Monday, March 20, 2006

Life Time Fitness--A Stock Price on Steroids?

Life Time Fitness, Inc. (LTM-$46.50) currently operates sports and athletic, professional fitness, family recreation and resort/spa centers under the LIFE TIME FITNESS brand. In addition to traditional health club offerings, most of the Company’s centers include an expansive selection of premium amenities and services, such as indoor swimming pools with water slides, basketball and racquet courts, interactive and entertaining child centers, full-service spas and dining services and, in many cases, climbing walls and outdoor swimming pools.
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Life Time currently operates 48 centers, primarily in residential locations across nine states. The Company operates multiple centers in several metropolitan areas, including seventeen in the Minneapolis/ St. Paul market, eight in the Chicago market, six in the Detroit market, and five in the Dallas market.

Life Time participates in the large and growing U.S. health and wellness industry, which the Company defines to include health and fitness centers, fitness equipment, athletics, physical therapy, wellness education, nutritional products, athletic apparel, spa services and other wellness-related activities.
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According to International Health, Racquet & Sportclub Association, or IHRSA, the estimated market size of the U.S. health club industry, which is a relatively small part of the health and wellness industry, was approximately $14.8 billion in revenues for 2004 and 41.3 million memberships with approximately 27,000 clubs as of January 2005. Based on IHRSA membership data and U.S. Census Bureau population estimates, the percentage of the total U.S. population with health club memberships increased from 9.1%, or 24.1 million memberships, in 1995 to 14.0%, or 41.3 million memberships, in 2004. IHRSA reports that total U.S. health club memberships increased from 24.1 million memberships in 1995 to 41.3 million memberships in 2004, resulting in a compound annual growth rate of 7.9%. Over this same period, total U.S. health club industry revenues increased from $7.8 billion to $14.8 billion.
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Life Time’s economic model is based on and depends on attracting a large membership base within the first three years after a center is opened, as well as retaining those members and maintaining tight expense control.

Management expects the typical membership base at the large format centers to grow from approximately 35% of targeted membership at the end of the first month of operations to 90% of targeted membership capacity by the end of the third year of operations--which, according to corporate, has been consistent with historical performance. Average targeted membership capacity is approximately 9,000 for all of the large format centers and 10,500 to 11,500 for the newer, large format centers. Generally, targeted capacity for a center is 1,000 memberships for every 10,000 square feet at a center
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Average revenue at 23 large format centers that were opened in 2003 or earlier exceeded $12.1 million for the year ended December 31, 2005.
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Management says that a typical capital investment for a current model center has averaged approximately $22.5 million from inception, which includes the purchase of land, the building, and approximately $2.7 million of exercise equipment, furniture and fixtures. In 2005, the cost of current model centers grew slightly, averaging approximately $23.5 million.
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The Company has never closed a center, and the larger format centers produced, on average, EBITDA in excess of 21% of revenue and net income of approximately 1% of revenue during their first year of operation.

Driven by increasing membership rolls, Life Time's profit rose 63 percent to $41.2 million, as revenue climbed 25 percent to $390.1 million for the year ended December 31, 2005.

Life Time forecast a 2006 profit of $1.25 to $1.27 per share, including a stock options expenses, or $1.37 to $1.39 per share excluding items. Analysts' average 2006 estimate is $1.36 per share, up 20.3% from share-net of $1.13 reported last year.
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The Company also sees a continued rise in membership and eight new outlets driving 2006 revenue growth by 22 percent to 24 percent to between $475 million and $485 million. Wall Street expects the company to post $475.5 million in revenue for the year.
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Life Time plans to open eight current model centers in 2007. The new centers that the Company plans to open will be built in both new and existing markets.
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Corporate believes that there is the potential for adding over 200 additional current model centers throughout the U.S. in existing as well as new markets.
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At December 31, 2005, the Company had centers under construction in each of the following new markets: one each in Georgia, Kansas, and Maryland.
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Existing centers built in 2004 and 2005 are not even running on all cylinders. According to Life Time, the 13 centers that opened in 2004 and 2005 averaged 58% of targeted membership capacity as of December 31, 2005. Management expects the continuing ramp in memberships at these centers to contribute significantly to targeted growth in 2006 as these centers move toward the Company’s goal of 90% of targeted membership capacity by the end of their third year of operations.

