Life Time Fitness, Inc. Q2 2008 Earnings Call Transcript

Life Time Fitness, Inc. (LTM)

Q2 2008 Earnings Call

July 24, 2008 10:00 am ET

Executives

Ken Cooper – Senior Director Finance

Bahram Akradi – President, Chief Executive Officer

Michael Robinson – Executive Vice President, Chief Financial Officer

Analysts

Paul Lejuez - Credit Suisse

Paul Swinand – Stephens Inc.

Edward Aaron - RBC Capital Markets

Laura Richardson – BB&T Capital Markets

Karen Howland - Lehman Brothers

Greg McKinley – Dougherty & Co.

Hardy Bowen – Arnhold & Bleichroeder

Kathryn Thompson – Avondale Partners

Tony Gikas - Piper Jaffray

Tom Shaw – Stifel Nicolaus

Sharon Zackfia - William Blair & Company

Michael Keara – Merrill Lynch

Vivian Ma – Oppenheimer & Co.

Presentation

Operator

Welcome to the second quarter 2008 Life Time Fitness earnings conference call. (Operator Instructions) I would now like to turn the call over to your host for today’s conference, Mr. Ken Cooper, Vice President of Finance.

Ken Cooper

Good morning and thank you for joining us on today’s conference call to discuss the second quarter 2008 financial results for Lifetime 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 second quarter and our underlying business trends. Following that Michael Robinson, our CFO will review our financial highlights. Once we have completed our prepared remarks we will take your questions until 11:00 am ET.

At that point in the call the operator will provide instructions on how to ask a question. I will close with a tentative date of our third quarter 2008 earnings call. Finally a replay of this teleconference will be available on our website at approximately 1:00 pm ET today.

I’d like to remind everyone that 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 this morning’s earnings release and in our SEC filings. Concurrent with the issuance of our second quarter earnings results we have filed a Form 8-K with the SEC. Certain information in our earnings release and information disclosed on this call constitute non-GAAP financial measures including EBITDA.

We have included reconciliations of the differences 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 turn the call over to our Founder and CEO, Bahram Akradi.

Bahram Akradi

On behalf of all Life Time Fitness I am very pleased to provide you with an update on our business. As I said in our last call the current environment is challenging but doable. We saw further proof of our ability to perform in a challenging environment in the second quarter.

Revenue was up nearly 19% and we delivered over 20% growth in net income. We exceeded our membership growth expectations and we continue to see strong dues growth. Both were ahead of our internal plan. Mike will provide greater detail on our financial performance shortly.

I would like to give you some color on a few items. First, as we have mentioned since we went public we felt one of our greatest [inaudible] in growing membership in a tough environment would be to use more direct marketing and lower enrollment fees. We have proven over the 16 years life of the company and my 25 years in the industry and by using this leverage we are able to continue to deliver membership growth.

The first half of this year has been no exception. Specifically in the second quarter we spent ten more basis points on marketing and reduced our enrollment fees. This has resulted in our 11.9% membership growth which as I mentioned before was ahead of our 10% plan. Further, this positioned us very well to accomplish our goal of 13-14% membership growth in the second half of the year.

One important thing to add is that we continue to maintain our dues structure. We have not and do not plan to discount our monthly dues. In the second quarter we completed the remodeling of four more of the seven clubs we acquired two years ago and held Grand Opening events for each one. While these clubs took more time and cost more money than our initial thoughts I can comfortably say they are now amazing healthy way of life destinations we at Life Time Fitness are all so proud of.

More importantly our members’ response has been absolutely great. I cannot wait until we can show you, our shareholders and analysts, these magnificent facilities. Now, with these facilities completed with better lay outs we will be able to attract more membership than we originally planned.

Also, with these four remodels we have completed six of the seven remodel projects we acquired from two years ago. We also opened three of our prototype facilities with great success. The new member sign up has been on a ramp expectation or better at each of these facilities.

In summary, for the second quarter we have delivered our plan for remodels and new club openings, customer satisfaction and we have achieved our financial and membership goals by using the known leverage as I mentioned before.

