Planet Fitness, Inc. (PLNT) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to the Planet Fitness’ Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at 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 2016 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’ Web site at planetfitness.com. I would like to remind you that certain statements we will make in this presentation are forward-looking statements, including statements relating to the proposed refinancing of the company’s senior secured indebtedness and potential use of proceeds to fund a special dividend and other equivalent payments. These forward-looking statements reflect Planet Fitness’ 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 2016 earnings release, which was furnished to the SEC today on Form 8-K as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise. In addition, the company may refer to certain adjusted non-GAAP metrics on this call. Explanation of these metrics can be found in 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 you everybody for joining us today for our third quarter earnings call. Our business has continued to get stronger as the year progressed. Third quarter system-wide same-store sales increased 10% compared with the comp gains of 6.8% and 7.6% in Q1 and Q2 respectively. At the same time we've expanded our reach through the opening of 37 new franchise locations during the quarter bringing the total system-wide store count to 20,242 at the end of September, an increase of 19% compared to same date a year ago. The combination of 10% comp growth and the addition of nearly 200 franchise locations over the past 12 months fuelled total revenue growth of 26% and earnings per share of $0.16, $0.02 ahead of consensus. Our recent performance proves that our formulae for tracking new members both casual gym goers and first-time gym members seems to work. It starts with our [indiscernible] environment featuring high quality branded cardio and strength equipment and the fact that we are able to offer our differentiated [indiscernible] is incredibly compelling for our cardio audience and is a huge set of advantage for Planet Fitness in all markets. Another proof of the [indiscernible] success is [indiscernible] by the company and our franchises to keenly reinvest in growing the business. This includes contributing 2% of lumpy dues [ph] to the national ad fund which allows us to participate in great brand building event such as our sponsorship of the Times Square New Year's Eve Celebrations and creative 3D and digital advertising that runs nationally throughout the year. On top of this another 5% to 7% is spent on local and regional marketing programs aimed at driving awareness and member signups. We're extremely excited about the upcoming New Year's Eve's event. This is our second year [indiscernible] sponsored and are hoping to start and showcase our brand again to over 1 billion people around the world. Equally important is the capital spent on keeping the Planet Fitness stores fresh and up-to-date. This is anchored by disciplined equipment replacement cycle that assures they get different store experience regardless the member visits store that opened this year or a decade ago. Our franchisees as well as our corporate sources have continued to invest in this endeavor throughout this year. While our membership experience is star of our differentiated fitness concept, we would not have been able to grow to our current size, reaching many people as we have without the superior business model we created for almost 25 years. The financial returns that we have been able to generate for franchise is still due to rapid expansion of Planet Fitness [indiscernible] by the fact that over 90% of approximately 200 stores sets to open this year are by the existing operators. At the same time most of all [indiscernible] development agreement are purchased by existing franchisees in order to further grow their businesses beyond their initial territories. This financial success extends to our shareholders as well. With a higher margin, recurring revenues coming from our fastest growing franchise segment combined with our asset light model, the company has consistently achieved strong double-digit earnings growth and generates free cash flow. Based on past performance and more importantly a long runway for growth ahead of us, we are excited to announce that we're in the process of refinancing our existing debt and adding incremental debt to potentially declare a special cash dividend. Our Board of Directors and management team are constantly evaluating the most prudent use of our strong balance sheet and free cash flow and believe increasing our leverage with potential to use the proceeds to fund a special dividend is a great way to maximize our shareholder value. With that I'll turn the call over to Dorvin.

