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Life Time Fitness, Inc. (NYSE:LTM)

Q3 2009 Earnings Call Transcript

October 22, 2009 10:00 am ET


Ken Cooper – VP, Finance

Bahram Akradi – Chairman, President and CEO

Mike Robinson – EVP and CFO


Scott Hamann – KeyBanc Capital

Bakley Smith – Jefferies

Paul Lejuez – Credit Suisse

Greg McKinley – Dougherty

Tom Shaw – Stifel Nicolaus

Ed Aaron – RBC Capital Markets


Good day, ladies and gentlemen and welcome to the Third Quarter 2009 Life Time Fitness Earnings Conference Call. My name is Towanda and I will be your operator for today. At this time all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Ken Cooper, Vice President of Finance. You may proceed, sir.

Ken Cooper

Thanks, Towanda. Good morning and thank you for joining us on today's conference call to discuss the third quarter 2009 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 Concurrent with the issuance of our second quarter results, we have filed the Form 8-K with the SEC.

On today's call Bahram Akradi, our Chairman and CEO will discuss key highlights from our second quarter and our underlying business trends. Following that Mike Robinson, our CFO will review our financial highlights.

Once we have completed our prepared remarks we will take your questions until 11 o’clock A.M. Eastern time. At that point in the call, Towanda will provide instructions on how to ask a question. I will close with a tentative date of our fourth quarter and full-year 2009 earnings call. Finally, a replay of this teleconference will be available at our website at approximately 1:00 P.M. Eastern time today.

This conference call contains forward-looking statements and future results could differ materially from the forward-looking statements made. Actual results may be affected by many factors including the risks and uncertainties identified in our SEC filings.

Certain information in our earnings release and information disclosed on this call constitute non-GAAP financial measures including EBITDA and free cash flow. We have included reconciliations of the differences between GAAP and non-GAAP measures in our earnings release and our Form 8-K. Other required information about our non-GAAP data is included in our Form 8-K.

With that, let me now turn the call over to our Founder, Chairman and CEO, Bahram Akradi. Bahram?

Bahram Akradi

Thanks Ken. I am happy to provide you with some color on our business trend through the first nine months of 2009. Overall, my reaction to the quarter is mixed. Our company continues to perform in this tough environment, but we remain steadfast that we are not satisfied, not even close.

All year along, our company has been aligned on four key focus areas. Number one is to generate free cash flow. I am pleased to report that during the quarter, we generated over $15 million of free cash flow and paid down $24 million of debt. We expect to continue generate free cash flow and pay down debt for foreseeable future. Mike will provide additional information on our capital structure initiative shortly.

Our next focus area is member retention, and this has become the most significant initiative our entire company has rallied around. We experienced a 10.6% attrition rate in the third quarter. This compares to an 11.5% rate in the third quarter of last year and was in line with the year-over-year improvement we saw in the second quarter. We believe this improvement was generated by a combination of the stability in our membership base in terms of usage, as well as our progress on our connectivity initiatives. We need to continue to see progress on this front.

Our third quarter environment – our third quarter improvement resulted in a trailing 12 months attrition rate falling from 41.5% to 40.6%. But we are still far from our ultimate goal. While we are headed in the right direction, I am disappointed at our progress to date. We will not be comfortable until we have achieved an attrition rate below 36%.

As we look to the fourth quarter, we expect to see an improvement from the 10.8% rate we have in the fourth quarter of 2008. If we can get to just under 10%, we feel it would be a good progress. However, this is good based only on hostile environment is. Certainly this continues to head in the right direction, but it is still far from our internal goal of 9%.

Many of our member retention initiatives are still in their earlier stages and have not made a significant impact on our entire membership, yet while we are hopeful that these initiatives will deliver the results we are looking for, we still have to wait and see the proof. If these initiatives work great, if not, we will regroup, reinvent, and come up with more creative ideas to fight attrition. One thing I can commit to is we will not rest until we achieve our goals.

Our number three focus area is reducing our cost without damaging our brand or our member experience. Mike will give you plenty of details on our cost initiatives. However, I am pleased to report that we continued to see cost savings across the company.

Most importantly, I was pleased that we – that for the second consecutive quarter, we expanded our center operations margins if you exclude the incremental rent from the sale lease back that we completed in the third quarter of 2008. To me, that demonstrates great alignment between the co-ops and our corporate teams working together to become faster, smarter and leaner, while making cost saving changes invisible to the members.