Now looking in the future I look for some near-term accomplishments. This quarter we will launch our New Member Communication Program, our new LTF Vision Network and new Member Connectivity Program and our new Member Advantage Value Add. We will grand open three new facilities and one remodeled acquired club. We will also continue to use the leverage we talked about before to deliver our plans. We are focused, excited and confident we can deliver our objectives.

Now I would like to turn the call over to our CFO, Michael Robinson, who will provide more color on our financial performance to date.

Michael Robinson

As Bahram indicated we are performing well through the first half of the year. As I did on my last call, I’d like to start my comments with an update on our capital structure.

In the second quarter we brought in approximately $104 million of sub 4% variable rate funding. This included the increase in the borrowing availability of a revolver to $470 million from $400 million without changing the terms of the facility and a $34 million variable rate mortgage loan. These debt sources allow us to take advantage of the current low short-term interest rate environment and give us the flexibility to pay them down or lock in fixed rates in the future. We are well positioned for additional capital. We have signed two Letters of Intent for sale lease back financing subject to customary closing conditions totaling $160 million from two separate companies and we expect to close on these transactions in the third quarter.

We expect these deals to be approximately P&L neutral with lease costs offset by reduced depreciation and interest expense. In addition we are negotiating on mortgages on several properties. Completion of these transactions will fund the bulk of our 2009 financing needs.

Moving to our P&L performance for the second quarter total revenue was up 18.7% from the last second quarter. This growth was due to several factors including membership dues growth of 18.2%. We continue to see a positive gap between our dues growth and membership growth which was 11.9% in the quarter or a 630 basis point difference. This gap continues to be driven by our price changes to either new or existing memberships over the past year or so.

In-center revenue grew by 22% in the quarter, again led by personal training. We continue to deploy new products, programs and services in each of our in-center businesses which also support our growth.

Highlights from our other revenue growth include our second same-store sales were again in the low end of our expected range for the quarter. We generated a 3.3% increase in same store sales and had a 2% decline on our 37 month mature same store sales. Year-to-date we generated 3.8% increase in same store sales and had a 1.9% decline in our 37 month comps.

This continues to be driven by a softer spa business, especially massage, as well as some revenue loss at some of our lower demographic locations. In the second quarter we had two centers enter the 13 month comp base and one center enter the 37 month comp base.

With respect to revenue per membership we generated a 6.9% increase to $361 in the quarter. In-center revenue per membership increased in the second quarter to $107 or a 9.8% increase over the second quarter. Both are good indicators we are executing our strategies and are at the high end of our expected range.

Moving to our margin analysis, the company’s operating margin remained at 20.7% for the quarter compared to the second quarter 2007. During the quarter we improved our G&A margin by 110 basis points primarily driven by the leverage of a growing business, focused efficiency improvement and the elimination of rent costs on our corporate office. As a reminder, we moved into an owned facility late in the fourth quarter 2007 from previously leased facilities.

Offsetting the G&A improvement was approximately 10 basis points of increased spend in marketing and 90 basis points of increased center operation expense. Both of these cost increases were related to our member acquisition efforts in the second quarter. Our second quarter operating margin decreased from 42% to 41.1% as a percent of total revenue for the quarter.

As we make our way down the P&L interest expense net of interest income increased to $6.9 million from $6.4 million last second quarter as we continue to grow our new center base and our average debt balances grow. Our tax rate for the quarter was 40.5% and was 40.4% year-to-date. This slight increase in our tax rate is due to reduced stock option exercise activity resulting in a lower tax benefit. We expect our 2008 effective tax rate to be approximately 40%.

That brings us to net income for the quarter of $19.8 million which was up 20.3%. Our net income margin for the quarter increased 10 basis points to 10.3%. Total common shares outstanding as of June 30, 2008 were 39.6 million shares, weighted average fully diluted shares totaled 39.3 million shares for the second quarter. We expect our total weighted average diluted share count for 2008 to be approximately 39.5 to 40 million shares.

Based on the 2008 second quarter weighted average share count our diluted EPS for the quarter was $0.50 up from $0.44 in the second quarter last year or 15%. As a reminder, the difference between our net income growth and our EPS growth is related primarily to the equity offering we completed in August 2007.

