Xponential Fitness, Inc. (XPOF) Earnings Call Transcript & Summary

So for those of you that don't know me, I'm Alex Perry from BofA Global Research. I'm really pleased and excited to have Xponential Fitness with us here today, including Anthony Geisler, CEO; and John Meloun, CFO. And Xponential Fitness is the largest provider of boutique fitness globally with 10 brands and over 2,600 studios opened across multiple different modalities. Xpo has fully covered from the pandemic with run rate AUVs now 10% above 2019 levels. So I'm going to lead off some Q&A, and then I'll open it up if we have any audience Q&A. So thanks again for joining us today.

Just first, it seems like the portfolio is pretty broad-based now with the BFT acquisition. Can you talk about how you're thinking about the broader portfolio and how you think about maybe scaling current brands versus another potential acquisition?

Yes. I mean, where the company sits today, we've got about a 4- to 5-year backlog, and we've sold about 2,000 franchise units that are yet to be opened in the United States. Those are currently in development. So the size of the business will almost double if we don't sell another franchise. So given kind of the macro headwinds that people are talking about, and we're not seeing those in our business. Our AUVs are at all-time high, franchise sales at an all-time high, store opening is all-time high. So we're comped 25% last year, 17% in Q3 and Q4. So we're looking at the headwind. We're seeing the macro. We're not seeing in our business, our business continues to excel quarter-over-quarter and kind of hit company records. But we know investors are concerned about interest rates, inflation, now banks. And so given that, we don't want to give anybody any worry about any future risk or executional risk and those kind of things. Like I said before, if the company was private, it would probably have 11 or 12 brands today. So there's definitely acquisition opportunities out there, a dialogue that I'm having. And at any time, we're probably 30 to 45 days away from being able to acquire something kind of in the mix. So when the opportunity arises, everything out there is probably not getting more expensive as time goes on. So we'll continue to keep our heads down, continue to keep hitting our 500 to 600 openings and continue to keep increasing AUV.

And then could you -- maybe we'll step back and talk about your sort of journey through the pandemic. I think you sort of led the overall fitness recovery. You were the first publicly traded fitness company to sort of surpass 2019 key metrics. We had an Omicron spike in January of last year that obviously wasn't great for the industry. So maybe talk about if maybe there's not as much seasonality in your drawing periods, but how you were able to recover so quickly coming out of COVID?

Yes. I mean I think we covered so quickly coming out of COVID because we went into COVID very slow. We had to make a decision on whether it was going to be a fight or flight kind of type position. And some of our competitors said, "Hey, we're just going to close up and basically kind of wait this thing out, wait to storm out." I got all the franchisees together on a call, and I said this is our Lieutenant Dan in Forrest Gump moment. And the storm is big, but the boat is bigger. And so we're going to go out. We're not going in for safe harbor. We're not tying up. We are going to close when we absolutely have to close, and we are going to open a moment we're absolutely able to open. It's public record that the State of Arizona, the governor there shut us down for no reason. And I sued the Governor in Federal Court to get our stores back open. So no other fitness company did that, no other franchise or did that for their franchisees, right? And so you need to be there when you need to be there for the franchisees. And so we made sure that we recovered quickly because we were still in the game. We shifted everybody from physical memberships to digital memberships because everybody thinks of the pandemic when they think back about it, like it happened at some time and then it went through and then it unhappened, right, and it came back. But really, it was indoor, outdoor and digital because it was 2 weeks to bend the curve and then it was 30 days to bend the next curve and 30 days to bend the next curve. And then we don't really know and then stuff opened and then it closed back down again and then the stuff reopened. And so there's a lot of variance, and we found that it didn't have to do with a federal government situation even at a state level or county level. It came down to a local police officer level. We had 1 Pure Barre where a officer came in and said, "Hey, we got a report that you guys are spreading COVID here. And so I'm here to report and look around, is there COVID here?" And he said, I need to take a look and look for him. So he looked throughout the store. He said, "I don't see COVID. So I think my job is done here." I said, okay. Great. Literally across the street, we went to reopen a Pure Barre. And when we pulled up the police department was backed in, in the front. We tried to do a 6 a.m. opening, and they were like, "No, still can't open," right? So I found that the permutations really came down to local law enforcement, cities mayors, is really granular. So we sold processed about almost $450 million in 2020. We still grand-opened 350 clubs. So we just kind of took the approach that it was business as usual, except for that thing called COVID. And we're just going to keep pumping through. We closed where we legally had to, but we didn't do any thing sooner than we needed to, and we opened as fast as we could. So we stayed in the game, which allowed us to recover faster. Some of our competitors, when COVID was "over," right? They had to fly back to where their boats were, untie them, dust them off, get a new crew and then go out to try and chase us. So we just kind of got out first because we never came in.

