Planet Fitness, Inc. (PLNT) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Jessie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Planet Fitness Third Quarter 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. With that, I’ll turn the call over to Brendon Frey, from ICR.

Thank you for joining us today to discuss Planet Fitness’ third quarter 2017 earnings results. On today’s call are Chris Rondeau, Chief Executive Officer; and Dorvin Lively, President and Chief Financial Officer. A copy of today’s press release is available on the Investor Relations section of Planet Fitness’ website at planetfitness.com. I would like to remind you that certain statements we will make in this presentation are forward-looking statements. These forward-looking statements reflect Planet Fitness’ judgment and analysis only as of today, and actual results may differ materially from current expectations based on a number of factors affecting Planet Fitness’ business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made in this conference call and webcast, we refer to you the disclaimer regarding forward-looking statements that is included in our third quarter 2017 earnings release, which was furnished to the SEC today on Form 8-K, as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise. In addition, the company may refer to certain adjusted non-GAAP metrics on this call. Explanation of these metrics can be found in the earnings release filed earlier today. With that, I’ll turn the call over to Chris Rondeau, Chief Executive Officer of Planet Fitness. Chris?

Thank you, Brenden, and thank you, everyone, for joining us for our third quarter earnings call. Building off our strong performance in the first half of the year, business continues to perform very well. Same-stores sales were positive for the 43rd consecutive quarter increased 9.3% on top of a 10% comp gain in the third quarter last year. Total revenue was up 12.1% in revenues in each of the three segments up from the quarter would franchise, our highest margin segment, increasing 30.6% and 31 new Planet Fitness stores opened during the period, bringing system-wide total stores to 1,432. As discussed on previous calls, over the past year, we’ve been conducting price elasticity testing in several markets throughout the U.S. and Canada to evaluate the impact of increasing our Black Card monthly dues. We are proud to held our Black Card pricing flat at $19.99 for the past 15 years while at the same time increasing its value to our members significantly. The value of our rest approximately benefit alone has increased dramatically as we’ve grown our store base from 20 stores in the Black Card was first introduced to more than 1,400 stores today across the U.S. Our members truly appreciate this part, and in 2016, 50% of Black Card members across the country use at club, other than their home club at least once. Since rolling out the Black Card membership, we have built designated Black Card spot areas in our stores, added total body enhancement franchisors and hydromassage beds. These numerous benefits, combined with the ability to bring our friend for free, continue to make Planet Fitness Black Card a great value for consumers. We are pleased to report that a price elasticity test results were overwhelmingly positive, and actually, increasing the average blended rate of new joints. As a result, in the close collaboration with franchisee leaderships, we decided to pull our outsource system wide to rollout the new $21.99 Black Card price beginning September 1, and required outsource implement the new pricing as of October 1, which is perfect timing ahead of our busy season. We remain as committed as ever to providing our members with an access to low-cost, high-quality fitness and are confident that this rate adjustment will allow us to continue to strengthen our member experience and provide increased value to our franchisees and shareholders. While franchisee growth continues to be the pillar of our store expansion strategy, we are scheduled to open four new corporate stores by the end of the year, including one each in Wilmington, Delaware, in Berlin, Vermont, and two stores in Erie, Pennsylvania. All of these stores started presale in the third quarter and are off to a solid start. As we have said at the time of the IPO, our plan is to open a handful of corporate stores per year in new and existing markets. We have the ability to capitalize and advertisement dollars or test during population densities in alternative buildouts. For example, our Berlin, Vermont corporate store is approximately 15,000 square feet versus our typical 20,000 square foot store. Berlin as a population of only 40,000 people within a 20-minute drive time, roughly half the average of our typical location. With that in mind, we are extremely pleased with the number of new members sign-ups during our presale thus far and encouraged by the demand for the branded small markets. We have a long runway for growth ahead of us with a potential footprint of 4,000 stores in the U.S. over time. While the vast majority of our pipeline is domestic stores, our franchisees continue to open new stores in Canada and the demand for our first location in Panama remains strong with the official grand opening, scheduled to open on the coming weeks. Speaking of our stores, our Camby had impact on our stores in Puerto Rico as the entire island was affected by the larger storm hit the region nearly 100 years. Of our 11 stores in the market, we have reopened two, and nine are temporarily closed with damage ranging from water destruction issues. Our franchisee is committed to the market and is working on a plan to reopen the stores in service community as soon as possible. Thankfully, our stores in Texas, Florida, Georgia and South Carolina in the path of Hurricane Harvey and Hurricane Irma were not significantly damaged and remained open and operating as usual. Having said that, Planet Fitness store employees in various regions particularly in Puerto Rico were personally impacted. And I was really truly inspired by the generosity of our franchisees and vendors who came together to raise approximately $300,000 to provide financial assistance help with housing, transportation, clothing and other essential items for employees and their families. With these funds, we formalized the Planet Fitness Disaster Relief Fund, which is a non-profit organization that will serve as a mechanism to provide relief to club staff moving forward. Coming together to support one another in times of need is what sets our franchisees apart from the rest. Finally, I’m excited to share that we have enhanced our leadership team to include two new positions. First, Craig Miller, Chief Digital and Information Officer, joining Planet Fitness with more than 20 years of experience in major consumer brands like Sonic Drive-In, Movie Gallery/Hollywood Video, PepsiCo and Bank of America. Rob Sopkin also joined as a Chief Development Officer. Rob brings nearly two decades of national regional real estate experience, spending the majority of his career working at Starbucks. Most recently leading U.S. store development and overstaying the integration of Starbucks’ store development with licensed stores in Canada and internationally. In addition, Cammie Dunaway, recently joined our Board of Directors, bringing more than 25 years of expensive leading the marketing in general management on global brands like Yahoo, Nintendo, Frito-Lay and Kidzania. In summary, it was another terrific quarter, highlighted by robust system-wide sales growth in earnings that exceeds expectations. Looking ahead, we are anticipating a strong finish to the year, which is incorporated into our increased outlook for 2017. While we just celebrated our 25 years in the business, I believe we’re just beginning to scratch the surface of plant that this is full potential. I’m confident that we are well-positioned to capitalize on the many opportunities that lie ahead and deliver increased shareholder value over the long term. I’ll now turn the call over to Dorvin.

