Planet Fitness, Inc. (NYSE:PLNT) Q3 2023 Earnings Call Transcript

Planet Fitness, Inc. (NYSE:PLNT) Q3 2023 Earnings Call Transcript November 7, 2023

Planet Fitness, Inc. beats earnings expectations. Reported EPS is $0.59, expectations were $0.55.

Operator: Ladies and gentlemen, thank you for standing by. My name is [Bhavesh] and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 2023 Planet Fitness Earnings Fiscal. At this time, all lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer session. [Operator Instructions] Thank you. I will now hand the call over to Stacey Caravella, VP of the Investor Relations. You may begin your conference.

Stacey Caravella: Thank you, operator, and good morning, everyone. Speaking on today will be Interim Planet Fitness Chief Executive Officer, Craig Benson; and Chief Financial Officer, Tom Fitzgerald. Both will be available for questions during the Q&A session following the prepared remarks. Today’s call is being webcast live and recorded for replay. Before I turn the call over to Craig, I would like to note that we posted slide on our Investor Relations website this morning that summarize the update that we will be discussing during our call. I would also like to remind everyone that the language on forward-looking statements included in our earnings release also applies to our comments made during the call. Our release can be found on our investor website, along with any reconciliation of non-GAAP financial measures mentioned on the call with their corresponding GAAP measures. Now I will turn the call over to Craig.

Craig Benson: Thank you, Stacey, and thanks everyone, for joining us for the Planet Fitness Q3 earnings call. I’m honored to serve as interim CEO of such a truly unique brand with a strong track record of growth as we enter the next chapter of the Planet Fitness journey. As a board member and a Planet Fitness franchisee, I know firsthand the power of this brand, the strength of our team, and our commitment to a welcoming, non-intimidating culture, all of which uniquely position us to continue to lead the industry. My priority is to lead the team as we execute on the current strategy, with a focus on enhancing store returns. We look forward to finding an outstanding CEO candidate to lead us in capturing the growth opportunities ahead of us.

Let’s move on to our results. We ended the third quarter with more than 18.5 million numbers. System wide same store sales growth was 8.4%, primarily driven by new member growth and more than 19% adjusted EBITDA growth. As a result of our performance and given our outlook for the fourth quarter, we are raising our full-year financial guidance targets for revenue and adjusted EBITDA for 2023. Tom will go through that later on. We feel really good about our membership trends. We added nearly 110,000 net new members in Q3, outperforming net growth for the same period last year as well as 2019. We continue to see our strongest net member growth for Gen Zs. We now make up a quarter of our membership base. We believe we are unique among most multiunit brands and that the average age of our member continues to decrease.

This was further enhanced by another successful high school summer pass program. We had more than three million teens and two million parents and guardians sign up for this year’s program. At the end of October, our conversion rate of team participants to paying members is 5.5% versus 5% last year. More than 30% of our new joins in Q3 were previous members compared to about 20% pre-COVID. We also continue to see higher overall visits per member, as well as all age groups visiting more frequently year-over-year. We again experienced year-over-year improvement in our cancel rate as it continues its decline for the 9th straight quarter. Lastly, we opened 26 new stores this quarter, bringing our global store count to nearly 2,500. We have added 145 new locations since Q3 of last year, which is nearly three times the growth of the top 17 of our competitors combined.

It was against this backdrop of industry leading performance that we met with all of our franchisees last month to review the updates we are making as part of what we call our new growth model. We all left the meeting even more excited for the long-term opportunities that we have as a brand. We are addressing the biggest opportunities to further improve the attractiveness of our returns for our franchisees as they manage their capital deployment and timing of their investments, while maintaining our strong focus on a great member experience. We believe it is a win for the franchisees and for us as the franchisor. First on pricing. We are proud that we haven’t raised the $10 Classic Card price in 30-years. However, consumer expectations on price have changed in a highly inflationary world.