Yes. It makes a lot of sense. And then could you maybe just talk about any trends you're seeing within your brand portfolio? Is Club Pilates outpacing growth? I think that has been -- you've taken the royalty rate up on Club Pilates. I think that would signify that you're seeing some trends there that you really like. So maybe just talk about where you're seeing the growth within portfolio as well as the benefit of having 10 different brands across multiple different workout formats.

Yes. We look at the 10 brands as 10 flavors of ice cream, right? You'll always have your vanilla, chocolate, strawberry, that will be your favorite. But if some little kid comes in, I want to have cotton candy, bubblegum or whatever I need, the franchise fees are the same. The royalties are the same. So we're kind of agnostic as to what flavor we scoop, right? It's all the same costs, all the same labor. So we're just happy when they buy a triple scoop and get it open, right? And so that's really what we're looking for. When you talk about growth, from this point forward, Club Pilates probably is one of the brands that has a lot of growth potential inside of AUV still, but we have about 825 of the about 1,200 stores open, right? So what I get excited about that brand, when I bought it in 2015, it was doing $250,000 AUV at 6%. Today, it does over $800,000 AUV at 8%, right? So I like that, and that's what we want to replicate where we can, right? Now modalities like dance or rowing or things like that may not be as mainstream or popular as yoga or Pilates is today. But when I started Pilates business 8 years ago, people thought the reformers were rowing machines. They called it pilates in a lot of parts of the country. So there's an education that had to happen with that as well. But what I inspired by today is that our newest brands like Rumble and BFT that have the most white space because they're our newest brands, right? We can still sell probably 2,000 between those stores in an aggregate, and there's only about 1/4 of that sold, right? So you still have another probably 1,500 units combined between those 2, and you only have a few hundred open between all of them. So a lot of room there, but those stores are coming out at 500, 550 AUVs. So the way I look at it is they're being born twice as smart as Club Pilates was, right? Club Pilates started 250 and has tripled. These are starting at 500-plus and are continuing to grow.

Yes. And then last quarter, you talked about and you just mentioned the 2,000 domestic studio backlog that are contractually obligated to open. Can you just maybe give us some more color on the timing of when those units -- when we can see those units open? And then just remind us why the delta exists between that drives the backlog? And then also, do you see that 2,000 studio backlog building over time? So I think it's built basically since you guys have been public.

Yes. So usually, when you look at a franchisor and they have a big backlog of stores, it means they can't get funding or the franchisees don't want to open. But that's usually when they're selling 100 or maybe 200 franchises a year if they're doing a great job. We're selling 1,000. So -- and we've continued to sell 1,000. In 2019, we sold almost 1,000. So that's our pace. So when you look at our backlog, it's really 2 years of sales. Somebody else, they could have 200 in their backlog, and that could be 2 years of their -- kind of their gross sales franchises. So we sell them quickly to people, and we sell them in a multipack, right? We sell a 3-pack. So they have to open their first 1 in 6 to 8 months. There's a second one, another incremental, 6 to 8 months, right? and their third, another incremental 6 to 8 months. So when you think about the 1,000 that we sold domestically last year, think of that as 333 people who bought 3, right? So 6 to 8 months from now, the 333 get opened and then 6 to 8 months the 333 get opened. So it's kind of why you're seeing this sort of 500 to 600 range on openings. So I think as we go forward into this year, we've told everybody that since we're not acquiring an 11th brand right now, keeping up with selling 250 a quarter on 10 brands alone is not going to keep happening most likely because we're starting to run out of inventory, right? The demand is still there for franchise sales, but the inventory is starting to run out, right? You can only sell kind of your A markets once. And I don't want to go put 3 or 4 Club Pilates on the ground and end up taken the AUV from 800 to 200 right? So we want to make sure that we're being pragmatic about where do we put these stores so that it really becomes an incremental financial opening for us and for the franchisees. So they kind of continue to open.

