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Life Time Fitness, Inc. (NYSE:LTM)

Q4 2008 Earnings Call

February 19, 2009 10:00 am ET

Executives

Ken Cooper – Vice President Finance

Bahram Akradi – Chairman of the Board & Chief Executive Officer

Michael R. Robinson – Chief Financial Officer & Executive Vice President

Analysts

Paul Lejuez – Credit Suisse

Scott Hamann – Keybanc Capital Markets

Karen Howland – Barclays Capital

Jaison Blair – Rochdale Securities, LLC.

Hardy Bowen – Arnhold & Bleichroeder

[Unidentified Analyst – Morgan Keegan]

Operator

Welcome the fourth quarter and full year 2008 Life Time Fitness earnings call. My name is Ericka and I’ll be your coordinator for today. At this time all participants are in a listen only mode. We will facilitate a question and answer session towards the end of this conference. (Operator Instructions) I would now like to turn the presentation over to your host for today Mr. Ken Cooper, Vice President Finance.

Ken Cooper

Thank you for joining us on today’s conference call to discuss the fourth quarter and full year 2008 financial results for Life Time Fitness. We issued our earnings press release this morning. If you did not obtain a copy you may access it at our website which is www.LifeTimeFitness.com. In a moment Bahram Akradi, our Chairman and CEO will discuss his thoughts on our performance in 2008 and our expectations for 2009. Following that Mike Robinson, our CFO will review financial highlights in greater detail including specifics on our 2009 expectations.

Once we have completed our prepared remarks, we will take your questions until 11 am Easter Time. At that point in the call Erika will provide instructions on how to ask a question. I will close with a tentative date of our first quarter 2009 call and our annual shareholders meeting. Finally, a replay of this teleconference will be available on our website at approximately 1pm Eastern Time today.

Before I turn the call over to Bahram I’d like to remind everyone that this call contains forward-looking statements and future results could differ materially from the forward-looking statements made today. Actual results may be affected by many factors including the risks and uncertainties identified in this morning’s earnings release and in our SEC filings.

Concurrent with the issuance of our fourth quarter and total year earnings results we have filed an 8K with the SEC. Certain information in our earnings release and information disclosed on this call constitute non-GAAP financial measures including EBITDA. We’ve included reconciliations of the difference between GAAP and non-GAAP measures in our earnings release and our Form 8K. Other required information about our non-GAAP data is included in our Form 8K.

With that, let me turn the call over to our founder and CEO Bahram Akradi.

Bahram Akradi

2008 was a bitter sweet year for our company. We had many significant accomplishments, we also had tremendous challenges and overall it did not meet our expectations. There are things we did well and some things we did not perform to our satisfaction. We spent significantly more money on marketing and member acquisition costs to offset rising attrition rates. Meanwhile, we grew our memberships during this tough time.

We introduced some targeted membership initiatives that helped bring in membership counts and market share. They worked yet, they reduced our incremental average dues. The combined effect of higher acquisition and marketing costs with lower average dues resulted in a revenue shortfall that dropped to the bottom line and lowered our fourth quarter earnings significantly below our expectations.

This is obviously something we are focused to change. Radical macroeconomic change in the second half of the year did not allow us to react and adjust our marketing acquisition cost accordingly and as quickly as we would have liked. We’re changing this at this time. We’re already deep in process to adapt and improve our marketing efficiencies and acquisition costs to better match with the new conditions. While we’re still committed to achieve our membership goals and increase our market share.

Additionally, we’re making micro adjustments to the new membership programs we just introduced to make sure we achieve an average dues rate consistent with our internal goals. However, we’re not stopping here. From our corporate office to the field we have prompt and strong measures in place to identify and eliminate unnecessary costs without damaging the member experience we want to deliver or the brand we have worked hard to create. We will be mindful to not cut muscle but we will also not tolerate waste or inefficiency.

As it relates to our center growth plan, we have a number of centers under development construction. These centers will be constructed at a rate that will be comfortable and safely within the boundaries of our cash flow generated by operations and our current credit facilities not any faster. As it relates to future growth prospects, all I can tell you today is that we will be extremely cautious and selective in what, where and when. As the visibility to credit markets get better, we will be more clear with our expansion plans.

Now, I would like to end my comments on a great note. Our achievement in 2008 were many. We opened 11 state of art centers in a number of new and existing markets. We saw the success we can have on the east coast with the initial ramp of our Florham Park Club which opened in November and the early results of Berkeley Heights Club opened a few weeks ago.

We finished the remodels of nearly all our recently acquired clubs which brings these clubs back to the forefront within the communities they serve. We generated a 7% increase in our revenue per membership and nearly 5% increase in our revenue per membership for the year. We rolled out one of the most expansive member only website available to consumers in the health club space.