Last but not least, our fourth focus area has been growing the business. We will continue to find ways to grow the business without sacrificing the three focus area I just mentioned. Our real estate and development team has been busy looking as real estate opportunities in several markets both new and existing. We will continue to investigate those that show potential to meet our return hurdles and we will move forward only when we have terms that are very attractive to Life Time.

In the third quarter, we grew membership by 6%, clearly at the low end of our range of goals for the quarter. New membership acquisition has been very challenging. The good news is the quality of the membership is better as reflected in the improvement in our average revenue per membership and dues growth outpacing membership growth. We expect this environment to remain challenging for the foreseeable future.

I would like to close by making clear that the business environment has stayed tough as it was last fourth quarter. We still feel the headwinds and this has not changed for our sector. However, we remain committed to win in these headwinds.

With that, I now will turn it to Mike Robinson, our Chief Financial Officer. Mike?

Mike Robinson

Thanks Bahram. What I would like to do is provide my comments in three categories. First, an overview of the quarter from my perspective; second, detail on our liquidity and capital structure; and third, I would like to take you through key financial highlights.

Overall achieved – overall we achieved diluted EPS of $0.51. This included a small tax benefit I will talk about later. We achieved these results while not growing our top line as fast as we would have wanted. Same-store sales were down 5.4% for the quarter. But the good news is that all other key revenue metrics including mature same-store sales and average revenue per membership growth rates improved.

We’ve continued to be successful in controlling costs, including central infrastructure, marketing, and center operations. We continued to focus heavily on our capital structure, cash and debt availability. With the amount of construction accounts payable being paid down diminishing in the third quarter, we saw an improvement in the free cash flow generated. For perspective, for the first six months of the year, we reduced our construction payables by $41.2 million and generated free cash flow of $6.6 million. In the third quarter, we paid down construction payables another $11.6 million and generated $15.1 million of free cash flow.

Through the first nine months of 2009, our free cash flow was $21.7 million. We paid down approximately $24 million of debt in the third quarter and nearly $30 million year-to-date. We are targeting to be free cash flow positive for the foreseeable future and paying down debt by reducing our revolver balance.

As a reminder, we opened the three centers we planned in 2009 in the first half of the year. We currently plan to open three large format centers in 2010. For the centers we plan to open in 2010, we expect to open our Beachwood, Ohio which is a suburb of Cleveland location in January, our second center prior to midyear and our last one later in the second half.

Our capital expenditure expectations are $140 million to $150 million for 2009, reflecting the $50 million plus pay down of our construction accounts payable. For 2010, our preliminary expectation for capital expenditures is in the $100 million range, allowing us to complete the three clubs we’ve planned to open continue to invest in our maintenance and corporate CapEx and commence 2011 center construction.

We closed the third quarter with approximately $80 million in cash and revolver availability, up from $62 million at the end of the second quarter in 2009. Our net debt-to-capital came down to 48.5% at the end of the quarter compared to 50.2% at the end of the second quarter. Our covenant calculations for the quarter continued to show significant improvement versus our covenant limits.

Although the credit market remains very tight, we remain active in the mortgage loan market. However, indications from regional and national banks are that the interest rates are more costly than we would desire at this point. There is more favorable rates when working with small and local banks and that’s where our most of our time and effort is currently.

As we did not complete any finances in the third quarter, we still have 32 facilities with an asset cost in our balance sheet in excess of $500 million with no mortgage financing against them.

I would like to switch gears and talk about our cost control and efficiency improvement. We have focused on cost control across the country including central overhead costs, marketing and membership acquisition costs and central operating costs. Central overhead includes our construction in real estate and development groups, which we continued to downsize because of this slower growth profile.

Most of these cost reductions to date have resulted in capital investment cost savings and improved cash flow. To date, we have increased – we have decreased the headcount of our corporate office by approximately 20%. This includes central overhead and club G&A support and which resulted in $3 million to $5 million P&L savings.

Member acquisition and marketing costs improved in the quarter, driven by a number of initiatives including more surgical enrollment fee pricing and improved commission structures as well as more efficient marketing.

Marketing as a percentage of revenue was 2.7% for the quarter compared to 3.7% last third quarter. This is driven by better efficiency and a very small of presale activities. Our total commission costs in excess of enrollment fees are running approximately 50 basis points for the year, compared to nearly a 100 basis points last year.

Finally, we continue to gain our labor efficiency improvement in our centers as well as benefits from attacking many other center costs. There are approximately 25 to 30 lines of manageable expense at the club level and each one is fair (inaudible) scrutiny.