And maybe let's talk about that. What -- I mean I think Club Pilates, we know is the most mature. It sounds like [indiscernible] and maybe most of the [indiscernible] has been sold against where do we have the most runway in terms of still premium opening space? And then within that 2,000 studio backlog, what's the sort of density by brand?

Yes, density by brand is tough. I'd have to go through it and figure out the -- I don't have the percentages of all 10 of them memorized. But the majority of those will not be Rumbles and BFTs because we just started selling those, right? They won't be Club Pilates because there's only a couple of hundred of those. So it's really a -- it's a mix across, right? There's a lot of StretchLab still to open. We've got about 300-ish of those open today. We opened a store in the United States every 17 hours. So we continue to do these pretty quickly. They continue to perform. But when you look at the openings this year, you'll see openings still in Club Pilates, StretchLab, Rumble and BFT. We've got about 500 sold already to open of StretchLab, couple hundred of Club Pilates, a couple of hundred of Rumble, and then 100 in change in BFT. So the mix for 2023 will primarily be those 4 brands, which is great because Club Pilates obviously operates well. StretchLab is like a $750,000 AUV. It's one of our top-performing AUV brands. And then the other 2 brands, like I mentioned, are opening at $500,000 $600,000 AUVs. So all kind of holistic AUV drivers for the company.

So should we see a mix benefit for AUVs this year based on the brands that you're opening that could accelerate where you landed in 4Q alongside just organic member acquisition?

Yes, because the disproportionate amount of new studios opening are in the favorable AUV brands. So brands like Pure Barre carries a lower AUV, but that one is like 90% opened as far as openings to license sold. So there's not going to be as many Pure Barres coming. But then to Anthony's point, you're opening up all the favorable AUV brands. So as a proportion of those continue to get open, they're going to carry up the overall AUV.

And then just remind us what the domestic sort of white space opportunity potential is in the U.S. based on the 10 brands that you have now?

Yes. Today, it's 7,900. We use Buxton technology to actually go in and research our customers specifically. And we learned a lot about our customers, LTV, their home mortgage, what credit cards they use, cars they drive, all sorts of stuff. It's pretty crazy. They go and get their information from experienced public files. So it's really almost like credit checking every member. And so you learn a lot about them, not just that they're an affluent, predominantly white female that's educated, that makes X, right? That's kind of the easy stuff. We really dig into what this real core customer is, and then we go back out to the U.S. map, and we say, "Hey, given this is our core customer, and we're going to give them a 2-mile protective radius or 50,000 people, whichever comes first, show me all these circles, right, all these geographies that have my core customer in a dense enough way that allows us to yield a $500,000 AUV or higher," right? And we did that originally Club Pilates gave us 938 pins on a map with Longitude and Latitude. Those are the 938 franchises we sold at Club Pilates. And then once we had 800 plus open, you go back and you say, okay, the modality has grown, the brand has grown, you're seeing AUVs way higher than the way we design them as a minimum. What is 475 as a minimum yield and then the change in kind of brand and modality expansion and it yielded a couple of hundred more locations for us to kind of increase the TAM there by about 25%. And then we sold those to our internal franchisees and some external. And so I think that's what you'll continue to see from the company as we do that across all the additional brands. But we've done that for the brands and come up with the 7,900. So we literally have longitude and latitude pins for 7,900 stores. So this isn't like we took the population of some states or some county and then solve for X based on population. It's very specific on where we sell a store, where we put a store. And then when we open that store, what part of that circle we market to. So a lot of times, people make the mistake. They open up there in a 2-mile radius, so like, "Oh, the rich people live over there." so like let's start targeting the Northeast when really your customer might live in the south, right? And so we want to know where the customer is in that protective radius so we market to that low-lying fruit first.

