded. I’ll now turn the call over to Brendon Frey, Managing Director of ICR.

Thank you for joining us today to discuss Planet Fitness’ third quarter 2015 earnings results. On today’s call are Chris Rondeau, President and CEO; and Dorvin Lively, Chief Financial Officer. A copy of today’s press release is available on the Investor Relations section of Planet Fitness’ website at planetfitness.com. I would like to remind you that certain statements we will make in this presentation are forward-looking statements and 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 risk 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 third quarter 2015 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 pro forma 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, President and Chief Executive Officer of Planet Fitness. Chris?

Thanks, Brendon, and thanks everyone for joining us today. We are pleased to announce it was a strong quarter of growth. We continue to attract new customers to our unique fitness concept through new store expansions as well as growth in same-store sales as a result of our powerful national and local marketing advertising strategies. There are now over 1,040 Planet Fitness locations nationally, up 199 stores from the third quarter last year, as our well-capitalized group of franchisees aggressively opened more stores. At the same time, we continue to invest in national and local marketing programs that target the casual and first-time gym user by highlighting our welcoming and non-intimidating environment at an exceptional value with membership starting at just $10 per month. In a moment, Dorvin will walk through our third quarter financials and our increased outlook for the year. But in short, we see a positive momentum continuing during the fourth quarter. Our franchisees are eager to bring our branch both existing and new markets and have accelerated our store openings for the remainder of the year. Looking further out, our existing franchisees are set to double our footprint over the next seven years, over 500 stores scheduled to open within the next three years. We are excited about our first location in the Dominican Republic, a new market we announced last month and our second international country. This new store is exceeding initial expectations for new memberships but further underscores that our product offering is resonating with customers looking for non-intimidating, judgment-free fitness environments even outside the U.S., much like Canada. At the same time, our royalty rate will increase as a mix of our stores paying the current 5% royalty rate continues to grow. Today, only 32% of our franchise stores are paying the current franchise agreement royalty rate, so as you can see there is a significant opportunity to grow this high margin revenue stream without a lot of heavy lifting. Our performance will also be driven by a growth of our corporate store and equipment segments. We are pleased with our new corporate stores that opened this year in markets like Goldman, Boston and Canada, which we recently began franchising and have five franchise stores under construction. We see the opportunity to increase same-store sales at corporate locations in the low-single digits over the long term. The combination of membership growth and pricing from the higher penetration of our $19.99 a month blackcard membership and we also plan to open a couple of corporate stores each year. Meanwhile, the combination of new store opening and replacement cycle will fuel consistent growth of our equipment segment, which has increased over 24% year-to-date. My confidence in the future of Planet Fitness was recently bolstered following our annual franchise conference last month with over 1,000 attendees. It was a great event held in New Orleans. We had over 90% of our franchisees in attendance and the majority of which invested in their business by flying in over 500 of their own operators and managers to attend the breakout sessions. Everyone was fired up about the state of their businesses, the strength of the brand and the focus on executing our go-forward strategies aimed to bring our unique fitness concept to even more customers. We’ve never been in a better position to grow membership. There was significant opportunity to expand our footprint across a wide range of new and existing markets and continue to drive growth at existing stores. And we are extremely excited to be the presenting sponsor in Times Square this New Year’s Eve, which is perfect timing to kick off our New Year’s resolution season. I look forward to reaching more customers and positively changing their lives. With that, I’ll turn the call over to Dorvin. Thank you.