We presented over 50 healthy way of life events such as indoor triathlons to customers. We delivered over $270 million of debt and sale lease back capital. There was much to be proud of. In closing, we firmly believe in our business model it has proven to be resilient and successful. Our most valuable asset, our membership base, maintains strong usage levels and our feedback from our members continues to get better.

We are a very profitable company we intend to stay that way. With that, I will now turn it to Mike Robinson our Chief Financial Officer.

Michael R. Robinson

I would like to start with just a few thoughts on the impacts from the economy. At Life Time Fitness we believe the economy is a factor, it’s not an excuse. Accordingly, as I continue my comments you will not hear many references to the economy rather, I will provide you with specific thoughts and candid explanations on trends and results.

As I’m providing details on our fourth quarter and full year 2008 performance, I will provide 2009 guidance throughout my comments as appropriate. For the fourth quarter, total revenue is $194 million up 13.4% from last fourth quarter. We were up 17.4% for the year to $769.6 million. Our revenue growth in the quarter continues to be driven by two main factors including membership dues growth of 14.5% and 17.2% for the year.

Although the gap between dues growth and membership growth is the lowest in the past seven years, membership dues growth is still greater than our membership growth of 13.6%. Membership dues came in under our internal expectations for the fourth quarter primarily as the result of more individuals than typical and the introduction of lower price dues programs including a membership level targeted at an underserved demographic, individuals 21 to 26 years old and a team member friends and family program.

In center revenue grew by 13.1% in the quarter and 19.7% for the year. We did see deceleration of growth of personal training, Life Café and Life Spa in the fourth quarter. For instance, personal training grew over 20% for the year but the fourth quarter growth was closer to 10%. As we have seen throughout 2008 spa growth was our most affected business growing slightly in the fourth quarter and 6% for the year.

In 2009 we expect in center businesses will continue to grow as we ramp our membership levels and the accompanying in center activity in immature clubs. However, we also expect in center revenue per membership to reflect the same trends we saw late in 2008 namely flat to negative comparisons.

Let me also take a minute to provide some highlights on other revenue metrics. Memberships at December 31, 2008 totaled 567,110 which is an increase of 13.6% from last fourth quarter. Our membership growth rate was up from the 13.2% growth rate in the third quarter.

For a perspective on our membership growth our clubs in ramp are growing pretty much according to plan. A club like Florham Park is performing about 10% ahead of our internal plan. A club like Vernon Hills in Chicago is about where we expect and a club like City Center in Houston is below plan as we have not been able to catch up yet from the effects of Hurricane Ike this summer.

Mature club memberships have come down slightly but this has been partially offset by the performance of our acquired clubs that had remodels completed. For 2009 we expect membership growth in the mid single digits commensurate with our unit growth rate. With respect to revenue per membership, we generated a 30 basis points increase to $345 in the quarter. For the year, revenue per membership grew 4.9% to $1,427 which is approximately $119 per month.

For 2009 we expect this to be flat to down slightly given recent trends and the membership mix shift we saw in the fourth quarter. Our in center revenue per membership was roughly the same as last fourth quarter at $93. For the year, in center revenue per membership grew 7% to $414 or about $35 per month. We saw our membership base continuing to use our fee based programs and services due to their effectiveness. However, clearly our members have taken pause in what we feel is their most discretionary dollar. We expect in center revenue per membership trends to be flat to down also in 2009.

We were flat on same store sales for the quarter and we were down 5.2% on our 37 month mature same store sales. This was driven by lower membership levels, dues mix and lower in center sales. For the year we generated growth of 2.8% for 13 month same store sales and we were down 2.8% for the 37 month metric. For 2009 we expect recent trends to continue with potentially negative comps.

Before moving to margins I want to make some comments regarding any regional impacts we’re seeing. Predominately center performance has held up well with usually one to two centers in a market showing more signs of lower revenue and profitability and others. These clubs are typically on the low end of the demographic range for us.

In the fourth quarter, using same store sales and attrition rates as our proxy, we did see more pressure in markets such as Detroit, Houston and Phoenix. Although this is consistent with what we have seen other consumer businesses experience for the most part, we are still looking closely at these markets in particular to monitor performance levels.

Moving to our margin analysis, let me start with a discussion of the $0.08 charge per share that we incurred in the fourth quarter. These costs totaled approximately $5 million pre-tax and resulted primarily from the reduction in future center development. On the employee front we laid off approximately 100 team members mainly in construction, development and our training teams. This resulted in approximately $0.01 per share of costs between G&A and center operating expenses.

For site development we are typically pursuing many sites for possible club openings. Once deemed probably these costs are capitalized and reflected within other assets. We made the decision to remove several of these sites from the development consideration. This resulted in approximately $0.05 per share or a little over $3 million pre-tax of additional G&A expense in the quarter.

