Planet Fitness, Inc. (PLNT) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Christine, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Planet Fitness Second Quarter 2018 Earnings Call. [Operator Instructions]. Brendon Frey, you may begin your conference.

Thank you for joining us today to discuss Planet Fitness' second 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 you to the disclaimer regarding forward-looking statements that is included in our second 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 for our Q2 earnings call. We had a great second quarter highlighted by another strong financial performance. System-wide same-store sales increased 10.2% on top of a 9% gain a year ago and adjusted earnings per share grew 55% to $0.34 compared with $0.22 in the prior year period. Planet Fitness' differentiated approach to fitness, providing a high-quality, judgment free experience to first time and casual gym users at a great value continues to resonate strongly to consumers. Our growing membership base exceeded 12.1 million at the end of the quarter, up from over 10.4 million a year ago. Consumers' passion for what we offer in addition to our well-capitalized franchisees continues to fuel growth in both new and existing markets. We opened a total of 44 new franchise locations in Q2, ending the quarter with 1,608 stores in the U.S., Puerto Rico, Canada, Dominican Republic, Panama and most recently, Mexico, as our first door officially opened in Monterey, Mexico in April. To help lead our continued growth and development, Ray Miolla joined Planet Fitness in June as Chief Development Officer. Ray brings over 20 years of real estate development experience in domestic and international franchising from global brands like GAP Inc., Burger King, and Jamba Juice. We are thrilled to have him on our management team to support our franchisees and internal teams. Ray will work to build upon our current momentum as brick-and-mortar retail continues to be under pressure from online businesses and landlords are increasingly looking to Planet Fitness to drive traffic in their centers. Further adding to the strength of our management team, we recently announced that Roger Chacko has joined Planet Fitness as Chief Commercial Officer, overseeing the company's demand generating functions such as marketing, branding, PR and communications, sales and corporate partnerships, channel management, corporate strategy, analytics and consumer research. This newly created leadership role will position us well to execute against our vision of putting the member at the center of everything we do and our mission to deliver exceptional 360-degree branded omnichannel member experiences that create sustainable, profitable growth for the company. We've had the pleasure of working with Roger on a consulting basis this March, where he has served as interim Chief Marketing Officer. In that capacity, he has proven to be a tremendous asset to the company, positively impacting sterile areas of our business. Roger brings with him more than 20 [Technical Difficulty] leadership experience at global brands like Carlson Hotel Group, Bloomin' Brands, USAA, Mars, Danone, and Kellogg's. I'm extremely pleased to officially welcome him to the management team, and I'm confident that he will play an instrumental role in helping to propel the business and brand forward. Now turning to an update on the equipment RFP. After a thorough evaluation process, we have made a decision to add Matrix and Precor to our existing equipment provider offering, which already includes our long-time partner, Life Fitness. This means that since July 1, franchisees have the ability to purchase equipment from each of the three vendors. This decision came as a result of a lengthy and detailed vendor evaluation process that included franchisee leaders. Several important factors were taken into account, such as price, warranty levels, service and the technological capabilities today. More important, their ability and willingness to innovate and evolve to align with our ultimate vision to provide more personalized and connected member experience, leveraging technology in our clubs in the future. I am pleased that we were able to leverage our volume with each of the three vendors to get the best possible price for our franchisees while keeping our margin similar to the previous agreement. We anticipate using this contract cycle to assess each of the three vendors in March for their technology developments moving forward. Shifting gears a bit. I'm excited that in June, we launched an exciting pilot program in our home state of New Hampshire called the Teen Summer Challenge. In partnership with Governor Chris Sununu and the New Hampshire Department of Health and Human Services that allows all teenagers ages 15 to 18 in the state to work out for free in any of our 17 locations. With inactivity and obesity rates continue to be a concern, this program gives younger consumers the opportunity to incorporate regular exercise into their lifestyles, potentially the first time while on summer break. The sponsor has been extremely positive, and we've facilitated thousands of teen workouts since the program's inception. We look forward to potentially expanding this initiative beyond New Hampshire next summer. Programs like these continue to raise awareness of our brand with younger customers while having a positive impact on their lives. Furthermore, I am proud this year that Forbes recently ranked Planet Fitness on their 2018 Best Franchises To Buy list, with PF ranking number three in the high-investment category. This is a terrific endorsement of our brand and operating model and speaks to the great returns we are generating for our franchisees, many of which are reinvesting their capital and expanding their businesses. Finally, as we announced on August 1, we completed the refinancing of our debt with a new $1.2 billion risk securitization facility. Dorvin will go into more details about this deal shortly, but I do want to share that we are very pleased with the outcome of the transaction, which is the first of its kind for our industry and allow us to take advantage of the current interest rate environment and put into place a fixed rate debt facility. In summary, I'm very pleased with all of our recent accomplishments. We continue to post strong financial results across the board while enriching the lives of our 12-plus million members. With a long runway from growth and new opportunities for enhancing the membership experience, the future looks incredibly bright for Planet Fitness and all of our stakeholders. I'll now turn the call over to Dorvin.