Now let me provide you with some operating result highlights for the third quarter. Total revenue was $214.3 million, up 7.8% from last third quarter. Our revenue growth in the quarter continues to be driven by two main factors including membership dues growth of 10.4% for the quarter, which nicely outpaced our membership growth of 6%.

As Bahram indicated earlier, it’s a good sign of higher quality member joining Life Time. This dues growth greater than membership growth is driven by our unrelenting pursuit of a membership phase.

In-center revenue grew by 5.3% in the quarter. Our personal training grew approximately – our personal training business grew approximately 5% over last third quarter and the rest of our in-center businesses combined for over a 5% quarter-over-quarter growth. But our café business continues to register relatively strong growth.

Let me also take a minute to provide some highlights on other revenue metrics. Memberships at September 30, 2009 totaled 590,716 which was an increase of 6% from last Q3. Total memberships declined approximately 17,500 or roughly 3% from Q2 to Q3, driven primarily by the seasonal reduction of summer memberships, as well as the challenging environment which affected new membership acquisition and membership – and existing member retention. This is further proof we must continue to improve our retention rates. For the year, we expect membership growth to be in the 3% to 5% range as we have no additional centers planned to open this year.

Our third quarter same-store sales had a 5.4% decline and our 37-month mature same-store sales were down 8.7%. These two metrics as expected were negative and driven by lower membership levels, lower dues mix and lower in-center sales per membership. However, we’re pleased that the 37-month metric improved sequentially a quarter earlier than anticipated. In the second quarter, we were down 9%.

The improvement came primarily from the Wellbridge clubs which entered the comp base – mature comp base this quarter and performed well from a revenue perspective since three models were completed last year. Year-to-date, we have experienced a 4.2% decline in same-store sales and an 8.5% decline in our 37-month mature same-store sales.

With respect to revenue per membership, we generated $358 per membership. Revenue per membership improved sequentially from a negative 2% in the second quarter to a negative 0.2% in the third quarter.

In-center revenue per membership of a $100 improved from a negative 5.1% in the second quarter to a negative 3.1% in the third quarter. Although improved, we are still working hard to get both out of negative territory.

Center usage remains strong. Average membership usage continues to be up over prior-year metrics. In addition, the number of inactive members continues to decline in the quarter relative to the same period in the prior year.

Another common question we have received recently, are there any centers around – are there centers that have geographic trends that we are experiencing? We continue to see what you might expect. Detroit is the most pressure winning market, but it’s still hanging in there. The Northeast centers performance including New Jersey and the Baltimore, Northern Virginia areas has been generally strong.

Moving to our margin analysis, the company’s operating margin in the third quarter was 18.7%. This is a decrease of 250 basis points from Q3 2008, but in line with our expectations and a 70-basis point increase sequentially from the second quarter. The main drivers in the year-over-year margin decrease comes from the increase in center operating occupancy cost from a sale lease backed deals we executed in the third quarter last year, which added approximately $3.1 million of incremental rent expense or 150 basis points of center operating cost.

In addition, depreciation expense increased to 150 basis points driven by the second half 2008 completion of remodeled acquired centers, higher investment in the centers opened in 2008 and 2009, and the deceleration of revenue growth rates.

Our center operating margin for the quarter decreased from 41.5% to 40.5% as a percent of total revenue. Excluding the sale lease back transactions from the third quarter 2008, our center operating margins would have been approximately 42%. This improvement was due to several factors discussed earlier including better efficiency in our center staffing levels and further streamlining our central overhead staffing for our in-center business management.

Marketing expense declined by $1.5 million or a 100 basis points due primarily to reduced direct mail advertising and very little presale activity in the quarter. We expect marketing expense to be sequentially higher as a percent of revenue in Q4 driven by presales of two centers, as well as other market campaigns.

G&A expense increased approximately $200,000 but was 30 basis points better as a percent of revenue and 4.5% versus Q3 2008. This was a 100-basis point decline sequentially from Q2 2009 driven primarily by a reduction in COO expenses as well as other cost reduction and efficiency improvement efforts.

Other operating expense was up a 120 basis points as a percentage of revenue or $3.1 million. These expenses included construction related expenses related to the growth slowdown such as for the site write-offs and unused material disposal, triathlon series expenses, growth in our corporate wellness infrastructure, and losses on asset disposals. Some of this may be one-time, but we feel we may see some more of this over the next few quarters.

As we make our way down the P&L, interest expense net of interest income increased to $7.7 million from $7.2 million last third quarter, but was sequential – but was down sequentially from $7.9 million for the second quarter 2009. This sequential movement reflects our debt pay down during the quarter and the benefit from the low variable interest rates on a revolving line of credit.

