Planet Fitness, Inc. annual report, FY2016

Business Context and Reporting Period

Planet Fitness, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. The company is a franchisor and operator of fitness centers and also sells equipment to franchisees. At year-end, the system had approximately 8.9 million members and 1,313 locations across 48 states, the District of Columbia, Puerto Rico, Canada and the Dominican Republic. Of these locations, 1,255 were franchised and 58 were corporate-owned.

The filing is an annual report rather than a quarterly filing. Fourth-quarter 2016 revenue was $116.4 million, net income was $21.9 million, and net income attributable to Planet Fitness, Inc. was $10.6 million.

Financial Performance and Key Metrics

Metric	2016	2015	Change
Total revenue	$378.2 million	$330.5 million	14.4% increase
Franchise segment revenue	$116.5 million	$88.1 million	32.2% increase
Corporate-owned stores revenue	$104.7 million	$98.4 million	6.4% increase
Equipment revenue	$157.0 million	$144.1 million	9.0% increase
Income from operations	$115.7 million	$72.1 million	60.4% increase
Net income	$71.2 million	$38.1 million	86.9% increase
Net income attributable to Planet Fitness, Inc.	$21.5 million	$18.5 million	16.1% increase
Adjusted EBITDA	$150.6 million	$123.5 million	22.0% increase
Net cash from operating activities	$108.8 million	$81.7 million	33.2% increase

GAAP operating margin was approximately 30.6%, compared with 21.8% in 2015. GAAP net margin was approximately 18.8%, compared with 11.5%.
System-wide same-store sales increased 8.8%, including 9.0% for franchised stores and 4.9% for corporate-owned stores.
Franchise segment EBITDA increased to $97.3 million from $66.0 million; corporate-owned stores segment EBITDA increased to $40.8 million from $36.1 million.
Total Segment EBITDA was $148.5 million, compared with $104.0 million in 2015. Adjusted EBITDA included $2.1 million of net adjustments in 2016, including transaction fees, offering-related costs, severance and certain gains.
Capital expenditures were $15.4 million, primarily for existing corporate-owned stores, information systems and other corporate needs.

Liquidity, Debt and Capital Structure

Cash and cash equivalents were $40.4 million at December 31, 2016, compared with $31.4 million at year-end 2015.
Total debt, excluding deferred financing costs, was $716.7 million, compared with $492.3 million. Net debt after deferred financing costs was approximately $709.2 million.
The November 2016 credit amendment increased term-loan borrowings by $230.0 million to $718.5 million, reduced the term-loan interest-rate spread by 25 basis points and increased revolving commitments to $75.0 million. The company had no revolving borrowings outstanding at year-end.
The term loan matures in March 2021 and had an interest rate of 4.33% at year-end. A 100-basis-point increase in effective borrowing rates would increase annual pretax interest expense by approximately $7.2 million.
The company reported compliance with its leverage covenant. The applicable maximum leverage ratio was 6.5x, while the reported ratio was 4.3x.
Operating cash flow was sufficient to cover capital expenditures, but financing activities used $85.2 million, primarily because of distributions and dividends.
The company paid a special dividend of $2.78 per Class A share, or $169.3 million, and paid $101.7 million of dividend equivalents to Continuing LLC Owners. The related aggregate cash payment was funded substantially with incremental debt and cash on hand.
Recorded liabilities under tax receivable agreements totaled $419.1 million at year-end. The agreements generally require payment of 85% of specified realized tax savings to former and current equity holders.
Management stated that cash on hand, operating cash flow and available revolver capacity should be adequate for anticipated needs for at least the next twelve months, subject to the risks described in the filing.

Material Changes Versus the Prior Comparable Period

Revenue growth was led by the franchise segment, reflecting additional stores, higher same-store sales, increased royalty revenue, annual fees and franchise-related fees.
Franchise royalties increased to $64.6 million from $46.2 million. The average royalty rate increased over time and was 3.66% in 2016 versus 2.05% in 2012; the current standard rate for new U.S. and Canadian agreements is generally 5.0%.
Equipment revenue growth shifted toward replacement equipment sales, while equipment sales to new franchisee-owned stores declined year over year.
SG&A declined 10.0% to $50.0 million, primarily because 2015 included IPO-related compensation, offering costs and point-of-sale system implementation costs. The company continued to incur higher public-company and franchise-support costs.
Interest expense increased 10.5% to $27.1 million because of additional borrowings, including the November 2016 debt amendment and a $0.6 million loss on extinguishment of debt.
Income taxes increased to $18.7 million from $9.1 million as Planet Fitness, Inc. incurred a full year of federal income taxes and held a larger economic interest in Pla-Fit Holdings. The company also recorded a $2.8 million reserve related to an uncertain state tax position.
Franchisees opened 195 stores in 2016, compared with 206 in 2015. The year-end store count nevertheless increased to 1,313 from 1,124.
The company entered into a 15-year lease for a new corporate headquarters and expected to relocate before July 2017.

Outlook, Commentary, Risks and Unusual Items

Management identified substantial expansion potential, including more than 1,000 additional stores committed under signed area development agreements and a long-term opportunity to exceed 4,000 U.S. stores. More than 90% of new stores opened in 2016 were developed by existing franchisees. The filing does not provide formal quantitative revenue or earnings guidance.

Growth depends on new franchise development, franchisee financing, suitable real estate, continued membership growth, brand awareness and the ability to maintain store-level economics.
The 2015 point-of-sale and billing-system migration resulted in earlier termination of certain delinquent accounts and negatively affected 2016 same-store-sales metrics, although management did not expect a material long-term royalty impact.
The business depends heavily on independent franchisees. Franchisee financial distress, disputes, nonrenewals, operational failures or bankruptcy could reduce royalties and damage the brand.
Significant risks include competition, consumer discretionary spending, minimum-wage increases, payment-processing disruptions, cybersecurity and privacy incidents, dependence on third-party suppliers, and regulation of electronic funds transfers and indoor tanning services.
Variable-rate debt, tightening leverage covenants and approximately $1.4 billion of disclosed contractual obligations create liquidity and refinancing exposure.
Tax receivable agreement payments could be substantial and may accelerate upon certain changes of control, early termination or material breach. The filing provides a hypothetical estimated payment of $655.2 million if the agreements had been terminated at December 31, 2016 under specified assumptions.
Unusual 2016 items included insurance proceeds, a $2.8 million contractual tax indemnification receivable, a $1.8 million equipment-discount write-off gain, $3.0 million of debt-amendment-related third-party fees and a $0.6 million debt-extinguishment loss.
The company disclosed an arbitration dispute involving founder Michael Grondahl and stated that it does not expect the matter to have a material adverse effect.

Important Facts for Investors to Verify

Reconcile GAAP net income attributable to Planet Fitness, Inc. of $21.5 million with consolidated net income of $71.2 million and the $49.7 million attributable to non-controlling interests.
Assess leverage, variable-rate exposure, required debt amortization and the March 2021 term-loan maturity.
Review the $419.1 million tax receivable agreement liability, projected payment timing and potential acceleration provisions.
Evaluate whether the more than 1,000-store development pipeline converts into openings and whether franchisee financing remains available.
Monitor same-store sales after the billing-system changes and the effect of new-store openings near existing locations.
Review the sustainability of the special dividend and the extent to which distributions were funded with incremental borrowings.
Confirm the status and potential resolution of the uncertain state tax position and related audit.
Distinguish reported Adjusted EBITDA and other non-GAAP measures from GAAP earnings and cash flow, including the impact of add-backs and unusual gains.