Yes, that's actually an interesting point, and I didn't realize that. So beyond the 938, did you kind of -- you recreated like a Club Pilates light that was designed to operate on sort of different metrics in terms of like maybe not the base AUV rate? And does it still run at the same operating model as...

It's the exact same store. It's just that the core customer is less dense so could potentially yield a minimum of [ 475 ] versus [ 500 ]. But even in Club Pilates it was as designed at $500,000, the stores perform at over 800, right? So if the stores perform at [ 775 and 475 ] great, right? So be it in the way our franchisees looked at it is they had 2 or 3 or 4 Club Pilates and then they can't expand anymore, right? So we said, "Hey, we're in this bucket of stores." So we're not operating the business any differently. We're just going into a market, eyes wide open, saying there's a tad bit less of our core customer in this market. But those 475 stores will still yield more than 475.

And do the ones that are designed for the lower AUVs, they still run at similar operating margins as, okay.

Yes, it's literally the exact same thing. It's just dirt that we weren't willing to sell in the beginning until the modality and the brand really help to expand that TAM.

And then just shifting gears to internationally. I think you have a 1000 studios contractually obligated to open internationally. Maybe just give us more color there on the operating model internationally with the MFAs, the margin flow-through you see there? And then sort of maybe any color on what's embedded in terms of the guidance coming from international.

Yes, I'll give you the upside of how we set up and I'll let John handle the last half. But think of it as about 25 countries so far as kind of optimal places that we're looking to go, and you've got 10 brands, right? So it's 250 master franchise agreements that you could sign, right, internationally. And today, we're operating in 16 of those 25, right? So there's another 9 that can go, but we're not operating all brands in all the countries, right? So there's a lot of upside for us still in signing more master franchise agreements. But what we do is we go in and we find somebody to be us. We find somebody who's been a franchisor who's developed brands in their country, who has the capital and we signed a master franchise agreement with them. They typically pay about $400,000 upfront per brand per country. And then they start to sell what we call an SFA, which is a sub-franchise agreement, which is basically what we sell here. We're the franchisor, we're kind of our own master franchisor, right, and we sell a franchise agreement here. They do the same thing. So they become exponential there, right? They become the parent of Rumble or whatever it might be in Australia or whatever country it may be and they start to sell these sub-franchise agreements. So we will make a deal with a master that says you'll sell 100 Rumbles -- seller open 100 Rumbles over the next 5 years in Australia, right? And then they go out and sell sub-franchise agreements, they open stores themselves, and then we collect the economics, I'll let John kind of walk you through that.

Yes. So when you look at the international component, largely, it's 100% margin for us. There is about a staff of the department of about 5 people that support the international growth. But when you -- we guided the Street to $285 to $295, about 10% of the studios open are international, today out of the 2,600 and then when you think about -- going forward, about 25% of the studios that will be opening last year and this year will be international. From an economic standpoint, the way it kind of works is, we sell the license internationally because we're not the end provider of the service because the master franchisor acts as us in Australia as an example, they're ultimately responsible for serving that sub-franchisee. So when they sell a license, we get a rev share that ranges somewhere between 30% and 50% depending on each MFA agreement. So for example, we sell a license for $60,000 in Australia, we get $30,000 from the master franchisor. They send it to us rather than amortizing it over 10 years like we do in the U.S., we get to recognize it immediately. So the economics are the same in total, but the recognition is much more accretive on a per period basis. All the other lines like margin on equipment, we get 50% of the margin that they make, 50% of the merchandise, royalties we get half. The benefit we have is we don't have the SG&A. So when you think of guiding the Street from $285 to $295 with 10% roughly of the studios being international, about 10% of the guidance we gave is international in our P&L, but it has -- carries a higher margin than the 35% to 39% we kind of indicated to the Street that we'll perform out this year.