Our cash rate for the quarter was 36.8% down from 38.8% last Q3. The primary driver for a lower tax rate was a reduction in tax accruals resulting from a favorable outcome from our 2006 federal tax audit. We benefitted approximately $0.01 from this lower tax rate compared to last Q3 or approximately $0.02 from our 40% tax run rate. We continue to expect our 2009 effective tax to approximately 40%.

That brings us to net income for the quarter of $20.6 million, which was down 4.4%. Our net income margin for the quarter was 9.6% compared to 10.9% last third quarter. Weighted average fully diluted shares totaled $40.3 million for the third quarter. We expect our 2009 year-end share count to be approximately 40.5 million shares and fully diluted average share count to be approximately 40 million shares for the year.

These totals excluding any impact from the long-term incentive restricted stock grants in June, which at the present time we do not feel incentive will be achieved. Based on our 2009 third quarter weighted average share count or diluted EPS for the quarter was $0.51, down from $0.55 in the third quarter last year.

Moving to our operating data, as Bahram indicated, our third quarter trailing 12-month attrition rate was 40.6% down from 41.5% in the second quarter. Our quarterly attrition rate was 10.6% compared to 11.5% for the third quarter of 2008. This tells us that our membership base is responding favorably to our value and connectivity initiatives. As Bahram stated earlier, attrition is an area of significant focus and we are committed to reducing this further.

The number of open centers at September 30, 2009 was 84 compared to 77 at September 30, 2008. Off the 84 centers, 51 or 61% are our large current model and 56 or 67% of all centers have been opened three years or more, which we classify as mature centers. As of September 30, 2009 we had approximately 8.4 million square feet, which was 10.5% greater than we had at September 30, 2008 when we had 7.6 million square feet.

EBITDA totaled $63.7 million in Q3, up 4.2% from last third quarter. EBITDA margins decreased to 29.7% from 30.8% last third quarter. If you remove the impact from the sale lease back transaction, third quarter EBITDA margin would be 31.2%.

Cash flow from operations totaled $40.3 million for the quarter compared to $37.8 million last Q3. Year-to-date cash flow totaled $138,600,000 this is slight behind 2008’s first nine months performance. Free cash flow for the first nine months of 2009 totaled $21.7 million compared to a negative $217 million for the first nine months of 2008.

Turning to other financial highlights, cash outlays for capital expenditures for the quarter were $25.1 million including approximately $11.6 million of further reduction in construction accounts payable. We incurred approximately $8 million related to growth or construction of our new centers and $6 million for maintenance of our existing club base and corporate initiatives.

Total CapEx year-to-date was a $116.9 million. During the third quarter, our overall debt balances reduced by $24.1 million as of September 30th, compared to June 30th. As of September 30th, we have $387 million outstanding on our $470 million revolver.

Other balance sheet variances to note include working capital is down about $40 million from the end of last year, driven primarily by over a $52 million decrease in construction, accounts payable as we reduced our in-center growth, partially offset by $6 million of growth in accrued expenses primarily accrued taxes.

With that, let me discuss our updated guidance for 2009. We have already discussed our CapEx expectations, so let me move on to financial guidance. Reflecting the challenging environment, we have narrowed our revenue guidance to $835 million to $845 million or 8.5% to 10% growth. This compares to our previous revenue guidance of $830 million to $865 million.

We expect net income of approximately $71 to $72.5 million. This is an increase from our previous guidance of $67 million to $71 million. This results in diluted EPS guidance of $1.78 to $1.81 per share. This is also an increase from our previous guidance which was a $1.65 to $1.75.

Our total year guidance includes the one-time impact for the tax rate benefit received in the third quarter. In addition, in Q4 we anticipate increased marketing spend from presale activities on two centers and specific marketing campaigns. Also, we anticipate 4Q revenues to be seasonably lower due to the lack of summer memberships and the holiday season tends to restrict some of the in-center businesses.

That concludes our prepared remarks regarding our third quarter 2009 financial results. We are pleased to take your questions now.

Question-and-Answer Session


(Operator instructions). Your first question comes from the line of Scott Hamann with KeyBanc Capital. Please proceed.

Scott Hamann – KeyBanc Capital

Yes good morning. Just in terms of some of the things that you are doing on the retention initiatives Bahram, could you kind of give us some more detail of what was working throughout the year, what hasn’t been working, and how you’re going to address some of these issues going forward?

