Town Sports International Holdings' (CLUB) CEO Bob Giardina on Q2 2014 Results - Earnings Call Transcript

| About: Town Sports (CLUB)

Town Sports International Holdings, Inc. (NASDAQ:CLUB)

Q2 2014 Results Earnings Conference Call

July 30, 2014 04:30 PM ET

Executives

Carolyn Spatafora - Chief Financial Officer

Bob Giardina - Chief Executive Officer

Dan Gallagher - President and COO

Analysts

Sean Naughton - Piper Jaffray

Scott Hamman - KeyBanc Capital Markets

Operator

Greetings welcome to the Town Sports International Holdings Incorporated Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Carolyn Spatafora, Chief Financial Officer. Thank you, Ms. Spatafora you may begin.

Carolyn Spatafora

Thank you for joining us today. This is the Town Sports International Holdings earnings conference call discussing results for the second quarter of 2014. I'm Carolyn Spatafora, Chief Financial Officer of the company.

I caution listeners that any remarks we make in this conference call relating to matters that are not historical facts constitute forward-looking statements which are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which are outside our control, which may cause actual results to be materially different from any forecasts we have made. These risks and uncertainties are described in our reports filed with the SEC including those discussed in the Risk Factors, MD&A, and other sections of our annual report on Form 10-K for the fiscal year ended December 31, 2013 filed with the SEC on March 14, 2014.

We have issued a press release discussing our results for the quarter, which has been filed with the SEC under Form 8-K. We disclaim any duty to update or revise such forward-looking statements whether as a result of future events or otherwise.

In addition, for those of you who do not have access to this release and filing, we’ve also made them available at our website www.mysportsclubs.com. This conference call is also being webcast and may be accessed via the Investor Relations section of our website. Also a replay and a transcript of the call will be made available on our website July 31, 2014.

I now turn this call over to Bob Giardina, the Chief Executive Officer of Town Sports International, for a discussion on the operations of the company. And then I will provide additional financial discussions later on in the call. Bob?

Bob Giardina

Thanks Carolyn. Good afternoon and thanks for joining us for our second quarter conference call. Also on the call with me today is Dan Gallagher to President and COO. Today, I’ll quickly review the second quarter which had trends that are very similar to the first quarter and also update you on our initiatives to position our business for the changes taking place in the fitness industry. And then Carolyn will go through the results for the second quarter.

As you can see from our press release, our business in the second quarter was very similar to the first quarter. Same-store sales were down 4.5% with membership volume being the biggest drag on sales.

As we saw in the first quarter, membership trends continue to be impacted by softer guest traffic. We now have almost 5% fewer members than a year ago. But we do have a plan to reverse this trend and I will address this in a minute. Monthly attrition averaged 3.4%, slightly higher than the 3.3% of the prior year second quarter and in line with our expectations.

Our personal training revenue increased by 3.6% which was sequentially a slight improvement over the 2.9% realized in the first quarter. Total ancillary revenue was down 1.9% and also an improvement over the 4% decrease realized in the first quarter. We are not satisfied with the first half results and we are taking aggressive steps to leverage the many assets this company possess in order to drive membership and ultimately revenue and earnings growth.

As I mentioned on our last call, more than 125 fitness clubs have opened in our markets over the last two years and a large proportion of these openings have been lower cost model clubs. Also the trend towards boutique studios is accelerating even faster with more than 120 minutes opening in Manhattan alone over the last 12 months.

The number of options for consumers is greater than ever before. With that in mind, Town Sports is making strategic shifts to attempt to capture this expanding market. First, we have entered the boutique studio market with the July soft opening of BFX Studio in the Chelsea area, Manhattan. Studio operates three boutiques under one roof, Ride Republic, which is spinning, Master Class which is group exercise and Private Sessions which is private training. We’ve had more than 1,000 people through for trials and have received a lot very positive reviews including stories in Well and Good; Daily News; Fitness Magazine and Good New York to name a few. We’re offering a summer class schedule while we evaluate all factors of the studio including the technology that brings with it. We will have a grand opening in September and our next two locations one in the Financial District of Manhattan and one in Back Bay, Boston are under construction and we expect them to open by the end of the year.

Second, a new initiative for Town Sports that we have been working on this year that will allow us to attack the growing and most competitive area of our business. We planned to initiate at least 20 of our 160 domestic clubs to what we refer to as a high value low price model. The typical model for this new format will include a monthly membership fee of between $19.95 and $29.95 and the services we provide to these clubs will remain unchanged from what we deliver today.

