Town Sports International Holdings, Inc. (NASDAQ:CLUB)
Q4 2012 Earnings Call
February 19, 2013 16:00 pm ET
Bob Giardina - CEO
Dan Gallagher - CFO
Sean Naughton - Piper Jaffray
George Kelly - Craig-Hallum
Greetings and welcome to the Town Sports International Holdings Inc., Fourth Quarter 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Dan Gallagher, Chief Financial Officer. Thank you, Mr. Gallagher. You may begin.
Thank you for joining us today. This is the Town Sports International Holdings earnings conference call discussing results for the fourth quarter of 2012. I am Dan 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. These risks and uncertainties are described in our reports filed with the SEC.
We have issued a press release discussing our results for the quarter, which has been filed with the SEC under Form 8-K. In addition, for those of you who do not have access to this release and filing, we’ve also made them available at our website www.mysportsclubs.com. This conference call is also being webcast and may be accessed via the Investor Relations section of our website. Also a replay and transcript of the call will be made available on our website following the call.
Now, I turn this call over to Bob Giardina, the President and Chief Executive Officer of Town Sports International, for a discussion on the operations of the company. And then I will give a further detailed financial discussion later on in the call. Bob?
Thanks Dan. Good afternoon everyone. Thank you for joining us for our 2012 fourth quarter earnings call. 2012 was another year of improvement for Town Sports. We are extremely proud to have hit the $100 million adjusted EBITDA mark for the first time since 2008. And we are able to return $70.3 million to our shareholders in December. We are pleased that we achieved the EBITDA goal we set for ourselves at the beginning of the year. We were able to do this by managing cost, while continuing to drive our personal training and ancillary revenues. We were also pleased that our monthly due selling rates and our average joining fees collected both improved.
While the consumer has recently turned much more cautious again, we were hoping that it will be temporary, and we are confident that the foundation and ability to execute at a very high level that we now have in place were serviced well. We have worked very hard to rebound from the recession and rebuild our membership base from the low we experienced in 2009.
We are now at a point where our membership per club is near our pre-recession levels and this membership base is a foundation for continued strong cash flow. However, it also leaves us little room to continue to increase our overall member base without opening new clubs.
The acquisition of Fitcorp, which we announced last week, is a perfect example of the opportunities we plan to take advantage of to grow our club and member base and leverage our highly developed infrastructure and our strong financial position in the market where we believe there are many unfunded businesses. We ended the year with 510,000 members down 13,000 members from the year earlier.
In the fourth quarter, we experienced a loss of 12,000 members representing most of the loss experienced for the year. We estimate close to half of this loss is membership attributable to Hurricane Sandy. By removing the effects of Sandy, we still had a softer quarter in regards to membership as we continue to experience weakness in our corporate and restricted memberships.
As we moved into January membership trends were tracking to expectations in the first half of the month, but fell off track and did not meet our expectations in the second half of the month. We believe the driver of this was the rapid decline in consumer sentiment that has been reported and is connected to the reduction in net pay consumers earn given the changes in tax rates that went into effect in January.
When business is tough, it usually falls within three areas for us, execution, competition, or the economy. Based on how broad-based the slowdown has been quarter-to-date, we are confident there is an issue with the consumer. We were going to do everything in our power to make up for this January member shortfall, we continue to see softness and expect to net less than half the net member gain that was achieved in Q1 of 2012. Unfortunately, we are also seeing the softness in our ancillary revenue.
Given our increases in membership selling rates throughout 2012 coupled with the effects of the increase in annual rate loss maintenance fees collected, we expect average member revenue per member to increase in 2013. However, given the loss in members in Q4 of 2012 and the softness in net member gains in the first quarter thus far, we expect to see pressure on the membership revenue.
Turning to personal training, this remains a high priority for us and a point of focus for the management team. This is an area where we were impacted by Sandy in the fourth quarter. And we believe, we would have seen increased PT revenue for the quarter, if not for the closed clubs and disrupted lives of our members primarily in the New York City and New Jersey areas. Even with the challenges of the fourth quarter full year personal training revenue increased 5.2% and we generated approximately 13.7% of our revenue from personal training. The key here is that we know we have room for growth and our goal is to improve on this penetration by one percentage point per year.