Thanks, Chris and good afternoon everyone. I'll begin by reviewing the details of our third quarter results and then discuss our full year outlook as well as our proposed amendment to our credit facilities. For the third quarter of 2016, total revenue increased 26.4% to $87 million from 68.8 million in the prior year period. Total system-wide same-store sales increased 10%. From a segment perspective, franchisee same-store sales increased 10.3% and our corporate same-store sales increased 5.4%. Over 90% of our Q3 comp increase was driven by an increase in members. At the same time, our Black Card membership penetration was 59%, that’s a 180 basis point improvement over Q3 last year. Our franchise segment revenue was $27.2 million, an increase of 37.5% from $19.8 million in the prior year period. Let me break down the drivers of our fastest growing revenue segment. Royalty revenue was $15.1 million, which consists of royalties on monthly membership dews and the annual membership fees, this compares to royalty revenue of $10.9 million in the same quarter of last year, an increase of 39%. This year-over-year increase had three drivers. First, we opened 205 new franchise stores since the third quarter of last year. Second, as I mentioned, our franchisee owned same-store sales increased by 10.3%, which was primarily driven by higher members per comp store as well as a slightly higher dews per member and then third, a higher overall average royalty rate. For the third quarter, our average royalty rate was 4.01%, up from 3.65% in the same period last year, driven by more stores at our current royalty rate of 5%. Next, our franchise and other fees were $5.8 million, an increase of 56.3% or $2.1 million over the prior year period. These fees are we received from processing dues through our point of sale system, fees from online new member signups as well as fees paid to us in association with new and amended franchise agreements and area development agreements. Also within the franchise segment revenue is our placement revenue, which was $2.2 million versus $1.6 million in the prior year period, that’s an increase of 37%. These are fees we received for assembly and placement of equipment for our franchisee owned stores, the increase was driven by nine additional new store equipment sales during the current year quarter. And then, finally, our commission income, which are commissions from third-party preferred vendor arrangements used by all stores and equipment commissions for international new store openings was up $600,000 to $4.2 million, compared to $3.6 million year ago, and that’s an increase of 14.6%. This was driven by additional stores in the current year period over the prior year, as well as additional purchases from these vendors by existing stores. Our corporate owned store segment revenue increased 6.1% to $26.7 million from $25.2 million in the prior year period. This $1.5 million increase was driven by the increase in corporate owned same-store sales of 5.4%. Our system wide total membership increased from more than 8.6 million members at the end of our second quarter of this year to more than 8.7 million members at the end of Q3. Cumulatively year-to-date, we’ve increased our net members by more than 1.4 million members. Turning to our equipment segment, revenue increased by $9.2 million or 38.7% to $33.1 million from $23.9 million last year. This was driven by equipment sales to new franchise owned stores related to more new equipment sales compared to the prior year and an increase in replacement equipment sales to existing franchisee owned stores. Our replacement sales as a percent of our total equipment sales was 37% in Q3 with strong purchases by our franchisees re-equipping there clubs during the quarter. We expect replacement revenue as the percent of total equipment revenue to be in the 25% to 30% range on a full year basis. For our equipment revenue segment year-to-date this year we have sold to U.S. franchises 111 new equipment sales compared to 113 last year. These revenues are recognized when our services are rendered and completed from the assembly and placements process. Stores may open shortly thereafter but can be held up at times until the franchises receive their certificate of occupancy from local municipalities. I'll address our full year guidance on new equipment placements in a few minutes. Cost of revenue which primarily relates to direct cost of equipment sales and to new and existing franchise owned stores amounted to 25.9 million compared to 18.9 million a year ago, an increase of 37.5% which was driven by the increase in equipment sales I mentioned during this quarter. Store operation expenses which are associated with our corporate owned stores was 15.2 million compared to 14.3 million a year ago. This $900,000 increase was driven by a combination of factors including some incremental stored labor at several of our corporate stores as we increased staffing levels to provide a better member experience, along with some additional plans, repairs and maintenance expenses for certain of our corporate stores. SG&A for the quarter was $12.2 million, compared to $17.3 million year ago both periods include non-recurring expenses. Last year, they were primarily associated with our initial public offering and this year, they were in conjunction with the secondary offerings. Excluding these non-recurring expenses our total SG&A increased by $2 million or 22.2%. This increase is due to supporting our growing franchise operations as well as incremental ongoing public company expenses. Our operating income inclusive of the aforementioned non-recurring expenses increased to 26.2 million for the quarter compared to operating income of 10.3 million in the prior year period. On an adjusted basis, taking into account the one-time items and expenses related to our offerings, our adjusted operating margin was 32% in this quarter, versus 27.6% in the prior year quarter, an increase of 440 basis points. This was primarily due to revenue growth in higher margins from our franchise segment for we have leveraged the cost infrastructure in our fastest-growing segment. Our effective income tax rate for the quarter was 24.4%, compared to 62.5% in the prior year period. However as I have stated before, an appropriate adjusted income tax rate would be approximately 39.5% if all of the earnings of our company were taxed at the Planet Fitness Inc. level. On a GAAP basis, for the third quarter of 2016, our net income was $14.9 million, compared to net income of $0.7 million in the prior year period. On an adjusted basis, net income was $15.9 million or $0.16 per diluted share, an increase of 51.7% and up from $10.5 million or $0.11 per diluted share in the prior year period. Adjusted net income has been adjusted to exclude the impact of the public offerings, reflect