Thanks, Chris, and good afternoon, everyone. I’ll begin by reviewing the details of our third quarter results and then discuss our full year 2017 outlook. For the third quarter of 2017, total revenue increased 12.1% to $97.5 million from $87 million in the prior year period. Total system-wide same-store sales increased 9.3%. From a segment perspective, franchisee same-store sales increased 9.6% and our corporate same-store sales increased 5.1%. Over 90% of our Q3 comp increase was driven by member growth. At the same time, our Black Card membership penetration was 60%, up 130 basis points over Q3 last year. As Chris mentioned, following the successful test of the $21.99 pricing on the Black Card in approximately 100 stores, we made the decision to roll the price increase out system-wide on October 1. The impact on October results from the price increase was positive, and we expect Q4 comps to benefit from both volume and rate growth. And this has been factored into our upwardly revised guidance. Our franchisee segment revenue was $35.6 million, an increase of 30.6% from $27.2 million in the prior year period. Let me break down the drivers of our fastest-growing revenue segment. Royalty revenue was $22 million, which consist of royalties on monthly membership dues and annual membership fees. This compares to royalty revenue of up $15.1 million in the same quarter of last year, an increase of 46.2%. This year-over-year increase had three drivers: First, we opened 196 new franchise stores since the third quarter of last year; second, as I mentioned, our franchisee-owned same-store sales increased by 9.6%; and then third, a higher overall average royalty rate. For the third quarter, the average royalty rate was 4.33%, up from 4.01% in the same period last year, driven by more stores at more current royalty rates. Next, our franchise and other fees were $7 million compared to $5.8 million in the same quarter a year ago, an increase of 20.7%. These fees are received from processing dues through our point-of-sale system, fees from online new member sign-ups as well as fees paid to us in association with franchise and transfer fees and area development agreement fees. This increase was primarily driven by additional stores and increase in same-store sales and higher franchise and transfer fees as compared to the prior year period. Also within franchise segment revenue is a replacement revenue, which was $2.4 million compared to $2.2 million last year. Finally, our commission income, which is made up of commission from third-party vendors arrangements and equipment commissions for international new store openings, was $4.1 million compared to $4.2 million in the prior year period. Our corporate-owned store segment revenue increased 7.1% to $28.6 million from $26.7 million in the prior year period. The $1.9 million increase was driven by the increase in corporate-owned same-store sales of 5.1% and increased annual fee revenue. Turning to our equipment segment, revenue increased slightly to $33.4 million from $33.1 million. The increase was driven by higher replacement equipment sales to existing franchisee-owned stores, partially offset by lower new store equipment placements versus a year ago period, as a number of new store openings originally planned for Q3 this year shifted into Q4. Year-to-date, our placement – our replacement equipment revenue represented 48% of total equipment revenue. Our cost of revenue, which primarily relates to direct cost of equipment sales in new and existing franchisee-owned stores, amounted to $25.8 million compared to $25.9 million a year ago. Store operations expense, which is associated with our corporate-owned stores, was $15.6 million compared to $15.2 million a year ago. SG&A for the quarter was $14.1 million compared to $12.2 million a year ago. Both periods include non-recurring expenses related to secondary offerings. Excluding these non-recurring expenses, total SG&A increased by $2.9 million or 25.6%. This increased expense was primarily to support our growing operations and infrastructure, including higher payroll and related costs as well as cost of being a public company. Our operating income, inclusive of the aforementioned non-recurring expenses, increased 29.8% to $34 million for the quarter compared to operating income of $26.2 million in the prior year period. On an adjusted basis, taking into account the non-recurring expenses I just mentioned, our adjusted operating margin was 35.8% this quarter versus 32% in the prior year quarter, an increase of 380 basis points. This was primarily due to revenue growth and higher margins as we have continued to leverage our cost infrastructure. Our earnings before taxes, inclusive of the aforementioned nonrecurring expenses, increased 29.4% to $25.4 million for the quarter compared to earnings before taxes of $19.7 million in the prior year period. As a result of our fourth quarter 2016 amended credit facility and increased term loan borrowings, we incurred approximately $2.6 million in higher interest expense in the third quarter of 2017 compared to the prior year period. Our GAAP effective income tax rate for the third quarter was 25.7% compared to 24.4% in the prior year period. As we’ve stated before, because of the income attributable to noncontrolling interest, which isn’t taxed at the Planet Fitness Inc. level, an appropriate adjusted income tax rate would be approximately 39.5% if all earnings were taxed at the Planet Fitness Inc. level. On a GAAP basis for the third quarter of 2017, our net income attributable to Planet Fitness Inc. was $15.3 million or $0.18 per diluted share compared to $3.4 million or $0.08 per diluted share in the prior year period. Net income was $18.9 million compared to $14.9 million in the prior year period. On an adjusted basis, net income was $18.7 million or $0.19 per diluted share, an increase of 17.9% compared with $15.9 million or $0.16 per diluted share in the prior year period. Keep in mind that Q3 included higher interest expense of $2.6 million as a result of the prior year Q4 refinancing. Adjusted net income has been adjusted to exclude nonrecurring expenses and reflect a normalized federal income tax rate of 39.5%. We have provided a reconciliation of adjusted net income to GAAP net income in today’s earnings release. Adjusted EBITDA, which is defined as net income before interest, taxes, depreciation and amortization, adjusted for the impact of certain non-cash and other items that are not considered in the evaluation of ongoing operating performance, increased 22.4% to $43.4 million from $35.4 million in the prior year period. A reconciliation of adjusted EBITDA to GAAP net income can also be found in today’s earnings release. By segment, our Franchise segment EBITDA increased 31.2% to $29.9 million driven by higher royalties received from additional franchisee-owned stores, not included in the same-store sales base; an increase and franchise-owned same-store sales of 9.6%. More stores at higher royalty rates, as well as higher commissions and other fees, including higher franchise and transfer fees. Our Franchise segment adjusted EBITDA margins were 85.1% compared to 85.5% in the prior year period. Corporate-owned stores segment EBITDA increased 14.2% to $12 million, driven primarily by a 5.1% increase in corporate same-store sales and higher annual fees. Our corporate store segment adjusted EBITDA margins increased by approximately 400 basis points to 44.3%. Our Equipment segment EBITDA increased 7.4% to $7.7 million driven by higher margins. Equipment segment adjusted EBITDA margins increased 110 basis points to 22.7%. Now turning to the balance sheet. As of September 30, 2017, we had cash and cash equivalents of $93.3 million compared with cash and cash equivalents of $40.4 million as of December 31, 2016. Our borrowing capacity under our revolving credit facility stood at $75 million as of September 30, 2017, while total bank debt, excluding deferred financing cost, was $711.3 million, consisting solely of our senior term loan. In summary, we had a really good quarter highlighted by strong system wide same-store sales growth and EPS that was ahead of projections. Based on our year-to-date results combined with the expected benefit to fourth quarter system wide same-store sales from the higher Black Card pricing, we are raising our guidance. We now expect revenue for the year ended December 31, 2017, to be between $425 million and $430 million, up from our previous guidance of $409 million to $415 million, and adjusted net income to range from $79 million to $81 million, up from our previous guidance of $75 million to $77 million. This translates into adjusted EPS between $0.80 to $0.82 compared with our previous guidance of $0.76 to $0.78. Adjusted EBITDA is now expected to increase between 20% and 22% to a range of $180 million to $183 million for the year. We now expect system wide same-store sales to increase between 9.5% to 10%, up from our previous guidance of 8% to 9%. We still anticipate selling and placing equipment into approximately 190 to 200 new stores. But based on the current store opening schedule, we believe we’ll be towards the high-end of that range. And as Chris mentioned, we are on track to open four corporate stores in the fourth quarter. The equipment related to these corporate stores is not in our placement guidance as we don’t recognize equipment revenue on corporate store equipment placements. Finally, we expect the average royalty rate for 2017 to be approximately 4.2% compared to 3.7% in 2016. The 50 basis points increase is higher than the 30 to 40 basis points we previously guided to based on the number of franchisees that have opted to amend their existing franchise agreement and increase their existing royalty rate by 1.59%and eliminate the commissions they pay on certain operational purchases. It is important to note that the increased royalty revenue that we’ll receive due to the plus 1.59% royalty rate change is being offset by the corresponding decline in commission income as we will no longer receive commission on purchases by these stores. Therefore, we do not expect an impact on our bottom line results from the acceleration in the royalty rate increase. As of the end of Q3, approximately 400 stores have amended their franchise agreements to plus 1.59%, and we expect additional amendments in Q4. I’ll now turn the call back to the operator for questions.