Lastly, we have assets which we have made available for sale where we took a lower of cost or market adjustment. We recognized approximately a $0.02 per share or a little over $1 million pre-tax charge to reflect current market value primarily in depreciation expense. The clubs operating margin decreased to 15.1% to 22% as compared to the prior fourth quarter.

For the year our operating margin is decreased to 19.1% from 21% in 2007. The main drivers of this margin decrease in the quarter were the charges I just discussed, roughly $4 million of incremental rent due to the sales lease backs and rent on clubs recently opened and incremental membership acquisitions costs. This was offset slightly by approximately $1 million of lower depreciation that went away with the sale lease back transactions.

As we look to 2009 we expect lower operating margins driven primarily by lower center operating margins coming from higher member acquisition costs, the recent dues mix trends and increased occupancy costs from the sales lease backs that we did in August and September 2008. As a reminder, we’ll incur approximately $17 million of annual rent for those two transactions. We offset approximately $4 million of depreciation annually due to these transactions as well as lower incremental interest expenses.

Further, we expect G&A leverage to come in 2009 as we maintain a very flat organization. This has been a hallmark of ours for the past five years. Marketing is expected to be relatively flat as a percentage of sales. We expect depreciation expense as a percentage of revenue to be up driven by the completion of the remodels of the seven leased centers, higher center investments and deceleration of growth rates in comparison to the cap ex increase.

Interest expense net of interest income increased to $8.2 million from $6.4 million last fourth quarter as we grew our new center base and our corresponding average debt balance during the quarter. For the year total interest expense was $29.5 million as compared to $25.4 million last year. We anticipate interest expense to increase in 2009 as our average debt balances are higher compared to the prior year and we recognize lower capitalized interest as we reduce our construction progress.

Our tax rate for the quarter was 39% as compared to 39.7% last fourth quarter. For the year our tax rate was 39.7% compared to 39.9% for 2007. We expect our 2009 effective tax rate to be approximately 40%.

Net income for the quarter was $13 million compared to $19.1 last fourth quarter down 31.7%. Our net income margin for the quarter decreased to 6.7% from 11.1%. For the year, net income was $71.8 million up 5.6% and our net income margin has decreased to 9.3% from 10.4%. Total weighted average diluted common shares was 39.2 million shares for fourth quarter. For the year our average diluted common shares totaled 49.3 million. We expect our total 2009 share count to be approximately 40 million shares.

Based on our 2008 fourth quarter weighted average share count our diluted EPS for the quarter was $0.33 down from $0.48 in the fourth quarter last year. For the year, our EPS is up 3% to $1.83. Moving to operating data, our 2008 attrition rate was 42.3% and accordingly we changed our estimated average life of a membership in the fourth quarter to 30 months. The number of open centers at December 31, 2008 was 81 compared to 70 at December 31, 2007.

Our current number of open centers is 83 with our Berkeley Heights New Jersey and Atascocita Lake Houston Texas centers opening in early February. Of the 83 centers, 50 or 60% are our large current model and only 55% of all centers have been open three years or more which we classify as mature centers.

In 2008 we grew our square footage 18.7% to 8.1 million square feet as compared to 6.8 million square feet we had at the end of 2007. In 2009 we planned to grow approximately 6% to 8% or 500,000 to 700,00 square feet. EBITDA totaled $50 million in Q4, down 6.8% from the last fourth quarter. For the year, EBITDA was up 12.1% to $221.5 million. EBITDA margin for the quarter was 25.8%. Our EBITDA margin for the year was 28.8% which is down 130 basis points from 2007 primarily due to the sales lease backs during the year and the charges discussed earlier.

Cash flow from operations totaled $183.1 million in 2008 which grew 28.8% from the $142.2 million generated in 2007. This 28.8% improvement in our operating cash flow compares favorably with our EBITDA growth rate of 12.1% and was driven by favorable cash tax treatment from accelerated depreciation on assets placed in service in 2008. Cash flow from operations in the fourth quarter totaled approximately $39 million compared to approximately $35 million in the fourth quarter of 2007.

Cash outlays for capital expenditures for the quarter were $104 million. For the year we paid a total of $464 million in total capital expenditures. During the fourth quarter our overall debt balances grew by approximately $66 million to $713 million as of December 31st. Our net debt to capital ratio was 52% for the fourth quarter as compared to 50% for the third quarter.

In capital structure news, our entire team is very proud of our achievements in 2008 as we raised in excess of $270 million of capital in the form of debt and sales lease back transactions. Although the credit markets remain very difficult, we still see some semblance of activity. In December, we added a single club mortgage and some equipment leasing. In addition, we’re working on several other mortgages and a sale lease back transaction. Generally, we’re dealing with local banks and investment groups on these deals.