Moving to our operating data the number of open centers on June 30, 2008 was 74 compared with 64 at June 30, 2007. Of the 74 centers 42 are current model and 54% have been open three years or more which we classify as mature centers. As of June 30, 2008 we have approximately 7.3 million square feet which is 16.7% greater than we had at June 30, 2007 when we had approximately 6.3 million square feet.

EBITDA totaled $57.4 million in Q2 up 18.4% from last second quarter. EBITDA margin decreased 10 basis points from 29.9 to 29.8%. Memberships at June 30, 2008 totaled 547,497 compared to 489,489 memberships last Q2, up 11.9%. This exceeded our expectations for membership growth which was particularly pleasing since our attrition rate increased slightly to approximately 38%.

We have seen a few more people leave our centers in the current environment but at the same time we are seeing more people join. We have been able to offset increased attrition with new membership additions. In the second quarter we delivered a net membership increase of over 26,000 memberships as compared to 15,000 memberships last second quarter.

We have changed our estimate for the average life of a membership from 36 to 33 months for new memberships starting in Q2 2008. This change resulted in a very minor increase of enrollment fee revenue of $130,000.

Cash flow from operations totaled $105.7 million up from $66.2 million in the first half of 2007. This 60% increase is driven by our EBITDA growth rate and increase in deferred taxes related to accelerated depreciation on new assets placed into service thanks to the economic stimulus package of 2008 and working capital control.

In addition there was approximately a $4 million cash use last year on the tax benefit for stock option exercises which was not duplicated due to the low stock option exercise volume because the stock price being lower this year compared to last year.

Turning to the balance sheet highlights the largest activity continues to be driven by our continued growth of new center construction. Cash out lays for capital expenditures for the first half were $235.6 million which included approximately $168.4 million related to growth for the construction of new centers, $40.6 million for the gross cash costs for the remodels of acquired clubs and $26.6 million for maintenance of our existing club base and corporate initiatives. To finance our growth we will continue to use our strong operating cash flow, debt and sale leasebacks.

During the second quarter our overall debt balance grew by approximately $92 million to $723 million as of June 30. This includes $429 million outstanding on our $470 million revolver. Our net debt to capital ratio increased during the second quarter to 53.9%. One other balance sheet variance to note is our working capital deficit grew $18.2 million to $139.2 million driven primarily by growth in construction accounts payable and accrued expenses. Both are in line with our business growth.

Now as it relates to our outlook for the rest of the year we are reaffirming our guidance for 2008. We expect to open seven more centers in 2008 and finish the year with a total of 81. We expect three centers to open in the third quarter and four to open in the fourth quarter. Our next clubs to open will be in September in Rockville, Maryland; Houston, Texas and Birminghills, Illinois, a suburb of Chicago.

Our revenue guidance is maintained at 19-22% growth which equates to approximately $780-800 million. We expect net income growth of 21-23% which equates to approximately $82-83.5 million. This results in diluted EPS guidance of 16-18% growth which equates to $2.06 to $2.09 per share. Regarding our capEx guidance we maintain expectations of $440-460 million in net cash outlay for the year. This includes approximately $370-390 million for growth which works out to approximately $35 million per club for the class of 2008.

It also includes approximately $35 million of maintenance capEx on our existing club base and $30-35 million on one-time remodel costs net of leasehold improvement credit and asset sales for recently acquired clubs.

During the second quarter we saw very good but slightly lower revenue growth as compared to the first quarter. This was driven primarily by the 9.9% membership growth rate in Q1. With a sequential quarter increase of membership growth to 11.9% in the second quarter we expect a top line growth increase as we move into the second half of the year.

Additionally we expect slightly lower operating margins driven by marketing and membership acquisition costs as we continue to drive membership growth and an increase in lease costs from the sale leasebacks we expect to close in the third quarter which of course are offset by lower appreciation and interest costs.

For the third quarter we expect revenue growth of approximately 20% and net income growth of approximately 20%.

As we stated in our last call before moving to the Q&A session I wanted to address a few items that have been posed as questions to us more than once in our many discussions with our investor base.