Thanks, Chris and good afternoon, everyone. I'll begin by reviewing the details of our third quarter results and then provide our outlook for the balance of the full fiscal year 2015. For the third quarter of 2015, total revenue increased 8.4% to $68.8 million from $63.5 million in the prior year period. Total system-wide same-store sales increased by 6.9%. From a segment perspective, franchise same-store sales increased 7.3% and corporate same-store sales increased 1.7%. Our franchise segment revenue was $19.8 million, an increase of 25.4% from $15.8 million in the prior year period. Within the franchise segment revenue, our royalty revenue was $10.9 million, which consist of royalties on monthly membership dues and annual membership fees. This compares to royalty revenue of $7.9 million in the same quarter of last year. This year-over-year increase had three drivers. First, we’ve opened 195 new franchise stores since the third quarter of last year. Second, as I mentioned, our franchise owned same-store sales increased 7.3%, which was primarily driven by higher members per comp store as well as slightly higher dues per member. And then third, a higher overall average royalty rate. For the third quarter, the average royalty rate was 3.65%, up from 3.39% in the same period last year driven by more stores at our current royalty rate of 5%. Next, our franchise and other fees were $3.7 million, so we had a slight increase of $0.1 million over the prior year period. These fees are received from processing dues through our POS system, fees from online new member signups as well as fees paid to us in association with new franchise agreements and area development agreements. As a reminder, last year, our processing fees were recorded as revenue with an offset in cost of goods sold expense. We now receive processing fees net of direct expenses. On a like-for-like basis, if processing fees have been earned net of expenses last year, then this revenue bucket would have increased by approximately $1 million. Also within total franchise segment revenue is placement revenue, which was $1.6 million and also a slight increase over the prior year amount of $1.5 million. These are fees we receive for assembly and placement of equipment for our franchise owned stores. And then finally, commission income of $3.6 million which are commissions from third party preferred vendor arrangements used by our franchisees, and it was up $0.8 million compared to $2.8 million a year ago driven by additional stores in the current year period over the prior year as well as additional purchases from existing stores. Our corporate owned store segment revenue increased 10.8% to $25.2 million from $22.7 million in the prior year period. The $2.5 million increase was primarily attributable to revenue from four new corporate owned stores opened since July 1 of 2014 and not included in the same-store sales base. And to a lesser extent, an increase in corporate owned same-store sales of 1.7%. In terms of system-wide membership, we had a slight decrease from more than 7.2 million members at the end of Q2 to slightly over 7.1 million members at the end of Q3, which is consistent with seasonality seen in prior years. However, as I discussed, our comps increased year-over-year from both our corporate owned stores as well as our franchise owned stores with a high percentage of that growth coming from growth in new members. Turning to our equipment segment. Revenue herein decreased $1.1 million or 4.5% to $23.9 million from $25 million. The decrease was driven primarily by the planned timing of replacement equipment sales to existing franchise owned stores, which were higher in Q2 this year as well as lower equipment sales to new stores in the quarter due to a handful of above average size stores in certain markets, which were placed in Q3 of 2014. Year-to-date, our average revenue per new store is consistent with the first nine months of 2014. Finally, as we expected, our equipment sales were also impacted by lower pricing. This was the result of a couple of factors. First, our equipment pricing was down due to the new vendor agreement that went into effect July 1, which was profit neutral to us. This will continue to reduce revenue until we anniversary the new pricing structure midway through next year. Second, pricing was also impacted by some promotional activities related to equipment sales, which were recognized in Q3. On a year-to-date basis, our total equipment revenue increased by $17.4 million or 24.7%. Cost of revenue, which primarily relates to direct cost of equipment sales to new and existing franchise owned stores, amounted to $18.9 million compared to $20.2 million a year ago, which is in line with the decrease in equipment sales as well as slightly lower volume rebates due to the timing in the prior period, which I will discuss later when I address EBITDA margins. Store operating expenses, which is also associated with our corporate owned stores, was $14.3 million compared to $12.5 million a year ago. The increase of $1.8 million was primarily driven by incremental expenses related to the four new corporate owned stores opened since July 1 of 2014. SG&A for the quarter was $17.3 million compared to $8.6 million. The increase of $8.7 million was primarily related to an incremental $7.9 million of non-recurring expenses in the quarter in connection with the initial public offering and $0.8 million of additional expenses incurred to support our growing franchise operations as well as additional or increased expenses as a result of being a public company that we did not have in the prior year period when we were a private company, such as higher D&O insurance expense, our audit legal fees, Investor Relations expenses, et cetera. Our operating income, inclusive of the aforementioned non-recurring expenses, decreased 25.9% to $10.3 million for the quarter compared to operating income of $14 million in the prior