Thanks, Chris, and good afternoon, everyone. I'll begin by reviewing the details of our second quarter results and then discuss our full year 2018 outlook. For the second quarter of 2018, total revenue increased 31% to $140.6 million from $107.3 million in the prior year period. Total system-wide same-store sales increased 10.2%. From a segment perspective, franchisee same-store sales increased 10.4%, and our Corporate Stores same-store sales increased 5.7%. Approximately 70% of our Q2 comp increase was driven by net member growth with the balance being rate growth. The rate growth was driven by a 40 basis point increase in our Black Card penetration to 60.5% compared with last year, combined with a $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 250 basis points of this increase in same-store sales. Our franchise segment revenue, which, beginning in 2018, now includes national advertising fund revenue, was $58.2 million, an increase of 53.9% from $37.8 million in the prior year period. Let me break down the drivers of our fastest growing revenue segment. Royalty revenue was $38.3 million, which consist of royalties on monthly membership dues and annual membership fees. This compares to a royalty revenue of $23.6 million in the same quarter of last year, an increase of 62.6%. This year-over-year increase had 3 drivers: first, we opened 206 new franchise stores since the second quarter of last year; second, as I mentioned, our franchisee-owned same-store sales increased by 10.4%; and then third, a higher overall average royalty rate. For the second quarter, the average royalty rate was 5.5%, up from 3.9% in the same period last year, driven by more stores at higher royalty rates, including stores that amended their franchise agreements. Next, our franchise and other fees were $4 million compared to $6.3 million in the prior year period. These fees are received from processing dues through our point-of-sale system, fees from online new member sign-ups, fees paid to us for new franchise agreements and area development agreements as well as fees related to the transfer of existing stores. The decrease is due to the number of stores that have amended the existing franchise agreements and increased their royalty rate instead of paying higher operational expenses. In addition, the change in how we recognize ADA and FA fee revenue was about $700,000 headwind in Q2 of this year compared to the prior year quarter. As we outlined previously, we now need to recognize these fees over a 10-year period versus at the same time the related franchise agreement and lease assignment. Also within franchise segment revenue is our placement revenue, which was $3.1 million in the second quarter compared to $2.9 million last year. These are fees we received for assembly and placement equipment sales to our franchisee-owned stores. Our commission income, which are commissions from third-party preferred vendor arrangements and equipment commissions for international new store openings was $1.6 million compared with $5 million a year ago. The decrease was attributable to the number of stores that have amended their existing franchise agreements and increased the royalty rate instead of paying the higher operational expenses, as discussed above. And then finally, national advertising fund revenue was $11.2 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, 2018. As a reminder, prior to this year, the NAF contributions really only had an impact on our balance sheet. Due to the 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 21.1% to $34.3 million from $28.3 million in the prior year period. Of the $6 million increase, $2.7 million was driven by the six franchise stores in eastern Long Island we acquired in January, $1.3 million was due to the four Corporate Stores we opened in late 2017 and $2 million was driven by corporate-owned same-store sales increase of 5.7%. Turning to our equipment segment. Revenue increased by $6.9 million or 16.8% to $48.1 million from $41.2 million. The increase was driven by higher replacement equipment sales to existing franchise-owned stores and four additional new store equipment sales in the U.S. versus a year ago. For the quarter, replacement equipment sales were 56% of total equipment sales compared to 53% a year ago. Our cost of revenue, which primarily relates to direct cost of equipment sales to new and existing franchise-owned stores, amounted to $36.7 million compared to $31.5 million a year ago, an increase of 16.8%, 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 million compared to $14.6 million a year ago. The increase was primarily driven by costs associated with the six stores acquired on January 1, 2018, the four new stores opened in Q4 of last year, and costs associated with stores planned to open this year. SG&A for the quarter was $17.2 million compared to $14.8 million a year ago. This increase was primarily related to incremental payroll to support our growing operations and infrastructure as well as higher equity compensation. The incremental payroll is mainly attributable to additional hires the company made during the second half of 2017, and mainly, in our franchise segment. We'll begin to lap many of these cost increases starting in the third quarter, and therefore, we don't expect SG&A dollars to grow on a year-over-year basis at the same rate we experienced in the first half of 2018. National advertising fund expense was $11.2 million, offsetting the aforementioned NAF revenue we generated in the quarter. Our operating income increased 27.6% to $48.8 million for the quarter compared to operating income of $38.3 million in the prior year period. Although operating margins decreased approximately 90 basis points to 34.7% in the second quarter of 2018, this decrease was driven by the gross up on the income statement from the NAF revenue and the NAF expense mentioned earlier and negatively impacted operating margins by approximately 300 basis points compared to a year ago. On an adjusted basis and excluding the impact of NAF, adjusted operating income margins increased approximately 120 basis points to 38.6%. Our GAAP effective tax rate for the second quarter was 23.3% compared to 36.4% in the prior year period. As we have stated before, because of the income attributable to the noncontrolling interest, which is not taxed at the Planet Fitness corporate level, and 