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Executives

Dan Gallagher – CFO and SVP

Alex Alimanestianu – President and CEO

Analysts

Sharon Zackfia – William Blair

Laura Richardson – BB&T

Town Sports International Holdings, Inc. (CLUB) Q3 2008 Earnings Call Transcript October 30, 2008 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Town Sports International Holdings, Inc. conference call. My name is Christa [ph], and I’ll be your coordinator for today.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator instructions)

I would now like to turn the presentation over to your host for today’s call Mr. Dan Gallagher, Chief Financial Officer. Please proceed, sir.

Dan Gallagher

Thank you for joining us today. This is the Town Sports International Holdings Earnings Conference Call, discussing Third Quarter 2008 results.

I'm Daniel Gallagher, Chief Financial Officer of the Company.

I caution listeners that to the extent we make any forward-looking statements in this conference call, they are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which are outside of our control, which may cause actual results to be materially different from any forecasts we have made.

We have issued a press release discussing our results for the quarter, which will also be filed with the SEC under a Form 8-K. In addition, to those of you who do not have access to this release and filing, we have also made them available at our Web site, www.mysportsclubs.com.

This conference call is also being webcast and may be accessed via the Investor Relations section of our Web site. Also a replay and transcript of the call will be available via the Company's Web site following this call.

I will now turn this call over to Alex Alimanestianu, the President and Chief Executive Officer of Town Sports International for discussion on the operations of the Company. And then I will give further detailed financial discussion later in the call. Alex?

Alex Alimanestianu

Thank you, Dan, and good afternoon everyone. As you are well aware, the economic environment has been tumultuous since the last time we’ve reported our earnings, especially in our core New York City metropolitan area.

We finished the first half of the year with solid results including stable year-over-year attrition rates, and we expect the first half trends to continue through the balance of the year. However, in July and August and as the financial crisis escalated in September, we saw consumer behavior change, and as a result we saw new member sign up for shorter plans and attrition rates move higher than expected.

As many of you know, September is a very important new member sign up month for us, second only to the month of January. In this year, the challenge of acquiring new memberships in the month of September was made more difficult by the steady stream of negative economic news and the drop in consumer confidence. As you see from our guidance for the fourth quarter, much of the fallout from September and the third quarter generally will have a bigger impact in October and after.

While we were able to grow our total membership in the third quarter, we expect it to be down in the fourth quarter as a result of likely increases in attrition and continued slower new member sign ups.

Now, looking at some key performers in the caters for the quarter, our comparable revenue growth of 2.2% for the quarter was down sequentially from 3.2% in the second quarter. Our attrition rate averaged 3.58% per month in or 11 days (inaudible) than prior year.

On the positive side, our personal training revenue was up 12.3% in the third quarter which is an improvement from the first half of the year. Member participation in personal training grew 16%, which we believe is a result of better execution in this area of the business.

Corporate membership sales continued to grow versus the prior year, but the year to date double-digit rate of growth in new unit sales has slowed to single digits as companies are more focused on cost controls, lay offs and other critical needs.

Another positive for the quarter was the performance of our new club portfolio which continues to perform ahead of expectations. In the quarter, we opened one multi-recreational club in Westborough, Massachusetts, our 23rd club in Boston. This brings the total number of clubs in operation at the end of the period to 164. We also began pre-opening sales at our new multi-recreational club in Hicksville, Long Island our 12th club in the market.

Looking out over the balance of 2008, we now expect to open a total of 9 clubs this year, as two clubs that we plan to open in 2008 will open in early Q1, 2009. In addition to the 6 clubs opened in the first 9 months, we expect to open 3 clubs in the fourth quarter including our first club in the Providence, Rhode Island market.

So, while our members and perspective members are sorting out their current employment and financial positions and outlooks, we too sorting through the different moving parts of our business and reacting to the recent market changes in consumer behavior.

While we will play defense and cut costs where possible, we also believe a good offensive game plan will help turn today’s challenging economic environment into a great opportunity for us to take our inherit share in the industry as the weaker players inevitably shakeout.

