Planet Fitness, Inc. annual report, FY2015

Planet Fitness, Inc. — FY2015 Form 10-K Summary

Business context and reporting period

Planet Fitness is a franchisor and operator of low-cost fitness centers, with additional revenue from fitness-equipment sales to franchisees. The filing covers the fiscal year ended December 31, 2015; fourth-quarter 2015 results are also presented. The company completed its initial public offering on August 11, 2015, and Class A common stock began trading on the NYSE on August 6, 2015.

1,124 system-wide stores at year-end: 1,066 franchised and 58 corporate-owned.
Approximately 7.3 million members in 47 states, the District of Columbia, Puerto Rico, Canada and the Dominican Republic.
Franchisees had signed area development agreements to open more than 1,000 additional U.S. stores and more than 100 additional Canadian stores.
The company operated through Franchise, Corporate-owned stores and Equipment segments.

Financial performance and key metrics

Metric	2015	2014	Change
Total revenue	$330.5 million	$279.8 million	+18.1%
Income from operations	$72.1 million	$61.5 million	+17.2%
Operating margin	21.8%	22.0%	Down 0.2 points
Net income	$38.1 million	$37.3 million	+2.2%
Net income attributable to Planet Fitness, Inc.	$18.5 million	$36.8 million	Down 49.7%
Adjusted EBITDA	$123.5 million	$100.5 million	+22.8%
Pro forma adjusted net income	$53.2 million	$42.2 million	+26.2%
Net cash provided by operating activities	$81.7 million	$79.4 million	+2.8%
Capital expenditures	$19.5 million	$16.7 million	+17.0%
Cash and cash equivalents	$31.4 million	$43.3 million	Down $11.9 million
Total debt and capital lease obligations	$492.3 million	$387.5 million	+27.1%

Revenue growth was led by equipment revenue of $144.1 million, corporate-owned store revenue of $98.4 million and franchise segment revenue of $88.1 million. Franchise segment EBITDA increased 24.3% to $66.0 million; corporate-owned stores segment EBITDA increased 13.8% to $36.1 million; and equipment segment EBITDA increased 20.8% to $31.9 million.

Corporate-owned stores produced a 36.7% segment EBITDA margin. Reported corporate-owned-store four-wall EBITDA margin was 41.8%, or 36.8% after a 5% royalty adjustment. System-wide same-store sales increased 7.7%, including 8.3% for franchised stores and 1.9% for corporate-owned stores.

Fourth-quarter 2015 revenue was $105.8 million, operating income was $28.8 million and net income was $17.2 million. Fourth-quarter results were affected by the company’s seasonal pattern, with membership joins generally higher in January.

Material changes versus prior comparable period

Stores increased from 918 to 1,124, including 206 new franchised stores and three new corporate-owned stores.
Members increased approximately 20% year over year; PF Black Card members represented 57% of membership versus 42% in 2011.
Average monthly dues per member increased to $15.64 from $14.24 in 2011.
Average royalty rate increased to 3.27% from 1.67% in 2011, while the current franchise agreement rate is generally 5%.
SG&A increased 58.2% to $55.6 million, primarily due to IPO-related compensation and costs, information-technology spending, public-company costs and expanded franchise support infrastructure.
Interest expense increased 12.6% to $24.5 million after the company added $120.0 million of term-loan borrowings in March 2015.
Income-tax expense increased to $9.1 million from $1.2 million as the post-IPO public company became subject to additional federal and state taxes; prior periods benefited from pass-through tax treatment.
Net income attributable to Planet Fitness, Inc. declined despite higher consolidated net income because the post-IPO structure allocates a larger portion of earnings to non-controlling interests.
The company completed a migration to a new point-of-sale and billing system. Management expects earlier termination of delinquent accounts to pressure reported same-store-sales metrics during 2016.