a normalized federal income tax rate of 39.5% as if we were a public company for the current year and the comparable prior year periods and excludes several non-recurring costs. We have provided a reconciliation of the adjusted net income to GAAP net income in today's earnings release. Adjusted EBITDA, which is defined as net income before interest, taxes, depreciation and amortization, adjusted for the impact of certain non-cash and other items that are not considered in the evaluation of ongoing operating performance, increased 33.5% to 35.4 million from 26.5 million in the prior year period. A reconciliation of adjusted EBITDA to GAAP net income can also be found in the press release. By segment, our franchise segment EBITDA increased 47.2% to 22.8 million, driven by higher royalties received from additional franchisee owned stores, not included in the same-store sales base, an increase in franchise owned same-store sales of 10.3% that I mentioned earlier, as well as higher commissions and other fees. The prior year included certain non-recurring expenses associated with the Initial Public Offering that I mentioned earlier as well. After adjusting for these non-recurring items, franchise segment EBITDA margins increased by approximately 335 basis points to 85.5%. Corporate owned store segment EBITDA increased 14% to 10.6 million, driven primarily by a 5.4% increase in corporate same-store sales as I stated a few minutes ago. Our corporate store segment adjusted EBITDA margins increased by 185 basis points. Our equipment segment EBITDA increased 45.7% to 7.2 million, driven by higher equipment sales. For the quarter, equipment adjusted EBITDA margins decreased slightly by 100 basis points to 21.6% but is in line with our stated equipment margin range of 21% to 22%. Let me summarize little quickly the highlights of another very strong quarter. Revenue rose by 26.4%, same-store sales were up 10%, our fastest growing franchise segment grew revenue by approximately 37.5% with adjusted EBITDA margins up a 185 basis points. Our average royalty rate for the quarter increased to 4.01%. Our corporate store segment revenue grew 6.1%, driven by the 5.4% comp gain. Equipment segment revenue increased 37 -- 38.7%. We sold our franchisees 37 new equipment sales this quarter compared to 28 new equipment sales last year bringing us to 111 new equipment sales in the U.S. year-to-date. Our adjusted EBITDA margins were up approximately 215 basis points, and then we grew our adjusted net income by 51.7%. Now let me turn to the balance sheet. As of September 30, 2016, we had cash and cash equivalents of $66 million and borrowing capacity of 40 million under our revolving credit facility. Our total bank debt at the end of September was 488.4 million, excluding deferred financing costs, consisting solely of our senior term loan, which bears interest at LIBOR plus 350. As Chris mentioned we are seeking to amend our existing credit facility to increase our term loan borrowings by approximately $230 million. The total borrowings under this amended credit facility based upon the calculation of EBITDA in accordance with our credit agreement which includes incremental adjustments of approximately 12.5 million, that are in addition to our trailing 12 months adjusted EBITDA as of September 30, 2016, puts the company at a gross leverage ratio of approximately 4.6 times. In connection with this potential amendment the company is considering paying a special cash dividend of up to approximately $280 million with the proceeds from the additional borrowings as well as available cash. This specific timing and amount of the dividend has not been determined. Should the refinancing and special dividend be completed, we would feel very comfortable with our debt to credit agreement adjusted EBITDA leverage ratio, given the anticipated leverage ratio would be only slightly higher than our two previously credit facility amendments at March 31, 2014 and March 31, 2015 combined with the strong free cash flow that this business consistently generated and are confidence in our business model. Should this refinancing occur, we would incur approximately $2 million of additional interest expense in Q4, the reduction in our adjusted net income per diluted share of approximately $0.01. Now to our outlook. Based on our third quarter performance, we are raising our full-year guidance. We now expect revenue to be in the range of $373 million to $378 million, up from our previous guidance range of $366 million to $372 million. We still expect 2016 system wide comparable sales to the increase in the high single-digit range. With respect to new stores, we think it’s more helpful to guide on a number of new store equipment sales and placements versus new store openings. As I explained earlier in the call, we recognized the equipment revenue for new stores, when our services are rendered and completed from the assembly and placement of equipment in new stores. The date a store actually opens has very little bearing on our top performance. For 2016, we expect the sale in place equipment in approximately 195 to 200 new domestic stores, which is consistent with our projections earlier this year. Also as a reminder, we recognize our revenues on equipment purchases by our international franchisees differently compared to when we sell equipment to franchisee here in U.S. Domestically, we take paddle [ph] to the equipment from the equipment manufacture, we ship the equipment to the franchisee location and then we generally assist the franchisee with the assembly and placement process for this equipment whereby we also recognize a placement fee for those services. In other words, we have done gross revenue, cost of goods sold and our gross profit. Internationally, we do not take paddle to the equipment from the manufacturer, but rather the manufacture sells this equipment directly to the international franchisee and then pays us a commission on the sale that’s equal to the gross profit that we would have recognized as if that transaction had occurred similar to here in the U.S. Another way to think about it is that we have lower revenues for these new store sales outside the U.S. but it generates about the same gross profit dollars. For the full year, we’re expecting to receive commissions on international new store equipment sales of approximately 8 to 9 new stores. Adjusted net income is now projected to range from $65 million to $66 million with adjusted EPS between $0.66 and $0.67 up from our previous adjusted EPS guidance from $0.63 to $0.66. Our new EPS guidance reflects the $0.02 upside we delivered in Q3 partially offset by a $0.01 of additional interest expense in the fourth quarter associated with this proposed financing that I just mentioned. And now with that, we’d like to turn the call back to the operator for questions