year period. On an adjusted basis, taking into account one-time items and expenses related to our public offerings, our adjusted operating margin was 27.6% in this quarter versus 24.2% in the prior quarter. This was primarily due to revenue growth and higher margins from our franchise segment where we’ve leveraged our cost infrastructure in that growing segment. Let me address our income taxes and amounts related to taxes on our balance sheet at the end of our third quarter. You may recall that prior to the initial public offering, we were an LLC entity where federal income taxes and most state income taxes were borne by the LLC members. All prior periods, including the period from July 1, 2015 to the date of the IPO, did not include federal income taxes because of the LLC structure and distributions in lieu of taxes flowed through our cash flow statement as partnership distributions. Also, during the period from July 1, 2015 since the date of the initial public offering, we recognized a GAAP net loss primarily as a result of the expenses associated with the IPO but recognized taxable income during the period post the offering, which were taxed at the Planet Fitness Inc. entity. As a result, our effective income tax rate for the third quarter was 62.5% compared to 1.3% in the prior year period. As we have stated before, an appropriate pro forma income tax rate would be in the range of 40% to 41% if all of the earnings of the company were taxed at the Planet Fitness Inc. level. We have used 40.3% in the calculation of our pro forma adjusted net income. On a GAAP basis, for the third quarter of fiscal year 2015, our net loss was $3.9 million compared to net income of $8.1 million in the prior year period. On a pro forma adjusted basis, net income improved to $10.3 million or $0.10 per diluted share from $9.7 million or $0.10 per diluted share in the prior year period. Pro forma adjusted net income has been adjusted to exclude the impact of the initial public offering, reflect a normalized federal income tax rate as I stated above as if we were a public company for all of the third quarter and exclude several non-recurring costs. We have provided a reconciliation of pro forma 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 11.8% to $26.5 million from $23.7 million in the prior year period. A reconciliation of adjusted EBITDA to GAAP net income can also be found in the press release. By segment, our franchise segment adjusted EBITDA increased 30.3% to $16.3 million driven by higher royalties received from additional franchise owned stores not included in the same-store sales base and an increase in franchise owned same-store sales, as well as higher commissions and other fees. While we had higher operating expenses to support our growing franchise business, we were able to leverage our cost infrastructure and as a result, after adjusting for non-recurring items, our franchise segment EBITDA margins increased by 300 basis points. Corporate owned store segment adjusted EBITDA increased slightly by 0.5% to $9.7 million. As I mentioned earlier, we opened four new stores since the third quarter of last year. Those were in December, January, March and April. As we expected, these stores have experienced lower operating margins than mature stores as they build their member and revenue base. Keep in mind they are not at a mature top line revenue yet and expenses such as marketing, rent, et cetera, are abnormally higher on a percentage of revenue basis compared to mature store operations. Additionally, we had a foreign exchange loss as a result of an intercompany loan to a Canadian entity of approximately $0.5 million. It has not been our practice to add back the impact from foreign currency changes related to our intercompany loans. Our corporate store segment adjusted EBITDA margin decreased by 400 basis points with the Forex impact accounting for approximately half of that decrease and the majority of the balance being the result of these newer stores that I just mentioned not yet operating at mature margins. Our equipment segment EBITDA decreased 14.1% to $4.9 million, mostly driven by the aforementioned lower sales. For the quarter, equipment EBITDA margin decreased by 230 basis points. I’d note that we’re up against a tough margin comparison from a year ago where our volume rebates were higher due to timing. The remaining driver of the margin difference year-over-year was primarily the lower pricing, I’ve referenced before, and the impact is more pronounced in this quarter due to the fact that it’s a low volume quarter for equipment sales. Nothing fundamental has changed in the equipment business and we still expect annual EBITDA margins for the equipment segment to be in the 21% to 22% range, although our equipment margins may vary at times during the year due to the timing of pricing promotions. Turning to the balance sheet, as of September 30, 2015, we had cash and cash equivalents of $28.5 million and borrowing capacity of $40 million under our revolving credit facility. Total bank debt at the end of September was $503.6 million, consisting solely of our senior term loan, which bears interest at LIBOR plus 375 and our net debt was $475.1 million at the end of the quarter. Based on our ability to generate significant cash flows, we feel very comfortable with our current capitalization. Now to our outlook. Based on our third quarter performance and how we see our fourth quarter developing, we’re raising our full year outlook and now expect revenue for the year ending December 31, 2015 to be between $318 million and $321 million and pro forma adjusted net income to be in the range of $50.5 million to $51.5 million or $0.51 to $0.52 per diluted share. System-wide same-store sales are still expected to grow between 7% and 7.5% and we plan to open between 192 and 197 new franchise stores and three corporate stores for the full year. Operator, we are now ready to take questions.