Bahram Akradi

Good question, Scott. Let me give you meaningful color where I can. Let me first start by telling you that I am extremely disappointed with our 10.6% attrition rate that we had in the Q3. So in a long shot, I can tell you things aren’t working at this stage in any shape or form where I would want to brag about.

We have a lot of initiatives in place. My gut feel tells me it is way too early, both from members, absorption, understanding of all these things that we are doing, whether if it has a real impact or not, and also our team members. So when I think about the impact that you are asking for none of the stuff we are working on I expect to see anything dramatic out of it till very end of this quarter, and hopefully for sure sometime in the first Q of 2010.

I have to tell you that in – and I have been sharing this with – as I have been able to talk in the public forums, business is as tough as I have every seen it in 20 some years. And I am sure some of the other people will have the same question, so I will just cover it here. In all the past recessions, I felt no impact in our business.

All we had to do is lower the initiative fee and we got the membership accounts, we were able to pull the people in by doing increased promotions, increased marketing. In this particular time, things are just not working. I mean we are – when we do advertise, we don’t see the impact that we would expect to get out of it. And so we are working on huge value proposition.

One of the things we are going to focus on take our in-center businesses and provide values to our members that it’s not available to our members and they couldn’t get those type of services elsewhere at those rates such as swim lessons, hair cut for kids, sandwiches that are totally healthy, but yet they are really low price.

So across the board, we are looking at how we can improve the customer value proposition substantially enough so that they can see and notice the differences. And we are hoping that the in-center items will probably have much higher sales not generating more EBITDA or more really any more dollar benefit in terms of the profits, but – so they will actually have lower margins on their own revenue, but yet we would think that we can generate improvement.

I have no real data other than it’s too small. We tested this with like the café products in one club and then we rolled it out to about another eight or 10 clubs and the initial test is very promising, okay?

Now as of middle of October, we have rolled that out across the country and I don’t have enough data to tell you. But we are working, and I can tell you Scott, we will not give up as I said earlier, we will continually work, try to figure out how we can get a more sticky experience for our customer. Does that answer your question?

Scott Hamann – KeyBanc Capital

Yes, that answers Bahram. And then just a quick follow-up, in terms of the attrition rate that you are seeing, previously you had talked about it kind of being isolated in the non-user element of the clubs, which had been shrinking over the last several quarters, is that still the case, and are there any other kind of notable trends you can tell us about mature versus the other centers in terms of attrition?

Bahram Akradi

Yes, we don’t see any – we are not seeing any more contraction on the number of days where a non-user is pulling the trigger of dropping out. I mean that – we used to go where there was maybe two months or three months where people haven’t been using the clubs, they would start coming dropping out and it got down to a low as low 45 days, they haven’t used a club and they come and cancel. That hasn’t gotten any worse.

But the – and as you guys can figure this out mathematically, we have just fewer people who aren’t using the club right now, because they have been attritioning [ph] out of the heavier rates, so that stabilized, I don’t think we are getting any more additional impact to that. It’s just hard.

I mean when I will talk to other people in the industry, about fourth quarter last year, we saw a 20% bump in attrition across the – at least those people I talk which is quite a few of the large operators. So ours was in mid-30s, ran up to 42, it was similar in most other players. And it hasn’t – despite all the effort it hasn’t really been dramatic improvement. I mean we’ve cut it back maybe a 1.5% or 2%, but just that miniscule in terms of what our overall goal is.

I am still optimistic that we can get there with all the initiatives, but it’s going to take, it’s going to take some time to my dissatisfaction, and my impatience running that results yesterday, I think I just got to become more patient and just accept that it may take till second or third quarter of next year before we can see a significant reduction, and I hope that we do see it.

Scott Hamann – KeyBanc Capital

Thanks Bahram.


Your next question comes from the line of Bakley Smith with Jefferies. Please proceed.

Bakley Smith – Jefferies

Hi you guys, good morning.

Mike Robinson

Good morning, Bakley.

Bakley Smith – Jefferies

So I just wanted to dig in on some of the same things everyone will hit on here. But membership acquisition cost, to what extent do you think that you can – that you can sort of lever this thing or – do you feel at this point that you are basically – are you having to spend more, obviously you are having to spend more than you’ve liked to acquire members, but do you see any signs on the margin where you are getting some leverage on that spend of acquisition, like are you getting some roll – like some run out on the activities that you do?

Bahram Akradi

I don’t quite understand your question. So but I do – I will try to give you some information, I think it is prudent for everybody to understand. If I would spend an extra $3 million on marketing and felt like it was pulling in more memberships, I will gladly spend the money. So it’s not like we are trying to save money on marketing. It’s just not working.