[Operator Instructions] Your first question comes from Jonathan Komp with Robert W. Baird. Your line is open.

Yes. Hi, thank you. Chris, I want to start off, I mean, obviously, the third quarter, you did not have any benefits from the pricing action yet. And the comps still accelerated quarter-over-quarter despite a tougher comparison, double digits last year. So I’m just curious as you look at the business, if anything stands out in terms of drivers of that momentum and how you see that playing out going forward.

Yes. I think it still, as I talked in the past, you can’t underestimate the impact of this, I call the marketing machine once, an interview that. With each new join and each the clubs are opened in fact the effect of 9% gets putting the marketing, this was drive in this the member growth as well as some rate growth. But mostly the member growth is what’s driving this comps. I think we just continually see the benefits of that. Also coupled with, as you mentioned, some small benefits of our POS system have gotten just more refine and processes. But majority of it is that marketing machine acting is a drive. And I think slide selection actually, because you still approve, as we said in the past, we just get better at what we do with location we open. So we get the real estate and better site selection drive better comps as well.

Great. And then when you look to the full year outlook for unit opening, and I think the commentary just gave implies pretty strong Q4 openings. And I’m just curious what you’re seeing from franchisee demand there, maybe both domestically but also internationally? I’d be curious if you had any insights, Panama, how is that faring so far with the first opening? And any other color there?

Yes. Panama opens a couple of weeks here. Presale there’s been some very strong – that’s a franchisee actually from the state that is down there. The glimpse here with these comps, the franchisees continue to be bullish on the business and continue to earnings back and open more stores. That’s why we, again, doing the 200 stores over a year.

Yes. I just add to Jon. Obviously, in development cycle it’s a long period of time. As you know, and depending on when you take over a box. If it’s a plain then yellow box you might be able to get it open in three months or so. If it’s more complicated or certainly a ground-up, which we’re doing a few more ground-ups now. That could take up to 1.5 years or so. So today, our franchisees are out there. They’re working on Q2, Q3 of next year or Q4 for site selections, providing those potential sites into the company. And we obviously have already reviewed sites for Q1 of next year. So as Chris said, the franchisee base continues to be very excited about the brand and continuing to build out. And there’s a lot of action going on right now for the last two months of the year, which gets us up to that 190 to 200 that I mentioned in my comments.

Okay, thank you. I’ll pass it on.

Thanks, Jon.

Thanks, Jon.

Your next question comes from Randy Konik with Jefferies. Your line is open.

Yes, thanks a lot. So I guess, question for Chris. But not to digress but when you think about another space like the tax base where you see mass market or Amazon, they get bigger as they get bigger, they keep getting bigger still. They built this supply wheel of momentum they call it, right? Your business kind of feels like it’s approaching the same or it has approached the same type of flywheel momentum? You partially touched on it with the marketing how it keeps feeding upon itself. So when you see this kind of build we’re seeing accelerating comps. We’re seeing just the words do very well. You touched on the Burlington example. Do you think – do you kind of think about, as you kind of gain more market share in your pushing out these competitors that you kind of think about changing or moving to a higher target level of density potential in the markets you want to serve? Like, for example, in New Hampshire is x percent but it’s lower in California, for example. So I’m just trying to get a sense of how you think about this flywheel momentum in the business, whether it be to marketing dollars received from a new member or the success factor of entering a small markets like Burlington with a smaller box? Yes, how do you kind of think about this it in the tax base today?