As we had discussed before one of the more significant changes that we’ve seen in the industry over the past few years is the increase in pay-per-use fitness options. We had already offered a wide array of group exercise classes that were included with memberships and everything from Spinning to Yoga. We’ve been working to add more fee-based classes to our offering. The great example is our popular Ultimate Fitness Experience or UXF cross-training class that was launched in 2012.
In addition to the fee-based classes, we also have UXF Burn which is now part of our group exercise program offering. In the fourth quarter we began installing a UXF Zone and select clubs. Our UXF Zones provide our members and trainers with space that is much more conducive to personal training with an increased focus on functional training. As of today we have approximately 25 clubs with the UXF Zone installed and while it is very early days, we’ve seen improvements in personal training and small group training at these clubs.
We expect to have UXF Zone installed at 100 clubs by the end of 2013. This is another way to strengthen our competitive position as we develop into a destination for personal training and specialized classes with the added benefit of traditional health club facilities. The cost of converting 600 to 800 square foot of space to UXF Zone is somewhat minimal at approximately $25,000 per club. In 2012, we’ve also expanded on our signature fee-based classes such as Bar Method which is more of a ballet-inspired type program incorporating ballet, Pilates and Pilates Tower.
With respect to personal training memberships after seamless success of our one-session per month introductory products that we launched in the summer of 2011, in the summer of 2012 we launched our four-session per month product and then our eight-session per month product in the fall in order to offer members more options and flexibility when it comes to purchasing personal training products.
Both have been well received and as of December PT revenue generated from the PT membership product comprises approximately 40% of our total PT revenue for the month and we expect this percentage to be north of 50% by December of 2013. Now for club growth, we ended both 2012 and 2011 with 160 clubs. On this fourth quarter call last year we discussed the strong start than our 2011 club openings were off to and those clubs continue to do well.
We’ve been working hard to ramp up our club growth again to take advantage of the secular health and wellness trends. We were disappointed we were not able to achieve our 2012 club growth target of one to three clubs, but we are now making enough for that with a recent signing of (inaudible) for a planned Q4 opening of Greenpoint Brooklyn and the planned acquisitions of the West End Sports Club, a single location on the West side of Manhattan and the Fitcorp chain of five clubs and four managed facilities in Boston. Collectively this gives us seven new club locations and quickly puts us ahead of our original 2013 target of three to six clubs.
We will continue to look for additional opportunities for 2013 club openings and believe we can add at least one more and possibly two for a total of eight to nine club openings in 2013. I should note the new Williamsburg location, we have signed and previously discussed as moved to 2014. These acquisitions fit perfectly within our strategy of expanding our club base in the Urban New York City and Boston markets.
In the past, we were very successful on integrating and quickly improving results from acquired locations and we see these acquisitions playing out the same way. We plan to make necessary capital improvements and rebrand these clubs and we will quickly benefit from our sales and marketing strategies and the support of our management on our terrific cluster of clubs.
We were particularly excited about the addition of the Fitcorp chain. We will now have an even stronger presence in Downtown Boston in particular with the additions of the Prudential Center location and the Boston Racquet Club. The Fitcorp team is one of the best in our business at catering to corporate clients and its founder, Gary Klencheski will be instrumental in taking our corporate dimension to another level including the potential to add additional corporate management sites. We feel very good about the progress we have made now in terms of opening clubs and we plan to continue to sign new leases and work at acquiring additional clubs that fit within our strategy.
Looking to 2014, we are targeting 6 to 12 club additions. The club additions this year is expected to be modestly dilutive given the expected timing of the acquisition of the greenfield opening. We were excited to again be adding new locations to our markets.
And with that, I’ll turn the call over to Dan to discuss the fourth quarter financials and our outlook for 2013.
I’ll go through the income statement highlights for the quarter and our year-end balance sheet and then discuss the outlook for the first quarter of 2013.
In the fourth quarter, our consolidated revenue was $114.2 million, a decrease of 1.4% from the fourth quarter of 2011. Our total member count at the end of the quarter was 510,000, a decrease of 12,000 members from the end of Q3 and 13,000 from the end of 2011.
The number of restricted memberships totaled 38,000 as of December 31, 2012. While it is very difficult to estimate the impact on our clubs from the wide scale disruption of Hurricane Sandy, we estimate that close to half of the membership loss in the fourth quarter was due to the impact of the hurricane.