We are exploring whether we have an opportunity to take price on our Classic Card without sacrificing member growth. To that end, we have been testing different price structures, messaging, and price points in several markets around the country for more than a couple of months now. As we are a recurring revenue model, we plan to continue running these tests to understand the impact that increasing price has on membership growth. Now to our membership levels. Our membership recovery coming out of the pandemic closures has resulted in all time high system wide membership levels. Additionally, the stores that will mature as of March 2020 are back to pre-COVID membership levels on average. And importantly, our 2023 cohort of new clubs is indexing very close to pre-pandemic new store ramp levels.

However, the cohort of nearly 700 stores that opened from 2019 to 2022 have experienced much slower ramps to maturity, given that their early critical years of member growth were interrupted by COVID. This is nearly 30% of our system. These stores have not yet benefited from consecutive years of typical first quarters. As a reminder, 60% of our net member growth for the year historically occurs in Q1. We expect these stores to eventually grow to membership levels consistent with the rest of the system, but they will take longer and will likely way on the returns across a given franchisee’s portfolio. The cost to build a new store continues to be approximately 30% higher than in 2019. The total CapEx cost today, which includes total cost to build, reequip, and remodel a Planet Fitness are up nearly 70% over the 10-year life of a franchise agreement versus a decade ago.

And while the pressures are primarily from external factors, such as inflation, higher interest rates, we are addressing the things that are within our control, and further enhance store returns and lessen the increased CapEx burden for existing stores. Our management team has been working on the new growth model for a good portion of the year, trying to balance improving new store returns without significantly impacting our P&L. Our plan is focused on reducing the capital requirements for opening and operating a Planet Fitness franchise. This includes making changes to the franchise agreement, adjusting the timing for cardio and strength reequips based on usage, and committing to reduce CapEx for new build and remodel, while also looking for ways to reduce operating expenses.

We believe that the changes we are making will free up a significant amount of capital for our franchisees in the near-term, providing them with additional flexibility and resources to build their store portfolios for the long-term. Tom is going to walk us through the details momentarily. The new structure is standard for all agreements moving forward and our franchisees can also take advantage of it for their existing stores. In closing, our management team has taken responsible and data driven approaches to adjusting our franchisee return model, which we believe set us up for sustainable growth. We recognize that the operating landscape has changed, and therefore, we are evolving for the long-term sustainability of the model without compromising the member experience.

We believe we are pulling the correct levers to drive the right long-term outcomes and to ultimately increase returns for all of our stakeholders, both internal and external. Now, I will turn it over to Tom.

Thomas Fitzgerald: Thanks, Craig, and good morning, everyone. Today, I’m going to address three topics. First, further details on how we are evolving our model as Craig referenced, second, our Q3 financial results and lastly, our 2023 outlook. We learned valuable lessons as the franchisor of a fitness brand during the pandemic, including the importance of building and maintaining a trusted franchisee, franchisor relationship. We were nimble and quickly made changes to support our franchisees and their most pressing needs while our stores were temporarily closed. This included 18-month extensions for both new store obligations under area development and on reequipped cycles for existing stores. These extensions provided franchisees with greater flexibility and liquidity to help meet their various obligations while stores were temporarily closed and until membership levels began to recover.

The result was that we did not permanently close any of our stores due to COVID versus the industry, which experienced a 25% reduction of all gyms in the U.S. And in today’s post pandemic world with persistent higher inflation that have significantly increased new store construction costs, we are using that experience to further refine our model and position us and our franchisees for continued sustainable growth. As Craig noted, this isn’t just a win for our franchisees. It is also a win for us as the franchisor, and we believe it is also in the best long-term interest of our shareholders. As part of the plan, we are making changes to how we hold franchisees accountable to their new store build obligations, as well as updating our joint fee structure.

Let me walk through each of the five parts of our new growth model in more depth. The first component of our plan is to extend the length of our franchise agreement from 10-years to 12-years and to eliminate the initial $20,000 franchise fee. Franchisees will be required to remodel at the 12-year mark and pay a franchise fee at that time. The franchise fee change is meaningful to our franchisees who are required to pay the fee when the store opens, but less impact to our P&L as we recognize it over the life of the agreement. The second element of our new growth model is to extend the timing for re equips to achieve a system average of six-years for cardio and eight-years for strength. Clubs that have higher than average usage will still be required to re equip at five and seven-years, while clubs with lower usage will be seven and nine-years.