Yes. It’s a great question. I think what we see any think the more close we have in the market like the more – rise or the more shift rise and I think were seeing, like you told me 17 stores in New Hampshire 10 years ago, that seems crazy. And now we’re New Hampshire, 17 stores in one out of every two health club members is a member 10% of the population were a member in New Hampshire. And realistically, we can apply to open another one or two stores have begun in New Hampshire were still not there. And I think as like you said, the more stores we open, the more we can open. Brand awareness is up, the market penetration is up it just goes on proximity becomes a bigger place, so the Black Card gets bigger. So it moves many different levers. To the Berlin, I think Vermont, when you think that, so the 20-minute drive as I mentioned is only 40,000 people. It’s kind of Berlin itself got 2,800 people believe it or not and it’s a neighboring town to [indiscernible] (26:23), which is only 7,000. So it’s very rural. And that store is increased already over indexing the average. So you’re the only club around for miles. To them, it’s like Disney World’s coming to town and we’ve got more hype and more media, free press. It’s like the landlord national tenant’s come in space it gets everybody excited. So and that’s not even in and that 4,000 number that we say our potential is. So this is – it’s still a test, there are about 20 of these with our franchisees that we are working through. But this should open up the doors for another level of raw opportunity for us. So I think I’ve said in the past, in some ways, we’re in uncharted waters. This industry never really seen or value greater than 500 or 600 stores in crumble goes back to the area and now it’s down 600 or 400 these days. 24-hour fitness in LA but in that 500, 600 number for many years. And we blew through that 2012 and here we are now with 1,400. And I think it’s just we have the right model, the right business and the right marketing plan that continues to just drive comps and drive growth.

Yes. And maybe it’ll be helpful because something we always have gotten from the market is the question mark around that 4,000 number. So I guess it’ll be helpful is any kind of thought process on what was considered in that 4,000 number because you kind of made a mention that the 4,000 doesn’t even include something like that you’re seeing succeed in this smaller type box. So I’m just curious on how you thought about that initially and what a smaller box could provide going forward?

Sure, Randy. We use a company called Buxton as you know, and we’ve using them now for the last five years or so. And we were really kind of a dream client for them. Because if you think about us versus a QSR, where you know who’s walking in the door, maybe, if there’s a royalty program, we know where every member lives. And therefore, when we were able to give them back in that day probably 500, 600 stores so we could give them a very broad cross-section of America. From urban to rural to East to West, different ethnicities, et cetera. So what they were able to do then was to plot those members in and around, call it, 500-plus stores to see what kind of market penetration we were getting in that time on a store by store basis. And then based upon those demographics, based upon those store sizes in terms of member accounts, we were able then to plot out the rest of the U.S. What I would say today is that there is clearly markets where we over index in terms of a higher market penetration. As you mentioned, and as Chris was talking a while ago in New Hampshire we have like 10% of the population. In the Northeast, we’re about 4.5% to 5% of the population. And then you go out West, it’s barely 1.5% or so in terms of market penetration. But there is very distinct markets in some of these different regions of the country where we already have 8%, 10%, 12% market penetration in the market. And so the way we look at it then, is now we can plot the 1,400 stores and we can see where our market penetration is doing very well. Maybe we have a lot more stores there and we’ve been there longer. But then we go to other markets, like in LA, which we haven’t been in LA for a long time now. But as we put more and more stores, we see that those stores continue to perform. To Chris’ point earlier, which we believe is driven by the benefits of the Black Card, the value proposition that you get from a $10 membership, from the $21.99 and rest of processes, et cetera. So we still feel very confident in our ability to hit that 4,000 number.

That’s very helpful. My last question is, the beauty of your model is the simplicity of it. Not to put Amazon again, maybe I think wish I was Jeff Bezos but they kind of more fair business into adding AWS, for example. So I guess back to Chris thinking about Amazon started with this type of business, move into AWS. Do you think about given the – obviously the huge opportunity to grow and more and more stores, the margins are high, et cetera. But are there types of things that you think about strategically from a transactional perspective business-wise that you may going to explore give the strength of the brand and mix, and the industry, et cetera?

Yes. I think, you’re right. The store there’s a lot of growth there. As far as I think the 10 million members is growing, there’s definitely some levers that we can take advantage there. I think some of the technology that we’re working, we’re probably talk about here with the cartilage so on is, what will gain from that knowledge standpoint, what we learn from what our members are doing and using the standpoint. Now we can actually see what their likes, dislikes are, how do we advertising at that point, what’s our partners would be, what buttons they are clicking on, are they clicking on – run they clicking on Spotify, all it goes and on and on. So the industry never had the opportunity to capture data like that, all we could ever tell when we actually walk to the door, we had no idea with what we’re doing. So I think that will open the opportunities with Craig, our new CDIO, he’s gone to blaze all over this stat, I think, where we see our clubs today, and what we’re going to gain from a data standpoint and how we can increase the members from experience and better manage experience where we are in three years from today or two year from today will be light years ahead of today.

Your next question comes from Dave King with Roth Capital. Your line is open.

Thanks. Good afternoon guys.

Hi. How are you doing?

I guess maybe first, sticking with Randy’s line of thinking on the flywheel a bit. Maybe switching gears also. How do you think – or have you guys looked at all at the lifetime value per average customer? How that compares to your acquisition costs? Is there anything you can share about how those metrics have trended over time? And then as you’re touching on that maybe you can talk about the trending cancellations and churn? Thanks.