In any case, we will continue to focus on heightening the member experience in our clubs and strengthening financial performance by moving forward with the five key operational initiative that our COO, Marty Annese and his team are pursuing, namely an operational excellence system which creates an emotional connection with members and promotes member satisfaction and referrals, building and stabilizing talent level in the clubs and in operations generally, driving membership sales by among other things, optimizing our sales by channel and developing value-based promotions, driving member retention and driving revenue growth.

But we will also be particularly prudent about capital expenditure for growth in the near term. At this time, we expect to reduce our unit growth to 46 new clubs in 2009 as we wait for signs of a consumer recovery and for real estate opportunities to become increasingly compelling.

This 46 new club count includes 2 clubs that slipped from this year to next. With respect to maintenance capital expenditures, we expect to increase slightly our level of investments so that our existing clubs can deliver the quality experience that our members expect.

The success of our Company over its 34-year history has been driven by our strategy to offer an affordable and convenient way for our members to achieve their fitness and lifestyle goals and by our mission to improve lives through exercise. Nothing has changed in that regard and we’ve been through recessions before and we will come out of this one a better and a stronger Company.

Now, I would like to turn the call back over to Dan Gallagher to provide more details regarding our financial performance to date. Dan?

Dan Gallagher

Thank you, Alex. Looking at our third quarter results, our consolidated revenue were $128.1 million, an increase of 7.8% over the prior year. The growth was driven by an increasing membership revenue, which rose by $10.6 million or 7.6% to $104.5 million. Ancillary club revenue rose $1.7 million or 8.1% to $22.2 million for the quarter, including 12.3% increase in personal training revenue.

Revenue at our comparable clubs, those clubs opened over 12 months increased by 2.2%. This increase was driven by member growth of 0.9%, an overall average price increase of 0.9%, and ancillary and other revenue growth of 0.4%.

Total operating expenses for the quarter were $116.5 million, an increase of 11% from last year's third quarter. This includes a fixed asset impairment charge of $839,000 or approximately $0.02 per share in the quarter. Backing up that charge, total expenses were up 10.7%.

Payroll and related expense increased $5.8 million or 13.5% to $49.2 million as compared to $43.3 million in the same period last year. The increase was driven by a net increase of 10 clubs during the 12 month ended September 30, 2008, as well as an increase in payroll related to the sales staff.

Because we continue to run promotions on our joining fees in an effort to drive membership sales, and because we are limited in the amount of payroll costs that can be deferred by the amount we collect in joining fees, we experience an increase in sales related payroll expense of approximately $2.1 million this year versus prior year.

Club operating expenses totaled $44.4 million, an increase of 4.8% over the prior year. Rent and occupancy related expenses increased $2.6 million while advertising and marketing expenses decreased $1.5 million.

Depreciation and amortization expense was $13.4 million with 10.5% of sales versus 9.2% of sales in the year ago quarter. With our revised sales outlook and planned new club openings, we expect depreciation and amortization expense to approximate 10.9% in the fourth quarter of 2008.

We recorded an asset impairment charge of $839,000 related to a club we have elected to close prior to the expiration of its lease.

Operating income for the quarter was $11.6 million compared to $13.9 million in the prior year's quarter. The afore mentioned increase is in payroll, increases in depreciation and amortization, and the asset impairment charge were the major reasons for the decline in operating income. We’ve included in our earnings release made available today an analysis of our EBITDA for the quarter.

EBITDA was $25.6 million for the third quarter, a 1.4% increase over the third quarter of 2007. Our EBITDA margins were 20% for the third quarter of 2008 as compared to 21.3% for the third quarter of 2007. Adjusting 2008 EBITDA for the asset impairment charge, EBITDA totals $26.5 million with a margin of 20.7%.

Personnel interest expense was $5.8 million for the quarter, compared to $6.5 million in prior year’s quarter. The reduction in interest expense was principally due to the decrease in the interest rate charge in our term loan facility. Interest charge in our term loan averaged 4.3% for the quarter ended September 30, 2008.

Our term loan borrowings were under the LIBOR based rate option to September 30, and given the recent volatility of LIBOR, we have moved to our term loan facility borrowings to the bank’s primary based option which is primary for 75 basis points or 5.25% ON [ph]. This ON rate is based on the bank’s prime lending rate prior to any impact of the federal reserves 50 basis point cut yesterday.

Fully diluted earnings per share were $0.14 a share compared to $0.19 per diluted share in 2007. Earnings per share were $0.16 per share excluding the effect of asset impairment charge.