Management also believes that organic growth in centers’ products and services can make material contributions to the top-line. Life Time’s centers offer a variety of in-center products and services, including private and group sessions with highly skilled and professional personal trainers and dieticians, relaxing LifeSpa services, engaging member activities programs and a nutritional LifeCafe restaurant. These are potentially lucrative revenue streams, with a high degree of visibility.
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From 2001 to 2005, revenue from the sale of in-center products and services grew from $26.3 million to $97.7 million and in-center revenue per membership increased from $173 to $300. The Company believes the revenue from sales of its in-center products and services will continue to grow at a faster rate than membership dues and enrollment fees.
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Life Time is also putting in place a broad infrastructure that will enable the Company to bring further services to members and broaden top-line growth. Corporate is expanding the scale and scope of the LIFE TIME FITNESS brand through the build-out of a national presence by delivering products and services in the areas of exercise, education and nutrition. For example, the Company is growing its Experience Life magazine, leveraging an internationally recognized and award winning triathlon, and expanding its proprietary line of nutritional products.
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The Company uses a centralized marketing agency to generate membership leads for its sales force, to support its corporate business plans, and to promote the Life Time brand.
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Life Time has a commissioned sales staff in each center that is responsible for converting the leads generated by the centralized marketing agency into new memberships.
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Buyers of Life Time common stock, however, should be aware that material risks do exist:

· Delays in opening new centers could hurt the Company’s ability to meet its growth objectives. The ability to open new centers on schedule depends on a number of factors, many of which are beyond corporate control, including but not limited to: obtaining acceptable financing for construction of new sites; obtaining entitlements, permits and licenses necessary to complete construction of the new center on schedule; and, delays due to labor issues, material shortages, and weather conditions. In 2005, membership dues and enrollment fees contributed 67.5% and 5.2%, respectively, to total center revenue.
· The opening of new centers in existing locations may negatively impact same-center revenue increases and operating margin because new centers openings may attract some memberships away from other centers already in operation [geographies]. The 10Q Detective did want to bring to our readers attention that three of the remaining six openings in 2006 will be in existing markets.
· Life Time currently has significant operations concentrated in certain geographic areas, and any move to locations in new markets will involve increases in SG&A expenses to build brand recognition, which might pressure corporate profitability.

The balance sheet is strained, primarily due to center construction costs. As of December 31, 2005, Life Time had negative working capital of approximately $(66.1) million.

The 10Q Detective is obligated to wave this red flag to our readers. Net cash provided by operating activities was $108.0 million for 2005 compared to $80.4 million for 2004. The increase of $27.6 million was primarily due to a $15.3 million increase in net income adjusted for non-cash charges. However, free cash flow from operations was $(82,624) and $(76,419) in 2005 and 2004, respectively.

The 10Q Detective anticipates free cash flow from operations to be negative in the coming quarters, too. Life Time expects capital expenditures to be approximately $220.0 to $230.0 million in 2006, of which approximately $25.0 to $30.0 million will be for the updating of existing centers and corporate infrastructure. This number could be subject to change, for corporate expects the total cost of new centers constructed in 2006 to increase above the $22.5 million average due to higher land costs and higher construction costs in other states where the Company plans to open centers.

The 10Q Detective does applaud management, for total operating expenses have held steady at 79% of net revenue in the last three years. [ed. note. No comment from an auditing point of view, but the Company's wholly owned subsidiary, FCA Construction Company, LLC, is in charge of all the constructing concerns.]