At the end of October, during our busier membership sales days, we had up to 131 clubs temporarily closed due to the storm and a week after the storm, 16 of these clubs were closed or 10% of our chain. While we are on the topic of the hurricane, I should note that we incurred a fixed asset impairment change of $3.2 million in the quarter related to damage at four of our clubs and in particular two clubs, our Waterstreet Club in Downtown Manhattan and our Long Beach Long Island Club both of which remain closed today. Based on current permitting and construction schedules, we are targeting to reopen these clubs in the third quarter of 2013.
Moving back to membership, monthly attrition for the fourth quarter averaged 3.5% inline with our expectations and up slightly from the 3.4% level for Q4 last year. Given the consumers softness that Bob discussed earlier, we expect monthly attrition to increase in the first quarter of 2013 and approximately 3.6% up from 3.4% in the first quarter of 2012.
We continue to improve on the average monthly dues selling rates with the average monthly dues of members joining in Q4 2012 of $66.39 versus $62.52 in Q4 2011. Also we saw our average joining fees improved to $57.81 per member from $51.03 in the same period a year ago.
Total ancillary club revenue was down slightly to $20.8 million from $20.9 million a year ago. Within ancillary revenue personal training revenue decreased 2.4% to $14.8 million. While to difficult to estimate the precise impact from Hurricane Sandy during the quarter given club closures and usage patterns in the aftermath of the storm, we estimate the personal training revenue was impacted by approximately $600,000 to $700,000.
Revenue at clubs opened over 12 months decreased by 1.1% for the quarter. The components of comparable club revenue were as follows; membership decreased 1.4%, price declined 0.4% and ancillary club revenue and fees and other revenue increased 0.7%.
Given our net number loss of 13,000 members for the full year of 2012, coupled with the softness we are seeing with net member additions and ancillary revenue trends in the first quarter, we expect comparable club revenue to continue to be negative and to be slightly more negative than Q4 2012.
Turning to expenses, total operating expenses increased 3.4% to $109.9 million for the fourth quarter of 2012. Operating income for the fourth quarter was $4.3 million compared to $9.6 million of operating income in the fourth quarter of 2011.
Operating income in Q4 2012 includes the aforementioned $3.2 million in fixed asset impairment charges related to Sandy and approximately $3.1 million of cost including payroll cost related to the $3 per share dividend paid in the fourth quarter. Net loss for the quarter was $0.5 million or $0.02 per share compared to net income of $3.3 million or $0.14 per share in the fourth quarter of 2011.
Net loss includes net after-tax charges of approximately $4.3 million or approximately $0.18 per share. These charges include the impact of the fixed asset impairments charges related to our $3 per share dividend including incremental interest charges and net discrete tax benefits of $340,000.
Adjusted EBITDA totaled $23.2 million in Q4 2012 versus adjusted EBITDA of $22.9 million in Q4 2011 a slight increase of 1.5%. This puts adjusted EBITDA for the full year at $99.8 million versus $89.5 million for 2011.
Cash flow from operating activities for the full year 2012 totaled $60.1 million as compared to $74.9 million for the full year 2011. In 2011, cash flow from operations benefited from a net tax refund of $6.6 million while in 2012 we paid cash taxes of $0.8 million.
Cash flow also decreased to the timing of payments and collections made associated with prepaid expenses, accounts payable, accrued expenses and deferred revenue. Total outstanding debt as of December 31, 2012 was $315.7 million. Our cash position was $37.8 million for a net debt level of $278 million compared to net debt of $243.9 million as of December 31, 2011.
This increase in net debt reflects the $60 million term loan issued in the fourth quarter that was used to partially fund the $70.3 million special dividend. Capital expenditures totaled $22.5 million in 2012. This is approximately $3.5 million lower than the high-end of the range we were expecting when we gave Q4 guidance in late October.
Certain renovations at clubs moved from Q4 2012 into Q1 2013. We expect total capital expenditures in 2013 to be between $37 million and $42 million. Our capital expenditures remains includes an estimated $11.5 million to $17 million related to the seven known new clubs Bob referred to earlier plus the potential for up to two additional clubs.
Now turning to our outlook based on the current business environment, recent performance and current trends in the marketplace, and subject to the risks and uncertainties inherent in the forward-looking statements, our outlook for the first quarter of 2013 includes the following.