As a reminder, all stores that were opened at the end of 2021 received the previous reequip extension. So, today, on average, those stores are on a 6.5 and 8.5 year schedule already. Therefore, we expect this change to have minimal near-term impact to our financials. The second cardio reequip will coincide with the 12-year remodel requirement reducing the number of disruptions to the club and its members from seven to six in the first 24-years of operation. It eliminates two consecutive years that members have to deal with disruptions in today’s model. For the third component of the new growth model, we are targeting a 5% to 10% reduction to the investment required to build a new store without compromising the member experience. In addition to value engineering the store build, the targeted reduction includes the waived initial franchise fee and the changes to the mix of equipment, which we have been refining this past year as our members are consistently seeking more strength and less cardio.

The latter has the added benefit of reducing CapEx investment and strength equipment costs less than cardio, and we are also adding additional open spaces for stretching and working out. We expect that this will continue to be a headwind to equipment segment revenue. However, we will continue to examine potential adjustments to our equipment pricing and margin as appropriate to protect our margin dollars per placement and reequip. The fourth part of our new growth model affects our area development agreements, where we will transition from grace periods to the more typical cure period mechanism, which will lead to greater clarity and alignment on our development pipeline. Grace periods allow the franchisee an additional 12-months to open location if there was a delay outside of their control.

Franchisees will now enter a six-month cure period if they are in default on a unit obligation, which is a more common practice in the franchise world. Now, the fifth and final element of our new growth model is to shift from the franchisees paying us a fixed fee for online joins to a fee equal to a percent of member’s dues for all joins regardless of the join channel. This new structure allows us to participate in the upside on potential future price increases. There are many specifics and nuances that we are still working through as we transition to this new structure. As Craig noted, this is the model that we propose to our franchisees, and we are highly encouraged by their enthusiastic response to it. We expect most will accept it. Now, I will cover our third quarter results.

All of my comments regarding our quarter performance will be comparing Q3 2023 to Q3 of last year, unless otherwise noted. We opened 26 new stores compared to 29. We delivered same-store sales growth of 8.4% in the Q3, franchisee same-store sales grew 8.2% and corporate same store sales increased 10.1%. More than three quarters of our Q3 comp increase was driven by net number growth, with the balance being rate growth. Black Card penetration was 62.1%, a decrease of 80 basis points. The decrease primarily reflects the continued increase in our Gen Z membership growth and the conversion of high school, summer, and pass participants to paying members. For the third quarter, total revenue was 277.6 million compared to 244.4 million. The increase was driven by revenue growth across all three of the segments.

The 21.6% increase in franchise segment revenue was primarily due to increases in royalties, web joint fees, and national ad fund revenue. The royalty increase was primarily driven by same-store sales growth, royalties on annual fees and new stores. For the third quarter, the average royalty rate was 6.6%, up from 6.5%. The 12% increase in revenue in the corporate owned store segment was primarily driven by same-store sales growth and new store openings, as well as the four stores that we acquired in the second quarter. Equipment segment revenue increased 6%. We completed 22 new store replacements this quarter compared to 27 last year. For the quarter, replacement equipment accounted for 78% of total equipment revenue. Our cost of revenue, which primarily relates to the cost of equipment sales to franchisee owned stores, amounted to 53.8 million compared to 48.5 million.

Store operations expense, which relates to our corporate owned stores segment increased to 63.1 million from 57.9 million. SG&A for the quarter was 33.3 million compared to 27.1 million. Adjusted SG&A was 30.7 million. This includes a $2.6 million adjustment for CEO transition related expenses. National advertising fund expense was 17.6 million compared to 17.0 million. Net income was 41.3 million, adjusted net income was 51.8 million and adjusted net income per diluted share was $0.59. A reconciliation of adjusted net income to GAAP net income can be found in the earnings release. Adjusted EBITDA was 111.9 million, and adjusted EBITDA margin was 40.3% compared to 93.9 million with adjusted EBITDA margin of 38.4%. A reconciliation of adjusted EBITDA to GAAP net income can be found in the earnings release.