We’re focused on finding the best use of capital for the company. From a cost perspective we believe they will be within our expectations and goals, if not we stand ready to slow down our new club growth even more. As of December 31st we had approximately $55 million in cash and availability on our revolver and as of today we have 33 large centers with an asset cost on our balance sheet well in excess of $500 million with no mortgage financing against it.

During the pre-earnings call on February 5th I commented on our revolver credit facility covenants. Because of the flexibility we have and the timing of capital expenditures and the strength of the cash flow delivery of our business, I’m comfortable with our covenant position. We have room in these covenants even at the low end of our guidance. However, I’m comfortable in telling you that if we are directionally headed towards the low end of our guidance we will be slowing our cap ex spend even further.

Before I move to our 2009 guidance discussion I’d like to make a few balance sheet comments. Accounts receivable was up $1.6 million for the year and $800,000 sequentially from the third quarter. This increase is related to the growth in our corporate businesses. As you know, we do not have accounts receivable on our core business, that being memberships because all members are on EFT and we recognize only cash received as revenue.

Pre-paids and other current assets are down $5 million for the year and are down $4.5 million sequentially from the third quarter. This was driven by a reduction in land that we intended to sell in the next 12 months of approximately $5 million during the year and as a result of sales completed and transfers to long term land held for sale but a projected sale did not occur.

Other assets are up $7 million for the year but down $6.2 million sequentially from third quarter. This year-over-year growth is related to increased property held for sale, both transfers from other current assets as well as property purchased in 2008. The sequential reduction is driven by a decrease in development cost capitalized for future center development which was part of the charge I previously discussed.

Accrued expenses decreased $.8 million from last yearend and more than $9 million sequentially from the third quarter. The sequential change is driven primarily by changes in accrued taxes. Deferred revenue reduced 5% year-over-year. This is a direct reflection of the lower enrollment fees we are currently charging to attract new memberships. Deferred membership origination costs grew 11% year-over-year. Deferred origination costs are growing at a much slower rate than previously because we are experiencing more direct costs in excess of our enrollment fees which we expense immediately.

With that, let me turn our attention to our guidance for 2009. First, from a development perspective we currently plan to open up to six centers in 2009. The total number we opened will be dependent on our cash flow and the credit environment. We have the flexibility to change our cap ex spend and will proceed with prudence. We’ve already opened two of these centers, one in Berkeley Heights New Jersey and the other in Lake Houston Atascocita area of Houston Texas.

We have control over the timing of construction of these centers so the actual numbers of centers we open will be dependent on our cash flow, operating cash flow and debt levels. If we’re able to maintain our strong operating cash flow or bring in additional cost effective financing we will continue on our build schedule.

I know you are all looking at a downside scenario as are we. To the extent our operations take drastic changes to the negative, we are positioned to open up one more club and then hold indefinitely on the remain clubs under construction. As we look to 2010 we will use the same cautious approach.

Regarding our specific financial guidance. Our revenue guidance is 8% to 12% growth which equates to approximately $830 to $860 million. We expect net income of approximately $60 to $68 million. This results in diluted EPS guidance of $1.50 to $1.70 per share. Our cap ex guidance is approximately $150 to $200 million in 2009 of which we expect approximately $35 to $40 million will be the maintenance of our existing club base. This works out to be approximately $3.50 per square foot for our centers and about $10 million in corporate initiatives.

Total new construction cap ex will be approximately $110 to $160 million. We plan to fund these capital expenditures with cash from operations and our revolving line of credit. Please keep in mind we could reduce this cap ex spend well below these guidance numbers if necessary. That concludes our prepared remarks regarding our fourth quarter and full year 2008 financial results.

On behalf of our entire executive team I want to thank our national base of team members who deliver upon our member experience and business operation expectations. We all remain very excited about the future of Life Time Fitness. We are pleased to take your questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Paul Lejuez – Credit Suisse.

Paul Lejuez – Credit Suisse

Can you guys maybe talk about, just to use as an example, a club that was performing well that has suddenly turned on you and one that you are disappointed in? You don’t have to name it I just want to try to get an understand about the kind of revenue declines that you’ve seen in that club, how has attrition changed, how are you able to cut the staff, if at all, at this point and what happened to the four wall EBITDA, just so we have an understanding of the types of declines we might be seeing at what might have previously been a strong club.

Michael R. Robinson

I’m not going to point to a specific club but I’ll give you a general idea. We talked about a few of these in the past. A club might be seeing somewhere between 5% and 10% lower revenue coming from a few percent drop in membership levels. As you go from that level down to EBITDA where we expect a mature club to be delivering in the high 30% EBITDA margins, that club is probably now delivering in the lower 30% EBITDA margins.