[Operator Instructions] Your first question comes from the line of Sharon Zackfia from William Blair. Your line is open.

A couple of questions first on the decision to do a cash dividend that's pretty unusual so can you talk through why you would want to take on more leverage to do the cash dividend and particularly with private equity still earnings so much of the shares?

Yes, Sharon. This is Chris. Yes, myself as well as the board looked for many ways of prudent uses of the cash and with the leverage that we are currently down to and at this point it seemed like a way to maximum value back to shareholders at this stage of the game.

Just to add to that briefly is that and I've stated this all the way back to the time that we were public, which is as barely over a year ago because of the asset light model and the significant free cash flow generation of this business we de-levered on the net basis pretty significantly including the two financing's that we did back at the end of Q1 2014 or 2015 and between each of those two times now we've basically de- levered about a term. So we’re down to rather around three times and we've stated that our goals is to be between about three to five times we think that that's an appropriate leverage ratio and when we look at our business and the confidence and the fact -- the comment I made a minute ago, we believe that the best use of their cash today is to return the cash to shareholders. And as mentioned our sponsor is still in, although they've had now three transactions, but the rest of our shareholders will obviously benefit in this as well and we just believed that this is the best use of the cash at this time, we would still in connection with the proposed refinancing we are also increasing our revolver from the current 40 million to 75 million which will also then give us additional liquidity available for other uses of cash down the road.

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

We did consider that and have discussed that at Board meetings and I believe the overwriting factor frankly at this point is, we're a brand new public company, we've barely been out now this is our fifth quarter I guess as a public company and there is not a lot of new massive public companies that have implemented our regularly quarterly dividend and frankly once you do it I think the right policy is as you stick to it overtime and so at this stage of our company as a public company we believe this was the right transaction possible transaction to take place as opposed to implementing a quarterly dividend right now.

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

Yes, I think it was up 36 bps this quarter and you are right I've said that it should be in that 25 to 35 range and part of the reason that I've stated that is that -- and you will recall Sharon that in our 1,000 plus stores that are in the pipeline, that are committed under area development agreements, a number of those stores have the grandfather [ph] royalty rate at the time the ADA was sold. And so knowing exactly the mix of new stores that are going to be coming online, when we go back to let’s say Q1 and we're looking for guidance and the way we gave guidance this year, we felt that was the appropriate range and it’s turned out to be pretty close. As I said we're up 36 bps for this quarter. And so, that's how we got to the range that we've indicated.

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

A couple if I may, and firstly on the new stores Dorvin, you talked about a 195 to 200 placements and then you have eight to nine new international, which I don't think is included in that -- in those placements if I followed you correctly. Could you put that store count in the context that of your openings, I think what you previously talked about lower end of 210 to 220, obviously I know it doesn't really matter to fourth quarter revenue, but it does matter to recurring revenue as you think about '17, so what are you thinking -- the overall number of stores that will be opened as -- just consistent with previous guidance for '16?