And by segment, franchise adjusted EBITDA was 67.6 million and adjusted EBITDA margin was 68.9%. Corporate store adjusted EBITDA was 44.4 million and adjusted EBITDA margin was 39.2%. Equipment adjusted EBITDA was 16.4 million and adjusted EBITDA margin was 24.8%. Now turning to the balance sheet. As of September 30, 2023, we had total cash, cash equivalents, and marketable securities of 474.1 million compared to 472.5 million of cash and cash equivalents on December 31, 2022, which included 46.4 million and 62.7 million of restricted cash respectively in each period. Year-to-date through September, we used 125 million to repurchase shares. Total long-term debt, excluding deferred financing cost, was 2.0 billion as of September 30, 2023, consisting of our four tranches of fixed rate securitized debt that carries a blended interest rate of approximately 4.0%.

As a reminder, we don’t have debt coming due until September of 2025. Finally, moving on to our updated 2023 outlook, which we included in our press release this morning. Historically, our new store openings typically SKU to the fourth quarter, and in particular to December, as franchisees work hard to open their new stores before New Year’s Eve. However, similar to the past few years, we continue to experience unpredictable delays in the various steps to open a new store. Chief among them is the extended permitting time line in many municipalities. With less than two-months remaining in the year, we have narrowed in on a range for new store openings and franchisee equipment placements that we believe accounts for the things that we and our franchisees can control.

We now expect between 150 and 160 new stores and between 130 and 140 equipment placements in new franchise stores. We continue to expect system wide same-store sales growth to be in the high single-digit percentage range given our strong membership trends. We now expect that reequipped sales will make up approximately mid 60% of total equipment segment revenue for the year. Our franchisees continued to invest in their existing stores as evidenced by the fact that we expect our full-year reequipped revenue to be greater than what we had originally forecasted. Given our strong sales during our reequipped promotions year-to-date, we expect light Q4 reequipped sales as franchisees are allocating capital up to building new stores. This is the primary driver behind our revised expectation of approximately 14% revenue growth and approximately 18% adjusted EBITDA growth.

We now expect approximately 33% growth in adjusted net income and adjusted earnings per share growth of approximately 35% based on shares outstanding of approximately 89 million. We continue to expect net interest expense to be in the low $70 million, CapEx up approximately 40%, and D&A up in the high-teens percent range. As we mentioned last quarter, we will revisit our three-year outlook, which we initially provided back in November 2022, next year when we provide our targets for 2024. In the meantime, our teams are working with franchisees on their development, remodel, and reoccur claims for 2024 as they determine their near and long-term capital requirements and priorities under this new structure. We believe our new growth model will further enhance franchisee returns, continue to increase our leading competitive position, and deliver long-term sustainable value that benefits our shareholders and our entire system.

I will now turn the call back to the operator to open it up for Q&A.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Randal Konik from Jefferies. Please go ahead with your questions.

Randy Konik: I guess, Tom, what would be helpful for us on the call is you talked about you’re going to give us 2024 guidance in a couple quarters. But what would be helpful is just to get some perspective on how we should be thinking about directional change in unit openings going into next year. And just like shaping of the curve around equipment revenues, I think you said there shouldn’t be all that much change from a replacement perspective. So just help us think about puts and takes about just next year without obviously, you’re not going to give us specific guidance, but just framing out the kind of path from here would be super helpful going in for next year.

Thomas Fitzgerald: Randy, thanks for the question. I appreciate that there is a desire to know that it is difficult to talk about at the moment because that is the work that is ahead of us, right. We made these changes for a couple of reasons. One, to free up the capital for franchisees. Particularly the big move is to move the remodels that we are doing in 2024 to move them out. Now some of those that are more brand damaging will have to get done, but ones that we can take a little time on, we will. And so that frees up the capital. So – and then also making some other changes to improve the – while we think the returns are strong, making them even stronger should help drive some unit growth. How both of those things play out, in 2024, directionally to your question, is the work ahead of us and our teams to work with our franchisees and really sort of play all this through, both in terms of how they see their pipeline, but also just executing the agreement changes.

So anyway, Craig, go ahead.