Turning to our liquidity, total debt at the period end stood at $315.9 million, and cash is at $10.7 million, giving a net debt figure of $305.3 million. In addition, we have a $75 million credit facility in place, of which $63.1 million was unutilized as of September 30.

Cash flows from operations for the first nine months of 2008 totaled $76.9 million compared to $62.6 million for the quarter, comparable period in 2007.

Capital expenditures totaled $63.2 million year todate, and we expect capital expenditures for the full year of 2008 to approximate $90 million to $95 million. This annual amount includes $22 million to continue to upgrade existing clubs. We will spend approximately $9 million to enhance our management information system and $5 million towards the construction of a new regional laundry facility in our New York market. The remainder of our 2008 capital expenditures will primarily be committed to building new clubs.

We also expect to receive approximately $9 million in tenant incentives from this construction from our landlords during the full year of 2008. While we are still evaluating our investment plans for 2009, we currently expect total capital expenditures to range between $60 million and $70 million. We expect to open 46 clubs and close 4 clubs in 2009.

As of September 30, 2008, we had 4.25 million square feet of club facilities under management compared to 3.9 million square feet at the end of the third quarter of 2007, a 10% increase. Our target is to bring our total club count to 166 clubs with a total of 4.31 million square feet by December 31, 2008. Our net club increase will be 5 this year, with 9 openings and 4 closures.

As you know, we previously announced a 19-month stock repurchase program to purchase an aggregate of 25 million of the Company’s common stock, which is expected to continue through December 2009. We have not made any repurchases todate.

As previously stated when we announced a program, repurchases may be made from time to time at our discretion and depending upon a variety of factors including prevailing market conditions.

During this quarter, our growth in net members were weaker than anticipated. We are forecasting this membership trends to soften further in the fourth quarter. Based on the current business environment, our recent performance and the current trends in our marketplace and subject to risk and uncertainties in our forward-looking statements, the Company is lowering its guidance for 2008. We expect to open 9 new clubs in 2008, down from 11 in our previous guidance. Two of our clubs are currently under construction will open in early 2009 instead of late 2008.

We now expect revenues for the full year to be in the range of $504 million to $508 million or approximately 6.5% to 7.5% growth over 2007. This is down from my previous outlook for revenues of $510 million to $520 million or 8% to 10% growth.

We now expect net income to be between $16.5 million and $17.5 million for 2008 for the fully year and EPS to be between $0.62 and $0.66 for the full year. This is down from my previous guidance of $0.80 to $0.84. This EPS guidance assumes 26.5 million shares outstanding and does not assume any potential share repurchases.

We would now like to turn the call over to any questions anyone has.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Sharon Zackfia with William Blair. Please proceed.

Sharon Zackfia – William Blair

Hi, good afternoon.

Dan Gallagher

Good afternoon, Sharon.

Sharon Zackfia – William Blair

You may have said this, but I didn’t catch it. What was the membership number at the end of the September quarter?

Dan Gallagher

519,000

Sharon Zackfia – William Blair

Okay. And then can you give us insights into what you are really looking at in the fourth quarter from a membership standpoint? I know you said you expect it to soften further, but it will helpful to maybe compare and contrast the last six weeks versus how much pushing you’ve given yourself for the next two months?

Dan Gallagher

Generally I’m disclosing – I’m trying to give a little more guidance than we would typically do under normal circumstances. So, don’t want to make this to be a preclusive to what would come in future quarters’. But it’s safe to say that October we’ve seen a higher rate of cancellations than we would have expected. This time we had our call back in July. We are actually forecasting attrition to an approximate 3.8% for the quarter – fourth quarter based upon what we are seeing in October.

Sharon Zackfia – William Blair

Are the issues that you are seeing are primarily concentrated in New York or are you seeing that lead into your other regions?

Alex Alimanestianu

Sharon, this is Alex. The New York metro area suburban markets, not all of them but certainly a majority of them are being impacted significantly more than other areas. Manhattan is actually performing better in most respects than areas. Boston is also performing well. And as Dan said, we are not going to breakdown regional variances to this degree. But it’s really the New York City suburban market that seems to be having the most net member loss impact.