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. For 2018, following the passage of tax reform late last year, an appropriate adjusted income tax rate would be approximately 26.3%. On a GAAP basis, for the second quarter of 2018, net income attributable to Planet Fitness Inc. was $25.9 million or $0.29 per diluted share compared to net income attributable over to Planet Fitness Inc. of $12.4 million or $0.16 per diluted share in the prior year period. Net income was $30.4 million compared to $18 million a year ago. On an adjusted basis, net income was $33.2 million or $0.34 per diluted share, an increase of 53.3% compared with $21.7 million or $0.22 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 second 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 21.8% to $58.4 million from $47.9 million in the prior year period. A reconciliation of adjusted EBITDA to GAAP net income can also be found in the earnings release. On an adjusted basis, and excluding the impact of NAF, adjusted EBITDA margins increased approximately 50 basis points to 45.1%. By segment, our franchise segment EBITDA increased 23.3% to $40 million, driven by higher royalties received from additional franchisee-owned stores not included in the same-store sales base and an increase in franchise-owned same-store sales, up 10.4% as well as a higher overall average royalty rate. Excluding NAF revenue and expense, our franchise segment adjusted EBITDA margins decreased by approximately 120 basis points to 85.9%, with a decrease due to higher SG&A expense compared to the prior year. As I mentioned earlier, the increase in SG&A was primarily related to the incremental payroll we added in the second half of 2017 to support our fastest growing segment. As we move through the back half of 2018, we expect to start to leverage our franchise segment cost structure and drive margin expansion in the fourth quarter. Corporate-owned store segment EBITDA increased 14.2% to $14.7 million, driven primarily by the 5.7% 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 by approximately 140 basis points to 44.7%. This decrease in adjusted EBITDA margin was primarily the result of the 4 new Corporate Stores that are not yet at a mature run rate. Our equipment segment EBITDA increased 16.8% to $11.5 million, driven by higher replacement equipment sales to existing franchisee-owned stores and higher new store equipment sales versus a year ago. Our equipment segment adjusted EBITDA margins were 23.8%, flat with last year. Now turning to the balance sheet. As of June 30, 2018, we had cash and cash equivalents of $147.8 million and borrowing capacity under our revolving credit facility stood at $75 million. Total bank debt, excluding deferred financing cost, was $705.9 million at the end of Q2, consisting solely of our senior term loan. As we announced on August 1, we completed a refinancing of our existing senior secured credit facilities with a new securitized financing facility. We are pleased to report that the deal was well received by the lending community and the interest rate we'll be paying reflects the investment community's confidence in our business. Now to the details of that transaction. We closed our whole business securitization, which includes $575 million of four year notes due in September of 2022, with a fixed interest rate of 4.262% and $625 million of seven year notes due in September of 2025 with an interest rate of 4.666%. The blended weighted average life is 5.5 years at a blended weighted average interest rate of 4.47%. Additionally, the securitization transaction includes a variable funding note of $75 million that was undrawn at the closing and function similarly to the previous $75 million revolver. After expenses related to the transaction of approximately $27 million as well as the prepayment of the existing debt facility of approximately $706 million, the net proceeds from this transaction are approximately $467 million. Our debt-to-adjusted EBITDA leverage ratio using Q2 trailing 12-month adjusted EBITDA, pro forma for this transaction is approximately 5.9x. Based on the current outlook for the business and long runway for growth, we're now targeting a leverage ratio in the range of 4 to 6x on an adjusted EBITDA basis. We believe that given our free cash flow generation, our asset light model and our long runway for growth that this targeted debt-to-adjusted EBITDA range is the appropriate capital policy for the company. With the net proceeds of approximately $467 million from this securitization, combined with our current cash position of $147.8 million, we plan to return capital to shareholders from time to time. To that end, I am pleased to announce that the board recently approved a $500 million share repurchase authorization, up from the company's previous level of $100 million. Now to the full year outlook. Based on our confidence in our business and as a result of the new financing, we are updating our full year guidance. First, we now expect revenue to increase by approximately 26%, up from approximately 20%. We now expect adjusted EBITDA to grow in the 16% range, with D&A in the neighborhood of $35 million. Net interest expense is now expected to be $49 million for the year, which includes an approximately $5 million write-off of previously capitalized deferred financing cost considered a nonrecurring cost, and therefore, not impacting adjusted net income and adjusted EPS guidance, and expense of approximately $1 million related to the new capitalized deferred financing cost. We now expect adjusted net income and adjusted EPS to grow approximately 33%, down from our previous guidance of approximately 40%, reflecting the above-mentioned revenue growth and the incremental cost associated with the new financing, which is expected to reduce adjusted EPS by approximately $0.07. Our adjusted EPS guidance is based on an adjusted weighted average shares outstanding of 98.8 million shares and assumes no share repurchases. We are also tightening the assumptions used in developing our full year guidance. System-wide same-store sales are now forecasted to increase in the 9% to 10% range, and we are expecting to sell and place equipment in approximately 200 new stores. We still anticipate replacement equipment sales to be approximately 40% of total equipment sales. And finally, we're 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 John Heinbockel from Guggenheim Securities.