First, why am I comfortable about securing financing that fits our needs in this environment? I think the quick response is we have a strong balance sheet that is made up of great, well located income producing assets. As a reminder of our 74 open centers we own 54 of which 32 are without mortgages with an asset value well in excess of $500 million. These assets are attractive, especially as we continue to improve our model works.

Like our operating environment the credit markets are challenging. However, I hope that most of our recent transactions and terms are indicative that we have partners that want to work with us. Again, comfort knowing we are working on many options with many institutions. While it takes time I see the progress.

The second question, does your initial pricing in Florham Park, Vernon Hills and City Center indicate lower returns? The quick answer is absolutely not. Our initial pricing for these clubs is to start individual dues at $89 per month. As we build the business plans for these centers we looked at pricing of $59 and up. The key is to match price and capacity. The higher dues the lower the capacity needed to achieve our returns. Starting at the low end of our Onyx pricing range does not alter that return scenario. What it does is allow for more initial membership base to jumpstart the ramp.

From there we can either ramp to a specified capacity or raise dues and decrease capacity to commensurate with the experience desired. The advantage we are in is that these are higher density areas. They allow us the flexibility to start at a good price point and build from there.

That concludes our prepared remarks regarding our second quarter 2008 financial results. We continue to be pleased with our performance.

With that we are happy to take your questions.

Question-And-Answer Session

Operator

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

Paul Lejuez - Credit Suisse

Mike can you just maybe repeat what you said in terms of the financing you had lined up? I just want to make sure I got that. My question for Bahram, I’m just wondering if in this environment you are seeing any change in terms of the supply and capacity across the competitive landscape. Are you maybe seeing some smaller fitness centers really start to struggle and maybe close and are there any particular regions where you think that might be likely? I’d be curious to hear your thoughts there.

Michael Robinson

In the second quarter we closed $104 million of incremental financing. We have $160 million of sale leaseback financing under Letter of Intent which we expect to close in the third quarter and we are negotiating on several properties with mortgages.

Bahram Akradi

Let me take you through the question you asked. Typically during the prolonged, tougher consumer environment it takes maybe as much as a year or so for some of the clubs that are struggling to actually come to the grips that they want to close their doors or quit going through the struggle. We are seeing some of that around the country. Occasionally we talk to those people to see if we can help them out in any shape or form by providing a place for their members and I believe that because this tougher consumer environment has been longer than initially expected I think we are going to see more of those starting to surface here in the next 6-12 months.

We are well prepared to do what we can to benefit from it. As far as being specific to a region, I can tell you we see it all over. It is not one area versus another.

Operator

Your next question comes from Paul Swinand – Stephens Inc.

Paul Swinand – Stephens Inc.

My question is on some of your connectivity initiatives. I know Bahram has talked about you need to do a lot more, you need to execute better. As you increase your churn rate a little and you have more new members how do you run your connectivity programs and how does that actually reach the members and what metrics do you think that is going to impact?

Bahram Akradi

What we have done is we provide a great experience to our members in the four walls of our clubs and we have been doing that. Our member communication in terms of connecting them properly to the areas of their interest has not been a very technologically modern approach and taking full advantage of the current technologies available through the web and the new way of communication between folks, customers, etc. We have really been working on this not the last three months…we have been working on this at least over 9-10 months. We are just really excited to get this launched.

It is not just a web. It is not just a communications system. It is not just club within club. It is really just the entire way we are going to be doing business and how the clubs are organized once we launch this so that whatever your interest level is, whether it is tennis, basketball, cycling, yoga, pilates, whatever your interest is we have a much, much more…literally it is revolutionary in the way it is going to change…immediate connectivity with those customers about the areas of their interests.

I just can’t wait until you will actually be able to experience this within the next 90 days it will be rolled out to all of our clubs. It is much harder to describe it because it is not a 5 minute deal. Really it is a complex system we are changing all around and we are pretty excited about that.

We also are launching our LTF Vision which is our own television network of programming which allows us to bring in more dynamic and exciting programs to our members and communicate important issues via our production team and communicate that with them. What’s new, what’s happening, what’s hot and do it in a really fast, exciting way that would really keep them engaged and want them to watch that TV screen.