So you send out a direct mail piece today relative to some time ago, the impact is so much less that it’s almost like a waste of dollars that you are spending. So we are working hard on reinventing how we spend our marketing dollars, so that it will create more impact to our member attraction as well as member retention.

So I am not going to get into the nitty-gritty of all the things we are doing, because obviously those are our trade secrets and day-to-day business, and I don’t want to divulge our entire strategy. But I think it is important of you guys all of you to know it is much tougher. And I understand – I see the market go up to 10,000 or so and everybody being bullish direct so far. We haven’t seen the headwind led up at all for our business.

Mike Robinson

Bakley, let me – go ahead.

Bakley Smith – Jefferies

That’s what I was driving at.

Mike Robinson

Let me talk a – let me talk a little bit about the other side of that and that’s the commission cost or the commissions on the enrollment fees. We’ve actually have seen some leverage in that this year. And we hope that we can continue to drive more of that leverage over time. And that leverage is coming from making sure that as we are – as we work across every one of our areas, we are properly positioning and pricing enrollment fee.

And that we have got a commission structure that winds up, it drives the right types of elements which for us is dues growth. And so again, we have seen some leverage in that piece of the business. We have moved from about a 100-basis point of cost last year to about 50 basis points of cost. And as we move forward, we expect to help drive more leverage out of that.

Bakley Smith – Jefferies

Okay. One other quick one if I could. You talked about the 37-month and obviously we saw a turn there that’s the positive thing. But you also mentioned that and I was a little confused, which is some new centers entered. I mean if you could kind of normalize to the degree that you can for any ins and outs. I mean do you – even if you just took it back another year, the four year old centers, I mean do you – how do you feel about that sort of membership group, is the attrition, is it the churn in that group (inaudible) again where you wanted to be, but do you see anything directionally that’s making feel better, worse, I mean where are we with the older centers?

Mike Robinson

Well, let me start with it from my perspective. It’s still negative and we are not happy at all that it’s negative. While we talked about and what the – the changes from second quarter to third quarter going from a negative 9% to a negative 8.7% was a positive move for us.

When we analyzed that, the base reason for that is that new centers that came into the comp the leverage centers have performed better from the revenue perspective and they certainly have performed better from the revenue perspective since we completed the remodels that we did last year.

If you look at – we expect this to improve. We anticipated improvement really in the fourth quarter. We got this improvement. We had a little bit of this improvement in the third quarter. And so that’s a good sign, but again, it’s negative and we don’t like that all. And to really drive that to zero and positive, as we have talked about before, we need to see our attrition rates get back down into the 36% range or so.

Bakley Smith – Jefferies

Okay. Okay, thanks very much.


Your next question comes from the line of Paul Lejuez with Credit Suisse.

Paul Lejuez – Credit Suisse

Hi guys.

Mike Robinson

Good morning.

Bahram Akradi

Good morning, Paul.

Paul Lejuez – Credit Suisse

The mix of new members, wondering which types of memberships might be light relative to plan is it just individuals or have family signups also have been somewhat disappointing. And then maybe a little bit longer term with weaker membership growth relative to your plan, has it changed your view in terms of how you might think about growing beyond next year?

Bahram Akradi

This is a good question, and I will take it on. Part of this – part of the things that is working is structurally changing the way we paid commissions. And so I think the improvements in dues outpacing membership growth is really correcting something we weren’t doing great in the 2008 and back. And there are some more modifications

I am working on to rollout in the next few months with our another – another yet another phase of improvement in our commission structure for our sales team that I believe will hopefully effect dramatically on the attrition rate of our business as well. So it’s not necessarily a mix of – that we are doing anything better for people to buy family or this, it is just that the sales people are approaching it the right way now rather than only focused on delivering a unit. So that is going to continue to improve our dues pace relative to the average dues. And I think we can get – we can continue to see improvements from that front.

As it relates to how does the membership growth impacts our future growth? If we cannot overcome the same-store improvement that we are talking about, if we cannot overcome attrition rates going to mid-30s, which I believe we will, I don’t know how yet.

But as I am telling you we are trying a lot of things that are too early to tell if they’re working or not. Those that work we will do more of them. Those that don’t work we will get rid of and focus on other things. And if none of them work we will invent new ways to get. We will get to that number one way or the other.

And when – and so we are going to grow the way we are growing now based on the conditions that we are feeling today. We are not going to stop building. We will continue to build. And – but we will build in the same pace we are building right now.

I remind you guys even though our numbers are significantly below our expectation, we are still significantly profitable. So these are not clubs that are not making money, they’re just not making as much money.