So two topics. So first, I know you guys do check with your franchisees periodically about their replacement equipment intentions. So where are we in that cycle, right, the replacement equipment cycle? Are we sort of hitting the sweet spot of that ramping up? And then with the way new equipment is being developed, I guess, particularly cardio, does that have the potential to accelerate the cycle, right? And so instead of waiting 5 or 6 years, people will do that, the franchisees will bring the new equipment in somewhat sooner.

Sure, John. This is Chris. I'll tell you the technology part now. It's already mentioned in my script. The - we're going to go one year with all three manufacturers, more so to check to see how they scale with our technology endeavors, if you will, and how we build out our ecosystem. So it is a little bit of a process before we get from point A to point B to figure out who is the best partner and how do we integrate it all. We're also launching our app, which will have some integration as well and possibly a wearable, so that ecosystem builds out so that the member has an experience that's intertwined with all of their doings. So with that being said, fast forward a year or two, if it proves it is a great benefit and members like it and does cause you to Black Card upgrade or a stickiness, I think it could accelerate some. I don't think it will be greatly - I mean, nobody's going to replace their card after a year or two, but why wait until year five if it's already paid off? They might do it a little sooner. So possibly, yes, I think maybe a little bit.

Yes. I think, John, on the replacement cycle, I think we're kind of at a normal run rate in terms of franchisees hitting that 5 year cycle and 7 year cycle. And if you go back 3 or 4 years ago, I think there were some reluctance as we started really emphasizing the branding and to make sure that we're keeping our stores as fresh as possible, et cetera. But if you look in the last couple of years or so, it can vary a bit by quarter just depending on when the store opened and what the franchisee might be doing with other store development going on. Maybe some remodeling taking place, et cetera. So that can vary it a bit. We'd like to push as much of it in the summer months, kind of late - early to late Q2 and then into Q3. But frankly, franchisees do it throughout the year. So it's - I'd say we're in a pretty normal state in terms of how you would compare it to other time periods.

Do you - is the idea that after the one year period, you go back to an exclusive with someone? Or it could be all 3 or 2, or totally open whiteboard?

Yes. I'd say it could go back down to 1 or 2. I don't think maybe three probably makes that much sense. But definitely 1, possibly 2. But time will tell over the next year. It was a great negotiation. It worked out really well for the franchisees perhaps this last round here. And all the manufacturers are very eager to work with us on our technology and what we want to accomplish as well as some integration with possible wearable and our app, so that it clearly intertwines so all their member's data is really gathered in one spot, if you will. Then we can see the data and what they accomplish as a member of our clubs.

And then just lastly. What are your thoughts on marketing spend longer term, right? You look out 3 to 5 years, right? At some point, you reach a level where you don't need to keep growing that double digit. And so thoughts on that. And then if you were to dial that back, do you combine the two marketing buckets? Do you treat each one separately? How do you - what's your early thoughts on that?

Yes. I think because we continue to comp as we are, and you see momentum here in our comps over the last 10 years now. And I think it's really a factor of the ever expanding marketing budget. So I guess the question is, how high is too high? I don't know if and when we get there, if it's really that number. I think it comes back down to the whole 4,000 club potential. 4,000, yes, I think that's definitely doable for sure, even more so now than ever. I really feel strongly that by the time we get to 4,000, it's probably going to be higher than, just from the evidence of what we're seeing in New Hampshire where we're - we just opened our 17th store and there's probably three more coming on the pipe in the next year or so. So I think just the increased marketing spend continues to grow, it continues to just dig deeper into the 80% of the population that doesn't have a gym membership. So I think, if anything, John, what you may see, which I - could be doable is that instead of having as seven local and two national, that maybe you slice the more national and get better economies of scale that will leverage on buying.

You're next question comes from the line of Jonathan Komp from Baird.

A couple of questions. First, Dorvin, I might have missed it. Did you give updated full year guidance for adjusted EBITDA?

I said that we expected it to grow in the 16% range. And we had said previously, kind of mid-teens. So we kind of took it to the upper end of where we had been before.

Okay, great. That's helpful. And maybe backing up within the guidance. Could You just clarify in terms of the revenue guidance increase, the moving parts there?

Yes. We were approximately 20%. We moved it to approximately 26%. Frankly, it really - a major portion of that relates to the equipment side of the business, which, as you know, is our lowest margin piece. We had previously said about 190 to 200 new store placements. And we upped that to approximately 200. So we're feeling more confident in that range. As you also know, here we are now in August. And we certainly have more insight in terms of the balance of the year than you would back kind of into Q1. But basically, a good chunk of the revenue upside relates to the equipment side of our business.

Okay, great. And then just the tightening of the same-store sales to the high-end, I think, certainly implies good performance going forward, kind of at least high single digits in the back half. I wanted to just get your current thinking on the momentum of the business and some of the drivers that you see as you look to the back half.

Yes. We feel good, I think, you'd get from our prepared remarks, in terms of where our business is today. And we had a great Q2 in terms of comp. We will be up against the price increase in Q4 that went into effect last year on October 1, as I reflected on my comments earlier. Roughly 25% or so of our comp in Q2 was related to the pricing. So we'll have another Q3 here where it's - we're up against the lower price last year. But I guess, the way we will look at it is we've had good comps year-to-date. And we, in essence, feel like in that 9% to 10% range is kind of a good full year number knowing we have to go up against Q4's price increase that took place last year.

Okay. And maybe just to clarify that, and last one for me. But I know that price increase, I think, effectively was like a mid-single-digit price increase flowing in over a couple of years. So is that necessarily a tough comparison? Or should you continue to see a nice year-over-year pricing component?

Well, we clearly had in both Q1 and Q2. As we talked this year, we had an impact in terms of that $2 price increase from $19.99 to $21.99. And our overall acquisition of rates basically held pretty constant, and that's what we saw during the pilot that we did last year prior to making that pricing decision on October 1. But we - I guess, the way we think about it in terms of how we forecast our business in Planet and then specifically for the balance of the year, we feel good about the momentum we had. We think we'll have a good Q3 and Q4. But in terms of just kind of the guidance for comps, I think, that 9 to 10-ish is a good number.

You're next question comes from the line of Oliver Chen from Cowen and Company.

This is Jona [ph] on for Oliver today. How do you feel about the current pace of new membership growth and where do you sort of expect that growth to trend going forward? And just another question. Could you just talk about potential franchisee concentration risk? I'm just curious if you saw any changes in the financing environment given that interest rates are increasing.

