Planet Fitness, Inc. (PLNT) Q1 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Planet Fitness First Quarter 2018 Earnings Call. [Operator Instructions] Thank you. I will now turn the call over the call over to Mr. Brendon Frey of ICR. Please go ahead, sir.

Thank you for joining us today to discuss Planet Fitness' first quarter 2018 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 the disclaimer regarding forward-looking statements that is included in our first quarter 2018 earnings release, which was furnished to the SEC today on Form 8-K as well as our filings with the SEC referenced in that disclaimer. We do not undertake any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise. In addition, the company may refer to certain adjusted non-GAAP metrics on this call. Explanation of these metrics can be found in the earnings release filed earlier today. With that, I'll turn the call over to Chris Rondeau, Chief Executive Officer of Planet Fitness. Chris?

Thank you, Brendon, and thank you, everyone, for joining us today for our Q1 earnings call. I'm very pleased that we delivered another strong financial performance, highlighted by system-wide same-store sales growth of 11%, which is on top of an 11% gain a year ago; and adjusted earnings per share of $0.27, an increase of 42% over $0.19 in the prior year period. We continued to expand the Planet Fitness brand in both established and newer markets through the system-wide opening of 47 new locations and ended the first quarter with a total of 1,565 stores in the U.S., Canada, Dominican Republic and Panama. And as of last month, we now have a presence in Mexico, following the very successful opening of a franchise location in the city of Monterrey. We also ended the first quarter with more than 11.8 million members and are quickly approaching 12 million, milestones we believe this industry has never come close to seeing before, with an all-time high of roughly 7,500 members per club at the end of Q1. It is clear that our welcoming nonintimidating environment and accessible price point is increasingly resonating with the casual and first-time gym user. Another recent highlight is our franchise conference, which was held in Vegas in March and included a record attendance with approximately 1,300 franchisees, club staff, corporate team members and vendors participating. The theme of this year's event was opportunity, as we are energized and bullish on the tremendous opportunity we have in front of us: to grow the brand, open more stores and improve many people's lives. We also focused on harnessing the passion within our system, delivering on our purpose to providing a unique non-intimidating, high-quality fitness experience at an incredible value and empowering our people to providing welcoming top-notch member experience in our stores each and every day, which we believe is a huge competitive advantage for us. Another key focus of the week was our technology vision for the future. We outlined how we are exploring new ways to deliver a more personalized and connected fitness journey to our members via our equipment and enhanced mobile app and by leveraging apps. The system is energized about the possibilities ahead of us, and we look forward to working with our partners and franchisees to leverage our size, scale and data to enhance our members' experience in the coming years. Turning to our current equipment RFP. We continue to have productive dialogue with our current equipment supplier, Life Fitness; and potential equipment vendors, Matrix and Precor. As we've discussed before, in some of our stores, we're testing new equipment from each company that provides an enhanced user experience. We are in the process of our fee negotiations, and we plan to share more detail on our Q2 call. As announced in April, Rob Sopkin, former Chief Development Officer, decided to leave Planet Fitness to pursue other opportunities. We have already initiated an aggressive search for his replacement. I'm confident that the strong development team we have in place will continue to successfully execute our growth strategy and support our franchisees as they open new stores. Until we fill the CDO role, Dorvin will be overseeing Rob's functions. And equally important, our new store pipeline remains robust, with over 1,000 stores in the pipeline and 600 scheduled to open in the next 3 years. Our franchisees are as energized as ever about expanding their presence in new and existing markets. Finally, the depth of our leadership team continues to be a focus for us to support and pursue our aggressive growth. With that in mind, we have begun recruiting for the new position of Chief Marketing Officer. As we embark on our next life cycle as a company, this is a great opportunity to build upon the great work and talent of our existing marketing team and help guide us through the future, with an increased focus on things like data and technology, optimizing our national and local advertising funds and the development of exciting new partnerships. In summary, 2018 is off to a solid start. System-wide same-store sales increased 11%; we strengthened our leading position in unaided brand awareness in the gym category; and membership figures continue to surpass the industry records we previously established. Looking ahead, we are very confident about achieving our full year outlook, and we remain extremely bullish on the long-term prospects of the business. In the U.S. alone, where 80% of the population doesn't have a gym membership, we have the opportunity to more than double our store base to 4,000. Meanwhile, we see several other compelling growth markets for our high-value, low-cost fitness concepts, including Canada and Mexico, with Mexico having even lower gym participation rate than the U.S. I know our franchise groups share our enthusiasm about the future, and they are eager to continue to building their businesses and focus on generating strong returns. With that, I'll now turn the call over to Dorvin.