As of December 31, 2005, Life Time had total consolidated indebtedness of $273.3 million, or a total debt-to equity ratio of almost 89 percent! Readers ought to keep in mind that these debt levels, which may limit management’s flexibility in obtaining additional financing and in pursuing other business opportunities, could temper the Company’s growth prospects. As of December 30, 2005, the times interest earned ratio (which indicates how well the firm's earnings can cover the interest payments on its debt) was 5.75 times.

The 10Q Detective does acknowledge that the Company could wring needed capital out of company-owned centers through sales-leaseback financing(s). As of March 1, 2006, Life Time operated 48 centers, of which the Company leased 12 sites, were parties to long-term ground leases for four sites, and owned 32 sites.

Despite the Company being a capital-intensive, cash hog, managements’ aforementioned call for fiscal restraint does not seem to apply to senior executives.

According to the Company’s recent DEF 14-A SEC filing, Bahram Akradi, 44, who founded the Company and is the CEO and Chairman of the Board of Directors, made $870,000 in base pay last year, $467,327 in cash bonuses, and $71,652 in ‘other’ compensation. The 2005 ‘other’ amounts for Mr. Akradi included $25,852 for personal use of company aircraft, $17,837 for home connectivity, $14,443 for personal use of a company car and other car expenses, a $12,000 car allowance and $1,520 in executive medical benefits.

This does not even include the $2,485,500 in restricted stock (75,000) shares, which vest equally over a three-year period. For more on DO AS I SAY, NOT AS I DO –the perks heaped on other senior executives was just as crazy—we recommend that our readers flip to page 11 of the Company’s Annual Proxy Statement, page 11, entitled “EXECUTIVE COMPENSATION -Summary Compensation Table.”

In addition to the aforementioned perquisites, Life Time Corp. is also involved in many related-party transactions that personally benefit senior executives. For example, In October 2003, the Company leased a center located within a shopping center that is owned by a general partnership in which Mr. Akradi has a 50% interest. In December 2003, the Company and the general partnership executed an addendum to this lease whereby the Company leased an additional 5,000 square feet of office space on a month-to-month basis within the shopping center.

The 10Q unearthed why it is that Life Time has to play nice with Mr. Akradi:

The 10-Q filing reveals that Life Time has financed 13 of its centers with Teachers Insurance and Annuity Association of America. The loan documents provide that the Company will be in default if the Chief Executive Officer, Mr. Akradi, ceases to be Chairman of the Board of Directors and Chief Executive Officer for any reason other than due to his death or incapacity or as a result of his removal pursuant to the Company’s articles of incorporation or bylaws. As of December 31, 2005, $127.4 million remained outstanding on the notes.

The stock price of Life Time has climbed 73.30% in the last year, buoyed by positive surprises in sales and share-net in each of the last three sequential quarters. On a valuation basis, the stock is staring to look a little pricey. Life Time is selling for approximately 29.3 times 2007 consensus estimates of $1.59 per share (on a 2007 run-rate of $480 million). Life Time’s PEG ratio is flashing a yellow ‘go slow’ signal—at 1.42 times projected five-year compounded earnings of 25% per annum.

The stock price of Life Time is on steroids, and is tracking well above its 200-day moving average of $38.88 per share. We believe momentum players are climbing onboard, too—which should drive the stock price higher. Average daily volume in the last 10 trading days is 306,078, up approximately 50% from its spot three-month average. The time to cover short positions is approximately 11 days.

The 10Q Detective prefers to sit this one out. Granted, as previously mentioned in this report, Life Time’s revenue and EPS have room to run, but we are concerned that the current premium in the stock leaves little room for a stumble. Should the timing of new center openings fall behind schedule, fixed costs will pressure operating margins, and—we predict—the share price will tire.

Granted, Life Time offers health benefits to its members, but to its shareholders, the share price and related volatility is sure to raise their blood pressure(s)!

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