Yes. On the member growth, same-store sales, still a large majority is coming from member growth, net member growth. So - and I think with our year-end 9% to 10% range, same-store sales, we're confident with the momentum we have and the ad dollars we continue to spend, that will continue to drive great membership numbers.

Yes. I think in terms of just the environment, as you know, we have a lot of larger franchisees today in terms of their number of units. And frankly, the number of openings they have scheduled throughout the year. A lot of these guys are generating significant free cash flow to really invest the capital back into the business, and that was one of the comments that Chris said in some of his prepared remarks. But from a financing perspective, we've not seen any of that, certainly, from our conversations with our franchisees in terms of whether that would be an obstacle are not. It doesn't appear to be. And most of these guys with the level of EBITDA that they have today, if they can't get the financing, they won't - frankly, they just put it back in terms of the free cash flow. But no significant changes at all on the financing environment.

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

Dorvin, you mentioned the increase in interest expense, obviously, because of the increased debt and also, your authorization. But I think said your guidance for adjusted EPS for the year assumes no share repurchase. So can you talk about that? Do you intend us to believe that third quarter and fourth quarter won't see repurchase? Or is it just for the ease of you can't know what the share count is going to be at the end of '18 and don't want to necessarily guide to that?

Yes. It's the latter. I just didn't want to put a stake in the sand with respect to how many shares might be bought back in, say, Q3 or Q4 because, obviously, you guys are modeling out your quarters. And so I just made the assumption so that you could know how we were calculating kind of the guidance ranges. I think that you probably got from my prepared remarks and the fact that the board increased our plan from the $100 million to the $500 million. And given the $460 million that came in on a net basis from this transaction with the cash on the balance sheet that there's certainly an intention to execute against that plan.

Great. Considering the take up for new members, Black Card to $21.99 was successful and there's not the amount of price transparency on Black Card as there is for your standard membership, to use that word. Is there any thought, even at a franchise level or certain markets perhaps with higher rent or labor cost to increase Black Card membership for existing memberships?

No. We keep a standard pricing throughout the entire country, John. But - and we don't have any - we don't allow like once to get a high rent district to charge more for the Black Card or what have you. But you can change enrollment fees, though, from time to time on different - on both White Card and Black Card. So there is actually revenue there that the franchisees can make up. Although enrollment, the max you'll ever really see is a $49 royalty, so it's still fairly inexpensive. But the uptick with the Black Card, even with the new price increase, is the same. Really strong at that 60% range, so - which is great to see. It hasn't slipped. So I think we'll keep it there. I think the pricing - but the big question really is now is between technology and maybe some other Black Card features in the spire area if we come up with some more. We're always looking and testing new things there is do we get higher penetration or do we command a $22.99 or $23.99 in the future, so - and reciprocity, as I mentioned in the past, is always #1. When we have 2,000 stores, it doesn't mean we can get more for a Black Card pricing as well. So I think that's probably more where you'll see it from.

You're next question comes from the line of Peter Keith from Piper Jaffray.

It's actually Sean on for Peter today. Just on member growth again. So it seems like the average members per store remained at that 7,500 number, if you compare it to the industry is still elevated. So is there any consideration of accelerating store growth in the coming years to catch up with member growth? Or are you comfortable with per store member count moving higher?

Yes. I'm sorry, could you rephrase that question for me?

The crux was just is there any consideration of accelerating store growth in coming years to catch up with average member per store growth? Or are you comfortable with per store member count moving higher?

Yes, I think - I mean, the way we look at obviously is we sell franchisee's area development agreements and there's a development schedule with respect to that agreement. Now they can build it faster. And in many cases, they will. And franchisees are looking in - and many of our franchisees have more than one area development agreement. So they're constantly working with a broker network, working with our real estate folks that we have corporately in the field to find the next best spot in their particular markets. But with that said, I mean, we certainly can easily accommodate that average number per store in most of our stores. We build generally a 20,000 square-foot box. We have a lot of stores that have more than 10,000 members. But with that said, obviously, we want to, and our franchisees, want to maximize the market to get the most market penetration you can get. But I would say that the fact that we're growing members per store is certainly - it helps the overall economics of a four wall but it doesn't necessarily mean that just because of that, you're going to see an acceleration of store openings. But we continue to work with our franchisees with respect to their ADAs and to try to find the best optimum real estate available for that next door.

All right. I appreciate the detail. Just a quick follow-up. As you do you open new stores in existing higher volume markets, how do you feel about the cannibalization impact that may occur? How do you work, and what things you look at to mitigate that?

Sure. So we had the benefit in our model, with the membership model, we know where every single member lives that's a member of a particular store. So if you take a multi-store market that still has development opportunities within that market, we can plot those members of each individual stores, see how far they're driving to get to that store. We can utilize a lot of third-party data on drive times using economic levels of those particular markets, adjacencies with respect to other retail in the market. And then with franchisees, boots on the ground, our real estate people in the field, we know where new shopping centers may be being redeveloped or built, et cetera. So that's how we take all of those factors into consideration when we're - we and the franchisees are working to find that next particular location. But I think the benefit we have is that because we know where they live, we can butt up as close to but maybe not too much. And in some cases, you want to have a little bit of overlap if that particular store is over declining in terms of members per store. Maybe you're not effectively maximizing that market if you have more than the average number stores. But anyway, that's the benefit we have and those are the factors we take into consideration as we plan further penetration in the market.