[Operator Instructions] Your first question is from Randy Konik with Jefferies.

Hi. Thanks. Good afternoon, guys. How are you?

How are you doing, Randy?

I’m great. A couple of questions. So you raised the outlook for franchise openings to a range of 192 to 197 from 187 to 191. Can you just give us some perspective on what’s driving the accelerated openings? And does that impact -- I think there’s like 500 openings on tap over the next few years. Can that number be not only accelerated, but kind of be raised? I’m just trying to get some perspective on what the franchisees are up to? Thanks.

Actually they’re always constantly working on real estate deals that a lot of times comes down to striking the deal ahead of what they expected to. So basically what it is, is they just open the stores faster, which is driving the equipment revenue. On top of the 500 that’s supposed to open next three years, we constantly sell more territory, so we continually -- even though they’re opening stores and adding to the pipeline on the other end of it. So there’s no way they are actually like pulling it forward for instance.

Got it. And then I guess the other thing that was interesting in your commentary was, we’ve heard about the strength in the initial stores in Canada and now it sounds like there’s additional territories beyond that from an international perspective, it seemed promising. Can you just give us some more perspective on what that may look like, because obviously we can get a good perspective or a good sense of what Canada may look like given its proximity to the U.S., but can you give some color on other markets you’re looking into? Thanks.

Yes. Still concentrating for sure at the states where we get a 4,000 club potential. Canada has got just over 300 potential and just began franchising there and selling territories, so despite currently under construction and more to come over the upcoming years. Dominican, like I mentioned and did a press release last month on that new store, that was the franchise partners we had in Puerto Rico who are great operators, did a lot of the due diligence and legwork to open in Puerto Rico, which owns the territory, acts very different than the states. Much of the same landlords with Dominican, so they wanted to venture there and so far is doing phenomenal. So no other plans really for any other international countries but I would say that Dominican is probably a good toe in the water to figure out Central South America maybe in the future.

Got it, thanks. And I guess my last question is, Dorvin mentioned the higher dues per member. I’m assuming is that a function of higher blackcard penetration? Can you give us some color what that was and where blackcard penetration is relative to a year ago? Thanks, guys.

Randy, as I stated earlier in terms of our comps this year in the third quarter, a high percentage of that was driven by member growth, which obviously is good but we also saw some rate growth as well. So it continues to increase slightly. I think we had said that we are at 55% at the end of last year and we continue to see that edge up just a little bit. But most of our comp growth in the quarter was driven by member growth.

Your next question is from Sharon Zackfia with William Blair.

Hi. Good afternoon. I apologize for my voice. I’m battling a bit of a cold here.

Sharon, I think we got two actually.

I guess it’s travelling the country. So I guess two questions. First, I know you guys have a tremendous advertising budget but it feels like to me I’m seeing more broadcast advertising than I had before and I don’t know if it’s a matter of Chicago and something you’re doing in this market, but I’m just curious if there’s any shift in what you’re doing with that broadcast part of the marketing spend? And then secondarily on SG&A, I think you’ve on an adjusted basis pretty consistently have been better than expected since you’ve been public and just curious what’s kind of coming on better than you initially expected in SG&A?

Yes, as far as the advertising, I wouldn’t say nothing much has really changed there. It’s all pretty much the same, but naturally every month with more memberships, the national advertising continues to grow. So, if anything it should only increase over time but nothing drastically has changed in the advertising front.

Yeah, I think Sharon from an SG&A perspective, obviously we’re still in our second quarter here as a public company and building that infrastructure to support what we didn’t have to do as a private company. I think that’s a little bit of it as we continue to focus on what our real needs are both in personnel and then just the third party kinds of costs that you have as a public company. And then I think the last point is continued to get a little bit of leverage with the growth that we’re having. And as we talked about in our prepared remarks, a lot of that growth is obviously coming from our franchise business where we can lever our infrastructure.