Key changes include things that we talked about before, we’re seeing an attrition rate that may have been running in the mid 30s up to over 40% and the replacements in new memberships coming in are coming in at a little bit lower average dues so those are the big drivers for that. I do want to stress though that as we look up and down all of our open clubs, the margin rate that we are seeing is still what I would call a very good margin rate. Again, like I mentioned the EBITDA rate that we’re seeing is still above 30% in those clubs and in this environment I think we’re pretty proud of that.

Paul Lejuez – Credit Suisse

That attrition rate that you give is a weighted average so presumably there are some clubs that are above that. I’m just wondering how many of them are at a 50% attrition rate for example.

Bahram Akradi

That’s a great question. Very, very few and those are clubs that the bulk of our membership is a single membership. The single membership clubs have always had a higher attrition, just the nature of the single member has the highest attrition then the couples a little less and then the families is the lowest in terms of attrition. So, the clubs that have had single population at large they were probably in the past in the 40s and now they’re over 50. But, there are very few of our clubs are that way.

Operator

Your next question comes from Scott Hamann – Keybanc Capital Markets.

Scott Hamann – Keybanc Capital Markets

In terms of the enrollment fees cap falling in to center ops can you quantify what the actual impact was for the fourth quarter and the full year and kind of in this environment where I assume you’re going to keep enrollment fees pretty close to zero what your expected impact would be for 2009?

Bahram Akradi

I’m going to give you color first and Mike is probably going to give you some numbers. During the 2008 as I have mentioned since the day we went public, during the recessionary time the easier thing to do is to just lower the enrollment fee and allow people to get in and try to keep them in our particular case through our great programs, great experience and programming. In 2008 we saw deterioration in attrition and then unfortunately in the fourth quarter instead of us being able to rein that back in it ramped up dramatically and the entire fourth quarter it just kept getting worse instead of better.

So, what we have done is generally lowered the initiation fee and increased the marketing cost to go ahead and attract new members to replace. Having spent the number of years I’ve been in the business I have no problem knowing that we can continue to get more memberships in the door via more aggressive marketing, more aggressive promotions, it’s not where I would like us to be and it’s not where I would like us to end. We would really like to be able to normalize the attrition to the level where we don’t have to spend nearly as much on member acquisition.

To that effect, some of the changes we made, some of the moves we made in the late 3Q and 4Q were very quick changes to deal with a very radical change in the macroeconomic and therefore the results where a little less than our expectation and of course they have huge impact on the P&L but we have been working literally seven days a week this year on making, as I mentioned in my comments, macro adjustments on how these promotions run, how we work on the marketing and how we work on the enrollment fees so that we put in the proper controls in place and therefore I don’t believe we have as much of a risk on the upside down scenario that we experienced latter half particularly more aggressively in the second half of last year in the cost of acquisition versus the enrollment fee.

So, that’s in my opinion going to be completely under control unless the macroeconomics get dramatically worse again and we would have to make additional shifts and I can’t talk to that. But, if things stay the way they are now, not getting worse I believe we’ll be able to control that better. Now, I’m going to give it to Mike to give you some numbers he might want to share with you.

Michael R. Robinson

What you’re specifically I think referring to is what’s the affect on center operating expense and the driver for that is when you reduce the enrollment fees and those enrollment fees go below the commission that we pay to our sales people rather than defer those direct costs we expense the excess. For last year for the total year that ran about roughly 1%. That was about a 1% drag on your center operating expense and that did increase in the second half of the year.

Scott Hamann – Keybanc Capital Markets

Just on cap ex, if things do worsen up here pretty quickly, I know you can trim back your growth plans, how much – you probably incurred some capital expenditure in the past for these two clubs that are already open so how much about the $35 to $40 million in maintenance cap ex could you get that number down to for the full year?

Michael R. Robinson

I think we could get the full year down to well below $100 million.

Operator

Your next question comes from Karen Howland – Barclays Capital.

Karen Howland – Barclays Capital

You talk about how some of your initiatives this past quarter as far as lowering your dues level drove membership growth but you’re not reverting that presumably no longer offering those initiatives to drive higher member growth. Can you talk about the profitability of those members versus the lost members entirely? I would think in this market environment you would continue to try to drive member growth even if it is at a lower profit level.

Bahram Akradi

I did not tell you we are eliminating the promotion. What I did say is that we would make micro adjustments. I think we can do better, we may have given discounts in places we don’t need to give to get the memberships that we have gotten and in center areas we need to continue to give those discounts to get those membership counts.

So, it’s just having a little more time now that things have settled, that the dust has settled to go through club by club, market by market as I have done with my marketing team all of the last two to three weeks and really comb through our facilities one club at a time, one market at a time to make sure we can think through with much more detailed thought process and focus rather than kind of a one block introducing a membership type.