Sure, Dave. One of the things that we have the benefit of this – was down side with all these members and particularly at all of our older stores. So the older stores are going to have a longer tenure of members. We talked about attrition. And as you guys know, we talk about it in terms of looking at members that had been a member of Planet Fitness over 12 months, and what happens after that. And that cancellation rate is 1.5% to 2.5% or so a month. But I think that a lot of the things that we see happening in our clubs today, particularly in markets where we hit more market penetration, we look at tenure, we look at the different sections, the different types of our members. I mean, 49% of our members are millennials, how do they react. And as Chris talked about earlier, using technology in the future is going to be huge because we want to be able to do cater to what they want. And one of the things that – when they come into the clubs or they are going to act differently then members that four or five years ago. And so with some of the technology that we are working on with our equipment partners that we’ll be able to rollout, we’ll be able to offer them more then they have today. And we believe that that will provide some stickiness as well. Some of the other things that we’re doing is just in the technology areas around our mobile app to be able to really enhance that app and to be able – particularly as one example to have data on the – on what members do and what are their accomplishments to be able to – to get that back to them as they walk out front door, give them a hi-fi, so that it encourages them to come back the next time. But those are the kinds of things that we’re working or that we have kind of the radar to be able to continue to provide that stickiness factor.

Okay. And maybe along with that last piece. Where are you in terms of beginning to evaluate or test some of that enhanced equipment is that something we could see in the near-term. I think in the past you guys have talked about, or I guess there is a potential to maybe see that drive maybe some equipment installs. How far out is that opportunity?

Sure. Dave this is Chris. We installed the first club in September in New Jersey between now and January we have another 14 clubs going in. And it will be five of each of the three manufactures that will we part of the RFP, so we talk about – our contract with Life Fitness ends at the end of June, starting our RFP process and it’s with Matrix, Precor. So all three of the manufactures will be in with that cardio by January and we’ll start to trend to see the how the equipment is used. Now we can actually see how it’s using. It’s really interesting. And then as we mentioned, it’s actually because the way it’s working is the Black Card memberships will have a higher experience. So hopefully, that we’ll drive higher Black Card sales in time and time will tell. One more thing, this technology and the beauty of this cardio is it’s going to be updated overnight through the Wi-Fi. So it’s not like you brought credit that’s five years old, you can’t get an upgrade. You can do it on the fly. So DLX can be like 2.0, 3.0 as we learn from our customers doing make it better. So that’s still in process of learning as we roll this out and learn from the user ability. But I think it could be pretty interesting what it can do for us in the future.

Okay. And then I guess on the guidance, Dorvin. How much of the increase was related to the Black Card pricing growth, I guess what sort of adoption of the $21.99 I assume – I think you may have said the number the stores that are in that. But I guess what sort of adoption at the stores and should we be holding that 60% penetration constant, what’s the grandfathering rules? Any color there would be helpful.

Sure. So existing members, they were retaining their membership. So before we raise the products our Black Card is $19.99, those Black Card members continue to pay $19.99. Although, Black Card members pay the $21.99, so that’s how the membership works. And as I mentioned in my remarks earlier, with respect to our upper guidance on comps, we think that the $21.99 price impact for Q4 will be kind of in the neighborhood of 70, 75 bps. So that’s embedded into the way we put forth our guidance. With respect to a kind of the Black Card percentage we’re at 60% at the end of Q3. During our pilot, we saw small to negligible decrease in Black Card percentage. We don’t expect that to be huge or to be very similar to the pilot. We’ll see now as we go full with all the clubs here in Q4. But that’s how we factored it into our Q4 comps. Our full year comps rather.

Yes. Thanks for taking the questions and good luck for the rest of the year.

Thank you, Dave.

Your next question comes from John Heinbockel with Guggenheim. Your line is open.

So based on your sense of franchisees uptake right of the swap right between the royalty rate and commission income could the royalty rate be well above 5% next year or no?

Yes. John, we’re not going to talk about kind of guidance for next year yet. We’ll do that when we release our year-end results. I would say that, obviously, the clubs that have amended, you’ll see a higher royalty rate. We don’t know yet how many of all those will adopt by the end of the year so that we get a full year impact to that next year. Again, as I mentioned, it’s all set by commissions. We expect a lot of them will. But keep in mind, John, as you know, we still have a number of stores out there that are significantly under the 5%. So when you add the 1.59%, you may still not be at 5%.

Okay. And then when you think of, if you look and how much you are spending in marketing, how close are we or do we ever get to a point where you can relax the local spending requirement in maybe – as an offset to that, is raising the royalty rate further. Is that something that could be done? And is that something could be done sooner rather than later or no?

Yes. I’d say probably later rather than sooner. I may, I think it’s still so much more to penetrate this markets and really what is the true from capacity of the clubs as far as 7,000 members or is it 9,000 members. We’ve don’t think really now to get there. I think it’s when we realize we’re not selling anymore member growth and we’re not keep spending a number dollars and realize to be that tipping point, which I think is quite a ways off before that’s happen. I think part of the royalty rate question; I think it’s going to more energy to drive in comps in few years, it’s keep driving comps store. So it doesn’t make more money and more profitable than we can buy share down the road. I think for now, we’re playing a good spot. I think franchisee putting the money and to build more scores. So not just taken home and put it as the workforce. So we kind of wind on the other end anyway.

And then lastly. You think about this RFP versus prior once. Do we see in the commentary on technology? Do we see a quantum leap in what’s available out there? And if there is a significant leap forward, would you see – or could you see franchisees replacing equipment before they’re required to? Or will they still probably wait until that’s up?

I mean, I believe that we can prove that it enhances customer experience. And even more so, increases Black Card percentage, that will be the true tale and that will get people to get excited about doing it early. I think it’s not getting that happen, that’s a no-brainer, really.

Okay. Thank you.

Your next question comes from John Ivankoe with JPMorgan. Your line is open.

Thank you. A couple of questions if I may. Firstly, in terms of the grandfathering in of the change in the Black Card fee. Is that you grandfathered in the totally end of their term? Is it multiple years? I mean, what exactly do you mean by grandfathering and when to you get start all Black Card members to be on $21.99.

I mean, there’ll be a point even in three, four, five, 10 years that not everybody will be at $21.99 because they are down to the grandfathered in as long as they don’t cancel their membership, they don’t lose that rate. But they cancel and come back, then you lose it, which time will tell. But I think to that point, just mentioned we could see some benefit of some stickiness from them realizing that if they cancel this membership, if you’re not using it for few months, that you don’t have to get this rate back. So we could get some help from a down the road and that end of two.