And so just to summarize that, so $400,000 upfront fee per brand, 30% to 50% sublicense fee, 50% of a normalized equipment margin and then, call it, a 3.5% royalty rate?

Correct.

Got you.

With no SG&A. Very little.

Well the same exact revenue lines here as we do internationally, but we get half the revenue and on the SG&A. Think of it that way.

Perfect. That's really helpful. In terms of -- I guess, maybe just shifting back to the AUV progression, you did $522,000, it was like the reported 4Q AUVs. Can you maybe talk to us about the components of that growth? Is most of it being driven by memberships, how much of that is pricing?

Do you want me to take this. Yes. So when you actually look at -- when you become a member, you lock in your membership price. So therefore, it doesn't -- we don't come back and say, we're going to raise your membership, right? So 95% of all the system-wide sales growth we saw this year was volume. So we're actually adding more members per studio, not just because we're opening more studios, actually more members per studio then we have only 5% is price. And really the price is coming from a member leaves if they come back or the replacing member comes back, they are coming back at a higher price. So we attribute the member coming back as neutral, but the incremental revenue that we're picking up on that member is the 5% is price. So the good thing about it is as we continue to add more and more studios, the installed base continues to grow on top of that. So generating a lot of system-wide sales and additional flow-through for the -- from a royalty perspective.

Perfect. So I had ran some numbers. And so if I'm right here, you make about $146 per member per month with about 256 members per studio. Is that roughly right? I guess the question is, where could that $146 ultimately go? It's actually probably lower than what some high-end big box gyms are charging for memberships. And then where -- is that 256 like an at capacity number where -- or is it like the studios have the ability to have 300 members?

Yes. So when you look at -- depending on how you run your math, the one thing you're probably missing is we have a lot of members -- or nonmembers that come into our city or walk-ins, that kind of stuff. So there's additional upside on the walk-in member that comes in. Where you actually can start realizing more benefit is we do retail in our studios. So you are getting -- like Pure Barre, for example, is a very high retail brand. So getting all the brands to be performing at a higher retail. We are doing a lot of B2B deals, which I think you've been aware of. So things like C4, for example. So we're starting to sell more and more product inside our studio. So taking more wallet share from in studio perspective is another opportunity. Always have the ability to kind of raise price on our members, but it's probably just like your cable bill, like you always get aggravated when you raise price on a member, so not something we'd probably do in the near term, but there always is that opportunity. And we take price up all of the time. So again, when a member leaves and we bring in -- we adjust our pricing over time. So as capacity in a studio fills out, we raise price, so it's the supply and demand. So the first member is probably paying the least, the last member who just came in is probably paying the most. So as that first member leaves, that next one comes in is going to be paying more than the one previous. So you continue to take price along the way, which will drive up AUVs.

And presumably to go beyond the sort of 250 members per box, you can just add class capacity and that could get north of 300 or thinking about it?

It's definitely possible. It became more possible in post-COVID, where you do have some work from home and even where you have in-office where employers have become more flexible, let's call it, given the -- given the market. So somebody had to leave at 4 o'clock at the end of the day, now to hit a 4 o'clock class versus a 5 o'clock class or 6 o'clock class. That's kind of doable in some businesses, if you could go work out at noon during your lunch or whatever it might be, my assistant all the time. So [indiscernible] going to be 8:30 that day? Or can I go take a class -- and of course, really hard in our industry to say no, you can't go take a class. But employers are becoming kind of more and more tolerant of that, especially when it's a health and wellness thing, right? If it's like, "Hey, I want to come in late because I want to take a long breakfast with a friend," that's probably less flexible. But if they say they're going to take a class and work out and those kind of things then they're a little bit more happy to hear that.

In terms of -- you mentioned B2B partnerships. I think that's become a larger part of the story this past year. Maybe just talk to us about the evolution of that, the economics of those partnerships, maybe which ones you're most excited about?