Michael Robinson

The metrics that we internally will be watching as keys to the success of this really come in three ways. They come in what we call net promoter or NPS that really focuses on customer and customer satisfaction. We would expect to see that continuing to move up. We are going to certainly look at the attrition or churn rates and then also we expect to see a continued growth in our in-center revenues of which some of this touches and so we will keep an eye on our in-center revenue growth and in particular are we delivering within the expected range of in-center revenue per membership growth which we expect to be in the high single digits.

Bahram Akradi

Because the communication between us and the members in the areas of their interests it is so natural that we would much rather know what members are using what interest points of the club very, very accurately which we haven’t been able to do in the past.

Operator

Your next question comes from Edward Aaron - RBC Capital Markets.

Edward Aaron - RBC Capital Markets

The interest expense came in quite a bit lower than what I was expecting. Could you just give us a sense if there was any capitalized interest in the quarter versus what it was last year?

Michael Robinson

There is always some capitalized interest. We capitalized interest on projects that are under construction. It was not significantly higher relative to last quarter. We really have benefited though from a lower interest rate environment within our revolver. That is probably the biggest key there.

Operator

Your next question comes from Laura Richardson – BB&T Capital Markets.

Laura Richardson – BB&T Capital Markets

When you talked about sale leasebacks being P&L neutral, why would you or maybe you are thinking about doing a lot more of these. What are the advantages to owning the 54 centers? Especially in an environment where people are worrying about leveraged companies. It seems like you could unleverage yourself pretty easily that way.

Bahram Akradi

All along we told our shareholders that we like to own our real estate for flexibility and giving us the equity in our company that gives us the ability to grow in just about any type of economic challenge. Basically mathematically when interest rates were lower on the spread on the long-term financing we were ahead by being able to do the mortgage financing at the P&L level. With interest rates slightly higher for long-term mortgages we are more P&L neutral. You are right on track. At this point we have at the end of this quarter…

Michael Robinson

We have 54. 22 of them have a mortgage.

Bahram Akradi

We are talking about six of them right now. So after those six we still have 48 plus a bunch of facilities that are under construction that will open this year. So we have a supply of facilities that are complete, cash flow positive and there are many different people interested in sale leaseback deals with us. That is a source for us that we will utilize as necessary. So you are right on track.

Laura Richardson – BB&T Capital Markets

What would it do to the balance sheet if you did a leaseback on everything you could possibly do?

Bahram Akradi

We would be debt free and have cash in the bank. So ultimately we will like I said depending on the price of the stock, depending on finance rates and depending on sale leaseback rates we will do the appropriate thing and we take the right measures to help the shareholders’ value the best way we can do it and the long-term success of the company. We have those options ahead of us and I emphasize as Mike has said that is why we have no concern at what having the ability to get the financing to grow the company per our plan.

Laura Richardson – BB&T Capital Markets

What is your average club worth if you sold it to someone?

Michael Robinson

I don’t have a current market value for every one of the clubs. I can tell you that obviously as we have gone through market appraisals on clubs, the clubs that we mortgaged late or in 2007, those appraisals came in on average 110-130% above our costs. Other clubs, certainly the appraisals we are seeing come in above costs and in some cases significantly above costs. But again I don’t have a specific market value.

Laura Richardson – BB&T Capital Markets

Cost is what is sitting on your balance sheet?

Michael Robinson

Yes, cost is sitting on our balance sheet.

Operator

Your next question comes from Karen Howland - Lehman Brothers.

Karen Howland - Lehman Brothers

I know typically we’ll look at growth of both members and dues on a year-over-year basis. However if I look at it sequentially it looks like your member growth accelerates from the first quarter to the second quarter but your dues, enrollment and in-center revenue decelerated somewhat. Is that to do with the timing of the members coming on? Did most of them come on in the latter half of the second quarter? Can you help me work through that?

Michael Robinson

You are correct. It is timing and it is a comment I made in the prepared remarks where we saw 9.9% membership growth in the first quarter and 11.9% growth in the second quarter. That membership growth takes a little while to work through the system and so you saw a little bit of deceleration in dues growth and in-center revenue growth really built off of some of that first quarter activity.