Thanks, Chris, and good afternoon, everyone. I'll begin by reviewing the details of our first quarter results, then discuss our full year 2018 outlook. For the first quarter of 2018, total revenue increased 33.2% to $121.3 million from $91.1 million in the prior year period. Total system-wide same-store sales increased 11.1%. From a segment perspective, franchisee same-store sales increased 11.4%, and our corporate stores same-store sales increased 5%. Approximately 80% of our Q1 comp increase was driven by net member growth with the balance being rate growth. The rate growth was driven by an 80 basis point increase in our Black Card penetration to 59.9% compared with last year, combined with the $2 increase in Black Card pricing for new joins that was put in place system-wide on October 1, 2017. During the quarter, the increased Black Card pricing drove approximately 150 basis points of the increase in same-store sales. Our franchise segment revenue, which beginning in 2018 now includes national advertising fund revenue, was $54.6 million, an increase of 48.4% from $36.8 million in the prior year period. Let me break down the drivers of our fastest growing revenue segment. Royalty revenue was $34.4 million, which consist of royalties on monthly membership dues and annual membership fees. This compares to royalty revenue of $20.9 million in the same quarter of last year, an increase of 64.6%. This year-over-year increase had 3 drivers: first, we opened 199 new franchise stores since the first quarter of last year; second, as I mentioned, our franchisee-owned same-store sales increased by 11.4%; and then third, a higher overall average royalty rate. For the first quarter, the average royalty rate was 5.4%, up from 3.9% in the same period last year, driven by more stores at our current royalty rate, including stores that amended their franchise agreements. Next, our franchise and other fees were $5.7 million compared to $7.3 million in the prior year period. These fees are received from processing dues through our point-of-sale system, fees from online new members sign-ups, fees paid to us for new franchise agreements and area development agreements as well as the sale and transfer of fee of existing agreements. The decrease is due to the number of stores that have amended their existing franchise agreements and increased their royalty rate instead of paying higher cost of goods for operational expenses. In addition, the change in how we recognize area development agreements and franchise agreement fee revenue was about a $1.8 million headwind in Q1 of this year compared to the prior year. As we outlined on our Q4 call, we now need to recognize these fees over a 10-year period versus at the time the related franchise agreement and lease is signed. Also within Franchise segment revenue is our placement revenue, which was $2.1 million in the first quarter, flat with a year ago. These are fees we receive for assembly and placement of equipment sold to our franchisee-owned stores. Our commission income, which are commissions from third-party preferred vendor arrangements and equipment commissions for international new stores, was $2 million compared to $6.5 million a year ago. The decrease was attributable to the number of stores that have amended their existing franchise agreements and increased their royalty rate instead of paying higher cost of goods for operational expenses, as discussed above. Finally, national advertising fund revenue was $10.5 million compared to 0 last year as the new GAAP rules related to how we account for NAF contributions went into effect on January 1 of this year. As a reminder, prior to this year, the NAF contributions really only had an impact on our balance sheet. Due to recent accounting changes we must now recognize these contributions as revenue and record the expenses associated with managing the National Ad Fund as marketing expenses. Our corporate-owned store segment revenue increased 21% to $32.7 million from $27 million in the prior year period. The $5.7 million increase was driven by the 6 franchise stores in Eastern Long Island that we acquired in January; the 4 corporate stores we opened in late 2017; corporate-owned same-store sales increase of 5%; and increased annual fee revenue. Turning to the Equipment segment. Revenue increased by $6.7 million or 24.8% to $34 million from $27.3 million. The increase was driven by higher replacement equipment sales to existing franchisee-owned stores and higher new store equipment placements versus a year ago. Our cost of revenue, which primarily relates to direct cost of equipment sales to new and existing franchisee-owned stores, amounted to $26.5 million compared to $21.1 million a year ago, an increase of 25.4%, which was driven by the increase in equipment sales during the quarter. Store operation expenses, which are associated with our corporate-owned stores, increased to $18.4 million compared to $15.2 million a year ago. The increase was driven primarily by costs associated with the 10 stores opened or acquired since the first quarter of last year. SG&A for the quarter was $17.6 million compared to $13.8 million a year ago. The increase was primarily related to incremental payroll to support our growing operations and infrastructure as well as higher equity compensation and expenses related to our franchisee conference held in March, which was not in the prior year quarter. National Advertising Fund expense was $10.5 million, offsetting the aforementioned NAF revenue we generated in the quarter. Our operating income increased 17.7% to $38.9 million for the quarter compared to operating income of $33.1 million in the prior year period, while operating margins decreased approximately 420 basis points to 32.1% in the first quarter of 2018. The decrease in operating margins was threefold. The most significant of which was the addition of gross-up of NAF revenue and expense mentioned above, which decreased margins by approximately 300 basis points; second, the impact of 4 new corporate stores opened since March 31, 2017, and are not yet at a mature run rate; and third, higher SG&A compared to a year ago. Our GAAP effective tax rate for the first quarter was 22.7% compared to 28.5% in the prior year period. As we have stated before, because of the income attributable to the noncontrolling interest and not taxed at the Planet Fitness corporate level, an appropriate adjusted income tax rate for 2017 was approximately 39.5%, if all the earnings of the company were taxed at the Planet Fitness, Inc. level. While for 2018, following the passage of tax reform late last year, an appropriate adjusted income tax rate would be approximately 26%. On a GAAP basis for the first quarter 2018, net income attributable to Planet Fitness Inc. was $19.9 million or $0.23 per diluted share compared to net income attributable to the Planet Fitness Inc. of $8.8 million or $0.14 per diluted share in the prior year period. Net income was $23.5 million compared to $17.9 million a year ago. On an adjusted basis, net income was $26.2 million or $0.27 per diluted share, an increase of 42.3% compared with $18.4 million or $0.19 per diluted share in the prior year period. Adjusted net income has been adjusted to exclude nonrecurring expenses and reflect a normalized tax rate of 26.3% and 39.5% for the first quarter of 2018 and 2017, respectively. 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 noncash and other items that are not considered in the evaluation of ongoing operating performance, increased 15.4% to $48.8 million from $42.3 million in the prior year period. A reconciliation of adjusted EBITDA to GAAP net income can also be found in the earnings release. By segment, our Franchise segment EBITDA increased 14.5% to $36.7 million, driven by higher royalties received from additional franchisee-owned stores not included in the same-store sales base and an increase in franchisee-owned same-store sales of 11.4% as well as a higher overall average royalty rate. Excluding NAF revenue and expense, our Franchise segment, adjusted EBITDA margins decreased by approximately 400 basis points to 84.1%, with the decrease due to the higher SG&A expense compared to the prior year. This increase in SG&A was related to the incremental payroll and the franchisee conference expenses discussed above. Corporate-owned store segment EBITDA increased 13.8% to $12.2 million, driven primarily by the 5% increase in corporate same-store sales, higher annual fees and the 6 franchise stores we acquired in January. Our Corporate Stores segment adjusted EBITDA margins decreased 125 basis points to 38.9%. This decrease in adjusted EBITDA margins was primarily the result of the four new corporate stores that are not operating yet at a mature run rate. Our Equipment segment EBITDA increased 22.6% to $7.5 million, driven by higher replacement equipment sales to existing franchisee-owned stores and higher new store equipment placements versus a year ago. Our Equipment segment adjusted EBITDA margins decreased approximately 40 basis points to 22%. Now turning to the balance sheet. As of March 31, 2018, we had cash and cash equivalents of $127.1 million, and borrowing capacity under our revolving credit facility stood at $75 million. As a reminder, we utilized approximately $29 million to complete the aforementioned 6-store acquisition during the first quarter. Total bank debt, excluding deferred financing cost, was $707.7 million at the end of Q1, consisting solely of our senior term loan. Now to the full year outlook. For the year ended December 31, 2018, we still expect revenue to increase by approximately 20%, adjusted EBITDA to grow in the mid-teens percentage range and adjusted net income and adjusted EPS to increase by approximately 40%. The assumptions used in developing our full year guidance have not changed. System-wide same-store sales are forecasted to increase in the high single-digit percentage range. We're expecting to sell and place equipment at approximately 190 to 200 new stores again this year and anticipate replacement equipment sales to be approximately 40% of total equipment sales. Finally, we are assuming an effective tax rate of 26.3%. I'll now turn the call back to the operator for questions.