Craig Benson: So, I just wanted to add one thing, I mean. As you know, we rolled this out the 16th October to our franchisees. These are big organizations in many cases, and so it takes time for them to process these changes as well. They had no sort of inkling about what we are going to bring to the huddle, and so they are processing this as well. So it is going to take us a little bit of time to get it to their organizations, most of us to our organization. So that is, I think, a big portion of what Tom’s talking about.

Randy Konik: Got it. And then would you – so then to handicap it, would you think that the updated unit guidance you gave for this year would be kind of the floor or close to the floor based on the pipeline you kind of have that you can see? And then just on top of that, just kind of elaborating, Craig, you talked about some of the pricing change work or at least testing you have been doing, I believe, on the White Card. How do you – what have you learned so far in those tests? Maybe give us a little flavor there, so we can get some perspective on what’s been changing in those tests, price elasticity, price sensitivity, so we can get a feel for just how high the probability is that you could lift off that $10 a month White Card price point?

Craig Benson: I’m going to let Tom talk about the pricing, but I just wanted to sort of talk about where we are as far as store openings go. Listen, Tom said it right at the beginning of the call. It has become increasingly difficult to forecast openings because of changes, especially in the permitting and the entire process of inspections and getting a certificate occupancy. And so what used to be a little more straightforward – or maybe a lot more straightforward, has changed for the worst. And so we are dealing with that the best we can. And our franchise are working very hard and trust me, I’m one of them. So I get what’s happened in the marketplace, and it is frustrating as all get out to have things ready to go but not be able to complete the opening.

Thomas Fitzgerald: Yes. And Randy, on the pricing one, as you know, with the subscription model, we have to read it longer than you would a typical QSR retail test. And so we are reading it through. We have got roughly 100 stores and a few different DMAs in the $15 test. And so it is $15 when we are not on sale, it is $10 on sale. So we are reading it both in those sort of sale periods in what we call the evergreen non-sale periods. And at the end of the day, our criteria is we don’t want to sacrifice member growth. We think like a retailer or restaurant transactions for them, member growth for us is the sustainable lifeblood of this business. If we can maintain that while adding some dose upside, then we will. But we don’t want to say – given we are trying to get people off the couch, and cost is a barrier to getting off the couch.

We just want to be very careful about how we learn our way into what is a better place than where we are today. It may take us a little time, and these tests may prove to be that or they may prove not to be that we have to run some other tests, but it is definitely not something that – with only 2 price points we can’t bet bunches on hunches. We got to scientifically figure out what’s better than what we have. And if we find something, we will move to it.

Craig Benson: And then I just want to add one thing. Part of ours is not just the entry price. It is the length of time somebody stays a member. So to the extent, price influences that in a dramatic way. That is harmful to our business, and we are looking at the lifetime value of a member.

Operator: Our next question comes from Simeon Siegel from BMO Capital Markets. Please go ahead with your questions.

Simeon Siegel: So can you guys just talk a little bit more, you got to the decision to change the store level to our model. I guess is there an agreement as to what the save dollars will be used to, or are you going to ask for a commitment towards the new gyms or something else or is this more to help their returns? Is this a concession or are you seeing a change in the structural requirements to run gym. So Tom, I think you mentioned maybe see a way to improve the margins for your own equipment. So kind of thinking that through, and then just really just thinking through if replacements and remodels where historically necessary to keep the gyms fresh, how do you ensure that loosening these restrictions won’t hurt that customer experience. And then just lastly, I guess, do you believe this is the end of negotiations or is there anything else to expect to come for franchisee benefits?

Thomas Fitzgerald: and we have been working on this for months with the Board and what the leadership team here, looking at various things that we could consider. I think we have talked about on some calls when we have been asked, is there anything you can do. And we thought this was kind of the sweet spot of all things that help them on the liquidity side, recognizing the higher cost of inflation -. Sorry, what inflation has done to the build cost and the remodel costs, give us some time to value engineer those remodels. If they are brand damaging, then they have to get them fixed, whether that is a corporate store that we acquired from somebody else or a franchise store. At the end of the day, this is still member first in our thinking.