Yes, I think what we do a great job at Xpo is figuring out, hey, what -- our day job is, we opened gyms. What do you do for a living? We opened these boutique fitness studios and we try and make the much -- as much money as we possibly can. But then I ask everybody, well, what's your night job and what are you doing on weekends, right? Like what's Xpo side hustle, right? And so that's where you see things like XPLUS, our digital business or the XPASS that allows you to buy one pass and go to all 10 brands. I want to say at the same time, but have the optionality to do them all. And so we look at that and then we kind of develop those and we went past that and we said, okay, well, how do we monetize these in a different way, right? Because when you look at customer acquisition costs, we're just out there buying Facebook PPC ads or search or whatever it might be and kind of everybody is chasing the bottom in the CAC world. So said, well, is there a way to monetize XPLUS in a different way? Is there a way to monetize XPASS in a different way and our relationships. So the majority of what you see in that B2B partnership today is a deal I did during COVID where I went back to our credit card processor, and I've been in this business for 20 years. So our credit card processor is our credit card processor because they were a startup 20 years ago when I was a startup. And so we're processing $1 billion last year and $1.3 billion or more this year, right? That's a lot of money. And so we went back to them during COVID and said, "Hey, look, we want to do a multiyear partnership with you. But you're going to have to pay us a chunk of money upfront, and we're going to take 1% of the credit card processing on a go-forward basis, right? So as you see system-wide sales start to grow, 1% of it is coming back to us a rebate from the credit card processor. And then we went out and did deals like lululemon, where we basically took our XPlus and relicensed it back out, right? And so now you'll find our XPLUS at lululemon and Mirror. You also find it on Google Play, you'll find it on every LG TV when you buy a new LG TV now. And so we continue to do that. We licensed out XPLUS to the 23,000 state rooms on Princess Cruises. When they leave Princess cruises, they get an XPASS on the ship, they get to work out in a brick-and-mortar gym. And so we're really trying to push Xpo to be a health and wellness kind of lifestyle business, right? We want people to get sick of seeing us so that if they saw us on a cruise ship, they turn on the TV in the house and they saw us and they walked into lululemon store and saw our content. I was just working out at a hotel in Laguna a couple of days ago, and they had a mirror on the wall when I walked in it was playing our content, right? And so everybody does in that gym is exposed to it on the mirror, right? The mirror sits in Nordstrom stores where there's lululemon retail. And so we really like it because it's helping lower our customer acquisition cost, right? And I've kind of coined a term called negative CAC, which these people are paying us. Lululemon pays us a lot of money to then market our 4-wall business to their Mirror customer. Same with Princess. Princess paid us a lot of money and they continue to pay us on an ongoing basis in each of these B2B deals, but it's driving lead flow -- free lead flow into the brick-and-mortar businesses. So I really like and what gets me excited is about how we've leveraged some -- you make a 60-minute video, and you're able to relicense that video 5 different ways as well as on our own XPLUS platform that has people just paying for directly. So continue to see that from us on a go forward.

And then I wanted to ask about XPASS as well. Maybe just talk to us about the evolution of XPASS and where you see that going over time? And how it differentiates itself from the other class aggregators out there like a Gympass, which seems to be, at least in New York City, taking off pretty good in a ClassPass?