[Operator Instructions] Your first question comes from the line of Oliver Chen from Cowen and Company. Please go ahead.

Dorvin, on the margins by division, how are the margins versus your expectations? And what was driving the equipment margins in terms of the trend there? And our second question was just about the opportunity in terms of the overall number of units over time and the members per club. You've had such really strong momentum. What are your thoughts on how you're viewing the addressable market at this point?

We came in pretty much on our expectations for the quarter from a divisional margin perspective. The specific question with respect to equipment margins. We stated in the past, kind of in the 22% to 23% range, which is where we have been historically, a little bit lower this particular quarter, primarily because of the mix of some of our re-equips that we had during the quarter. There is a little bit of a lower margin between cardio and strength at times. But we're talking varying just a few basis points. So maybe slightly below, but as I said, we've guided to right around the 22%. In terms, I think, of units over time, I stated a few minutes ago that we're - the guidance we gave for the year, we're maintaining that guidance of 190 to 200 stores that we would place equipment in, which is consistent with pretty much where we've been for the last two to three years and what we've stated is more of our long-term goal of that, call it, close to 200 a year. Our pipeline is still over 1,000 stores. Our franchisees are continuing to - the larger ones are opening more than they were before. The smaller guys are still doing about the same. As you know, we've had some consolidation in terms of some of the ownership. But the pipeline continues to remain strong. And with the comps we've had, I mean, this is the highest average members per store that we've ever had. So we feel pretty good about the overall kind of 4-wall economics of the stores.

I think I'm going to add to that, the 7,500 members per store, is it kind of goes back to what we've talked about in the past, is it kind of more confirms the 4,000 unit potential. Because eventually we've got to continue to open more doors to satisfy the member need.

And when you do monitor the members per club, how do you balance that against just making sure your customer service and the satisfaction is really high? I know you've done a very good job with recognition in that front. But is there a tipping point from which units become just too full.

So yes, so we have - in 20,000 square-foot typical box, we have many, many stores that have 10,000 members per store. I'd say when we get to that, call it, 12,000 number, it probably gets a little dicey. But I think when we talk about our market planning, when we use - plotting our members on a map using our Buxton software. We talk about how we can put the next location in. And we see where, in a store, where we had 12,000 members, for example, we know where each and every single one of our members lives, so we purposely can put stores in order to help alleviate the stress of the other store and expand the market.

And lastly, Dorvin, the comps had been impressive on top of strong comps. Do you feel like the mix will stay the same between the number of members versus pricing in terms of 80% of it being net member growth? Or will that mix change over time?

Yes. I think this is the first quarter in quite a while where we've shifted from, call it, 90% being member growth to 10% being rate growth, and obviously, the pricing that was put in effect back at the beginning of Q4 last year had a bigger impact this quarter than it has historically. I mean, it's clearly, we and our franchisees, we run our operations to try to maximize that Black Card percentage because it - every incremental dollar, there's a lot of variable of that flow through to the bottom line. But I think that 80-20 is probably not a bad number. Certainly, in the nearer-term, once, if we ever get to the point of where there is additional offerings with respect to Black Card membership, in club or out of the club, I could see that maybe changing. But we feel pretty comfortable with where it's at right now.

Your next question comes from the line of Dave King from Roth Capital. Please go ahead.

I guess first on Mexico. What can you say about the pace of initial sign-ups in Monterrey? And then I guess more broadly speaking, what's the long-term plan there? Do you expect to find multiple ADAs beyond JEG-Fit? And what's the sort of longer-term expectation? Is it still 400 locations?

So that store opened ahead of expectations. It actually opened with 5,000 members first week it opens its doors. So it was a great, great turnout. That particular group is going to open a couple of more stores there in a couple of different demographic markets to figure out, help us learn from that what our true potential is in Mexico. Kind of a general rule of thumb from what I've heard from other sources is that it's 10% of the U.S. is kind of how they look at it, which I think as we open a couple more stores will help us prove out what that true potential is, based on the other demographic markets that, that opens in. But it was a great turnout. We had a great media event for the grand opening. I actually attended it. People were extremely happy. Usage was great. A lot of people you could tell were their first timers as well, and I think there's a lot of potential down there. And Unlike Dominican Republic or Panama like we've mentioned in the past, this one definitely has more potential, more like a Canada. So it gives more growth for us as a company. As far as how we grow it, whether it's ADAs or master franchises, still up in the air, for determination on how that plays out. But we'll see how it goes in the next couple of stores.