Your next question comes from the line of Ray Jadrosich from Bank of America Merrill Lynch.

Dorvin, I just wanted to follow up on your comments about the franchise segment margins for the year. Can you talk about how we should think about that segment's margins longer term? And then give a little bit more color about what drove the - why the margins are down in the first half of the year and then what will drive the improvement in the back half?

Yes. Rafe, as we talked about in Q1, very similar to Q2. The comparison on a year-over-year basis was that we had some additional labor and stock compensation expenses in that particular segment that were in the back half of last year. So we were comping over this year's first quarter and second quarter. A little bit of an apples-and-oranges comparison to add a little bit of extra expense in the first two quarters. What I've said was that as we get to the back half of this year and particularly in Q4, we should see then a more favorable comparison on a year-over-year basis from a total expense perspective. Additionally, as I've said in the past, I think this is a mid-80s margin business. And yes, you can get some leverage, I think, over time. But we also believe that we're at 1,600 stores today. And if you go back 3, 4 years ago, the fleet was smaller. And I think one of the benefits of our business and the economics of the model is that we continue to work diligently with franchisees in planning out that market and providing whether it's training or support or et cetera to be able to have the best four wall model out there. And so I don't see us necessarily pulling back on expenses but I think as revenue grows, we should be able to get some leverage there. But in general, the way we model it, it's a mid-80s EBITDA margin business.

That's really helpful. And then I also want to follow up on your comments about your comfort with the 4 to 6x leverage range going forward. I think historically, you let your leverage ratio come down to around 2.5x. And then you'd add more debt. Just going forward, should we read that as you'll stay within that 4 to 6x range? And then if you do, as you keep increasing your debt, what are the priorities of capital allocation? Will you continue to return capital to shareholders?

Yes. I mean, we obviously will work with our board over the longer term on what's the right use of cash from a capital perspective. But given that we put this particular structure in place, I think it does a lot of things for us. Number one is it extended our tenor because we were getting close in terms of the existing credit facility; number two is we have a fixed rate facility in place, which is certainly beneficial within this rising interest rate environment. But it also then gives us the benefit of as we grow EBITDA, if we want to add on another tranche to the WBS, it's very flexible to be able to do that. And in putting this together, we look at our business and the fact that it's pretty capital-light, it's going to naturally delever just as it has in the past. And we had stated that we felt like that range was kind of 3 to 5-ish. Part of that was given that we were in a variable rate structure facility, et cetera. And I think the way we're looking at it longer term now is that our model can support more leverage than it has in the past. And given that we've, with our board, have increased our buyback plan now to $500 million, I think, over the longer term, as we generate more cash flow and grow EBITDA, I think, you'll probably see additional tranches, and it will just be increased capital return to shareholders. I think that over time, the board will probably consider, in addition to share repurchases, could likely consider other ways such as quarterly dividends, et cetera. But at this point in time, the board chose to increase the share repurchase plan. And as I said in my remarks, from time to time, we expect to execute against that.

Your next question comes from the line of Dave King from Roth Capital Partners.

On the corporate-owned comp, the strongest, I think, it's been in a while, can you talk about what drove the acceleration there? And then on revenue guidance, did you say how much we should expect from NAF? And then how much should Black Card pricing contribute to the third quarter?

This is Dorvin. We did not say in terms of how much of that was driven. What - I guess, what I'd say on your first question was from a comp store perspective, I mean, our Corporate Stores are lower than the franchises. They've historically been because they're a more mature fleet, if you will. But it is probably at one of the higher points it's been in the past. And I think it's a combination of a couple of things in particular. I think running and operating those stores really right now, I think, our management team is doing a great job to execute against our plan. I think that our marketing efforts in terms of how we're in the market, we're continuing to execute against that. I think that we've invested some money over the past, probably 2 to 3 years in renovations in some of our stores which would include not just renovating the store but also replacing equipment, on schedule, like our other franchisees have done. And I just think that with a good focus on running those Corporate Stores within the markets we're in, we've been doing a really good job of executing. And yes, I think our comps were pretty good a year ago but they continue to get better and we'll continue to execute against our marketing strategies.

Okay. And then you cut out a bit. Did you say what the pricing benefit should be in the third quarter?

Yes. We said that in Q2, it was about 25%, was due to the pricing increase. We did not indicate what it would be for Q3 or Q4. But what we said was that we expect to be, on a full year basis, 9% to 10%. On a full - year-to-date, roughly, pricing has been right around that 20% to 25% range. I would expect it to probably be similar to that. What we don't know is obviously going up, as I mentioned to the earlier caller, how Q4 will be versus the prior year since it will then be apples-to-apples on a pricing basis. But that is implied within our guidance of 9% to 10% comps.

Okay, understood. And then on the [indiscernible], how should we be thinking about average price per equipment package? And then are retrofits still going to be a part of the new kind of tech-driven offerings? What sort of time frame should those start to come in? And then is it too early, or have your franchisees indicated at all how they're thinking about doing some of the tech-driven stuff? Is it through these retrofits, or is it through new installs? What are the thoughts there?