Yes. It makes definitely an opportunity to communicate for sure. I think most of board assume that forever means forever. Okay. I’ve certainly haven’t sense that the franchise community were struggling for profitability. In fact, just the opposite. And yet, this is a nice shot in the arm for profitability at the franchise level. So is there anything that you’re giving in order to get this, I mean, whether it is, to the previous question more marketing dollars or equipment or higher store growth? In other words, also referencing a previous question, whether they put back in the flywheel do they basically give back some of the benefits that they are receiving.

I think it’s goes back to the extra $2 and as I said, 9% of marketing fee between LAS and NAS. So I think marketing fund that goes drive more marketing put them back in. But I think as I mentioned the fact that they keep putting more money back into the building more stores, and hopefully, with this extra shot in the arm, you’re right, that closes already, really profitable. So now looking to more, that they continue to open more stores and keep them excited about the brand as long as they’re excited and as I mentioned in the past, I feel like I have two sets of customers. One is our franchisees and one is our members. And if we can keep our franchisees super happy looking for members even happier or so, I think we keep them excited for the brand and see them to grow.

That’s great, Chris. And it certainly seems that there’s a lot of things that are lining up right now for a meaningful step up whether it’s in 2018, 2019, or 2020 in terms of that 200 new clubs a year. I mean what did you currently thinking about in the pipeline and is this kind of what we’ve been waiting for in order for the penetration of the brand that spend even faster than it already has.

Yes. I’ll give you an answer. But I think they’re excited and I think retail as we continue to see on TV every day there’s another group of – chain of stores closing stores and downsizing and we’re right in perfect warehouse for them. The other reason landlords want us and it was the model the comps the way they are and with this new $21.99 and what that can do for stores. I mean it’s simply excited. I mean, there’s nowhere else to put it besides that people are ready to rock ’n roll.

Yes. I would add to it, John, we’re very excited to have Rob Sopkin onboard as well. And obviously, he comes from big brand, lots of location, understanding retail, understanding what drives retail. And one of the things that we have ahead of us here is over the next four or five years, we’re going to have a lot of locations that are going to come up for lease renewals. And if you go back five, six, seven years ago, we were competing for Maine in Maine with a lot of the names that are maybe not even in business anymore but we weren’t always getting Maine and Maine. And we’ve had examples just here in the last 12 to 18 months where franchisee and at least they came up and they relocated. A couple of cases in the same shopping center by they want from an elbow to parcel, et cetera. And end cap significant increase in revenue by just getting better visibility being in a better site. So one of our markers from a real estate perspective is not only to find a couple of hundred stores a year of brand new sites, but we’ve got to continue to upgrade, if you will, some of the locations or existing stores. So I think that’s another opportunity for us in some of these markets to be better front and center and to be able to drive more members per store by better real estate locations.

And I promise last one. Relocation is typically slow development, ground-ups, typically, slow development. this effect on the other end, you have a lot of opportunity to accelerate development. Obviously, this is a really important question and understand if you don’t want to guide specifically. But as we think about the next couple of years, should we expect net adds similar to 2017? Or do you think we can start to take you up to some extent?

No. I mean, I’m going to defer back to the same kind of guidance I’ve given in the past and we did this with IPO you’ll remember. We said, we thought we could do a couple of hundred stores a year. We thought that made sense. You probably heard us use the term, we call it thoughtful growth. We deal still rejects that’s John. I mean, we’re in a real estate committee, that will besides proposed by either our franchisees or their broker networks that comes into our headquarters here because we approved every real estate location and we’re still rejects them in. And we do it for number of reasons but some is wait till a better site comes along. Given the momentum we think we have in real estate world. So I think as of now, and we’ll give guidance next year, early in the year for full year 2018. But I still think kind of that 200 stores a year is a good number to think about.

Thank you so much.

Your next question comes from James Hardiman with Wedbush Securities. Your line is open.

Good afternoon, thanks for taking my call. So quick clarification. So you talked a little bit about some of the new technology pilots, I guess, we could call it with Matrix, Precor and Life. You kind of talked about that hand-in-hand with the notion that your equipment, we’re looking to react your equipment contract come June. Is that sort of the new technology? Is that’s what’s going to largely drive how you think about your supplier agreement as we look to June or are those sort of two separate events?

No, it’s a – June happen regardless, but the pilot program with that technology is probably going to be biggest part of the deciding factor. Price is important, but functionality is probably more so of the customer experience is better and so you can get more Black Card sales from it. That’s most important. If you do that, then you might get some retention and stickiness and then drive higher Black Card percentages. So I think that’s going to be more of the deciding factor. So that’s why pilot is truly important. Once again be able to capture the data, we are – we’ll know what members are doing and what they’re experiencing, how do teed up more of what they like and get rid of what they don’t like and update the content real-time. And then Black Card members, more experience, better experience, so that the White Card members instead of having a typical treadmill experience to upgrade and we actually have a design believe it or not that you can literally upgrade your membership on a piece of cardio. So you can be on the treadmill, see the person next to you running to the Grand Canyon, you say I want to do that, I don’t want to just run out of a track. You put an upgrade and you’re running on Grand Canyon and your upgrade is new Black Card membership. So it’s a truly dynamic technology stuff that we’re working out to be really, really cool for us in the program for the business.

Well, that’s really helpful. And then you’ve talked in the past about sort of the algorithm how we should think about same-store sales contribution from clubs of various ages. Clearly, some if not all of your clubs are outperforming those expectations. But should we think that some of the stores that are one to two years old are ramping more quickly or is it more that your mature stores are continuing to bring in more and more members and maybe the feeling on member of potential for a given club. It’s just greater than it was in the past?