That's all good color and good to hear. And then switching gears. In terms of the six corporate-owned stores you acquired, assuming those weren't included in the comp. How well are those comping? And then how is the productivity there versus the corporate average?

Sure. Six really good stores out on the eastern side of the island. As we stated, synergistically, it made a lot of sense. We own the Western part of the island. This particular franchisee that was retiring on the eastern side of the island. Long Island is one of our better markets, and these stores are very comparable to our existing stores or the stores we had out there in Long Island. So very complementary in terms of top line and EBITDA contribution. So we're really pleased with the acquisition.

And then I guess lastly for me in terms of the 4 newly opened corporate-owned ones. How are those - it sounds like those - obviously, they haven't matured yet, because they just opened. But what can you share about membership or - memberships or revenue contribution thus far, and what's the kind of productivity ramp?

I mean, we have a maturity curve that we always look at whether - frankly, whether it's a franchisee or a corporate store. I mean, when you think of the base number of stores we have and the number of stores we open per year, we're opening stores every month. So we know what the averages are looking back over the past several years of stores that opened in any particular month or any particular quarter. I'd say those 4 stores, the corporate stores are tracking right in line with other stores in that same vintage. So very comparable maturity curve.

You're next question comes from the line of John Heinbockel from Guggenheim Securities. Please go ahead.

Guys, let me start with you'd referenced consolidation among the franchisees. Where do you think, I mean, obviously it picked up, it looks - what I gather here that will continue here for a bit. What impact do you think that has on the business, if any, right, in terms of expansion, capabilities, operational execution? Is there any impact from that as we go forward?

As we talked in the past, I'd say a lot of these operators have got to build really big businesses and bring in some of the private equity groups to help bring a lot of sophistication to the back offices. Back when these franchisees were not only the - they acting as the CMO, the development guy, the ops guy and the financial guy. So allowing the franchisees to get back on the streets and do what they do best, and that's to open and build stores, service members and let the private equity build their back offices. I think some of the smaller consolidation, which has been good for us is a lot of the smaller maybe 1s, 2s, 3 guys that are in and around these other ADAs are being acquired by the larger groups around them which then opens the door for more market expansion, because cannibalization is not as much of an issue. So I think that's also a good way to look at it.

And another topic here. We've talked about the incentives, right, that some of the health insurers have provided to members or potential members. Has there been any discussion about - because I think one of the things we talked about is that the standards for reimbursement is pretty high. Has there been any discussion of that coming down but then maybe it was more compliance around people actually visiting, maybe 8 visits or something instead of 12 but actually doing more while they're there. Is there a discussion among side of that - that's sort of a nonstarter.

It hasn't happened yet, no. But I think whether it's partnerships through companies or corporate memberships or partners with insurance companies, I think it's both probably on the table to look at in the future. And hopefully, I think with some of the data we begin to capture and be able to report on in the future, especially with the cardio, should it all should work out correctly, it will allow us to give more insight to the insurance companies, more about how many calories they're burning, what their heart rates are as opposed to the fact that they just showed up today. And hopefully, that drives the requirement of 12, 15 visits a month, which is almost unattainable in a lot of people's lifestyles.

And then lastly, you referenced the impact from some investments in payroll and the franchisee conference, right? So 400 basis points is $1.5 million to $2 million. How much of that is nonrecurring? I guess the franchisee conference is nonrecurring. But is a lot of that maybe 75%, 2/3 of that recurring through the remainder of the year?

Yes, John, about half of it was related to the conference. We do the conference now every 18 months. So we're comping over that - or not comping, I guess, so to speak. But about half of that incremental expense related to the conference.

Your next question comes from the line of Sharon Zackfia from William Blair. Please go ahead.

Maybe I'll follow up on that last question and then a separate question. So the run rate of SG&A growth obviously picked up quite a bit in terms of year-over-year growth on the first quarter. For the full year, are you expecting the dollar growth to kind of be in that mid-20% range, which it's been for the last few years? Or is there a step up for the full year as well? And then secondarily, on the revenue, it's pretty hard to kind of contain revenue growth for the year to 20%. I think if you kind of go through the math, it implies maybe 16%, 17% revenue growth for the rest of the year given your phenomenal first quarter. And you get 10% from the ad fund alone. So can you help me think about why revenue growth would decelerate so much the rest of the year?

Let me take the last one first. There was a little bit of a timing shift from our expectations of really Q1 in terms of the cadence of new store placements. I mean, we're talking a handful but as we talked about in the past, it can kind of shift a little bit from quarter-to-quarter. We still, as I said, at the beginning, still feel confident of the 190 to 200 here as we said with 9 months to go. With that said, I think the balance of the year in terms of the cadence of openings, at least as we see it today, should play out pretty close to the way it's been in the past, albeit just a slight increase here, I think, in Q1. And then when you think about the flow through, it's obviously the lowest margin piece of the business flowing through it in this quarter, call it, 22%. So maybe there's a slight upside to that, but we're sitting here with the biggest driver of revenue, particularly Q4, coming in on the equipment side. And so with the insight that we have at the moment, we're comfortable in that 190 to 200. As we get to the end of Q2 and we report, I think we'll have a whole lot more insight then to leases signed and more specificity with respect to the openings in the top line side. I think in terms of leverage on SG&A, I think the rate will probably come down a little bit by the end of the year. I mean, as I stated a minute ago, we were pretty much on kind of where we thought we would come out from an expense structure perspective, albeit coming having kind of a one-timer in there. With revenue upside, if we were to have some, we would get some leverage on that by the end of the year because it's a relatively fixed-cost structure. But I would expect that to come down a bit over the balance of the year.