Members joining at these discounted prices at these select clubs will have privileges at only the club they’re joining unless they elect our Passport membership option. We will provide the members the access to [close] rate facilities and services including group exercise, pools, basketball and many of the same programs our members have enjoyed for almost 40 years. This will align us with the way many people who are generally new to fitness are approaching their fitness needs and it will allow us to compete directly against low cost competitors with a more complete offering. We studied how this has been done by other full service clubs in certain areas of the country and have a plan that we’re confident will boost membership and then both revenue and EBITDA for this with the clubs.

We expect to experience a decline in earnings initially as we convert these locations. This is principally due to the increase in advertising spend and the expectation that a portion of existing members will take advantage of this lower rates. These first 20 clubs are predominantly in the suburban markets, where we will be able to offer a much better experience for the member versus the competition, by leveraging the services and facilities that we already provide them.

I should also note these conversions will require very little, if any incremental capital spend. We will be putting this plan into action in the third quarter and we'll continue to convert clubs throughout the second half of the year. We expect about 20 clubs will be converted by the end of the year. We will monitor and access the performance before potentially converting any an additional smaller group of clubs being considered. This will not impact most of our clubs are within our urban market and benefit from our clubs’ strategy.

Lastly, we're continuing with our plan to close and consolidate select underperforming clubs and expect to close and consolidate approximately 5% of our clubs over the next six months. We are confident this will be accretive to next year's earnings as we consolidate underperforming clubs and transfer the members to our nearby clubs. The closings will be spread across each of four metro areas where we currently compete. Given all the changes that are taking place, our Board of Directors has decided that it will not continue to quarterly dividend at this time.

I want to provide a brief update regarding the pending sales of our 86th Street location. We have agreed to expand the closing date to occur on or prior to September 11th and in return the non-refundable deposit is increased from $10 million to $20 million.

As of June 30th, we received 5 million of cash related to this deposit and in this month of July we received another $5 million with remaining the $10 million held. Also the purchase price was increased by $3.5 million to $85.5 million. Reiterating what I said last quarter, we are carefully balancing the optimization of our existing base of clubs to drive EBITDA. We will see a lot of potential through the conversion and closing of clubs, we would select new clubs opening and rollout of our new BFX Studios. We are certainly not standing still and waiting for the business to come to us. We continue to deliver a high quality service to our members, but we need to either drive more traffic to clubs that have the potential to expand their member base or close in transfer members clubs that are not performing up to our expectation.

We believe that we the resources that we need to make these changes and execute on our initiatives, including a tremendous team that is making all this happen.

With that I will now turn the call over to Carolyn.

Carolyn Spatafora

Thanks Bob. I will go through the income statement and highlights for the quarter and then discuss our outlook for the third quarter of 2014. In the second quarter, our consolidated revenue reached 115.7 million a decrease of 3.7% from the second quarter of 2013.

Our total net member count in Q2 2014 decreased by 8,000 members to 488,000 members, the number of restricted members totaled 44,000 as of June 30, 2014. Monthly attrition for the second quarter averaged 3.4% meeting our expectations and up slightly from Q2 last year. We expect average monthly attrition for the third quarter of 2014 to approximate 3.8% up slightly from the third quarter of 2013. We saw a very modest improvement in average monthly dues of members charged in the second quarter 2014 at $59.75 versus $59.53 in Q2, 2013 while our average joining fees decreased 7.5% to $60.02 per member from $64.86 in the same period a year ago.

Total ancillary club revenue was down 1.9% to 23.6 million from 24.1 million a year ago due to declines in Sports Club for Kids while personal training revenues increased 3.6%. Sports Club for Kids improved sequentially, but remained down year-over-year.

Revenue at our clubs opened over 12 months decreased by 4.5% for the quarter. Comparable club revenue was affected by a decrease in membership of 2.9%, a decrease in ancillary club revenue, joining fees, and fees and other revenue of 1.3% and a price decrease of 0.3%.

Turning to expenses, total operating expenses increased 8.1% to $113.6 million for the second quarter of 2014. The increase in operating expenses in Q2 are mainly driven by the acquisition in opening of new clubs in 2013 and ‘14. Additionally last year's operating expenses benefited from a $2.5 million insurance recovery related to Hurricane Sandy.