But, we’re not going to eliminate them we’re just going to micro adjust it so that we can get better yield where we can get it and still get the membership and use those same prices where we need to use them to continue to get the membership count.

Karen Howland – Barclays Capital

So, it sounds like you’re going to continue to be promotional to try and drive membership growth but perhaps a little bit more strategic.

Bahram Akradi

A lot more strategic.

Karen Howland – Barclays Capital

Then are there any cash costs associated with if you do decide to go from the six centers that it sounds like you’re tentatively planning to three centers this year? Are there any costs of deferring that growth?

Michael R. Robinson

What you would do is you would slow the construction growth of those other centers so you would have some slight carrying costs but it’s not significant.

Karen Howland – Barclays Capital

When you say not significant is it less than $5 million?

Michael R. Robinson

It’s going to be less than $5 million or so.

Bahram Akradi

We already have four clubs that as Mike has said, three to four clubs that are remaining for this year’s opening schedule right now. We are moving very, very cautiously on the construction of those facilities and we’re watching the credit market and the internal cash flow and again, as we have repeatedly said, we have the control on slowing those furthermore or ramping them up a little bit more if the total comfort that the cash is available either through future financing or great cash flow operations. Otherwise, we just want to keep a certain amount of cushion in our dollars that we have available to us.

Karen Howland – Barclays Capital

Final questions, I know that you said that center operations margin should continue to deteriorate throughout the course of this year. If I think about an operating expense per center, is there any reason that would stabilize or should that continue because of the higher rent expense continue to grow as well?

Michael R. Robinson

On a per center basis again, if you spread those occupancy costs across all the centers rather than the specific centers that they were there, you are going to see on average cost increase in center operating expense. So, that would stabilize as we anniversary that in the August/September time period. Then, the other drivers to that increase in the cost side have been in 2008 membership acquisition costs and as Bahram talked about there, that grew through the year so I would expect there to be a little bit of pressure on that early in the year. But again, as we start to anniversary that, that would stabilize also and hopefully come down as we work hard on a number of the initiatives there.

Operator

Your next question comes from Jaison Blair – Rochdale Securities, LLC.

Jaison Blair – Rochdale Securities, LLC.

A couple of quarters ago you guys mentioned that approximately 25% of your membership base was categorized as inactive. Would you say that that number still kind of stands?

Michael R. Robinson

No, we don’t discuss the actual split of that but given the usage patterns that we continue to see at our clubs, we believe that that level is actually coming down and it makes sense that it would be coming down.

Jaison Blair – Rochdale Securities, LLC.

I guess the question I have for you is that quarter-over-quarter from the third to the fourth quarter your average memberships per unit dropped from 7,053 to 6,833 which is a pretty sizeable, I guess it’s about 3% and your average dues per membership were also down about 3%, in center membership was down about 12% . I continue to hear from management that you have a high level of variable costs, that there are a lots of levers you can pull and I think there are a lot of number crunchers that think boy we could reduce all the costs out of the business.

But as Bahram say you’re really unwilling to cut the muscle which I agree with because as soon as you really start to cut advertising expense my guess is your churn is harder to replace. However, during the quarter the sports fitness family recreation operating expenses were only down slightly from $211 in the third quarter per membership to $209. Now, some of that may be the sale lease back that you did in the third quarter but I guess I was expecting to see that number drop further especially given the decline of in center revenue.

Then, I guess the other question is you talked about being more efficient with your advertising which that was up double digits year-over-year so if you could kind of help me figure out – the data is not pointing to that you’ve got all these levers to pull and all these variable costs. The data is saying that your cost per membership were pretty stable while your revenues per membership have started to come down a bit.

Michael R. Robinson

I think there are a lot of points in there, let me try to address those one or two at a time here. From a 30,000 foot perspective you are right, the biggest driver that we saw outside of the charges that we took, outside of the sale lease backs and the expense there that sits in the center operating expense, the bigger driver that we saw was the fact that our incremental revenue per membership or our incremental dues came down and that’s going to put pressure on those margins especially if most of that cost base is built based on usage.

So, if the members are using the clubs at the rates that they continue to use the clubs and the membership growth is there then we’re much more limited and not to say that we don’t have opportunity but we’re much more limited in some of the variable cost portion of the business. So, the big driver to this is that we’ve seen average dues come down a bit mainly driven by the programs we introduced later in the year but our usage levels remain high.

Let me go back to a couple of statistics you talked about earlier and I think the first one you threw out was the average members per center. When I talk about that I always caution people about that because of the number of open centers that came in, for instance we opened four centers in the fourth quarter, we opened three centers in the third quarter, those as you would well expect have levels of membership that are significantly below the averages.