Can I ask - just a quick follow-up because SG&A has gone up as a percent of revenue since you've been public. Is this a line item that you do expect to leverage in future years?

There's a couple of things, Sharon. One in particular that I represent a little bit in the past and I think I had it in my prepared remarks a while ago. One element of kind of the "G&A side" has been our equity compensation. And we were not - when we went public, we were not at a, what I would call, kind of a full waterfall run rate because we have a 4-year vesting on our equity. And so when you initiate an equity plan, which we did, and you kind of get, call it, 1/4 of it, and then the next year, you have another grant, you get a 1/4 of that and 1/4 at the prior year. There's a little bit of the buildup of that, that we'll probably have. By the end of this year, certainly, call it, midyear next year, we will then have comped over that to where we're at a pretty good run rate on a go-forward basis. That's point number one. Point number two, and we've talked about this a lot, and I do believe that there is a benefit that we as a company have had by really reinforcing our field operations, whether it's training, whether it's operations, whether it's marketing. And we're a franchise business and to open a couple of hundred new stores a year, you've got to have some level of infrastructure to keep the brand consistency out there across all those mediums that I mentioned. And that's where our training program really comes into play in a lot of respects. And so we're probably doing 3x as much training today as we did 18 months ago as an example now. At some point in time, you make a very good point that you should be able to build it up to a point to where it at least ought to be a stair-step approach on a go-forward basis. But I think that Chris mentioned the new position that we're recruiting for, the CMO position. So that's really the only one that I would call as kind of incremental from where our base is today. So I think we're in a pretty good place with revenue growth to be able to start leveraging then the SG&A structure that we have built up incrementally if you look at it, over the last, call it, 18 months or so.

Your next question comes from the line of John Ivankoe from JPMorgan. Please go ahead.

I was wondering what the feedback was from the franchise conference that you had. Obviously, you have a list of successful people that aren't probably satisfied just by the nature of their success, they always want more. So I was curious what that more was. I mean what do the franchisees push back to you on in terms of what they wanted you to deliver more for them. What was the number one agenda item from their perspective?

It's definitely more territory. It’s not at all that looks which is good. But in general - I mean the undertone of this conference, hands down, John, was - in all the years doing this was the best camaraderie and morale I've seen yet and more bullish than ever. And what was interesting even for me to see is a lot of these franchisees were part of a private equity and it honestly took some chips off the table. To see that they were even more engaged than before, where you think you get nervous, do they throttle back. And it's - they're so bullish that - I was saying at the conference with 1,500 stores open and potential for 4,000. I really feel we're really in the third or fourth inning here, honestly. And I'm more excited myself personally than I ever have for the company in the future. And it was interesting to see that they all thought of it the same way. It's really, I mean, honestly besides the ones we just bought that the franchisee actually retired, I can't think of anybody yet who's really retired. They're all so all-in. So it's exciting to see, and I think that's why we - last year we opened a record number of stores at 210 and look like we're going to do - we'll have another great year this year. So it was all great to see.

Just to add one comment, John. Because I think it speaks to Chris's point about "they're all-in." We had 1 franchisee that brought 47 people to the conference. So think about the investment that, that franchisee did to bring their ops people, bring them in for training, give them - let them have that same kind of peer-to-peer conversations with other people. Three or four years ago, one, they weren't that big but they wouldn't have invested that much money to bring people to it. So it was pretty - really interesting to see that.

That's fantastic and certainly what I would expect. Is there anything that you really asked them for? I mean certainly if they want more territory, you could give them more sites to build or allow them to build more sites. So what was it that you kind of gave them on the agenda item in terms of what you wanted to see more of in '18 and '19, for example, than what you've seen in previous years?

I'd say my whole undertone of the conference was to continue to stay hungry and that really we were in the third or fourth inning here, that not throttle back, not rest on our laurels, let's go all-in and double down and continue to do what we do best and that's build stores and service members. So I want to make sure that they stay hungry and stay excited for the brand. So I think it truly resonated and that really was my message from a top standpoint in my general session.

And then final questions is on balance sheet. Any update in terms of looking at current credit markets, especially if interest rates are going to go up, and taking advantage and terming out the balance sheet now and putting more debt on the balance sheet?

Yes. I think, John, that's clearly been even more a focus of Chris and I with our board. And as I stated last year and early this year that this is a focus that we're on here for, call it, mid to early back half of the year.

Your next question comes from the line of Jonathan Komp from Baird. Please go ahead.

I wanted to start off by asking about how you're thinking about the same-store sales. I know you held the guidance for the year up high single digits, Q1 tracking above that. And I believe you get a little bit of incremental pricing yet coming up the next 2 quarters here. So how are you thinking about same-store sales and any kind of directional guidance on the near-term trends?

Yes. I think, Jon, as we look at our business and as Chris said earlier, we feel good about our business and what we've seen in terms of what our franchisees are able to deliver in Q1, you're right we've got a couple more quarters now where we've got the pricing impact on a quarter-over-quarter basis until we cycle that in Q4. Slight movement we've seen, I think I said 80 basis points improvement on the Black Card side. We're not really anticipating that, that will move much more as I had mentioned earlier in the call in terms of where that could go. I think that should stay, call it, flattish. As we think about the way we model the business, we don't, certainly in the nearer term, see that moving. It gets a little bit harder obviously in Q4 in terms of the comparison. But we believe that in that high single-digit range is still a good kind of number to peg for the balance of the year. It was certainly a little bit higher than Q1. We thought it would be a little bit higher in Q1, and then we expected to be a little bit less, particularly when we get to Q4. So that's the way we've been thinking about it in terms of the composition.