Revenue for Q1 2013 is expected to be between $119 million and $120 million versus $122.9 million in the first quarter of 2012. As percentages of revenue, we expect payroll and related expenses to approximate 37.5% and club operating expenses to approximately 37%.
We expect general and administrative expenses to approximate $7.5 million. This is up from the $5.9 million of general and administrative costs incurred in the first quarter of 2012. This increase is in part due to favorable insurance reserve adjustments recorded in the first quarter of 2012 that are not expected in 2013, as well as an increase in legal fees incurred during this first quarter of 2012 primarily due to the trial held in January in our action against Ajilon in which we were awarded damages in a net amount of approximately $400,000. We expect depreciation and amortization expense to approximate $12.2 million and net interest expense to approximate $5.4 million.
We expect net income in Q1 2013 to be between $3.5 million and $4 million and diluted earnings per share to be in a range of $0.15 and $0.17 per share assuming a 39% effective tax rate and $24 million weighted average fully diluted shares outstanding. We estimate that adjusted EBITDA will approximate $23.5 million.
That concludes our prepared remarks. We’d now like to turn the call over to any questions anyone may have.
Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you.
Our first question comes from the line of Sean Naughton with Piper Jaffray. Please proceed with your question.
Sean Naughton - Piper Jaffray
Question for you about the acquisition you announced in Boston, Fitcorp anything that you can tell us about the dynamics of that particular member that would just help us in any sort of modeling or just thinking about the potential impact from that acquisition?
I can actually talk about the culture and the business and why we were so excited about and then I’ll turn over to Dan in terms of the business side of their business. Fitcorp has been in business in Boston for more than 30 years. They were a strong competitor, a great competitor of ours for many of those years and we always watch what they did and what they did well and one of the things that they became very successful at was really going after the corporate market having an aggressive plan to do more than just corporate sales that really build the corporate wellness program.
So, we’ve been watching them for a long time and been friendly with them for a long time. When we looked at them in terms of the fit, not only do they have the strong management team that’s been there for 30 years which we respect highly but they have their commercial clubs which fit right within our cluster and giving us real strength.
As well as now this new corporate management division, which will allow us to have access to more corporate members in that more fast market as well as the other three markets that we operate clubs in. So there is a lot more to that deal than just the clubs that we were buying in terms of what they can offer our business.
And I guess if I can add a little bit Sean for modeling purposes, the chain itself is modestly negative from an EBITDA standpoint. But, we believe with the Prudential Center and some of the terrific clubs that they have with our marketing and our cluster we are going to quickly be able to turn those positive much likely deal with acquisitions that we did ways back. So it’s some we’ve done before where we take over clubs that are in need of some capital, so we are going put in some capital into these clubs. And like I said earlier, the Prudential club is a nice club that we are getting, but we’ll also get the Boston Racquet Club, so it fits really nicely with our urban footprint down in Boston.
Sean Naughton - Piper Jaffray
That makes sense. But just in terms anything on the – like the specific not – maybe the number of members or anything about how much these members pay on a monthly basis and anything along those lines or is that just too early right now?
It is a little early because, by the way we close – officially close, we are certainly expecting to close, but suffice to say that their member dues are very similar to Town Sports plus and dues. They are not a discount to Town Sports.
Sean Naughton - Piper Jaffray
And then, can you just talk a little bit about the potential leverage that you are expecting on the kind of the payroll and related expense side, just for Q1, it just seems to be that looks like a line item that’s going to come in a little bit lower than it was last year?
Some of the payroll costs are due to two closed clubs. We have two clubs right now operating; we are down two clubs per se. Our Long Beach Club and our Water Street Club, but we were also seeing – we are expecting some softness in our personal training and possibly our ancillary revenue, which is – has direct payroll attributes with it, so that will be down a little bit also, possibly sales commissions and bonuses as well.
Sean Naughton - Piper Jaffray
And then just lastly from a cash perspective, can you just remind us about the rate lock, is that on the 12/31 balance sheet or is that something that really hits right when you start the 2013 full-year and where that kind of sits as of right now?
Sure. So the rate lock fee is charged in the first week of January. So it’s not part of our December 31 cash and that gets recorded. As far as the P&L goes over 12 months in to membership dues.