When you open centers like that, that’s going to draw those averages down. So, I just caution people to make sure that when you’re looking at a number of these statistics that you keep the timing of club openings. The fact that these clubs take three years or so to ramp up etc., all are going to affect some of those numbers.

But, picture Jaison I think it’s important to say that you are correct, there has been more stress on that operating margin really coming from outside of some of the things that I talked about before, coming from the fact that usage levels remain high yet we saw some incremental reduction in average dues and those are things that Bahram talked about earlier. Some of that is driven by the environment that we’re in and there are things that we will be doing, have been doing to try and moderate that.

Bahram Akradi

Let me add a little bit of color about your advertising comment. As I mentioned I don’t particularly took any credit for being efficient in marketing in the last five months or so. We basically had to react to what was going on out there and throw a lot of money at marketing, throw a lot of money at promotions, paid a lot of money in commissions to try to bring in a significant number of memberships to offset a significant membership loss.

To generate 13% membership growth you just can’t be doing that in this environment unless you’re spending a lot of money. That money eats away at your margin. I don’t think that these are particularly fun times or business as usual. I think you’re very, very astute and you’re making great comments but the focus on our advertising efficiency and control of the acquisition costs and the balance of where we deliver the discounts and where we don’t, I think those things that now that things have settled down we have the ability to actually get focused on bringing more excellence in our thought process than we utilized in the 4Q.

So, I feel great about the actions we’re taking. I am cautious about the environment ahead. I think we will have a very, very challenging environment ahead in regards to acquiring members and keeping members. We have as Mike mentioned, our utilization report shows higher utilization in our clubs than the years past yet we have lower number of members in certain clubs in our facilities. So therefore, to your question is there more none users who are paying dues or less, I can tell you for fact that it’s probably significantly less non-users paying dues today than there may have been a year ago this time.

But, I think we’re getting close to a point but it doesn’t get – I believe most of our members are using the club as they’re paying dues. So, we feel optimistic that with our current adjustments we are making we’re going to be able to maintain a very profitable company. Margins that they are good, not near what they were a year ago or two years ago but then again we have to be realistic about what we’re dealing with out there.

Jaison Blair – Rochdale Securities, LLC.

If I could just follow up, have you projected at the low end guidance where your coverage ratios will be in ’09?

Michael R. Robinson

Obviously I run sensitivities all the time and as I made comments in the prepared remarks, I feel very comfortable that our covenants at the low end are well within our covenant packages and I also said that if we felt things were going towards that low end that we would be slowing down our cap ex spend even more and that that would also help protect those covenants.

Operator

Your next question comes from Hardy Bowen – Arnhold & Bleichroeder.

Hardy Bowen – Arnhold & Bleichroeder

Bahram can you comment on the state of the industry? What you see elsewhere? And, also your experience in January, do you think things are the same, getting better, getting worse?

Bahram Akradi

January was I believe not only for us but also for some of the other people in the industry I talked to a very robust member ship sales month. We spent a lot of money in marketing and we had strong promotions in place and in many cases, many of our clubs, two, three, four, five, six years old we sold probably more membership units than we have sold ever before. So, January was a robust month but I wouldn’t hang my hat Hardy on January going forward for the rest of the year.

There could be a lot of phenomena about January. It could be that people were so scared of spending money November, December, in January they came in they kind of made their resolution and said, “My health is the most important thing to me.” Ran in and joined the club, that enthusiasm can wear off by late February, who knows. We had a great January, I can’t undermine that at all.

The utilization of the clubs, I mean literally when I go to our clubs even as early as yesterday, the day before, parking lots are packed, people are coming in. Some of our clubs we’re shuttling people back and forth from crossover parkings. So, I don’t think that the consumer has walked away from exercise whatsoever. They’re dealing with pinching stuff every where they can but I don’t think this is one of those spaces that they will easily let go.

Hardy Bowen – Arnhold & Bleichroeder

I guess it’s hard to tell if the connectivity programs are beginning to get some traction in this kind of an environment but, what can you say about them so far?

Bahram Akradi

As I mentioned on my first portion of talks that we have just launched our new web and member based web it is truly in my opinion at the baby stages while we’re getting a lot of traction from members coming in, utilizing it, I think it is just way early. We are focusing on creating a true healthy way of life destination for our members so it’s social place, their country club, their health club, their resort kind of with their pools, etc. I think we can provide substantially more value to the consumer than anybody else.

If they took what we offer them per square foot, if they took what we offer them per list of amenities, if they looked at the quality of service, the quality of the place and their experience, they are paying significantly less relative to those things than they are paying elsewhere so I am bullish on our product.