And then I wanted to follow up on the question of flow-through a little bit. It sounds like a few of the pieces are maybe unique to the quarter. It doesn't sound like you're disappointed with the flow-through. Maybe this isn't totally a fair question, but I know in the past you've started to establish a pretty good track record of consistently raising the outlook. And I'm wondering if kind of the lack of a raise, if you will, is any sign of your less confidence in what you're seeing or in terms of the incremental investment that's needed to keep driving the business. Just curious. Any thoughts you have there?

Yes. I guess I would say it's consistent with the way that we've thought of our business, when we've given guidance, you go back the 2 previous years. We certainly haven't given quarterly guidance and we've as we get more visibility in the year, we certainly, as we felt more confident about it, we've changed that. But at the end of the day, I'll go back to the point I made a minute ago and that's such a huge chunk of the top line side is driven by equipment and a lot of that equipment sales hits in the last, call it, 6 to 8 weeks of the year. We don't anticipate that to change in a big way as of right now. We still think that franchisees - it's just the cadence that they've had now for years. And so to get that visibility into a lease signed construction - landlord turnover construction started, once we get to that, then it's relatively easy to kind of draw a line in the sand and when - when that club is going to be ready for the equipment and then get open. But I'd say we're pretty consistent with the way we're thinking about the balance of the year this year. At the same time, similar to where we were at this time last year.

And then the last one for me. I know this isn't a line item you guide to. But any thoughts, I know you had the $100 million ongoing buyback plan that you authorized at the start of the year. Any thoughts on appetite to take advantage of that?

I think that the way we work with our board is, we certainly - and we felt like we didn't have a big enough buyback plan in place and that's why we increased it last year when we did that. I think that it's aligned a little bit with John Ivankoe's question earlier in terms of how we're thinking about the right capital structure of the company. But clearly, our board and Chris are all aligned on, we still feel very confident in our model and the ability of continuing to have the kind of performance we've had. And we've got it there available to take advantage of if we need to in addition to if we were to do some type of recapitalization down the road. So that's the way that we've been talking to our board about it.

Your next question comes from the line of Peter Keith from Piper Jaffray. Please go ahead.

It's actually Bobby on for Peter today. Just around replacement equipment. Could you just remind us what the average total cost to replace cardio equipment is? And related to that, can a franchisee do a partial refresh if they want to adopt some of the new technology equipment that you guys discussed?

Yes. So a typical 20,000 square-foot box, which is the majority of what we open today is the total cost that to the franchisee - everything, freight, placement services delivered is in the $600,000-plus range, call it, $625,000-ish, in that ballpark. About 60% of that's cardio and about 40% of it is strength. And so they have to replace their cardio by the end of year 5 and strength by the end of year 7. So obviously, if you open your first door and your second, fifth and tenth store, you get into different cycles in there. And by the 1,500-plus stores, we've got stores that are going through their second or third or fourth cycle of some type of a replacement. Typically, a franchisee will not replace 100% of their cardio all at once. But they'll usually do it within a four quarter time frame. Some of them will. Some of them will just say, okay, we're going to replace all of our - like all of our treads all at once. But it's not unusual for it to be over a period of, call it, 3 or 4 quarters when they are replacing their equipment. The cost to the franchisee to replace the cardio within the contract term we're in today, as an example, for the last 3 years, the pricing has been exactly the same. So if you bought your cardio 3 years ago and you were to want to buy a new treadmill today, it's the same cost today as it was back then. So there's no difference between the overall pricing from that perspective. The point I'd made earlier with respect to the margins is that there can be a - in a particular cycle, in this case, the quarter. If you have a little bit of a higher mix between cardio or strength, it can vary a few basis points. it's not huge but it can vary a little bit. But in any event, that's the way the cycle works with respect to replacement and the COGS, if you will, for the franchisee.

And just real quick, a good strength in comp churn you have been seeing. Have you seen any improvement or change in the churn rate lately?

It has gotten slightly better over the last probably 12 months and probably...

You're next question comes from the line of Rafe Jadrosich from Bank of America. Please go ahead.

Dorvin, I think, can you talk about the impacts of the revenue recognition change to 1Q? And I think last quarter, you said you're expecting $4 million for the year. Is that still the same expectation?

Yes. It was about $1.6 million in Q1. So it may be a little bit north of that $4 million number that at that time, obviously, we didn't have everything totally finalized. But the - and that $1.6 million relates to the area development fees, the franchise fees and any sales or transfer fees. So those previously we were able to recognize pretty much upfront, whereas now, they're spread out over primarily a 10-year period. And then obviously, as I mentioned in my remarks earlier, the National Advertising Fund and marketing expense gross-up was about $10.5 million, P&L neutral, but $10.5 million on the top line, and then $10.5 million in our SG&A. So the net of it, Rafe, was about $1.6 million. I think it will be a little bit north of the $4 million for the full year.

And then that'll - a little bit higher than $4 million, that's revenue and EBITDA but not - no impact to cash.

Yes. Less revenue and income but not any impact to cash. Correct.

And then, Chris, you spoke about the equipment RFP. Can you talk about some of the - some specifics around the innovation and new technology that you're seeing in the pipeline?