Yes. So the margin and pricing is very, very similar to what we've seen in the past. Nothing really has changed there. Of course, technology is a part of it. It still in the pilot process. So the new orders coming through our technology orders, they're just typical cardio and strength equipment orders that they would normally be getting. Although now, through three different manufacturers, depending which one they choose to use. But right now, the pilot is at 15 stores. And we probably look to probably expand that to some more new stores this year. But nothing large scale. Probably another 5 to 10 more stores. So - but they're all just ordering the normal equipment at this point.

Your next question comes from the line of George Kelly from Imperial Capital.

So first of all, on Black Card pricing and the changes you made last year, it sounds like the market, it was received sort of as expected or even better than your tests showed. Is that a fair statement? And I guess, the more important question is how often can you revisit that pricing? Do you feel like it's in a good spot right now or is it something you could come back to in 2019 and look at again?

Yes. It's probably acting as expected in the test, in the pilot. Glad to see that now it's in all 50 states and nationwide that it's reacting the same as the 100 club test pilot we did last year. So that's great news. The one big reason we changed it was reciprocity. When we invented the Black Card, we had 100 stores. Now we had 1,500 - 1,400. Last year, we came up with making the change. But I think it's probably [indiscernible] for now for probably a little bit here. We have 2,000 stores, if I revisit it, or technology or a better - or a different type of amenity in the Black Card spire that really drives a lot of attention. And maybe yes, you'd maybe look to change it but I think to this point, I wouldn't look to be moving it anytime soon.

Okay. Got you. And then next question. In your prepared remarks, you mentioned a new app and wearable. Will those - could there be new revenue streams through either of those?

Possibly. And I think with - now, with Roger Chacko, the new Chief Commercial Officer, I think there's a lot of benefits we could have in him working with our CDIO as well on how we integrate and use our 12 million members and whether it's - if you think about wearables, right now, you're on a bike, for example, the wearable thinks you're sitting down. It doesn't know you're even moving or exercising. So the integration between the equipment and the app so that the customer has a full ecosystem of whether they're working out at home or they're on a bike or they're walking down the street is probably connected and tracking all their activities. So I think it's pretty powerful because right now, it's really not being done. So I think that's something in the future, but it is something we're working on. I think you're right. I think there is some benefits there that we could drive more adoption. Hopefully, we made a stickiness or maybe a Black Card perk that's built in there that does drive more Black Card pricing or acquisition.

Okay. Okay. And then last question for me. You've talked a lot about returning cash to shareholders and the free cash flow profile of the business. Do you - historically, you haven't been very acquisitive. Not really sure what you can say to it, but are you looking to other assets out there that you think would be helpful to own? Just any kind of discussion about that would be helpful.

Sure. I mean, our focus has been on really the big market here in the U.S. We're obviously in Canada. And Chris talked earlier about some other development. But the biggest opportunity, frankly, is here in the U.S. because we still believe that the opportunity is in the 4,000 range. And we don't want to take our kind of eyes off the ball in doing that. Now with that said, we made the acquisition back on January 1 of this year of the eastern Long Island stores. We made - that was an existing franchisee that was retiring. We made another acquisition back in Q1 of '14. Again, some similar situations where that franchisee wanted to go, and in that case, build out some other markets. We have a rover on all of those, as I think you probably know. So we have the ability to exercise that if we so choose. So far, we've certainly been looking at it when it's synergistic with our existing Corporate Store fleet. We'll always look at opportunities like that within the franchise segment when a seller or transfer would come to buy. I think in terms of outside of that, we certainly haven't really pursued an M&A strategy. I wouldn't say that we would never do that. But at the moment, I think our focus is clearly on continuing to help our franchisees build out their markets, do a lot of these other things that talk Chris talked about earlier with opportunities that we think we have ahead of us. Whether it's in technology or whether it's some of the other revenue types of opportunities. But that's our focus today. If the right opportunity came along, we might look at it but it's not a strategy today.

You're next question comes from the line of Matthew Brooks from Macquarie.

I understand that U.S. is the big goal here, but can you give a little bit more color or some data on the performance of the brand in Canada? I know it's early but in Mexico as well.

Yes. I mean, it's clearly early in Mexico. I think we and our franchisee opened a store. We're certainly pleased with that one store and we'll test another 1 or 2 there in that particular city. But Mexico will be a big opportunity if we continue to roll that out. I think in terms of Canada, you got to think about it a little bit in terms of how the system in the U.S. works. Years ago, one of the benefits we have today is the national advertising fund, which is a huge fund today with all the stores. Obviously, it's a smaller fund up there now as we continue to build out those stores. We're like between 25 and 30 stores now. But the overall economic model, I think, initially, there were some supply chain kind of forex issues with some of the products, not just the equipment but some of the buildout and some of the operational expenses going across the border from the U.S. to Canada. We've aligned now with some local vendors to help support some of those kinds of expenses or capital items up there. But I think the view by our franchisees in Canada - we have the two Corporate Stores in Toronto and then the balance of the stores are franchise stores. I would say that they're just as excited about continuing to build out their area development that's up there as well. And we think over time, as the scale gets bigger, it will even be - it'll even have additional benefits to it.

And it's correct, right, that the U.S. franchisees, some of them are funding the development in Canada and Mexico?

Yes. All of the Canadian franchisees also our domestic franchisees and as well as our Mexico franchisee, he's also a U.S. franchisee as well as Dominican Republic and also in Panama. So they're all U.S. franchisees. And frankly, it's - their running more territory and that's why it's U.S.-based franchisees.