I also mentioned I expect to see those line items of revenue increase a little bit as you work that membership growth we saw in the second quarter work into and through the system.

You are correct. It is timing.

Karen Howland - Lehman Brothers

About the financing, I was just wondering obviously you got strong terms for the one last quarter. I was just wondering if you got similar terms for the $160 which I think you said were for six centers you are expecting to close in the third quarter.

Michael Robinson

I’m not going to get into specific terms on that really for competitive reasons really right now. But again the statements I have made is we expect them to be relatively P&L neutral to incremental debt we placed on the books at long-term rates. The deals we struck in the second quarter really are taking advantage of short-term variable rates but give us a lot of flexibility as we move forward. Long-term interest rates we’re seeing more in the 7% fixed range. Somewhere 6.5-7.5%. So from a sale leaseback perspective I’m comparing really to those types of interest rates.

Operator

Your next question comes from Greg McKinley – Dougherty & Co.

Greg McKinley – Dougherty & Co.

Mike can you talk to us a little bit more about margin trends? I know you indicated in your comments that stepped up marketing efforts were going to dilute the margin outlook a little bit. What else is involved with that as we saw maybe a 60-70 basis point decline in center margin sequentially? What are the other factors impacting that margin?

Michael Robinson

The biggest driver for that is as we have been more aggressive in our enrollment fees we take to the P&L immediately any sales commissions we pay in excess of enrollment fees on a club by club basis. So there are occasions where we will be paying out total commissions in excess of those enrollment fees. Those go down immediately. They come through the center operating line and that was really the largest effect of that growth. In fact it was the effect that drove operating margins down the second quarter.

Greg McKinley – Dougherty & Co.

So up to the enrolment fee those are deferred on the balance sheet but in excess they run through the P&L?

Michael Robinson

That’s correct.

Operator

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

Hardy Bowen – Arnhold & Bleichroeder

In the test that you have done with the connectivity programs I am presuming the attrition rates do decline, at least in parts of the club where you can put these in?

Bahram Akradi

Of course we are seeing the desired results at the test clubs. Our corporate store, if you call it, we have been rolling these programs out and focusing on all the things we are going to roll out in the third quarter system wide in all of our clubs. Member satisfaction is incredible. Customers are connecting. On average they connect about 5-6 of the interest areas that we offer, about 36-40 of them. We really feel like this is a revolutionary change and I see it through collection of the programs we are introducing in the third quarter, middle to the end of the third quarter, to start providing real traction in the fourth quarter and so forth.

Hardy Bowen – Arnhold & Bleichroeder

Is your feeling, obviously the market growth has been extremely successful in creating more members, is your thinking that you should continue on the same plan or do less or do more? What is the general thought?

Bahram Akradi

In terms of building new clubs?

Hardy Bowen – Arnhold & Bleichroeder

In terms of marketing programs for new members.

Bahram Akradi

The marketing program we are going to continue what we have been doing in the second quarter. As I have mentioned before it is a natural leverage you use with your enrollment fee and your direct marketing. We can turn up the heat, making the traffic, generate more membership sales. During times like this you are going to see as Mike mentioned as well a little more people concerned about the dollars and dropping out and you get more people coming in because we provide a fantastic, healthy way of life, family entertainment for very little money. They could cut out one trip, one vacation for the family and save $1,500 or $2,000 for 3-4 days and use that money for the entire year and show up in our pool decks in our facilities and different types of programs every day.

We see a significant amount of people coming in and offsetting those people who drop out for other financial reasons that force them to go out. We feel very comfortable we can continue to deliver the membership growth that we have mapped out utilizing the new connectivity programs and new value adds as well as the old traditional levers which is initiation fee and direct marketing.

Operator

Your next question comes from Kathryn Thompson – Avondale Partners.

Kathryn Thompson – Avondale Partners

A two part question on the cash flow statement and balance sheet. First there is deferred income tax in cash flow from operations increase from roughly 8.9 from 2.5 last year. Could you just clarify the increase and also could you walk through the rationale of the classification of non-cash investing and financing activities at the end of your cash flow statement?