Yeah, I think it’s probably a bit more of the more mature clubs as opposed to a brand new store kind of ramping at a much faster rate than it did two or three years ago. And we believe and Chris has talked about this a lot over the last couple years or so that the franchisees willingness to invest and reequipping their clubs having fresh, no equipment in, some of the remodels and renovations are taking place, building nice Black Card spa areas. Those are the kinds of things that we believe are contributing to the fact that more and more of our mature stores are probably outperforming kind of the guidance metrics that I have talked about in the past. I’ve said older stores, call it four years, five years or older, are probably very low single-digit comps, 1% to 3% or so. And we’ve seen certainly let’s just say this year; we’re seeing no stores performing a bit better than that. So I think it’s a combination of a lot, but I think it literally has to do with the marketing dollars more of it, more penetration in existing markets, more value of the Black Card, hence the Black Card continues to increase all a bit slightly, but condense increase. And then have a better member experience that’s driving more members to store. I think that in essence just what’s the driving the model.

The other thing I only add James is that I’m talking about that where 90% of our openings every year by the existing franchisees, so one franchise group might have 20 stores in the market. So they have great brand new shiny stores and they have their regional legacy stores that they see how great the new ones going with how the new finishes, the new equipment looks. So even though we do require, they’re doing it on their own. So it’s – they want their portfolio of stores to be – so it’s not a 1G, 2G system, they want their portfolio of stores to all look the same. So it’s – they’re really – keeping their clubs looking fresh.

Really, helpful. And then last one for me sort of the state of the industry question. Obviously, your focus has been on doing what you do well, but I think you’ve had so much success that there’s almost always a response or an attempted response by some of your competitors. And I think the way you’ve laid out the industries that you know specialty clubs are doing well. You guys are consolidating the value segment and the traditional clubs are getting squeezed. So I guess two questions here. Are you seeing a response from other players in the value segment, gain traction whatsoever? How would you characterize that? And then do you think that traditional clubs are ever going to figure this out? What their response is going to be – you think that however turn it around?

Yeah, I think, around the innings we changed since the last couple of calls. I think there is been somewhat of a – I guess more of a slowdown in the low cost growth compared to how it was like two, three years ago when every single person you’ve talked to was opening up $10 club. And I think the beauty of it is they’re all opening ten dollars – because they wanted $10 club, they’re opening $10 a month gold [indiscernible] clubs. So they’re not really going after our culture – first time gym user type atmosphere. So I think of anything that probably making the LA fitness and 24 hour fitnesses, world’s top because they’re offering group exercise, spinning classes and everything else that $15 or $25 a month like a crunch or some. So, I don’t see everything have really changed other than what’s been happened.

And then how about on traditional side, if you don’t see any meaningful – for those guys?

Like the LA Fitness is in the 24 hours or so – I have seen – probably if anything slowed growth as well in the recent probably 18, 24 months compared to three, four years ago.

Great, thanks guys.

Thank you.

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

Hi, Chris and Dorvin. Thanks.

Hi.

Hi.

I was curious about your thoughts around partnerships and the longer-term as you think about partnerships across healthcare or food or technology companies and health and wellness and what might makes sense for your business as you think about on alliances as we see so much happening across different aspects of this? And Chris the digital technology, maybe you could contextualize soon really helpful like what might be more actionable within your business model? And what might be more just nice to know about but not really practical in terms of how you balance, what’s appropriate for your brand and you’re maintaining the right level of focus, which is the line with their core competency of what you do best? Thanks.

Yeah, I think what groups have partnered with, I think well the technology might be interesting with the – what users are doing on the cardio and what kind of results or businesses are doing, whose who that will be able to do, now to have that data to show to insurance companies might be a partnership. Right now, we’ve been reimbursing our insurance companies, naming that healthcare, blue cross, blue shield, it goes on the list, but all we can tell them that if the person walks to the door we have no idea of what they did. So it would be interesting that what the data captures do we have more opportunities to sell or tell a story to either – insurance companies are big corporation of what their subscribers are willing to doing and getting benefits, some might be part – some of the partnerships. So, the 10 million members, and I said I think there is ways new levers of brand. I don’t know if its – whether it’s weight loss apps or some other type of connection that we can even have or maybe a Black Card plus to give them opportunity to learn nutrition or something like that. As a partnership, as far as the – I think that’s probably [indiscernible] they could add to that. As far as the technology piece, how we can conceptualize that. I think when you think about technology and you think about wearables and fitness apps, I think what’s interesting is they all track and wearables track everything. But nobody – they didn’t – but nothing really recommends what you do next. And very few people can capture this data and know what to do with it. I think it’s going to be – especially for our members, 43%, as I said in the past they are first-time gym users. They didn’t know what to do with it. They don’t even know where to start let alone what the data is telling them to do. So I think to be able to capture the data, free algorithms to them serve up your next workout should be this and help them start their fitness journey and bring them through that fitness journey for years if we can. And we never really had the opportunity to do that before. Unless you had one person training if I remember you had, and had it for free because they are not going to pay for it. I think as you get down the road, how you learn we don’t know what people really like on cardio. Do they just press start, do they like to hill climb, do they like just watch TV and that’s it or what programs they like to watch. What – the Black Card members will be able to walk through the Grand Canyon or walk through the Paris or walk through Charles River in Boston. Well, if that’s what they like, let’s give them more experience and like that so it keeps them engage. It keeps them curious about their next workout. Otherwise, every day you come to the gym with the exact same thing, day in and day out. I mean it gives more in right, so how we can enhance that experience and get them curious about want to walk in the gym the next day.

It sounds like you’re hitting on all cylinders really across the awareness and the numbers you’re seeing. What would you say candidly is what are things you’re more concern about are there things you’re just monitoring or uncontrollable factors as we just assess risk and reward and obviously, we’re in a very, very good period with the numbers we’re seeing. Thanks.

Dorvin you can add to this. I think real estate is in perfect timing for us. That’s good. I don’t see interest rates going too crazy that would slow growth down. Right now, our franchisee because 90% of the growth is by existing franchisees. And they got a portfolio of 20 to 30 stores. A lot of them are just paying cash equipment build out. So it’s not like that will really necessarily be a big slowdown either for us. I think the big thing is to stay discipline and keep executing and look at what opportunities we have to understanding our customers better and I think the data we capture today and will be captured in the future we didn’t even really have that ability to look at what the team we have in the office today we never really had this depth five years ago or three years ago. So I think it’s every single was [ph] made in the last by 24 months or so but it’s all data-driven and I think the results as you’ve seen, the results are showing it. We’ll be able to look at the businesses with much more refine ladders, and make much sharper decisions, which is really driving this machine.