That sounds good. And just one quickly on the buyback. How do you think about when you're going to return capital? Does it depend on where the share price is? Or is the goal really just to continue to return the capital slowly over time because you're going to have an ongoing need to do that?

Yes. I mean, we didn't comment about that. I think you'll - as we report Q3 and Q4, you'll obviously see what actions we took in terms of that. But I think the - as I said to the caller earlier, the fact that we did the transaction, the fact that we've kind of stated our overall capital policy with respect to leverage ranges and with that cash on the balance sheet, the intent is certainly to execute against that plan.

And our last question comes from the line of Brennan Matthews from Berenberg.

I just wanted to ask about - I guess, you've been seeing some more consolidation among franchisees, particularly with some of the private equity guys continuing to get involved and kind of grow their store base. As you've maybe had conversations with some of them, I mean, are there any deep concerns that they've expressed to you? Maybe even more generally, kind of what the feedback is that you've gotten from them as their store basis have grown?

Yes. I think it's interesting and I think it comes back to the fact that TSG, who is our sponsor, the franchisor back - they came onboard 2012 with myself and the original partners and the fact that there after they've gotten out all their stock after the IPO. And now, they become a franchisee of ours is a testament to why all the private equity guys are getting involved is the cash returns of this business is better than - what we hear from them, it's better than they've ever seen. So - which is why they're so hungry to do this and is why TSG got back in. So they love the business, they love the simplicity or - I hate to use the word simplicity, streamlined business model. And they used to invest in fast food or what have you, all the moving parts and pieces and how they can scale this with 12 to 15 employees and really just be able to grow this business, they really like it. And we really like it. And the fact that these franchisees of ours have been great advocates of the brand and have built their businesses, be able to monetize some of their hard work and stay in the business. Not one of these groups has the franchisee really necessarily to retire. They all kind of went back to doing what they're best at, whether it's building stores or construction, what have you. And they got to the point when you had 20 or 30 stores in their portfolio and they're still trying to be the marketing guy, the development guy and the finance guy. So [indiscernible] groups have come in and brought in some sophistication to the back office and allowed the franchisees to do what they're best at. So I think it's a perfect world in all our aspects.

And we have time for one more question from Jonathan Komp from Baird.

Dorvin, I just wanted to circle back and make sure - I'm sorry to reask the question, so to speak, but in terms of their profit increase for the year relative to the revenue increase, is there anything else offsetting it just even if the upside is driven by equipment? It seems somewhat low in terms of the implied flow through. So I just wanted to ask if there's any other costs here embedded in that outlook.

No. I mean, I think the way if you think about comments from Q1 to Q2 now and then the answer to a - I gave you in terms of kind of the tieing into now the full year updated guidance, the - a good chunk of that upside, as I mentioned, is really related to the equipment side. Obviously, you have the increased interest expense. And I gave specific guidance for that. I also gave guidance on specific D&A. I'm not sure if - where your model was, John, but I think there were a couple of others that maybe the D&A was a bit out of line with kind of where our run rate is and where we expect to be full year. And then just a last comment, I guess, I'd make is that in terms of the EBITDA piece, we had - when we gave guidance, we had said kind of that $190 million to $200 million. Now we're saying $200 million. So that's the - a good chunk of the revenue upside. And the EBITDA, we had said kind of mid-single digits. So more 14%, 15%, maybe 16%. We're at the high-end of that now, 16%. So I think that from a flow-through perspective, we feel comfortable with that EBITDA growth of the 16% and then implied EPS growth with the D&A and they're using the tax rate that I told you that we would use. So I think the answer to your question is that that's kind of flowing through the way we model our business that way. But if you have anything further on that, I'd be glad to chat with you later.

Understood. And if I could just - the last one big picture given the legislative victory for the personal health investment today act recently. Obviously, still some hurdles there but any thoughts, big picture? Potential party who could really push and promote the cause if it were successfully brought into legislation?

Yes. I think it's really good, and I think this all comes back to what I talk about a lot. We're just the acceleration of a general awareness and wellness over the last few years is just acceleration has been great between wearables and farm-to-table restaurants and Whole Foods. And you look at wearables and fitness apps, the iPhone was around 10 years ago barely. Now there's 70,000 fitness apps or something. So this is just one more notch in the belt of just awareness and making - it's all exposure to wellness. And the more exposure that I feel the population has, the perfect storm for the industry and especially us because of the first time, casual gym user. You're going to start with us first. So I think it's great. I think it will pass. We'll see. But I'm positive that it could help us, sure, as this changes.

And there are no further questions at this time. Mr. Chris Rondeau, I turn the call back over to you.

Great. Thank you. So thank you for joining the call today. It's been great. I'm actually, believe it or not, in Grand Canyon on a three-week tour, cross country with the family. And it's been great to see clubs in every state along the way And tell you what I've seen. I couldn't be more proud of the brand consistency, the Judgement Free Zone and how our franchisees executing our business plan in all 50 states. And I've seen about 15 states at this time. So it's been really something to see. It's exciting. And I'm also really excited with the momentum we have so far for the first half of the year and how this momentum will carry the rest of this year. And our new Chief Development Officer as well as our new Chief Commercial Officer and our CDO, Craig Miller, who came onboard about shy of a year ago here. And now that all seats are filled, the next couple of years, it's going to be really exciting. I'm looking forward to scaling this business even more so. So thanks for the call today, and I look forward to Q3.

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