Michael Robinson

Deferred income taxes, as I stated in my prepared remarks Kathryn the economic stimulus package of 2008 calls for some accelerated depreciation on items placed on 20-year or less than 20-year asset classes for items placed in service in 2008. We obviously placed a significant amount of assets into service in 2008. We are taking advantage of the economic stimulus package. That is a direct result of the economic stimulus package of 2008. We expect that to continue in the third quarter and fourth quarter with those accelerated depreciation tax breaks.

They don’t change tax rate. They defer tax out but they are a significant positive cash flow item for us. Your second comment was on what are the non-cash items sitting in the cash flow statement.

Kathryn Thompson – Avondale Partners

The footnote on the schedule.

Michael Robinson

At any time there are a number of items that are non-cash related. It could be timing of things in payables, meaning construction in payables that really is not a cash item yet. The cash has not gone out the door so that is just a disclosure on that. That looks at the change in that line on a year-over-year basis. We also have when we purchase something through a capital lease obligation it is a non-cash item. The cash element of that comes through the cash flow statement but the long-term piece of that is really a supplemental disclosure on the cash flow statement because it is a non-cash element. That is what those supplement disclosures are for.

Kathryn Thompson – Avondale Partners

It just jumped out because as you said on a year-over-year basis you are comparing year-over-year and there was just a great wide discrepancy with two specific items that just, I wanted to get an idea. Is this something we’re going to see more going forward so we can account that on comps going forward? That is really why it jumped out.

Michael Robinson

Well on the capital leases it will really depend on some of our, in this particular case the significant majority of this is one land purchase that we looked at, looked at different alternatives and ultimately decided on this approach that made the best approach and is the most cost effective way for Life Time Fitness to acquire that piece of property.

Ideally we like to acquire property for cash right up front but in this particular case the seller did not want that and so we look for other ways to structure it where we had control ultimately of the property and this is what we did. I can’t sit here and say that will not happen in the future. It will depend on specific circumstances when negotiating and again in this case a land acquisition.

Regarding the purchase of property and equipment in accounts payable, that is really driven by the amount of activity that goes on in our construction group. As you can imagine there is a lot of activity going on with the opening of 11 centers this year and a significant amount of construction already underway for the openings in 2009.

Kathryn Thompson – Avondale Partners

So that would explain the difference between the $3.8 and the roughly $18 million year-over-year.

Michael Robinson

Yes that is correct.

Operator

Your next question comes from Tony Gikas - Piper Jaffray.

Tony Gikas - Piper Jaffray

Bahram maybe you can give us an update on the progress with the cafes? Mike just a gross margin trend looking at 2009?

Bahram Akradi

I’ll take you through the cafes. We are very pleased with the menu item changes, the bread changes and all the things we wanted to do on the execution at our test club which is again Corporate Office. The results are great. Customers are happy. I’m happy with what we are delivering in terms of quality, service, food, taste and nutritional aspects of it. We have not been able to roll that out as early as I wanted. We are just about ready.

We just signed our deals to get the delivery of the products worked out so that we can make the breads, etc. and have it delivered through the food service to all of the places across the country. While we are doing well with our café same store performance from this year to last year the bulk of the improvement in the food is going to be realized in the second half of the third quarter and fourth quarter. I look very, very forward to the results of that. I believe the customers will accept it much better as they have in Chanhassen.

Michael Robinson

Your question on gross margin let me start with a comment on overall operating margins. Operating margins were flat in the quarter. As we look forward we continue to see leverage that will come from our G&A business not only this year but as we go into 2009 and beyond. The biggest change to overall operating margins and it affects directly the center operating margins will be any leasebacks we put on the books on sale leasebacks. I expect we will see some lower center operating margins as we move into certainly third and fourth quarter until we would anniversary any of those lease costs that we would have on the books.

I do not expect that will drive any significantly lower operating margins though because of the leverage in G&A and the fact we will have some lower depreciation expense also. Of course you make up the rest of that from the lease perspective on the interest rate loans.

Operator

Your next question comes from Tom Shaw – Stifel Nicolaus.