G&A expenses increased $0.6 million to $7.5 million in the second quarter, driven mainly by increases in licensing fees related to the implementation of our new club operating system. We expect G&A costs to remain constant with Q2 at $7.5 million in Q3, 2014.

Operating income, excluding asset impairment charges, for the second quarter was $3 million compared with operating income of $15.2 million in the second quarter 2013. Excluding these same items, net loss for the quarter was $0.02 per share compared to net income of $0.19 per share in the second quarter of 2013, which also exclude non-recurring items. Adjusted EBITDA was $15.5 million compared to $25.7 million in Q2 2013.

Cash flow from operating activities for the first half of 2014 was $24.2 million as compared to $44.3 million in the first half of 2013.

Total outstanding debt as of June 30, 2014 was $323.4 million and our cash position was $77.4 million for a net debt level of $246.1 million compared to a net debt level of $251.4 million as of December 31, 2013.

Capital expenditures totaled 16.2 million for the first half of 2014 compared to 12.3 million in the first half of 2013. The increase was driven by investments in grand club openings as well as construction at our new BFX Studio. For the full year 2013 we continued to expect total capital expenditures to reach 45 million to 50 million which includes 20 million to 22 million related to the potential 2014 and 2015 club and BFX Studio openings.

Now turning to our outlook. Based on the current business environment recent performance and current trends in the marketplace and subject to the risks and uncertainties inherent in forward-looking statements our outlook for the third quarter 2014 includes the following. Revenue for third quarter is expected to be between 115 million and 116 million versus 117 million for Q3 2013. As a percentage of revenue we expect third quarter 2014 payroll and related expenses to be approximately 39.5% and club operating expenses to approximate 43%.

We expect general and administrative expenses to approximate 7.5 million, depreciation and amortization to approximate 12 million and net interest expense to approximate 4.8 million. We expect net loss for the third quarter of 2014 to be between 1.9 million and 2.2 million. And the loss per share to be in the range of $0.08 per share to $0.09 per share assuming a 46% effective tax rate and approximately 24.3 million weighted average fully diluted shares outstanding.

We estimate that adjusted EBITDA will be approximately 13 million in Q3 2014. We expect that the additional advertising spend coupled with reduction in average member dues at the clubs being converted to the high value, low price model to at first negatively impact EBITDA. We estimate the impact of the conversion to approximate $500,000 in Q3 2014 and as we convert more clubs another $1.5 million in the fourth quarter.

As the membership base of these clubs expands, the initiative will move from dilutive in 2014 to somewhat close to flat in 2015 with the real benefit being realized in 2016 and beyond. We expect this group of clubs to realize roughly a $10 million EBITDA contribution by the end of 2016. The critical ingredient in the shift will be an increase in our average members per club from approximately 2,300 members on average to 6,000 per club in 2016.

As Bob previously discussed we reviewed our club portfolio and established plans to close approximately 5% of our clubs by the end of 2014. Members of these closed clubs will be transferred to nearby clubs in our network. The Q3 guidance does not include the club closure charges that may relate to these clubs.

Given our mix in Q2 coupled with the impact of the conversion at the clubs to the HBLP model we now expect adjusted EBITDA to be approximately 35% lower than full year 2013.

This concludes our prepared remarks. We’d now like to turn the call over to questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Thank you. Our first question is from the line of Sean Naughton of Piper Jaffray. Please proceed with your question.

Sean Naughton - Piper Jaffray

Hi, good afternoon. Just thinking about the kind of the HVLP model you're going to on these 20 stores. Could you just elaborate a little further on what the price points are? It looks like you're going to be looking for a significant step-up from the number of members, but just price point and any changes in the services that will be offered inside of the club?

Dan Gallagher

Yes. Sean, this is Dan. As Bob mentioned, the services inside the clubs are pretty much going to stay intact, they’re still going to have the same group exercise classes, personal training will be provided in the clubs, sports clubs for the kids for the clubs that haven't. So we're not changing the services. As far as the price points, these are the clubs that are currently outside of our networks and on average have low, reduced than our general average, so now they’re right about $50 on average and we expect under the new model they’ll be just around $25 per member.

I think the critical thing is we expect the number count to go from an average of 2,300 members to 6,000 members by the end of ‘16. And it's really a volume thing. And as Carolyn mentioned, we're going to be spending a lot more advertising and up to five times more advertising. So these clubs, they average around $20,000 in advertising in 2013 and we’re going to spend more than five times per club going forward over this new model.