Sean Naughton - Piper Jaffray
And then on the comp, it sound likes it is going to still be a little bit challenging and any portion of the comp that's more impacted than others I am assuming membership is the biggest driver still at this point in time?
Yeah, I think the volume component the membership since we lost 13,000 members for the full year 2012 and we’re off to a slower start this year 2013 than last year that will be driving the negative, and I think the price component should actually be on the positive side, but I think the negative volume is going to more outweigh that.
Thank you. Our next question comes from the line of George Kelly with Craig-Hallum. Please proceed with your question.
George Kelly – Craig-Hallum
Couple of questions. First on another question on the acquisitions, does first quarter guidance incorporate anything from either the Manhattan or the Boston new close?
No, we’re actually expecting to close those sometime in the next 60 days its very possible it would be right at the end of this first quarter but nothing of any magnitude is put into this first quarter given that we expect them that happened very, very end of the quarter or at the very beginning of the next quarter so the answer, the quicker answer is no.
George Kelly – Craig-Hallum
And then, if the Fitcorp is right now modestly negative EBITDA, but you expect it to turn positive. Can you talk it all about just trying to model the revenue contribution that you expect once they close?
I think we’re probably better off doing that when we do close because then we’ll know exactly how many members they have at the date of the closing and things of that nature. But, Sean asked earlier their average dues per member is similar to our, so this is not a discount chain by any means while they fit right into our urban market. I am not really giving any revenue guidance or any other additional guidance regarding the acquisition other than the fact that we’re modestly negative EBITDA right now.
We expect that we can put some capital into these clubs and get them to quickly improve their results. And going forward they’ll start to improve from where they are now but we don’t have a precise guidance to give certainly until we actually closed on the deal.
George Kelly – Craig-Hallum
And then you’ve talked about the managed corporate facilities what is that landscape – is that a big, I mean, can you build out that team and try to push forward on managing more facilities to build relationship with the companies or?
I think in terms of Fitcorp’s history up until about six years ago they managed more than 20 centers but they were primarily in the Boston market because they didn’t have the network and footprint that we have. We believe that we do have that opportunity to not only add managed centers but its going to be really a driver for corporate wellness programs. So, we can really offer an end-to-end program with the corporate members, the family members and the corporate centers. So that’s why we’re at the early stage of really mapping it out first.
George Kelly – Craig-Hallum
And then just one last one, the cautious consumer environment, have you seen that any – as you look between the four major geographies, is it more so in any certain places any differences?
Yeah, it’s been pretty broad. So we’re seeing the behavior very similar and we’re very confident that it is coming from the consumer. As I mentioned earlier in my script part portion, when we look at our business there are really three components that we’re watching closely all the time. The first is execution and how we delivering our product and services. Second is, what the competition looks like how it has changed mark-to-market, year-on-year and then in terms of consumer behavior. We’ve seen consumer sentiment change drastically within the last couple of months.
We saw that after the first really payroll period in January, which is about the second week of January, we really start seeing a slowdown in Ancillary, Personal Training and membership sales. And our sort of increase that we’ve seen on the cancellation side is directly related to the members that are non users. So it really does go to the consumer side of the business.
We have seen more consumers coming in to club, so our guest traffic is picking up nicely it’s almost at levels of last year now, the conversion rates are at the same level. So we believe this is the temporary situation. We believe that once consumers understand our average member is probably losing somewhere in the area of about $1500 a year once our members understand the impact they have on their daily leaving with the raising cost of gas and the lower income from social security or the taxes that they’re seeing now. I think they’ll get more comfortable with the idea that they’re not going to give up their fitness levels.
George Kelly – Craig-Hallum
And then just one last one, are there a lot more potential acquisitions in the – to these two, I mean, I know you can sure do a lot do you – is there a chance in the next year you could do even more?
Well, we’re focused on it. And we’re focused on making sure that we stick to our strategy we’re staying within the four markets. Obviously that side of the business has picked up nicely for us then I think as the consumer feel has soften within the clubs that’s going to present the good opportunities for us. So there is the two side of it, we may be slowing down a little bit on the business side, which we think is going to turnaround we also believe that is going to be more opportunities on the acquisition side.
Thank you. We have no further questions at this time. I would like to turn the floor back over to Mr. Gallagher for closing comments.
Okay, thank you. That wraps up our call and we look forward to reporting our first quarter results in the future. Thank you.
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.
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