So we will continue at the pace we are building right now until we figure out how we can get the attrition down to mid-30s and same-store sales comping definitely positive particularly after they have taken such a reduction in what the production has become.

I have followed each club for all of these last – accumulatively out of these last four, five, six quarters, now we need to kind of figure out how to take them up. And when they comp positively nice enough, then we can ramp on the growth.

I don’t – or we will be financially in a position at the time that our debt ratios will be significantly lower than those necessary to acquire attractive debt. So we will then pivot and speed up again, but that’s what we have to do.

Paul Lejuez – Credit Suisse

Thanks. Good luck.


Your next question comes from the line of Greg McKinley with Dougherty. Please proceed.

Greg McKinley – Dougherty

Yes, good morning. Guys, could you refresh my memory a little bit in terms of how you look at center operating expenses on a four-wall basis, how should we expect those to behave seasonally? Obviously you have taken some pretty aggressive cost cuts there. Even so, I would have maybe expected those numbers to be higher just due to the cost of operating the outdoor aquatic facility, et cetera. So given the changes you have made, remind us of sort of how the seasonal – seasonality of those expenses occur? And could we expect those expenses to be even lower than in the fourth quarter?

Mike Robinson

Let me start with a blanket statement that we do expect – once we have anniversaried which we will in the fourth quarter, we do expect to see some center operating margin expansion, because of all other things that we have been doing at a club level, the labor efficiency continues to run very well.

I think in the second quarter, I told you that we were running at 3% or 4% positive labor efficiency. We continue to run at those rates. And our area directors and our general mangers have been just tremendous in ensuring that that we are looking everywhere we can to make sure that our cost structure is right, while still delivering the tremendous wild experience at that level.

The seasonal aspects of it, the biggest driver seasonally for this is what you pointed out and that is in the summertime, in the summer months, so a little bit of May, June, July, August and a little bit of September, we are running outdoor aquatics and higher general fitness classes and that brings a heavier labor burden to the clubs. So you saw – certainly the second and third quarter bared the brunt of those costs. And we would expect to see that come down again little bit in the fourth quarter.

Greg McKinley – Dougherty

Okay. And then Mike, can you just remind us quickly of your CapEx comments for ’09 and 2010?

Mike Robinson

Yes. In 2009, my original guidance was 125 to 150. I have narrowed that to 140 to 150. Really driven by the fact that our construction payable has gone from $63 million to $10 million, and that’s – and that was the driver for narrowing that range there.

And next year, preliminarily when you take out that construction payable move, that would say that we would be right in the $100 million, we will obviously update that in February, I’ll give you a range on that, but I wanted to let you know that’s kind of what we see right in that type of range right now.

Greg McKinley – Dougherty

Thank you.

Mike Robinson

You’re welcome.


Your next question comes from the line of Tom Shaw with Stifel Nicolaus. Please proceed.

Tom Shaw – Stifel Nicolaus

Hi, thanks guys. I guess a continuation of the center operations question, and Bahram I know you’ve had a pretty intense focus on the internal operations in this environment. But how early are we in the stages of those opportunities in making a more efficient box? And how will you know where to I guess stop the expense reduction before potentially damaging that membership experience which is so important?

Bahram Akradi

Yes, I think it’s a – this is a probably an intelligent question. And let me give you what to expect more clearly. As you guys all know cost cutting is only good to up to a point.

When you go through an environment like we have gone through, it focuses everybody and radically understanding the need to make changes and be more efficient. Efficiency as long as it’s invisible to the member, great. And once it becomes visible to our member, it’s no longer anything good. I don’t like our business model to continue to on succeeding based on cost cutting.

By end of this year, I would say to you that we would have to have next year, we need to win on the top line not on the bottom line. We have been winning this year, all year long based on managing the bottom line not really winning on the top line. That is not going to be the case next year. I want to make sure you guys don’t go in and think we keep cutting cost to achieve our objectives, it’s contrary.

What we need to do is we need to make sure the customer gets an incredible value proposition, one that entices them to want to be a member for maybe more reasons than they have wanted to be a member in the past. So I am committed, I am working around the clock with my team, marketing team, operations team. We will figure it out. And what I would like to see is we will – as I mentioned to you, we will win on the top line. And the amount of money you can generate on the top line is probably much more impactful next year than what we can save on the bottom line.

Having said that, we are not going to take our eye off of waist, so if we can see in some part of the club we are staffing, we don’t need to be staffed or is there way to manage our utilities rather, et cetera we will do so. But we have been working pretty hard at that already. Does that answer your question?