John that's a good question because we -- as I stated we felt like this was probably actually better information and ties to the way we ultimately recognize the revenue. So, if you take the two of those and we just talked pure openings for a second or -- pure stores for a second, then -- those numbers I gave you would basically take you from 203 to 209, when you add the domestic in the U.S. and you're right to the point that the international piece, you just don't get that revenue component as I mentioned before. But as I also stated that 195 to 200 range was in line with basically our previous -- the way we gave guidance in the past. So, here's the point and I alluded to it briefly, stores can open up in a months or quarter -- I'm sorry, we can place the equipment in a month or a quarter and it can open up in the following month or quarter. And the way the process works is as the franchisee is working whether with GC to get down to close to an opening date that they've been given. There's a lots of things that's going to happen from inspections to getting the rubber flooring down too, et cetera. And one big pieces of that is getting the equipment there. So, we for every franchisee in the U.S. we get a delivery date that's usually eight to 10 weeks out from that time period that they want their equipment delivered. And an ideal state, the equipment would be delivered and within two to three days the franchisee and their GC working with the local officials, will get their CO and then believe me the franchise will open up as quick as they can. But I'll give you a couple of examples as to why it doesn't. Our last opened store that we had scheduled to open on December the 26th of 2014, we had the equipment in there around 20th or 23rd of December and the local town official went on holiday vacation for Christmas and we were not able to open up that store till January 7th. So, last year and similar to -- it can -- it varies between the amount and the particular cut off here and that’s why we kind of defaulted this. But our store openings this year included a handful of stores that we actually sold the equipment into and recognized those revenues in December of last year but then those stores opened up this year. So two points I’ll make, I believe our guidance of now in essence, total stores of 203 to 209 is not consistent with the way we’ve been talking about guidance on pure openings, the last call we said kind of lowering of 210 to 220. So it’s pretty close to that. And then second of all, we are raising our revenue guidance and we feel comfortable with the revenue guidance even with this store count of placements versus those store count of openings that I Just mentioned.

Thank you for that explanation. As we think about ’17, how does the current pipeline look, how the franchisees is feeling, do you have any sense of timing of openings or placements are being want to talk about throughout the year?

Yeah, I think that if you go back to all the discussions that Chris and I have had with you guys as well as investors, at conferences or any road shows. We continually talk about the fact that our franchisees are you know 90% of all of our stores opened up by existing franchisees and many of our franchisees now are opening a much higher number of stores on an annual basis. And they’re also buying the majority of new stores that we sell from a new door perspective. And when you think of the 1,000 plus in the pipeline, that’s in general to -- these existing franchisees are the ones that are growing. With that said, we’ve always said we feel comfortable with right around 200 and the reason we say that is because, it’s been close to where we’ve been now for the last two, three years and we have a very disciplined process with how we approve stores. Every store that comes in we have to sign off on not only the location and that location can be consider cannibalization, et cetera within an existing franchisee’s territory, but certainly to the budding territory it’s another consideration we take into place, but we also really take into account the location, is this an ideal site for a new Planet Fitness store. And we end up rejecting a lot of sites throughout the year. And so we would rather do it on a measured approach then to try to just approve more and more sites that come into from a real-estate perspective. So we still feel comfortable in that kind of 200 a year range, but we will -- we’ll give guidance for specifically for 2017 when we announce our yearend results.

Thank you. And then just really quick, you did guide to it being kind of a soft interest expense number for fourth quarter assuming the refinancing. Do you have an idea or do you have a range, what you think the fully loaded GAAP interest rate will be for ’17 as we think about the models?

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

Yeah, of course I understand. Thank you so much.

Thanks, John.

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

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

Yes, I mean I wish would be -- look at the 10% same-store sales comp, I'd say blend into [indiscernible] as much move up our disciplined marketing strategy this year for example we had a national mandatory July sales also a national mandatory flash sale, one day flash sale in August and also I think in all kind of lends itself to a tailwind from New Year’s Eve quite honestly, now that we are a leading brand, we’re number one over Gold Gym, it’s the first time dethrone them, and a digital strategy this year that quite honestly didn’t really exist a year ago. So I think we factor all that in it's just the momentum that's carrying through the [indiscernible] in a very good way.

And it was more gross adds right, as opposed to there were less, summer times sometimes you get these -- people drop off and come back it was really the gross adds as not the people giving up the membership there?