Bob Giardina

And Sean, if I could just add, when we look at the competitive environment, what we see is really in the last two years; I mentioned that we had about a 125 clubs opened directly in competition with us. The majority of those locations were low cost clubs. And we classify those as low cost because what they typically are is they are 15,000 square foot facilities with equipment. They typically don't have the group exercise programs; they don't have a lot of different services. I think what we’re looking at is providing a better brand using our brand name. We have a better product; we have the better service in all the facilities at about the same price. So we felt that at this point the consumers are looking for it and we had to move into that area and we are doing it cautiously but we do see another wave of small number of clubs opening next year under this model.

Sean Naughton - Piper Jaffray

So the initial launch would be you think 20 clubs in Q3, I am sorry if I missed this. Go ahead.

Bob Giardina

The way we are looking at it, we are going to convert two in August, and then we are going to convert the balance of the other 18 by the end of the year. So, if we can accelerate it, we are going to, what’s nice about using our existing brand is first the brand equity; second, there is no maintenance CapEx that has to go into those facilities, the facilities are all in good and they have all the services and there is branding that has to go into it. So we can actually get the speed as quickly as we want. So as soon as we can absorb it, we are going to try to do it as quickly as possible but the 18 will be in the second half of the year, starting September.

Sean Naughton - Piper Jaffray

Okay. And then the incremental there maybe a few more that you would if this is successful and the memberships trends are to track the way that you guys are building out the pro forma, as you would potentially think that there could a few more, there could be some more clubs that would…

Bob Giardina

Yes, another 10 to 15 in beginning of next, Q1 of next year.

Sean Naughton - Piper Jaffray

Okay. And this is assuming that you guys closed approximately 8 to 10 -- bottom 5% you are thinking about…

Bob Giardina

Exactly. So, we really had to look at the entire portfolio and say which clubs. What was driving the whole decision is, where is the industry going? We are excited about the industry, the industry is still growing with the low cost, with the boutiques and we want to make sure we can play in all those areas. So by closing those clubs, we looked at clubs that we couldn’t convert; we said let’s close the clubs that we can't convert and then let's now really attack the market based on where the consumer is going. And we now feel we have three different products that we can go after them with.

Dan Gallagher

And we're still tracking to our plan to close 5% which is about nine clubs in 2014.

Sean Naughton - Piper Jaffray

Okay. And then I guess when you guys look at the just thinking about the attrition rates and I guess maybe the net number additions between urban and suburban. I mean how big is that gap? Do you feel pretty good about the clubs that are in more densely populated urban areas versus the ones that that are in the suburban side, are they getting hit a little bit harder, or are both of them being impacted by different forces?

Bob Giardina

I would say clearly the suburbans clubs were being impacted the most. But we are starting to see the trend towards the low cost clubs coming into the urban markets. What this will allow us to do is to start really looking at our portfolio and saying what clubs should we have to serve the market? So, I can see at some point even in our urban markets have all three free products.

But I think at this point in time, what we're looking at right now is which clubs are being impacted the most and it’s clearly the suburban market.

Sean Naughton - Piper Jaffray

Okay. And then I guess just lastly on the pricing, just across the clubs, I know, I think you guys took pricing a little bit in the fourth quarter last year on Passport. How is that, has it changed at all, are we still kind of at the same price points on Passport or has there been any changes there?

Bob Giardina

No, it's fairly flat at this point. I think what we're looking at right now is really maintaining and really working on the service level of our clubs. So, we are happy with the attrition levels. It continues to be about driving new members into the clubs. And that's why we're looking at having the three different products.

Sean Naughton - Piper Jaffray

Okay. And then one last question. Can you just talk about the decision to kind of remove the dividend, is it strictly is there anything in the covenants to kind of you needed to pull it on or is there something it just didn't look like the cash was going to be there, it looked like it was going to get a little tight to continue it?

Dan Gallagher

Yes, I can answer that Sean. There is nothing in particular in the covenants that the decision I am aware of. The Board does consider a multitude of things when then make a decision to announce a dividend and some of the color I can give without sure changing all the process that they go through, we missed our quarterly targets for the past three quarters and EBITDA is below our expectations. We're now just opening our first BFX model. We're closing 5% of our clubs and as you just heard we're converting 20 of our clubs existing clubs to HBLT model so our Board has decided to wait and see how these things progress before we go forward at the dividend.

Sean Naughton - Piper Jaffray

Okay that's helpful. Thank you.