Tom Shaw – Stifel Nicolaus

On membership count up 1.8% is there any way of aggregating the impact of the newly remodeled centers this quarter?

Bahram Akradi

Most of the newly remodeled facilities got done at the very, very end of the quarter so that was not from the new remodeled clubs. We see the results from the new remodeled clubs increase helping memberships in the third and fourth quarter and into the next year.

Tom Shaw – Stifel Nicolaus

Thus the 13.

Bahram Akradi

What you saw increased membership was just in the legacy clubs, lifetime clubs.

Operator

Your next question comes from Sharon Zackfia - William Blair & Company.

Sharon Zackfia - William Blair & Company

Could you quantify, you mentioned attrition is up a little bit more and I think it inched up a bit in the first quarter as well. Where are you running now on annualized attrition and is that continuing to trend upwards?

Bahram Akradi

Actually it has stabilized. As Mike said about 38% right now. We believe that part of that is due to the increased activity in membership price changes in the first half of the year companied with the economic factors, people coming in and having pressures. Like I said we’re getting more people coming in to join and more people a little more agitated effect as a whole on the entire club. We don’t expect it to continue to ramp up at all. We think it is going to be here or with the initiatives we are putting forward it might actually go back down a little bit.

Sharon Zackfia - William Blair & Company

Can you talk about how much of that attrition increase was planned? There must have been some expectation as you were increasing dues.

Michael Robinson

About one point of that we planned. So we would have expected to be running in the 35-36.5% range.

Operator

Your next question comes from Michael Keara – Merrill Lynch.

Michael Keara – Merrill Lynch

You have talked about rationalizing membership fees obviously with the dues increases over the past few years. I’m just curious is that what is helping…clearly in this economy in term of revenues 22% versus last year, what would that look like if…you have always said you’d rather have a person willing to pay $50 or more for a gym membership opposed to a person paying $35. Does that have a lot to do with the fact of what is driving the in-center business?

Bahram Akradi

That is part of it, not all of it. Our personal training business is performing according to our plans and we had increases built into our plans or growth in there. Café is doing better than last year. Also the aggregate as we have raised prices over the years we don’t immediately catch up all the old members to the full new price we are charging someone who is new. As people drop out and somebody else comes in we are replacing the memberships. Somebody may drop out in a club where they were at $49 and now we are selling at $59. The $49 member is going out and the $59 member is coming in. Not only are we getting the membership turned over, replacing that attrition with higher price dues customers.

So the combination of these things will work. Your question is would we get this increase only if we raised the dues. The answer is no because part of our attrition has been because of the fact we raised the dues so if we hadn’t raised the dues you would say you had a few more members. It probably would have been near the same.

Michael Keara – Merrill Lynch

What do you think the turn rate would have looked like? I know you don’t do it, but if you lock in people for a year or two contracts?

Bahram Akradi

I’m not going to even answer that because philosophically we think that is a very, very bad way of doing business with the customer. The customer should be at your club because you are keeping them satisfied and they want to be there not because their ankles are tied to the deal because of a contract. That is a fundamental difference. We do not agree with it whatsoever.

Operator

Your last question comes from Vivian Ma – Oppenheimer & Co.

Vivian Ma – Oppenheimer & Co.

Is there a salvage effort for those who are exiting at the time when the member is canceling? Do you try to get them to stay or after a certain period of time does someone call them back and see if they want to rejoin?

Bahram Akradi

We have always had plans to work with them. We have done things in the past. We have some new improved initiatives in the way we are going to handle that and it is not directly in reaction to the change in the percentages right now. It is really more based on the fact we think it is the right way of connecting to that customer and bringing them enough additional value that it makes it even a more difficult decision for them to leave Life Time. We are pretty excited about our roll out in the next month. You will see it and I think you will appreciate it as well as our members.

Operator

You have no further questions at this time.

Ken Cooper

Thank you for participating. We look forward to reporting to you our third quarter 2008 results which tentatively has been scheduled for Thursday, October 23, 2008 at 10:00 am ET. For these and all other key dates please see the Events section within the Investor Relations section of our website. Thank you and goodbye.

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