Tom Shaw – Stifel Nicolaus

No, that’s helpful.

Bahram Akradi


Tom Shaw – Stifel Nicolaus

Last one I will ask, given where attrition stands, it’s probably the less relented. But have you been able to measure any kind of change in the consumer based on either the enticement with the instant [ph] vouchers or some of the efforts the membership advantage program at this point?

Bahram Akradi

Yes. Those are the stuff where we see some small anecdotal comments. But our penetration right now to the memberships understanding or engagement of let’s say member advantage or the mind-blowing value in the in-center, at this point, as we speak right now is so low that I can tell you if that program is going to be effective or is the program that we should just disregard and focus on something else. It’s just too early.

I will – I know a lot more about which initiatives are working and not working in just about six months. And in three months from now, we will have more indication, but wouldn’t be all the indication I need. But after the first quarter of next year, I think we can really evaluate which programs are really paying off and which programs are marginal.

We have at least a half a dozen different programs that are literally moving aggressively in terms of their design, implementation and then absorption, and beyond that we have to test and course correct and then correct. There is a couple of two, three iterations of those before we could say if it’s working or not working.

Tom Shaw – Stifel Nicolaus

All right, thanks.


Your next question comes from the line of Ed Aaron with RBC Capital Markets. Please proceed.

Ed Aaron – RBC Capital Markets

Good morning. Thanks for taking our questions. So I guess the two main drivers of your business are attraction and retention of members. And it seems like if you (inaudible) with the attrition rate, seems like a bigger short fall would lie more on the attraction side than the retention side. But as you evaluate different initiatives and you mentioned a half dozen or so of them, it seems to me like those initiatives would probably more focused on the retention fees. Is that a fair statement?

Bahram Akradi

Yes. And here’s the deal. If we got to the attrition rates of mid-30s and sold membership accounts as we are selling just right now, our membership growth will well exceed our expectations, okay? I told you guys this last year as well. I know it’s hard to remember every conversion, you can promote and do a lot of promotions and make up for the shortfall for a while.

Eventually your promotions are no longer promotions, they are just everyday expectations. So we need to win on the retention side and then everything will fall in place. And it is just like a game of football, if your offenses in the team – in the field, the defense doesn’t have to run the field, you are not giving up point. And in our case, if our attrition is right, if retention is working, then getting new memberships is almost easier.

Ed Aaron – RBC Capital Markets

That’s fair. And then Mike, one thing we are trying to get our heads around little bit is just the seasonality of the quarterly attrition rates. You haven’t been giving us that data for that long. When you look over a longer period of history from Q2 to Q3, what does that the seasonal progression look like?

Mike Robinson

It’s – I am not going to say anything, it’s identical to what we have seen in second – in the last year or two, but it really does follow the same pattern. What happens is that you are moving off of the summer pool season and the summer – and the student season. And so you have – we just historically have had the highest number of attritions in that third quarter, which you would come to expect as you look at that late August-September timeframe. And so, back in ’07, ’06 and beyond, you always see the spike, the third quarter spike.

Ed Aaron – RBC Capital Markets

And then one more quick question if I could. You mentioned in your prepared remarks about I think it was the way to do the share count and something on the incentive comp side. Could you elaborate on that?

Mike Robinson

Sure. Sure. If you recall in June, the Board setup an incentive comp structure that had almost a million restricted shares for some high-performance hurdles to be met in 2011 or 2012.

In effect from our perspective, we are looking at it as is game-changing performance hurdles. And at this time as management has analyzed that, we do not believe that those performance hurdles would be achieved. Therefore, we have not taken expense on those for they accounted in the share base.

At a point in time where if we ever look at it and analyze it and believe it that there is a possibility of achievement of a part or all of that, the company would do a catch-up on that and recognize the rest of that expense pro-rately [ph] over the time period. But again as we look at it today, we do not believe that those hurdles would be achieved. So they are not in our share count or in our expense structure.

Ed Aaron – RBC Capital Markets

Great, thank you.


Ladies and gentlemen, this concludes the question-and-answer session. I would now like to turn the call back over to Ken Cooper for closing remarks.

Ken Cooper

Thank you for joining our call today. We look forward to reporting to you our fourth quarter and full-year 2009 results which tentatively has been scheduled for Thursday, February 25th, 2010 at 10:00 A.M. Eastern. Until then, we appreciate your continued interest in Life Time Fitness. Thank you and good bye.


Thank you for joining today’s conference. That concludes the presentation. You may now disconnect and have a great day.

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