I think this year, this spring, this summer we’re going to position this as a place you can stay and take a vacation in our clubs for a lot less money than going on a vacation. So, we’re going to fight as hard as we can to make sure our customer gets that message both by what we tell them and how we deliver. I believe we will win long term as we have thus far but again, we just do not like the deterioration in the margins we have had in the last six months and we certainly are all over it to try and correct that.

Hardy Bowen – Arnhold & Bleichroeder

In the northeast it seems the clubs are working if anything, better than expectations. Do you plan to look for more sites in the northeast proportionately?

Bahram Akradi

Right now we are still working hard on our pipelines and trying to find locations. I think Hardy that real estate is at a state of flux. Our opinion is that we’re going to see deterioration in the real estate prices. I don’t think that’s quite there yet so we do not want to get pregnant getting in to deals for two reasons, one, as I mentioned we don’t want to get pregnant in to any new deal that we’re not already substantially committed just because we don’t know what the macroeconomics is going to bring and what the credit market is going to be like.

But, at the same time, we’re looking. I also think that we will find opportunities in existing space that would be substantially below costs that you could start from scratch and we will work on those types of faculties as I have done them for years in the past and this wouldn’t be anything new for us to do.

Our club in Fairfax, Virginia has phenomenal returns and it was about a 60,000 to 70,000 square foot facility with it in line with a 4,000 of 5,000 square foot shopping center. We’re going to find all sorts of opportunities we haven’t had in the past years to allow us to grow. But, I want to be very, very clear that none of this will come at us taking a chance of spending dollars that we should be saving in this credit market.

Hardy Bowen – Arnhold & Bleichroeder

So you have to wait a bit for the real estate to come down in price?

Bahram Akradi

We believe that will happen. We’re not rocket scientists, we’re not Houdini, we could be wrong but I believe that will happen.

Operator

Your next question comes from [Unidentified Analyst – Morgan Keegan].

[Unidentified Analyst – Morgan Keegan]

Can you just comment a little bit more about this membership shift? It use to be I think 50% individual and 15% in family. Now, how significant of a shift will it be?

Michael R. Robinson

What we talked about, and it varies by club but generally we’ve seen about 50% to 55% individual and somewhere around 30% couple and about 15% family or so, generally in that range. In the fourth quarter we saw the individual memberships increase and they’re probably running more in the 60% range than they were previously.

Bahram Akradi

Let me give you something, I’d really be cautious in trying to extrapolate anything out of the last three or four months in to a long term projection. Let me just tell you why I feel that way, the market shifted so radically, we introduced a bunch of different programs, promotions, membership types, etc. to kind of combat that. We did not have in my opinion the appropriate levels of controls and right execution at each center so I don’t feel comfortable that we necessarily can take what happened and extrapolate it in to what it should be.

If I take one more quarter, this next 45 days with all the controls that we are putting in place, all the new micro adjustments we are making, I feel like I would be much more comfortable talking about any detailed numbers in terms of what happened, how we course correct and then what to expect.

Unless our execution in my opinion is near our desired levels I don’t want to read in to it that this is what is going to happen long term. So, I have to just excuse, I have to apologize for the fact that we acted and we acted promptly but as you do that sometimes you have to come back and do some micro adjustments, course corrections to make sure it is in fact giving you the results you want and not some other side effects that you didn’t want. I think we got a lot of those side effects.

[Unidentified Analyst – Morgan Keegan]

The last question, going forward, are you considering opening like smaller centers with fewer amenities? Just downsizing to lower the cost of construction, etc., to make it more affordable?

Bahram Akradi

That’s a great question. You’re asking me to tell you what I don’t want to tell any of my competitors what we’re doing. I’ll answer you like this, since 1983, since I’ve been in this business I personally have built clubs as little as 14,000 square feet and as large as 300,000 square feet. Initial stages of my career every center we built was smaller facilities inside of existing space.

So, we have the total capability of taking advantage of the appropriate market and I believe in the near future, the next two to three years there are going to be opportunities – no significantly multiple times what there has been in the past three or four years, five years in the areas of finding smaller boxes that you could get in to with much, much lower occupancy costs.

So, I’m not going to give you any sort of a direction of what we will do. I will tell you that we are examining, studying every other possibilities and we will take appropriate actions at the right time.

Operator

This concludes the question and answer portion of the call. I would now like to turn it over back to Mr. Ken Cooper for closing remarks.

Ken Cooper

Thank you for joining us on our call today. We look forward to reporting to you our first quarter 2009 results which tentatively has been scheduled for Thursday, April 23, 2009 at 10am Eastern. Our annual shareholder meeting will also take place on that day in the afternoon at our corporate office in Chanhassen Minnesota. Until then we appreciate your continued interest in Life Time Fitness. Thank you and goodbye.

Operator

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

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Source: Life Time Fitness, Inc. Q4 2008 Earnings Call Transcript
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