Cash flow, debt and liquidity

Operating cash flow was $81.7 million, compared with $79.4 million in 2014.
Investing cash outflow was $19.2 million, primarily reflecting $19.5 million of capital expenditures. The 2014 period included the $38.6 million cash acquisition of eight franchisee-owned stores.
Financing cash outflow was $74.2 million, including $176.5 million of distributions to Pla-Fit Holdings members, partially offset by $120.0 million of new debt.
Outstanding term debt was $492.3 million before deferred financing costs; scheduled principal payments are approximately $5.1 million annually through 2020, with $466.8 million due thereafter and final maturity in 2021.
The revolving credit facility provides $40.0 million of capacity and expires in 2019. The company reported a 3.5-to-1.0 leverage ratio at year-end versus a 6.0-to-1.0 covenant limit and stated that it was in compliance.
Management stated that cash, operating cash flow and revolver availability should be adequate for anticipated needs for at least the next twelve months, but noted that future performance and refinancing capacity are subject to economic and business risks.

Guidance, outlook, commentary and unusual items

The filing does not provide formal numerical revenue or earnings guidance. Management emphasizes continued franchised-store expansion, growth in system-wide same-store sales, increased PF Black Card penetration, higher royalty rates, brand investment and equipment replacement sales. The company believes its U.S. store opportunity could exceed 4,000 locations.

2015 Adjusted EBITDA included $7.7 million of IPO-related costs, $6.2 million of IPO-related compensation, $3.9 million of IT-system upgrade costs and $1.9 million of management fees, among other adjustments.
The TSG management services agreement terminated in connection with the IPO; 2015 included a $1.0 million termination fee.
The company recorded a $2.6 million gain from an adjustment to its tax-benefit arrangement, primarily due to changes in the effective tax rate.
Tax receivable agreements require payments generally equal to 85% of specified realized tax savings. The recorded liability was $140.2 million at year-end; the company estimated potential aggregate payments of $711.2 million over approximately 23 years under specified assumptions, and estimated an accelerated termination payment of $576.0 million as of December 31, 2015.
The company identified a material weakness in internal control over financial reporting relating to authorization of IT hardware purchases and processing of related invoices. Remediation was underway, but management concluded the weakness remained at December 31, 2015.
An arbitration matter involving former CEO and founder Michael Grondahl concerns non-competition, separation, valuation and indemnification issues. Management stated that it did not expect a material adverse effect.

Principal risks and contingencies

Dependence on franchisee operating performance, financing capacity, renewals and compliance with brand and regulatory standards.
Competition and potential market saturation, including cannibalization from new stores near existing locations.
Reliance on recurring electronic payments, third-party billing and information systems, and exposure to data breaches, outages and privacy regulation.
Variable-rate debt, substantial leverage, restrictive covenants and refinancing risk.
Long-term noncancelable leases, minimum-wage pressure and construction or equipment-cost inflation.
Regulatory and reputational risks related to franchising, automatic membership renewals, electronic fund transfers and indoor tanning services.
Concentration among equipment suppliers: two vendors accounted for 97% of equipment purchases in 2015.
TSG controlled approximately 65.8% of voting power, making the company a controlled company under NYSE rules and allowing reliance on certain governance exemptions.

Most important facts for an investor to verify

Reconcile consolidated net income of $38.1 million with $18.5 million attributable to Planet Fitness, Inc. and understand the effect of non-controlling interests on per-share economics.
Assess leverage, variable-rate exposure, debt maturities and compliance with the tightening leverage covenant.
Review the economic and liquidity impact of the tax receivable agreements, including possible accelerated payments.
Evaluate whether franchisee development commitments convert into opened stores and whether new-store growth affects existing-store performance.
Monitor 2016 same-store-sales comparability after the new billing system’s earlier termination of delinquent accounts.
Confirm remediation and independent testing of the material weakness in internal control over financial reporting.
Review recurring versus equipment-related revenue and the company’s exposure to two primary equipment suppliers.
Consider the effects of IPO-related expenses, higher public-company costs, taxes and non-GAAP adjustments when assessing sustainable earnings.