Great. Thank you.

Sure.

The next question is from John Heinbockel with Guggenheim.

So Chris, wanted to go back on franchisee capacity to grow, right, because when you look at these groups, they get some more stores in the marketplace, they mature, they throw off cash relatively quickly. And I would think that they would want to pursue kind of a race for share, if you will. I would think there’s a lot of capacity on their end, be it people, capital, real estate to actually get openings much higher than 200 a year. So what’s the capacity for them to do that and are you kind of holding expansion back to guarantee execution remains at a high level?

Yes, I would say naturally we talked about in the past, last year almost 90% of our stores opened by existing franchisees and the same is holding true this year as well. Naturally, the more stores they have, the more capitalized they are and also the bigger farm team they have and bigger office infrastructure they have. So they’re able to scale much faster. I think the real estate and with ecommerce compression like we’ve talked about, they’re definitely paying attention to that because now is the time to go. So at any given time, a franchisee could have multiple deals in the works hoping that one or maybe more come out. And that’s why I think these guys have deals come up. They just happen. So you all of a sudden may have been saying you open one this year and they open three or four. So, I think it could maybe move faster but I think what’s also good about it is they’re able to be more selective in choosing A plus sites where if you go back 309, you were taking B or C sites because you’re competing with Old Navys and Best Buys.

Okay. So there probably is some capacity but it also sounds -- because of the selectivity on the real estate side, there’s a limitation to how fast you’re likely to go?

Yes, I think it’s being more selective which is good, because I’d rather be plus site long term, right. So I think they’re going to have some acceleration because real estate is great for us right now, but I wouldn’t say it would be crazy high just because they’re going to be more selective and take that A plus site down and wait for it.

All right. And secondly, where are we on adding more value to the blackcard either inside the club or more particularly outside, because I don’t think you’ve added much outside in a while external to the club or is there more to come on that here in the next I don’t know year or so or where would you stand on that?

Yes, I’d say we actually put a franchisee, corporate team together to look at those blackcard spy areas as we call them, because as we’re seeing is the ones driving a higher blackcard percentage is definitely of our newer stores that have a spot sale to them as opposed to just throwing a few tanning beds and the massage chair in the corner. So, I’m looking to redesign those as the future stores open and remodel. But as far as future amenities, we’re constantly thinking of ideas with this new franchisee team to see if we can come up with the next hydro bed, for example, which did well for us when we started those about three years ago. Outside the four walls, we’re constantly talking to partners. It definitely seems like some of the larger partners are slow to make a deal, so we have a few things working on today. And locally here we are even trying to see if are we better to figure out local retailers or local businesses to see if it’s better. I mean, let’s face it, half of them are probably members of the club that want to – to offer a local businesses, some affiliation with the local Planet and the members that support local companies. So that could be an interesting localized affinity programs for the members.

Okay, thank you.

The next question is from Sean Naughton with Piper Jaffray.

Hi, good afternoon.

Hey, how are you, Sean?

Good. Just on the, Dorvin, you talked a little bit about this on the corporate store EBITDA. Understand there were some FX headwinds, but I think even if I remove that impact which I think you said was about half of the rate deterioration from Q2, it still looks like it's down sequentially. And I think you had most of those four doors that we were talking opened in Q2. So I'm just trying to figure out what incrementally might have changed in that particular line item there from Q2 to Q3?

Yeah, really nothing Sean. I mean, it’s I think we‘ve talked in the past about how a typical ramp is for stores that open and it can vary a bit obviously from a seasonality perspective, because if you open the store in December, January, you kind of get that initial push, which can help you get to higher revenue number, or higher – quicker breakeven et cetera. You are right, we opened and the stores I referred to, we opened a store in December, we opened one in January, one in March and one in April. So all four of those stores have not hit their full cycle yet, with three of them have not even hit the kind of that January – full January, February time period yet. So from our perspective they are on track when we model out kind of the type of return you want to get on that investment of opening those stores, but they are not at a full mature run rate basis today where you have, you are paying full rent, you are paying your full labor, et cetera, et cetera from an operating expense perspective as you continue to build that top line.