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

When you think about long-term, obviously you've got such a huge advantage that you mentioned the unneeded brand awareness, not just versus Gold, but I think about people in your own channel there, would you speak long-term about both the national ads found in the locals. At some point is there an opportunity for that drop a little bit just because the absolute right magnitude the absolute dollars spent will be so big that can drop a little bit and then could that tie in with maybe getting a 5% a higher royalty rate than the 5% you’re getting today at the upper end.

I think the more -- I guess the beauty of this franchise modeling and the way the royalty, the way the ad fund works is the fact that with every incremental member it constantly pushes more dollars even the older stores to get more members in pantry [ph] the market more or so will that give us the ability to raise royalties in the future, possibly, as we continue to push more members per store and make the unit economics more and more attractive I think there is an opportunity there. At the same token and I kind of look at a lot where the existing franchisee keep opening all these stores, 90% are opened by existing franchises. So the fact that they’ve put the money back to work in the system is also rewarded. So it’s hard to [indiscernible] putting it back to work for us is a good thing too.

Okay. Thank you.

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

So just a question on the members per club very impressive numbers obviously now we are getting over 7,000 members in that the members per club seems to be what's really driving the comp here. Can you just give us an idea or maybe just a range on what the maximum number of members per club that you guys can operate effectively or just an idea of how much higher that number can go, understanding there is a lot of moving pieces on different size, but how much higher can that number go do you think?

This particular question, so we get this a lot. On a typical 20,000 square foot box which is our average, we have many stores in that size, club and equipment that have north of 10,000 or 10,000 member. So, we can raise that average of 7,000 up without having to retool the box, I guess it's the easy way to put it. Which gives it a lot of room to grow. I think we started getting that, maybe 13 plus is where it starts to get all dicey, but until we get to 10,000 is a pretty east number to get to, without having to redo anything.

So, across the chain, 10,000 still fees -- I mean that feels like you could operate most of the boxes, it feels like that would be okay on the current footprint?

Yes, yes. And it really [indiscernible] type of member, the member we have is not a seven day a week for two hour user.

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

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

We're constantly looking at [indiscernible] strategy here, we've been investigating the latest events [ph], previous calls Latin America interesting to us, we think about how our stores in Puerto Rico, the recent store we opened here in the Dominican Republic, [indiscernible] another one on the way there and how we’re working a lot of other Hispanic market here in the states Miami, [indiscernible], San Antonio, et cetera. Those are still probably the first priority that we’re looking at this point. Nothing, no sign or solid concrete yield at this point.

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

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

Yes, a couple of things Oliver, I think earlier in the year I said it would probably in the low to mid-20s as the percent of my total equipment revenue and I said a few minutes ago that it would be between 25% and 30% of our revenue. So, a slight improvement there, so not significantly outlined of what we thought at all frankly. I think what we're seeing going on and we talked about this before in fact, Chris made in some of his remarks a few minutes ago is that, our franchisees have built up a significant business in these markets where they are at, with significant amount of EBITDA for a small business. And they have seen the power of not only what they spend locally, but what we spend nationally and being able to continue to drive more people to store. Now, what we don’t to do, is we don’t want to be out, we use this term around here called out nude [ph], and competition is competition and we talked about if there is generally a knock off in almost every market. But what you don’t want to do is you don’t want to have a six and seven years store that looks like its 12-15 years old. And we’ve preached that and preached that now for the last probably three years, before that we didn’t really push it at all, including Q1 of last year getting an agreement with our franchisees by the council and our independent franchise association on the specifics around replacing equipment. And so I think what you’re seeing is that these guys are protecting their investment, protecting their turf and believe that much of the house or car you have to continually invest in it to make it be the most attractive place in the market. And so that’s what we’re seeing going on, so maybe slightly better than where we would have thought back earlier in the year, but not significantly out of line.

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

Yeah it vary a little bit over time and that’s why we’ve said 21% to 22% and I think it’s been slightly higher than that a couple of times. In some times it comes down frankly to just a mix of equipment being sold particularly on the replacement side, because what and I think we’ve mentioned this Oliver that our franchisee doesn’t go in and just say, okay I got to replace all my cardio here in the next quarter. And it’s somewhat of our rolling effect of how they do that. And so the specific orders in a particular month or quarter for those specific pieces can vary a bit because we don’t have the exactly margin on every single piece that goes in to the store. You could have a 100 pieces of cardio in store, and then all the other and so they can vary a bit on an overall basis our new equipment sales generally are going to be between that 21%, 22%.