Sharon Zackfia – William Blair

You guys have been doing this for a while and you have seen attritions spike before. Then are there any kind of tools that you can use going forward, try to minimize attrition? I know there are a lot of customers facing initiatives that take a while to implement.

Alex Alimanestianu

Yes, I mean, it is a similar environment to what we saw after the outcome in 9/11 disaster. But it’s more of a consumer recession this time. So, it does feel a little different to us, but some things are similar. For example, the – in tough economic times usage actually increases in the clubs. September same store usage number of visits was up 10% over the prior year. So, the fundamental demand among the core members is very good. The difference between now and 9/11, another significant difference is that half of our members are under committed programs. So, that’s either one or two-year programs, so we don’t expect the dropout rates to get the historical highs that we had in ’02 and ’03 when almost all of the members were month to month, our members. But we are – we are developing several programs to reduce the growth in attrition primarily by fostering – by trying foster greater member engagement, but we are segmenting the membership in different groups based on – to what degree we think they are at risk in a consumer recession like this. And the – so we are trying to target specific groups on such things as usage and ancillary spent patterns, and then we are always trying to get the controllable cancels trying to improve there by pursuing the initiative that Marty is pursuing on the member experience side. We have intervention programs to save members who have given the 30-day notice of cancellation, and I can’t talk in too much detail about them. But we are fully engaged in trying to minimize the impact of the consumer recession on our attrition.

Sharon Zackfia – William Blair

Okay. Can I ask maybe one last question? As I go through the math, I mean you are looking $6 million to $12 million less in sales but an $8.2 million shortfall in operating income. Obviously, really high flow through on the revised guidance and understandable given the fixed [ph] percentage of your business. But as you look into ’09 I can’t imagine you are expecting a better environment in ’09, so what can you do from a corporate level perspective that retches down some of their cost structure (inaudible) trying to preserve earnings?

Dan Gallagher

If you look at our cost structure in general, we are fairly having under 6 in rent and occupancy are certainly fixed as is our depreciation once we had the clubs built. We are working on the utility costs as I mentioned on the earlier call. And while we have no definitive plans to cut payroll costs which is – it will approximate $200 million in 2008. We are going to be looking at our payroll very closely with Marty to see the other things that we can do to streamline and have a more efficient payroll setup or labor model of the club that will not impact the member experience. But if there are things that impact the member experience, we are not going to act on them but we are going to sharpen our pencils both on the corporate side and on the club to see if there’s things we can do to our payroll expense.

Sharon Zackfia – William Blair

Can you remind us what savings you expecting from laundry in ’09?

Dan Gallagher

$1 million to $1.5 million, I believe.

Sharon Zackfia – William Blair

Was that all in the back half?

Dan Gallagher

It will certainly be more in the back half, yes.

Sharon Zackfia – William Blair

Thank you.

Operator

(Operator instructions) Your next question comes from the line of Laura Richardson, BB&T. Please proceed.

Laura Richardson – BB&T

Hi, guys. Sorry about that business trend. Can you talk a little bit about the – any interest due to next year on the senior notes and the cash flow that you are expecting, put the CapEx cuts, senior discount notes and your debt – your valuation suggest people think you are going to pay. But can you talk us through how you do that?

Dan Gallagher

Okay. In general terms I’m not giving 2009 guidance,

Laura Richardson – BB&T

Right.

Dan Gallagher

But we did want to help you guys out a little bit with our preliminary CapEx numbers which are down substantially from this year. They are going to be in $60 million to $70 million range. Our interest on our senior discount notes, those are 11% notes become cash paid for the first time in August ’09. It will be between $7.5 million and $8 million that we owe for that, which I don’t foresee that being a problem at all. Our capitalization, we are very well capitalized right now with our February ’07 refinancing. Our revolver is in place all the way to 2012 and we are well ahead of our debt covanance. So, I don’t think we have any issues going forward on our debt.

Laura Richardson – BB&T

Okay. Thanks.

Dan Gallagher

Okay.

Operator

At this time, there no questions.

Dan Gallagher

Okay. I guess that’s it and wrap it up. And look forward to talking to everyone in February 2009 when we release our fourth quarter earnings and we will provide our guidance for 2009 at that time.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Town Sports International Holdings, Inc. Q3 2008 Earnings Call Transcript
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