Okay. So they're just in the ramp period and just the sequential numbers is a little less important. Okay. Understood. And then on the – you mentioned the placement revenue. I think it was up I think about 7% on the growth rate, and you opened up 25% growth in the franchisee clubs. I guess just the question is, is there – as the franchisees become potentially a little bit more sophisticated, and I think Chris, you mentioned that 90% of them already had doors before. Are they just becoming more familiar with the model, and they're kind of doing those placements themselves or is there anything there on timing as well?

No, I mean in terms of new equipment sales, we historically and plan this year to do significantly high percentage of those placements. We go out there, our team has been doing this for many years and the franchisees really want them to even though our OEMs will do that, but we do the majority of those and plan to do so as well. Occasionally when you get to Q4, just with a lot of stores opening and that capacity, sometimes we tend to let our third party do it, but it’s over 90% of all of the stores we do the placement ourselves.

Okay, that's good to hear. Best of luck in the next quarter. Thanks.

Thank you.

Thank you.

[Operator Instructions] The next question is from Rafe Jadrosich with Bank of America Merrill Lynch. Your line is open.

Hi. Good afternoon. Thanks for taking my questions.

Hi, Rafe.

So you're raising the guidance by a little bit more than the beat. Can you just give a little color on some of the trends you're seeing to-date in 4Q that is kind of giving you the confidence to raise the outlook?

I guess, what I would say, Rafe, is that referring back to Chris’ comments earlier that we continue to see that most of the development, very high percentage is from our existing franchisees that have the operations, that have the capacity to open more stores. Oftentimes it comes down to timing, as Chris mentioned earlier, finding that right location, et cetera, but what we’ve seen and the reason we are raising our guidance is that based on where we are at today versus where we were back at the end of when we announced our second results as we see a little bit more momentum in that kind of deal flow and then ultimately franchisees wanting to get stores open by the end of the year. I think as we’ve talked in the past, obviously there is timing related issues to that between December to January just in terms of construction et cetera, but based on where we see it today, we feel comfortable with taking up the guidance to that level.

Thank you. That's helpful. And then on the equipment growth, or just the headwinds you're facing now because of the tough comps, can you remind us when you start to cycle against the tough comparisons, when we might see that category or that segment inflect positive again?

You are talking about just equipment revenue growth quarter-over-quarter?

Yes.

Yeah, this is obviously a low quarter and has been traditionally a low quarter in terms of openings, the third. Obviously our – and as we’ve talked in the past, the Q4 is always a real big quarter and frankly Q1 can be a big quarter as well. A lot of it has to do with to the point Chris mentioned earlier in finding that kind of main and main locations to take the class A location versus settling for something else; oftentimes that can be one of the issues. But on a quarter-to-basis, we were pretty much on track where we thought we would be with this quarter and it was planned this way. So nothing out of the norm in terms of the revenue for this quarter. I mentioned that it was slightly down driven by some plant timing on reequips and as well as just a slight decrease in the new, but obviously the volume of the quarter is pretty small, so percentages can vary on that.

On a year-over-year basis, has there been any change in terms of when you would expect that to inflect positive again? Because I think it declined this quarter year-over-year. I think that's the outlook over the next several quarters.

Yeah, and I would refer back to that first comment I made in terms of just the timing. I think we had some stores that we sold in the equipment in fourth quarter last year, opened in early January in the first quarter. But no, we still see momentum in terms of openings. We had originally guided to right around that 190 mark or so and now we are saying 195 to 200. And we have provided kind of what we saw as a longer-term, say three-year horizon, close to a couple of 100 stores a year. So we are still in line with what our expectations were.

Okay, great. Thank you.

Next question is Jonathan Komp with Robert W. Baird.

All right. Thanks, guys. A couple of questions. Maybe first just a clarification on the franchise same-store sales. Dorvin, I know you've had a drag on the franchise same-store sales from the change in billing practices for the franchisees and I'm wondering if you could just clarify maybe how much of a drag that was. And I think it was greater than it was in prior quarters. So the results on an underlying basis excluding that looked quite strong. So I'm wondering if you could just clarify that for us.