So we have the 15 test clubs that were - talking about in the past, we've implemented in the fourth quarter and the RFPs underway. Which the RFPs probably looks like we're not going to have the full technology thing nailed down actually by the contract term, which is end of June. So we're still in the process of finalizing the RFP. But the technology, I think we have to think about it like it's a 1 year pilot to get through to figure out which is - how the technology is going to work to our favor, what manufacturer is going to be the best suited to do what we want it to do and accomplish what we want it to accomplish from a reporting standpoint and customer experience standpoint. So I think it's good to look at the cardio as a 1-year pilot when it comes to the technology front, which has been pretty intriguing to see it roll out, which is still in the early stages but the equipment piece is really going to be - the final RFP will be announced in the second quarter how we end up with the contracts.

When you just look at the franchise margins, the decline year-over-year, was that entirely from just the change in the way you're recognizing the NAF or is there anything else that was driving that?

On a GAAP basis, yes, the NAF because it grosses up the P&L and - the revenue and expense. So if you take that out, it was about 400 basis points' decline and as I said earlier, about half of that decline related to the franchisee conference, which we didn't have in last year's quarter. That will happen 18 months from now in essence. So it's every 18 months, so roughly half of that is you could call it kind of onetime if you will. And then the other half related to the salaries and stock compensation that I mentioned in a previous caller.

Your next question comes from the line of Randy Konik from Jefferies. Please go ahead.

On the National Advertising Fund, you talked about continued increases in unaided brand awareness and you're talking about real nice things happening from a seeding perspective in areas like Mexico and other international opportunities. How do you think about the ad fund, not changing in terms of the volume, but how do you think of maybe distorting it differently in terms of where you're placing the ad dollars, how the messaging might change? And do you think about distorting some of the ad dollars to potentially some of the international areas to kind of accelerate brand awareness in those markets since the U.S. market seems to be getting - has gotten to a place of nice brand awareness as it is today. Just give us some perspective how you're thinking about that going forward.

Yes, the NAF, is really like the National Ad Fund for U.S. It has to stay in the U.S. and Canada stays in Canada and so on and so forth. So we wouldn't cross spend that. I think that's what you're asking. So that's actually, Canada has its own NAF started with their 25 stores that are opened that are spent there. So it really wouldn't go outside of that. But I think in the U.S., as we continue to open more stores, with potential of 4,000, I think we need to continue to spend the dollars here to continue to drive that member growth, more members per store. That's what drives our brand awareness, which continues to be able to allow us to continue to penetrate and fill up of the markets we're not in yet. You think about Massachusetts, we had about 70-something stores. We have that many in California. We just have a lot more runway to continue to penetrate here and as I mentioned, that's - I think where we're looking for a new role we haven't had here is the CMO role. So we're on a hot pursuit to have somebody come in to continue to figure out how to use all the NAF dollars from the U.S. and the other countries as well for to best of their ability. And in the U.S. what's our next big thing over and above New Year's Eve, other partnerships that we can do that our competition just quite frankly can't do.

And then going back to the equipment, I know there's been focus on DRP, what have you. But when you think about just various trend changes you've seen in the market of fitness being in it for the decades you've been in it, do you think about the proportion of cardio versus strength changing at all? Do you think about changing amenities in the Black Card area at all like just getting perspective on any themes or trends you're seeing that you may change how you think about laying out the floor, both in the White Card area and then in the Black Card member experience area?

I think cardio, some recent trends that I've seen is when step mills came back, the revolving stairs. When they come back, when they run off of a patent from StairMaster and later they decided to make it in Matrix, they definitely made a big run-through and we've typically added two or three per store and now we're up to adding four, five or six per store. So I think the stepmills have come back. And rowing machines seem to have a little bit of a comeback as well. But honestly a comeback because you're putting two or three per store when we still have 30 or 40 treadmills. Treadmills are really still the bread-and-butter when it comes to cardio, especially in our model. And we still put that 100 or minus cardio pieces per store but cardio is by far, for our members especially, if you look at our floor from a gym workout space, it's probably close to 70% cardio makeup. So it's definitely where we trend to go to for sure. But I think that comes down to, when it comes back to technology, and you think about people check into a gym, not just us but the entire industry, no one knows anything about what any member is really doing. How long are they on a treadmill, how long are they on a bike. Is the same member on cardio and a bike or are they just using the treadmill and going home. So that's why I think the technology piece is going to really educate us as to what is the true makeup and what is the true likes of the members, so we can better their experiences. One recent find, just with the - it's still early, but 1 recent find is that the average workout on cardio for us right now is 18 minutes but the average cardio workout per member is 30, so they're hopping around. They're not just on 1 piece the whole time. So this is data that we just never could get our hands on. It just didn't exist. So it's how can we learn from that. To me, it looks like they're looking for different varieties, they don't want to be on the same thing for the full 30 minutes.

Yes. That leads me to my last question and thinking through the medium to long-term and opportunity of monetization of the member count getting towards 12 million now. Have you guys thought about like a list of data or capture inputs that you want to get like you just referenced member - of what - how many pieces of equipment per visit that this person is on and minutes on the piece of equipment. Can you give us some perspective on the types of data capture items that you're looking at or want to capture over time? With the new technology vendor - with equipment vendors or system vendors, et cetera, could you give us some perspective of what you want to get and how you think about that going forward?

It's really a good question. When you look at back to that comment I made about the 18 minutes but they're doing 30, so they're on multiple things. But not only that, but now when they're on the things, what are they doing? For example, we know - it's still early, but we know now that the virtual active, which is the running outdoors stuff, is used more by 21- to 40-year-olds. But over 40-year-olds, primarily right now they're using TV. So as we think about that, okay, well on the virtual active, are those people happen to be working out longer, which would then lead to better results which would then - can actually lead to retention. So then we need to get more people doing virtual active. Or is it Netflix, or is it Spotify? So once we learn what is driving behavior to work out longer and get results and burn more calories, then we can try to get people to do - others that aren't, get them to use that, whether it's free trials or incentivize them with some sort of perk of some sort because we know long-term we'll just gain on retention, which will get on the back end. So that's just intel that just - this industry could not get their hands on. And building our data room now, with our new CDOI here to be able to capture that data, it's just going to give a huge competitive advantage. And honestly, Randy, as long as I've done this, I think this is going to revolutionize what we do the same way we pioneered the $10 membership. I really think this is going to be the next 3- to 5-year driver for us.