Yes. I mean Gympass is kind of starting to pick up or ClassPass, I think, left off. But with all the aggregators even with XPASS, it really is the fill the last butts in seats. And that's what it's designed to do. It's not designed to replace my unlimited member who's paying a lot of money on a Monday at 5 and now they can't get a class because ClassPass or Gympass or XPASS is filling that seat. So it really is to get the aggregate together and allow that aggregated inventory to get sold off, right? For us, the way XPASS works is, let's say, somebody comes in and buys $100 XPASS, we take 20% off the top, and we put that $80 into an escrow. So when the member goes around and uses their XPASS, we pay down a class fee to the franchisee. Typically, it's a reoccurring subscription, right? And so it's used or lose it by the end of the 30-day period, and typically, there's about 10% breakage. So we end up with $0.30 or 30% of every dollar that comes in via XPASS and goes to the store as opposed to if that member goes into the store, we get 7% royalty, right, that comes up. So we make 4x as much money on a percentage basis when somebody comes via XPASS. But XPass has been awesome as well for customer acquisition, right Because there's kind of 2 people. There's the people that are snackers, right, that say, "Hey, look, I want to do a bar class today. I'll do a cycle class tomorrow, I will do yoga the next day," right? So we get to take those people. They're not out having to buy a membership. But core power yoga and then one is Orangetheory and one is something else, right, to be able to create their own XPASS would be very expensive for them to do, whether it was inside or outside our network. So it draws people to our ecosystem, right, because it's the only one that really gives you that pass across 10 different brands. So we'll continue to utilize it for that. And then you have your people that don't know if they want to do cycling or they want to do Pilates or yoga, they know they want to do something. So they buy the XPASS, and then come in and snack around like the snackers do and then they find a home, and then they end up signing up there. So it's working as customer acquisition or a negative CAC for the franchisees as well.

I wanted to ask a little bit about the health of the franchisee base, especially around sort of margins at the franchisee level and how those compared to prepandemic. Are they -- I think in the filings, they're designed to operate around 20% -- 25% to 30% operating margin. Are they -- is that where you see the base right now? Is it above that, below that?

Yes, I mean, you're arguing that you're going above that now from the standpoint of the studios that are designed to generate that at a $500,000 AUV. So now they've exceeded that. You take brands like Club Pilates that are doing $800,000, they're definitely doing above 30% margins, operating margin. So I think as you continue to see AUVs climb, obviously, the franchisee will end up making more money because they have a fixed cost, they're just charging more per member based off of what we talked about earlier. So AUV is how -- I think the one -- the way to really think about how healthy are our franchisees is closures, and we don't have closures in our studios. From the time we've owned them we've never had 0 closures. So if they weren't making money, they'd be going away. And obviously, they're not because we haven't had any closures in the system. So I would say the overall health of the franchisees is strong and getting stronger.

And we'll take if somebody isn't making margins that are not running the business properly, we will take those stores back, and we will transition those back out into the franchise network or if we have to relocate a location or something like that but the franchise unit itself stays alive and open, and then we'll refranchise them back out. A lot of franchisors like closures because then they can turn around and sell another $60,000 franchise in that area, right? But we are hooked on royalty. We're not hooked on the upfront franchise fee. And so it has to be recognized over 10 years. Yes, we get the cash, we don't necessarily need the cash. We want to put some franchisee in kind of in harm's way, right? So for us, we'll buy those stores back for $1 or something if that's what we need to do. And then we'll refranchise them back out to someone else.

That's a good segue. Actually I wanted to ask about transition studios. So I think you had reported in the K around 55 transition studios, roughly 2.1% of the overall base. Is that the right number we should think about? Should we see that 55% come down over time? Or do you see operating in that sort of 2% of your overall studio?

It depends on like what day and microsecond, you want to take a snapshot and we sold 25 of them last week. So number goes down. So it ranges anywhere. At one point, we had 5. During the pandemic, I think we had 75 or something with people moving and doing all sorts of things. So I don't know if it's a fixed number amount or a fixed percentage. I'd say your range has probably been in the past years from a 0.5% to 3% something. The other day, it was at 1.8% when I checked. But our resale teams are selling stores daily, right? And so it just kind of -- it kind of varies. But the numbers by number, will probably get larger as the system gets larger, but...

And then I just wanted to ask about unit build-out, both around the costing side. I think $350,000 on average billed out of unit. Have you seen that change at all? Others are calling out rising construction costs? And then any hesitancy from the franchisees to open units with what we're seeing from a rate environment?