Okay. And on the incremental term loan borrowings of $230 million, why was that dimension in the right number just as we evaluate risk and return in terms of that amount and [multiple speakers] on the competitive, when you look across your competition, which I’m sure is continued to be intense and is rising. What are competitors doing whether it be marketing or products or in-store experiences that you are kind of monitoring just to make sure that you remain on the cutting edge?

So, I’ll start that first. I would say it hasn’t changed in the sense of more competition or more units or more operators entering the market. In some ways I think it’s just the opposite, as I mentioned in the last call, the newer treat this year has been and it has another one recently of local low cost operators with 10-20 stores that say that, have tried to get in the market, tried to come up against us that, you know, five years ago and here we are today 10-20 stores and they’re looking for a way out because they just can’t compete against us in our space. In lot of the -- lot if not all our markets are local franchisees with their fellow franchisees far larger than any other local competitor. So they are those market [indiscernible] own right. So it’s almost been the opposite, it’s been a recent trend that’s happened this year and there has been some acquisitions and mergers already within our system reference as we’ve been taken out their local competitors which has been -- which has been intriguing for us and something I think we’ll see a lot more of. So it hasn't -- I think a lot of what I see in the low cost operators doing is because that I feel because it's probably not working competing with us because they’re trying to gravitate back to the old model, they are adding the heavy weight in, they’re adding the day cares in there and they’re not doing that because they’re competing well, they’re doing that because they can’t make it work. That’s kind of what I've seen from my end.

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

Okay, and just had a last question. We've done a lot of research on the election. What are your thoughts on the election if it interplays with the media exposure that you have or customer behavior or not, just curious if that's something that how you’ve been seeing in terms of difference in your elasticity of the media or in the way your customers behave or not?

Yes, I would say the only thing that really I kind have seen is movement of marketing, like there is always the marketing and disciplined and more planned approach is that, marketing dollars don’t go as far in October because of the election, so we held off our October sale now into November active license [ph] with the marketing with the media rates come down. And that's one thing we just had to move over which isn't really that big a deal. It's just one month but more strategic on our spend but other than that as far as the consumers is concerned the people working out as much as they ever did and no other changes there.

That's great. Thanks congrats. Best regards.

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

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

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

And then maybe on new store kind of signups or signups at some of the newly opened stores, anything to share there? Has that dropped off at all, obviously it feels like the growth rate overall from memberships has accelerated a bit, but it seems like comp drove a lot of that, anything in terms of -- anything to share on the new kind of stores and how the signups have been going there initially?

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

And maybe Dorvin one more for you in terms of the interest expense, that 2 million that you called out, is that pricing that's in fees, that's not anything in terms of incremental rate because we don’t know that yet, did I understand that appropriately?

Yes, it's basically on where we think we will -- I mean deal obviously just got announced today and we'll see where once we get it launched and where it ends up at from a closing perspective and pricing. But based on what we know today we think that incremental amount will be -- about a $0.01 in the quarter as I mentioned.

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

As Dorvin -- as you know we go after the 80% of population that don't belong to a gym and we put a -- what we think is a great value proposition out there to get people off the couch, and because A, people are going to try and they're nothing going to make it and that's why we have always stated that the way we look at it is, what happens after 12 months? Because frankly there's no comp out there that you could even compare us to. No one has the kind of members we have and et cetera, et cetera. So that math that we have talked about in the past is that the cancelation rate after you’ve been a member for greater than 12 months is low single digits a month, it can be 1.5% to 2.5% a month. And it has not changed as I mentioned a few minutes ago, certainly in the more recent time periods here.

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

Chris I want to follow-up on some of the marketing plans going forward and first on the digital piece and some of the promotions seems like there's a kind of lowering interest there, so I want to maybe ask you how you see some of those activities developing, going forward. And then secondly, this is more near term, with the second year of the New Year's Eve, title sponsorship, I'm wondering if you could talk about kind of how the plans look relative to the activities you had last year?