You're next question comes from the line of James Hardiman from Wedbush Securities. Please go ahead.

I had a few clarification questions. I guess, first, I think it was Sharon that asked the question about a really good first quarter and that not going through to the year. And I think you mentioned that there was some timing that shifted around with respect to placements. Just help me clarify, was the placement timing a benefit to the first quarter? And a detriment to the presumably to the remainder of the year? How should I think about that?

Yes, James. So in terms of total, we have both placements and openings, obviously. And so for the first quarter, we had 37 placements this year. We had 31 last year. So we came in at a bit higher in Q1, but we still believe that 190 to 200, which we guided to at the beginning of the year is still the same number we're guiding to now. So maybe a slight pull forward, if you will, I mean, these open - when construction is ready and the contractor's ready to take the equipment is when it goes. Obviously, they've got to get the rubber flooring down and a number of things have to happen before the placement team can get out there and get the equipment in. So there's obviously a mad rush there in the last few days because franchisee wants to get that store open as fast as possible, and they've already gone through presell, they've got members signed up and members ready to start working out day 1. So maybe just a little bit of a slight number stores that opened up a bit earlier than we would've thought as we look at our cadence for the year. I think for the balance of the year, the last 3 quarters, I think the cadence of remaining openings within that kind of guidance range I gave should be very similar to the way it was last year on a cadence basis. So that was the comment I made in response to Sharon's question.

And then a couple on the RFP. I guess I just want to be clear on the news flow that we should expect over the next few months. So the contract is up at the end of June. I think you mentioned that you'd have more to share on the second quarter call, which I'm assuming would be early August. But then you talked about a full year in terms of this cardio pilot. So help us - walk me through sort of how that's going to play out. And then Life Fitness, on their last call, they mentioned that they're proceeding under the assumption that it's going to be a nonexclusive deal with multiple suppliers. Obviously, there are negotiations underway so we have to take everything with a grain of salt. But that seemed like significant news. Maybe comment on however you feel like commenting on that. But maybe speak to some of the pluses and minuses off exclusive versus multiple suppliers.

Yes I'd say that because of the cardio technology stuff is still so new and still almost 1.0, would have you, and I think we need to go through a couple of iterations before we figure out who's is the right partner. I think it's too early to tell who's the right partner and I don't want to back ourselves into a corner and team up with the wrong one exclusive. So I think it's going for one year, figuring that cardio piece out. Negotiations are underway, but looking at what we see today, whether it's exclusive or not exclusive, whether it's all three or two or one. Our pricing, I think, is just so large now, although you think the volumes get it cheaper but also because if two or three are in the mix, they're getting competitive because they know they might lose the business anyway, so it's all worked out to our favor. So we'll be more on that in the Q2 call but notice isn't up yet and pricing is looking normal and the margins look fine.

But is the way to think about that, that once this contract comes up, there's going to be sort of a bridge contract over the course of the next year and then you'll have a final contract for a longer term period or how should we think about that?

Yes. That's one of the options, right?

And then I guess just lastly for me. I realize that your franchisees have replacement requirements in terms of the time frame, the turnover of equipment. Now that we're getting closer to the end of the current contract, how if at all is that affecting their purchasing behavior? I would've expected maybe some level of deferral ahead of the new technology being available. But your equipment sales have been really good. So help me understand if at all they're deferring those purchases ahead of that re-up.

That's a good question - so that if you bought a Life Fitness treadmill today for example and then down the road the technology launched, you could take literally the console of the current treadmill and put the new console on it. So it doesn't slow down that process so that they don't get - they don't have this equipment that looks like it's 10 years old.

Your next question comes from the line of Matthew Brooks from Macquarie. Please go ahead.

First I just want to ask about Mexico. How long did you have that store in pre-open to get to 5,000 on opening day? And how did that compare to, say, some of the openings in the Dominican Republic?

Yes. The presale was about 60 to 90 days roughly. It's kind of a normal time line that you see here in the states and a typical grand opening.

But you can say that with that many members opening in a country where it's the first location, you're not necessarily at a disadvantage because you don't have a brand. People are still attracted to the product in other countries.

Yes. I think a lot when you see Mexico, for example, there's not a lot of penetration in the gym space and there's not a lot of options unless you're extremely wealthy. And like 20% of the U.S. belongs to a gym membership. In Mexico it's barely 3%. So we don't have much brand recognition we just have a model that resonates with the larger part of the population than here in the United States does.

And two really quick housekeeping ones. Could you give us a mix of requips in the first quarter? And how many franchisees have amended their agreement to remove commissions?

I think it was right around 37% was the reequip percentage for the quarter. So we gave guidance for the year. It should be right around 40. So yes, it was pretty close to where we think we'll be for the full year. What was the last part of your question, Matthew?

How many franchisees have amended their agreement now? You've sort of been giving a running total on that, to remove the commission.

Yes. We're north of - I think we're right around 80% or so in total right now.

And there are no other questions at this time. I will turn the call back over to Mr. Chris Rondeau.

Great. Thank you, everybody, for joining us today, and it's another great quarter, and I look forward to the rest of the year and our Q2 call, give you more update on the equipment RFP at that point as well. So thanks again for the call, and look forward to catching up. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.