Yes, none, really. I mean you're seeing where we're just opened more stores last year than we ever have. So the rate has been going up for the last year plus, and we did better than we did the year before. So yes, rates are going up on franchisees. Yes, construction is going up, but we don't do a lot of construction. We're 1,500 square feet, right? And so a lot of times, people say, "Oh, well, Planet Fitness, they can't get open because they have air conditioning issues. What's your air conditioning issue". And I'm like, we just turn on the air conditioning when we go in, if it was addressed or an ice cream shop before or whatever it was, we come in, right? And so yes, construction has gone up, but the majority of our brands, we don't build any walls right? And StretchLab, nothing even plugs in. Benches sitting in the middle of the room. So there's not a lot of walls to build. There's not a lot of construction. Majority of the things we get have 4 walls, right, because they're part of a shopping center. And they typically have to have a bathroom already because they had to be ADA compliant at some point. So for us, it's a lot of paint and flooring and signage and minimal construction. So yes, it goes up, but we're not spending a lot on construction. So the actual dollar amount doesn't end up being a lot.

And then how are the franchisees typically financing the build-out? Is it mostly done through SBA loans? Are they using their own liquidity?

Yes. It's a mixture. Right now, we actually put in a preferred vendor last year who has about an entire quarter's worth of loans like in process to go ahead and get franchisee funding. They've seen about -- interest rate hike from about 6% to 8%, but they don't borrow a lot of our franchisees have to have equity in the business for them to qualify. So from that perspective, they're borrowing $100,000, $200,000. So that increase in interest rates is pretty nominal to the overall decision of whether or not you even want to get open. But they do have access to that. They do use the SBA. They do personal financing, whether they're taking loans on their HELOCs from their house or their 401(k) or however it is. But most of our franchisees are financially qualified before they even buy a license. So from our perspective, we know they have the capital and the wherewithal to be able to open studios.

Yes, we're only converting 2% of our lead flow into franchisees. So we have a very stringent process that really works 2 ways. One, we weed them out on our own because we don't like what they say or how they say it or what they're thinking, right? How they believe something or not? And we feed them with a firehose with education of what life is really going to be like as a franchisee, and some people don't like that. So they exit on their own, and we're okay with that because we want people to go into it eyes wide open, right? Like this is not a business that you're opening so that your kids that can't get a job somewhere else can come work the front desk because nobody else wants them. Like this is not an education for whoever to go learn how to run a business. This is not -- so we go through all of that because sometimes people show up and they believe they're going to spend $350,000 and it's just going to be a lot of fun, and they're going to sit on the couch and collect a check. And it's not like that. It's still a business, still a start-up, still has risk, still has to do work. And so we make that very clear to the franchisees. And so we discount people out. And we also scare a lot of people with reality. So we only end up converting about 2%. So some of that reality is, you're going to put money and you have to have liquidity, you're not going to have 100% financing.

And then I want to squeeze in one more. Can you just talk about how leverageable the model is? And how much do you think you need to scale SG&A as the business continues to grow?

Yes. So I mean we opened 500 studios last year. We didn't scale SG&A at all. Same process this year when we guided the Street. There's very little SG&A growth in the model at all because we run a back office, centralized SG&A. So everything from your accounting finance, HR, legal, real estate, retail, franchise sales, they all support all 10 brands. So when we bought BFT, when we bought Rumble, we added no additional SG&A. So when you start seeing the margin expansion on the bottom line, it's really us just generating more top line revenue, more margin, it falls to the bottom line. So opening up 550 studios at the midpoint of the range, really zero SG&A for back office SG&A that needs to be added because we could support the model with what we already have in place.

Yes, but 80% of that [indiscernible] charge is shared services. So when we bought Rumble, we hired a Brand President and Chief Marketing Officer, someone in charge of selling memberships nationally and someone in charge [ instruction ] nationally. And that's what we hire at the brand level and then everything else is on shared services. So we're able to acquire 2 new brands, sell hundreds of locations, get a bunch of stores open. There's a few hundred BFTs open internationally. So we're able to bring in 8 people on the brand side, no SG&A on the shared services side and then go run 2 great brands.

So you've seen less -- like in 2021, we were at 17%. Last year, we grew to 30%. This year, it will be in the high 30s. By 2024, we'll cross into the 40% margins, and that's all leveraging SG&A.

Perfect. Well, thanks again, Anthony and John for joining us and for a great discussion. Really appreciate it.

Thanks a lot.

Thank you.