I think when we talked back earlier, we had said that change into the POS system, which systemically removes non-paying members based on a certain schedule, versus in the past where it was more of a recommended policy and many franchisees would follow it, but some would not follow it. And we talked about what that impact could be, but I think the main point that I made the last time we had gone through this in detail was that, it would start impacting us slightly in Q3, more in Q4, more in Q1 or somewhere in Q1 to Q4, and then it would start to come back down into Q2 and then we fully anniversary I think Q3. And just to refresh everybody’s memory on that, the reason that it was a – through Q3 was that because of the way that we migrated those stores over to the new POS system and then the time period of working through members that might not pay the first month or the second month et cetera, it’s basically through September to the beginning of Q4 of when we will fully anniversary that. So we are now at kind of that full run rate that we would expect going into October, November, December, so our Q4. I would say a couple of things. One is that it’s not far off of what we had originally talked to you guys about, it’s a little bit better. We had said that it could be impacting us in kind of the 150 basis points to 200 basis points range for Q3 and then could be in the 400 basis points range in Q4 versus kind of the trends that we would have thought about just doing – looking at the prior year growth rates et cetera. So I think the good news is that, number one, we had – we think pretty good comps, particularly as we talked about – as I talked about a few minutes ago with a lot of that coming from member growth, but still seeing some rate growth, in spite of removing more members because of non-paying in Q3 versus what we would have – what we did in Q2 and Q1.

Great. And maybe a different topic, then, for Chris. I know last year in Q1, it looked like you had tremendous success adding new members. You added 1 million members during the quarter, and I know you had the New Year's Eve sponsorship. Based on the announcement you had last week, it looks like the New Year's sponsorship going forward might even be expanded from what it was in prior years. Wondering if you could maybe give a little more color on the plans coming into New Year's. I know it's a key time for the brand and maybe any thoughts on sustaining the strong member growth this year.

Yeah, sure. And also back to the seasonality of the member growth throughout the year, where Dorvin mentioned, Q1 and Q2 are the kind of at the peak and then you level down throughout the summer months. So large majority use the first quarter, January being the bigger of the three generally. In this New Year’s Eve, we are the lead presenter as opposed to kind of a sub, so there is going to be a purple stage and our logos and billboards and everything else, so it’s going to be a pretty big to do this year, which I can’t – I think as an industry, it’s probably the best industry to probably sponsor New Year’s Eve and I think being in 48 states and a 1,000 locations, we have the most coverage, so I think it should do really well for us. So it will be really interesting to see what happens this January for sure. But nothing different really as far as marketing, except we are just being a bigger sponsor for that New Year’s Eve.

Okay, great. Maybe one last one, if I could. Just on the – one more on the unit development outlook. It seems like a lot of the new units recently have come in California. I know it's a small market today, but in terms of numbers and percentages, it looks like it's growing pretty fast. So any thoughts you can share on kind of the current results you're seeing in California and kind of the willingness to increase the pace of development going forward there?

Yeah, we recently, recently meaning in the last probably two years, awarded a lot of area development agreements in California. We have kind of held off waiting for, being I guess, selective with the right groups that could accelerate growth quickly in California, and that’s why you are kind of seeing that kind of explosive growth in that area. The clubs are doing great there. I think being out there, most of the competition in that area is older competition, kind of much more like Bally’s, where those were days of the lack of CapEx in older stores, so it’s – again, back to the real estate, the franchisees out there are better franchisees for us that have territories on the Eastern part of the country that went out there. So they are veterans, they know what they are doing and they’re just taking advantage of the real estate growing fast.

Okay, great. Thanks guys.

Thank you.

Thank you.

The next question is from Jerry Gray with Cowen.

Hey. Thanks for taking my question. If I could ask on the royalty rate, it seems like you guys had some pretty good growth anywhere from 20 basis points to 40 basis points year-over-year each quarter this year. And I just wanted to know, is there anything kind of unique to your ADAs and your franchise agreements that might hold down that royalty rate in that 3% to 4% range longer than one might think? Because I know you guys had said not to expect very much growth for the next two to three years or so.