Yes. The digital stuff you know about that capabilities there to streamline and make performance better each and every time we do it. And lot of those I mentioned in the past calls is that for one instance is black card members are able to bring a free guest in to work out at no charge now captured the emails and we need to market to guests to see if we can them to convert to join. And email market is extremely cheap ROI is great. Another example is the online Dropbox so if somebody join online which is about 20 -- little over 20% of our monthly joins are online. So people have attempted to are join online but got cold feet halfway through it, we’ve now capturing their email first, so we are able to go after them and that’s a really ripe prospect naturally because they’re already thinking of doing it and got cold feet. So those are just two example, there were quite a few other who we can -- that we’re doing now that we actually [indiscernible]. And we’re learning a lot about that and getting better at it as time goes. On New Year’s Eve, it’s an exciting time for us naturally [ph] presence first year so we learned a lot on stage presence, logo placement. So we learned a lot of that and the hats will be released in December which we’re looking forward to, instead a little bit more flat going on, so look forward to that as well. So I think we’ll get some good hype this New Year’s Eve as well and I’m looking forward attending actually.

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

Yes, I mean remember we’re very careful on our openings now and I think luckily we as retailers we’re able to be more selective of our real-estate. Five years ago we almost had to take anything we could find and today I think it’s important to make sure that we get the A site and not settle for a B or C and D, and be outplaced in the future by somebody else coming in after the fact. So we’ll turn down -- for every three sites we look at, we’ll turn down two. 100% as we really selected one making sure that we have the main A site. Could we go fast, possibly, and could things turn out a little better for us, possibly, but I think it’s just making sure that we don't -- we always have those A sites and success for the franchisees according to us.

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

Hi guys its [indiscernible], thanks for taking my questions. I just wanted to ask you about the initiative to add more store labor into some of the corporate stores. Can you just, kind of talk about maybe the lift that you’ve gotten from that and then is that something that you would expect to expand?

Yeah, I think it’s still kind of early. I think its more customer experience and as Jim Esposito who is our new leader in Corporate Store started, he’s really getting in the same-stores and putting the instructor [ph], so maybe some upside in the future, but nothing, I think of just doing what’s right for the customer to be sure that it continues.

Okay. And then can you give some color on maybe some of your that the Black Card initiatives maybe how you’re partnering with third-parties and then how the kind of models to support black card is going?

Yes, I think is quite more around the remodel than it is third party at this point, I think that’s where we’re seeing more of the lift and a lot of franchisees the store making those black card area points, what we call black card spot, we’re putting lounge areas in them and even place some frosted glass doors and spa music in them a little more of that delta [indiscernible], so I think it’s probably what’s getting the franchisees to renovate and make the areas nice and most of them third parties.

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

Yes, some of those new stores are there was more than plenty some are getting into that mid-60s and did the mid high 60s [ph], so I think 60%, so I think there's probably still some room to move although the closer gets to it the slower I think that will gain as opposed to five years ago it was about 38%. So there is some movement there, but I always looking for black card parties, whatever new amenity we add despite [indiscernible] to attract more -- different people and more people to those areas nothing, [indiscernible].

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

Just follow up on the Black Card penetration. I'm wondering just if you can talk a little about where you see the upper boundary for that and how much you want to move your customer up to that price point.

This is [indiscernible] 55 plus range percent there's still some room to move there renovate stores and as peoples can even put those Black Card we will continue to see moves. And I guess the other one -- one key factor is reciprocity is a big one that happens to be the number one reason people choose it, if you look at the penetration in the northeast we're about 4.5% of the population is a member of our stores. A lot of more stores here starting franchisees in here where you got the California out west is little over 1% penetrations to a very that comes to our spark and some part of the stage though, those still more, those could be driving more Black Card incentives in the future.

And then could I ask about the regional penetration on this if you could talk a little bit about what you are seeing from a regional perspective in terms of comps for sales and performance of the franchise comp sets, will appreciate that.

There is really -- and Chris kind of talked about this a minute ago in terms of things we're seeing across the landscape if you will and I would say that there is nothing that really sticks out. We look at same-store sales by stay, we look at it buy we call it DMAs across the U.S. we have a decent sized number of stores dealing in a particular market and we haven’t seen anything in terms of one really huge outlier that's something that alarms us within a group of 15 to 20 to 25 stores you are going to have some over achievers and under achievers in there in some cases, but nothing that we would say there is something going on in that region. So I think pretty consistent across the landscape.

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

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

Thank you everybody for joining us today and it was the great quarter for us. Thank you for the questions and I look forward to our next call in the year call as going forward. So, thank you everybody for joining us.

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