And just lastly, a modeling question. Dorvin, on the equipment by, what are the longer-term parameters from which we should model that? Do you expect it to stay within a similar margin range? And are there any things we should know looking ahead and a multiyear basis? Would it be lumpy or would it be pretty smooth?

I think, obviously, as you know, there are current contract expires next June. So our margins will be clearly flat turning down then from a margin perspective. And I think we’ve guided or given data that we expect this year, our replacement equipment as a percentage of total equipment to kind of be in the 30% – call it 37% range. So that’s higher than last year. I think we’re at 28%, 29% last year thereabouts. More and more next two or three years, we’ll be coming up for the replacement cycle. So if we keep our new flat, you’re going to continue to see that replacement I think increase as a percentage. And just by nature tends to be lumpy, given that we want, we don’t want stores replacing equipment and call it November, December, January, February, March kind of time period. Albeit some do, but it tends to be fairly lumpy more than half usually is in Qs Q2 and Q3 kind of downtime period in terms of usage in the club, et cetera. But I guess as I said back and think about maybe a little bit longer-term, I still say, as I said, it was to John Ivankoe [ph] earlier, a couple of hundred stores a year, I think, make sense from a new openings perspective. I think placement will probably grow a bit as I mentioned a minute ago. And then the big unknown, which Chris talked a little bit earlier, would be as we negotiate under RFP for the next contract what it will all be about what technology is included in the equipment that we end up with, which brand we end up with. And is that still come with a price reduction. Is it all set with technology, et cetera, et cetera. We’re nowhere close to having that conversation yet. But I think that’ll be the factor that ultimately determines kind of what that margin rate is on a go-forward basis.

Okay that’s super helpful. Thanks. I’m really excited about the digital innovation and congrats on a great quarter.

Great, thank you.

Your next question comes from George Kelly with Imperial Capital. Your line is open.

Hi guys a couple of questions for you. Just to start one more on the machine technology enhancements. You mentioned different settings, walking through the Grand Canyon and different cities. Are there any other major enhancements that you think, that you’re excited about that could boost Black Card penetration? What else is exciting?

I mean, there’s a lot of different things. I mean there’s going to be you guys set your own Spotify account, your own Netflix account and remembers so the next time you swipe to get in, it remembers all your logins for you. So you don’t have to re-login every time you watch it. And even if you finish up the show you watched last night at home and watch on the treadmill and finish it up. And the beauty of it though is George we have learned from that, right? So if you like Spotify, well maybe put Pandora, maybe put the iHeartRadio. You just kind of can follow people of what they’re doing it might get to the point where you are actually learning people where each person’s experience is independently different from each other. So I think as we get smarter on what people are doing, is going to evolve the product, which is going to be really interesting as opposed to just having a treadmill that’s just doing the same thing for five years.

Sure, sure makes sense. And then taking question on pricing, when you’re doing the test about the new Black Card pricing, what gave you comfort that you could put – make that mandatory across the base what you see?

Sure, yes. So we reciprocity is by far the number one biggest used perk, if you will, of the Black Card. 50% of our Black Card members in 2016 took advantage of that perk and used the clubs at least once, other clubs and their home club and 20% of every Black Card workout last year was not at their home club, they were at a different club. So as we started Black Card, we had 20 stores, now we’ve got over 1,400. So that perk is a well-utilized perk and it’s tons of value to more $2, you’ve got access to 1,380 more stores. So it’s a great perk. Guest privileges can use perk to bring a guest for free. And inside our stores, we used to just have a couple of mechanical beds in the corner and that’s about it. And now we have we hope to call them Black Card spa, which is a little bit like the private Delta room in the Airport. So it’s a little lounge area, we have our tanning, the massage beds and massage chairs, we have TV to wait for your session. So it’s a little bit of an exclusive deal when you get in there. So the value has just increased greatly from when we came up with a $99.09 price, and the $21.99 for $2 is kind of a such a great value, it still no-brainer compared to actually better value in the I think.

Okay. And when you are doing the test so you didn’t – I mean it sounds like there weren’t any kind of major changes to – did you see any difference in Black Card adoption?

With the club we were up to it didn’t test it on 100 stores and it was zero – it was like zero [indiscernible] the non always like may be 2%, 3% max.

Okay, so that’s an easy twist. Thank you.

Yes.

Thanks George.

Your last question comes from Amanda Adami with Macquarie. Your line is open.

Hi thank you for taking my questions. Most of mine have been answered. I just wanted to make sure that I understood in terms of the shift from the new store openings that were scheduled in Q3 adjusted into Q4. I just wanted to know if any of the scheduled openings in 2017 have been pushed into 2018? And if so, if any of these were impact of hurricanes?

No stores impacted by the hurricane in terms of our openings. And we guided – if you go back to our last quarter, we guided to 190 to 200. So we’re still at 190 to 200. Small shift and just timing of a handful – small two or three clubs that could have shifted from Q3 into Q4. But as I’ve said before on the call, you go down to the last couple of weeks to try and open a club. And you ran into you can run into a number of issues to get your certificate of occupancy to get moved in and literally be the inspectors out of town for a couple of days to be coming in and make you do additional work to get the store open. We’re not concerned with anything that moved out of Q3 into Q4. We’re still very comfortable. And as I said, we expect to be at the high-end of that range of 190 to 200.

Okay great. Thank you so much.

Thank you.

This concludes today’s Q&A Session I’ll like to turn the call back to Chris Rondeau.

Thank you. Thanks for joining us. I’m excited to be able to show such a great Q3 and look forward to wrapping up Q4 here and speak with you all early part of next year. And actually see momentum with catalyst. We’re definitely capturing from this marketing and opening new stores and each new member is feeling this flywheel, if you will. I think you can see with the horsepower that this company is capturing from this market penetration as well as brand awareness. So it’s exciting to see the business is where it is and I think look forward to the future for sure. So thanks for joining us and have a great night.

This concludes today’s conference call and you may now disconnect.