Yeah, Jerry, couple of things to keep in mind is that, we still have as Chris mentioned earlier, about a 1,000 stores that are committed under existing area development agreements today that have not opened. Many of those stores are at the rate that was in effect at the time that they signed those area development agreements, so we still have stores that will be opening that will open at less than our current rate today, so that's point one. The second point is that as franchise agreements expire then they renew at the current rate, but if you remember, I mean, we've basically opened about half of our franchise stores in the last three years. So, those still have six, seven, eight years left kind of on their term, but we will start seeing stores in a more rapid pace start to expire to renew their franchise agreements in like 2017, 2018, et cetera. So that's the reason why I gave I think I mentioned this on the last call that to expect kind of a growth rate in that overall average of say 20 bps, maybe 30 bps on an annual basis.

Okay, great. Thanks. And then just on the comps, it seems like you had a little bit of upside relative to at least what I was looking for this quarter and the guidance for 5% to 6% for the second half. But you left the comp guide unchanged, which seems like Q4 is maybe trending a little bit slower. And it implies kind of about a 5% for Q4. Is there anything that's going on in the business that would slow that down? It seemed like you mentioned the POS hasn't been as much of a drag as you originally thought. So I just wanted to know if there's anything going on there that we should think about.

Not really and you are hitting on the point and when we originally gave guidance and had conversations around the POS systems, we said that Q4 would be a bigger impact than Q3 and we still expect it to be so because we’re now just starting to have all those stores in all of the members in the system that our POS system is systemically removing them. And that's why we guided down to that point when we originally put out our guidance. I did say it’s been slightly better than what I originally thought Q3 would be, but we didn't have a full kind of run rate at that point. So at this point we did not take up the guidance and we believe that that’s appropriate as we go into kind of our first full quarter of seeing the impact from our point-of-sale system change.

Okay, great. Thank you.

The last question is Phil Terpolilli with Wedbush Securities.

Yes. Good afternoon. Thanks for taking the question. Just wanted to go back to one of the earlier comments I think about New Year's maybe ramping a little bit versus a year ago, but also maybe throw in there weather, as well. I guess the last few years here there's been weather all over the place, favorable and unfavorable, impacted other retailers that I followed. But, I guess one, is it the same challenge for you in that key timeframe, I’d imagine, to sign people up?

One thing with our online joins, which is big sales port, believe it or not, so if snow went on, there's an expiration or so on, people can get drove back to the website, which is sort of a vast -- a large portion of the membership. So, generally no, and unlike I guess a coffee place or a burger place, it's whether they come in not, EFT is still there, so the same-store sales doesn’t really get affected that much by weather. But you're right; I mean it definitely is a bit crazy then northeast, whereas with the Florida for example, their summers are more than winter.

Sure. Okay. That's helpful. And then just on a competitive front, it sounds like you are still spending a lot behind marketing, but have you noticed any changes with any of, you know, some of the competitors that seem to be maybe trying to get smarter on price points or encroaching on your business at all?

I’d say, kind of what I've seen is, I guess six, seven years ago, no one even, everybody thought we were insane. No one was charging 10 bucks a month and now it’s everybody in every market is charging $10 a month, but it's only on price, and not the model of the atmosphere is very different. They’re not doing the judgment-free or cater to the 80% that we really try to go out after. So it’s almost like you’re getting to the typical LA Fitness or Gold's gym member is still just 10 bucks a month and not the first time, more casual user off the coast that we're going after. I think the other thing that's interesting when I see the lower price knockoffs is, they are not able to knock-off the model, they kind of take -- they take our model and keep the juice bars, the day care and aerobic classes. It's just a very different model, but just price. And besides, and the thing is, it's very sizeable, even the -- look at our biggest player in our space barely has a 100 stores, and we've opened 199 since third quarter last year. And then our franchise system, really the beauty of franchise system is we’re just able to grow and scale so much faster, we have 180 entrepreneurial groups that are being in the streets everyday looking for real estate running their operations and running their stores.

Okay, perfect. Thank you.

That was our last question. I will turn the call over to Chris Rondeau for closing remarks.

Well thank you everybody for joining the call today, again pleased with the quarter and really pleased with being able to raise our guidance for the rest of the year and look forward to our fourth quarter call in the future. And thanks for your questions.

Thanks everybody.

This concludes today's conference call, you may now disconnect.