Planet Fitness, Inc. quarterly report, Q3 FY2015

Planet Fitness, Inc. — Form 10-Q Summary

Business context and reporting period

Unaudited results cover the three and nine months ended September 30, 2015, compared with the same periods in 2014. Planet Fitness operates through franchise, corporate-owned stores, and equipment segments. At September 30, 2015, the company had more than 7.1 million members and 1,040 locations in 47 states, the District of Columbia, Puerto Rico, and Canada, including 982 franchisee-owned and 58 corporate-owned stores.

The company completed its initial public offering on August 11, 2015, selling 15.525 million Class A shares at $16.00 per share. Net proceeds of $156.9 million were used to purchase Holdings Units from existing owners. Planet Fitness owned approximately 37.1% of Pla-Fit Holdings’ economic interest while retaining 100% of its voting interest at quarter-end.

Financial performance and key metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Total revenue	$68.8 million	$63.5 million	$224.7 million	$183.8 million
Income from operations	$10.3 million	$14.0 million	$43.3 million	$42.2 million
Operating margin	15.0%	21.9%	19.2%	22.9%
Net income	$0.7 million	$8.3 million	$20.9 million	$23.5 million
Net income attributable to Planet Fitness, Inc.	$(3.9) million	$8.1 million	$16.0 million	$23.0 million
Adjusted EBITDA	$26.6 million	$23.8 million	$86.1 million	$70.3 million
Net cash provided by operating activities	Not separately provided	Not separately provided	$56.6 million	$49.1 million

Q3 revenue increased 8.4%, led by 25.4% growth in franchise segment revenue and 10.8% growth in corporate-owned stores revenue. Equipment revenue declined 4.5%.
Nine-month revenue increased 22.3%. Franchise, corporate-owned stores, and equipment revenue increased 25.1%, 17.3%, and 24.7%, respectively.
Q3 operating income declined 25.9%, primarily because selling, general and administrative expense more than doubled to $17.3 million, including IPO-related compensation and transaction costs.
Q3 net income attributable to Planet Fitness, Inc. was a loss of $3.9 million, reflecting $4.6 million of net income attributable to non-controlling interests and IPO-related expenses.
Q3 reported diluted Class A earnings per share were $0.04; the filing presents this measure only for the period after the August 2015 recapitalization and IPO.
System-wide same-store sales increased 6.9% in Q3 and 8.3% for the nine months. Franchisee-owned same-store sales increased 7.3% and 8.8%, respectively, while corporate-owned same-store sales increased 1.7% and 2.2%.

Liquidity, cash flow, debt, and balance sheet

Cash and cash equivalents were $28.5 million at September 30, 2015, down from $43.3 million at December 31, 2014.
The company had $40.0 million of unused revolving credit capacity.
Total long-term debt was $503.6 million, compared with $387.1 million at December 31, 2014. The increase primarily reflects $120.0 million of incremental term borrowings used, together with $20.0 million of cash, to fund a $140.0 million distribution to unit holders.
The senior secured term loan matures in 2021; the revolving facility expires in 2019. The company reported compliance with its financial covenant and a calculated leverage ratio of 4.0 to 1.0 versus a 6.5-to-1.0 maximum at September 30, 2015.
Nine-month operating cash flow was $56.6 million. Investing cash outflow was $13.8 million, including $13.8 million of capital expenditures. Financing cash outflow was $57.5 million, principally reflecting $171.1 million of distributions and debt-related activity.
Contractual obligations totaled approximately $921.3 million, including $503.6 million of debt, $142.0 million of estimated tax benefit arrangement obligations, $105.5 million of operating leases, $16.8 million of advertising commitments, and $23.3 million of purchase obligations.
A 100-basis-point increase in interest rates would increase annualized pretax interest expense by approximately $5.0 million, before considering the effect of interest-rate caps.

Material changes versus the prior comparable period

Revenue growth was driven by 195 additional stores opened since September 30, 2014, higher franchise royalties, stronger franchisee same-store sales, and increased vendor commissions.
Store count increased from 841 at September 30, 2014 to 1,040 at September 30, 2015, including 122 net new franchisee-owned stores and four additional corporate-owned stores during the nine-month comparison.
Corporate and other Segment EBITDA costs increased to $13.2 million in Q3 from $5.0 million, principally due to corporate overhead, IPO-related costs, and compensation.
Interest expense increased 28.6% in Q3 because of the additional $120.0 million of borrowings.
The company’s point-of-sale and billing system migration was completed in early 2015. Management expects earlier termination of delinquent-account billings to reduce royalties and negatively affect reported same-store sales metrics through 2015 and 2016, although it does not expect a material long-term effect on royalties.
The IPO and recapitalization materially changed the capital structure, created a non-controlling interest, and resulted in a $142.0 million projected liability under tax benefit arrangements.

Outlook, risks, contingencies, and unusual items

The filing does not provide formal quantitative revenue, earnings, or store-opening guidance. Management stated that cash on hand, operating cash flow, and available revolver capacity are expected to be adequate for at least the next twelve months to fund operations, capital expenditures, debt service, tax benefit arrangements, and working capital, even assuming no growth in sales or profits. Management cautioned that future cash generation and borrowing availability are not assured.

Key risks include dependence on franchisee performance, execution of the store-growth strategy, member retention, competition, brand and reputation damage, third-party systems and vendors, variable-rate debt, substantial indebtedness, and tax receivable arrangements.
Management identified a material weakness in internal control over financial reporting involving authorization of IT hardware purchases and processing of related invoices. Remediation was underway but had not operated long enough to demonstrate effectiveness as of September 30, 2015; disclosure controls and procedures were therefore deemed ineffective.
Q3 and nine-month results included $6.2 million of IPO-related cash and equity compensation, $2.1 million and $7.2 million of IPO-related costs, respectively, and a $1.0 million termination fee related to the former TSG management agreement.
Interest-rate caps with aggregate notional amounts of $328.0 million were outstanding at quarter-end. The company recorded a $1.5 million net reduction in their value in other comprehensive loss for the nine months.
The company reported ordinary-course litigation and claims but does not believe current matters will have a material adverse effect. It also had approximately $2.0 million of maximum exposure under guarantees of certain franchisee leases and debt.
No impairment charges were recorded for goodwill or intangible assets during the periods presented.

Investor verification checklist

Verify the sustainability of franchise growth, same-store sales, membership trends, and the more than 1,000 store-development commitments.
Assess the effect of delinquent-account billing changes on royalties and same-store sales comparability through 2016.
Reconcile reported net income, non-controlling interests, IPO-related adjustments, and non-GAAP Adjusted EBITDA.
Monitor leverage, variable-rate debt exposure, interest-rate cap coverage, covenant headroom, and the 2021 term-loan maturity.
Evaluate the $142.0 million tax benefit arrangement liability and its estimated payment timing.
Confirm remediation and independent testing of the material weakness in IT purchasing and invoice controls.
Review the company’s reliance on franchisees, vendors, third-party systems, and brand reputation, as well as the stated risks in the IPO prospectus.