Dan Gallagher

Okay.

Bob Giardina

Thanks Sean.

Operator

The next question is from the line of Scott Hamman of KeyBanc Capital Markets. Please proceed with your question.

Scott Hamman - KeyBanc Capital Markets

Yes, thanks good afternoon everyone. How are you guys thinking about cannibalization of some of your existing numbers as you convert some of these clubs especially if the offering is not going to be different and you're effectively lowering the price I mean is that something that concerns you?

Dan Gallagher

Not really Scott I think what we're looking at these 20 clubs are furthest away from the network. The majority of the members at these 20 clubs I would say 90% plus are not past members. So as we move further away from the core less people take the network. The benefit of having the HVLP in those clubs is that we can actually offer that the network by charging them a small fee. So as you consumer you can now walk in and get a full service facility in your neighborhood that has swimming and basketball and group exercise and pay between $19 and $29 a month and if you want to come into New York you’ll have a usage fee, you will use usage fee that I am going to come in your clubs. What that allows me to do now is to go after the low cost clubs that have been coming to our market and I am talking about they’ve been opening up steadily and these are typically franchises they aren’t well capitalized and we sit there and we really have to compete against the club that is charging anywhere from a third to a half of what we’re charging and now we have a product what we think is far superior and we’ll be able to go after that market.

Bob Giardina

Yes. I think the takeaway there on the cannibalization is that these are very far from our network and as we look at the membership statistics these are very much clubs that are using that single club and not even a number as much as some of our other clubs do.

Scott Hamman - KeyBanc Capital Markets

Okay. And in terms of the nine closures, can you give us a sense of how much of an EBITDA drag that they have on an annualized basis?

Bob Giardina

I don’t have it on my fingertip Sean. It’s not extremely significant but it’s only nine clubs, none of them are losing significant money on their own per se. But as we close them it’s going to be allowing us to remove the fixed cost component the rent and the payroll that comes along with the club so it’s going to be incremental to EBITDA in 2015 for sure, but there is only nine clubs.

Scott Hamman - KeyBanc Capital Markets

So how would you quantify that the positive impact of that?

Bob Giardina

We expect to retain about a third of the members of these clubs six months after the club is closed. Four of the clubs that are closing or very close to it’s not there at the end of their lease, so we don’t really expect to occur too many charges of that, so that's where we are with that.

Scott Hamman - KeyBanc Capital Markets

Okay. And then just following up on the question on the dividend, I mean it's kind of surprising the dividend went to zero and that just down, because you still have a lot of cash and unless there something that may have kind of corrupt in your thought process around that building still not happening. I don't understand why would be eliminate all the way to zero?

Bob Giardina

Yes, probably going to have much more than what I just said before, but I probably likely that the building is still, although it's been delayed for the second time which would give us a little bit of (inaudible). But it's been very much kind of balances there significant deposits. So the non-refundable deposit is up $20 million, so is that building still is not to take place, we have affordable sales of $20 million deposits that we can protect those sales with. It's not the same as the now $85 million somewhat sale price, but $20 million is a pretty substantial deposits in our eyes.

Scott Hamman - KeyBanc Capital Markets

Okay.

Bob Giardina

And that’s still has to close in, it’s expected to close sometime to close September 11.

Scott Hamman - KeyBanc Capital Markets

And there were some language in the release that to the expect that sale closes that you, if you want about see in the business you have to pay down debt is that, I mean what does that relate to?

Bob Giardina

Yes, sure. Part of debt agreement that from 2013 we carved this out, because the possible sales of a building was kind of full force at that point. So we call this out to say that we if we sell the building the net proceeds from the building does not, which is usually the case, does not have to go towards paying down debt and the only exception to that is if we don't reinvest in that proceeds in the business, I think it's over two years possibly longer. Then that portion did not reinvest, we have to go to pay down debt. And basically with our CapEx expectations what analysts call our maintenance CapEx and loan, we would get pretty close to reinvesting those funds and I think we are okay there. So, it will be more of a decision of ours as opposed to requirement.

Scott Hamman - KeyBanc Capital Markets

Okay, thanks.

Operator

Thank you. We have come to the end of our question-and-answer session for today’s conference. I will now turn the floor back to Mr. Bob Giardina for closing comments.

Bob Giardina

Okay. We would like to thank everyone for joining us today and we look forward to updating you on our next call. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. And we thank you for your participation.

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