Life Time Group Holdings, Inc. (LTH) Earnings Call Transcript & Summary

Just quickly, disclaimers for important disclosures, please see the Morgan Stanley research disclosure website, morganstanley.com/researchdisclosures. So I'm Brian Harbour from Morgan Stanley, and I'm happy to be here with Life Time, Bahram Akradi, the Founder and CEO; and Bob Houghton, recently joined as CFO. We were just talking about donuts before this. So now for something totally…

We are going to work everybody out.

So Life Time, as many of you will know, went public for the second time in 2021, one of the country's largest operators of health and fitness clubs, athletic country clubs as we're calling them today, which many of you're familiar with, over a 100,000 square feet full range of sports as well as pickleball, of course. And Life Time closing in on 160 locations and over 725,000 memberships today.

So maybe just a broad question to start for you, Bahram. You founded the company, I think, it was about 30 years ago, right?

Right.

And maybe just take us through the last few years where you had gone private in 2015. And then what has really changed during those 6 years where you were private in your opinion versus what the company had done before?

Yes. So the company was operating with the same standards, growing revenue and EBITDA every year. We weren't really getting the recognition in the public market, so it made sense to take it private. Being private, particularly with Leonard Green as the lead partner and then TPG allowed us to really focus on invention, recreation. So immediately after we went private, I worked a detailed plan for all the malls like David Simon's and GGP's mall which is now part of the Brookfield, et cetera, to basically create an opportunity to take these malls from 100 -- 1.3 million, 1.4 million, 1.5 million square feet of just retail to 3 million, 4 million square feet of mixed-use development anchored by a Life Time bringing 3,000 to 4,000 people. The unique thing about Life Time is our members are usually about 1.6x, 1.7x in terms of the demographic of the general area in terms of their income. So we bring in huge numbers of people, high-volume and high-quality customer to the mall. So as a result, we started working on a lot of deals, as of right now, Simon Properties is actually a small investor. They have about 70 million, 80 million in Life Time. But in addition to that, we have over 20 locations with them across the country where they provide us the land, but no economics, they give us low cap rates, and we can -- it is a win for us, win for them. Then after that, I started working on Life Time living concept where when we go into apartment buildings, we can help them ramp faster and have better rates and better attrition. So we were working on all of that and basically creating new ways for growing the company. And then, of course, beginning of 2020, COVID came and took our attention to other places.

So maybe we just talk about membership briefly and kind of where you are at this point versus pre-COVID? And then I think important to that also is just the pricing strategy that you've taken, right? And there may be some trade-off where you want to have fewer members than you would have had previously. But if those are higher paying, higher-quality members, that's a trade-off that you're willing to make. So maybe just talk about your strategy with some of that as well as…

That's great. So when I first started the business, we built these 100-plus 1,000 square feet clubs with all the amenities and we sold them too cheap, flat out too cheap. And it was basically hard to deliver the experience I wanted with those prices. So we gradually tried to inch those prices up. But because we had salespeople, they were the impediment to being able to sell a higher-priced membership. So it was very, very sticky, that pricing that we had established. During COVID, when we started reopening, I decided, we're not going to bring back salespeople nor are we going to bring back promotions. Without salespeople, we could change the prices easily from today to next week, I can have a club sell for $10 a month more and see what happens. If we want to go back, we can go back. So we tested all of those with the goal of having fewer members at the end than in mature clubs than we used to have with a higher average dues, higher in-center spend. And where we are at right now in some of the markets that opened super early, like Texas, most clubs are significantly above pre-COVID revenues with fewer members. I was talking to 1 GM in South Jordan. She's only $25,000 a month away from highest revenue she had pre-COVID with 2,000 less memberships. So we have room to grow, but we have no desire to get to the same intensity of a membership per location as we had before. We will significantly exceed the dues and incentive revenues with the new strategy. But we still have many of our clubs. So even April of this year, we just came up with final restrictions ending. So everybody thinks that in our business, just like retail, COVID ends and things would snap back to the subscription business. It takes 36 months to ramp a club. It takes 2 years to ramp a club back after COVID ended, not 6 weeks like some of the other retailers. But it's all coming. And so we're very happy with the progress. And we played strictly offense till August of this year. August of this year we had clear visibility that by January, February, March, we're going to eclipse the 2019 same-store sales. Therefore we started working our margin expansion strategy, finding out the efficiencies, and we're super excited about being in phase II of COVID recovery.

And I do want to get to the margin point. But, I guess, on memberships, what do you think is kind of the key to driving that next leg of growth in '23? And you've made some investments in programming and such. What will be key next year?

So we launched 4 unique focuses. One was ARORA, which is our qualified. It's a 55-year-old and above age group and 65 and above for qualified primary. That business is significant growth, I mean, like more than 100% on annual basis right now. The second one was a small group training where we changed the model, were used to come in to our club, pay the $150 a month of dues. But if you wanted to do something like Orangetheory or Barry's Bootcamp, you would have to buy that as a separate add-on deal. It was clunky. So we changed everything to what we call a signature membership. So basically it's 1 monthly dues and all of those small group training classes are also included like your large group classes. That business is growing. Pickleball is on fire. We've had at least 175,000 unique visits to people using the pickleball where we are, by far, the largest provider of pickleball as we are in tennis and swimming and other stuff. But it's one that I think allows Life Time to gain at least 50,000 to 60,000 net memberships next year. So we basically have implemented all of those, and we don't spend money in marketing. We're going to spend money in sales. We have no promotions and everything is focused on delivering the product that makes people wanting to come to the place.

The other thing that you've commented on is just your average revenue per month per member, which is, I think, approaching about $160. Do you have in your mind where that goes over time or how we should think about that?

That's an interesting question. For right now, today, every month roughly basically is about $190 for the new members signing up. So we sell 1,000 memberships in a day. It's about $190 average. The outgoing members are roughly about $160. So we have members who are paying less than the rack rate, but they've been with us for 5 years, 10 years, 15 years. They do get legacy rate increases, but not all the way up to the rack rate. So every time somebody drops out and somebody new comes in, it's worth $30. So in addition to that, as we add them, so over time that $160 is going to get up to $190, $190 is going to get to $200.

Okay. I think since it's a consumer conference, we have to talk about recessions, at least a little bit. And you've steered this business through several, right? So I think the question is just your observations as to what happens to membership, spend per member, attrition during those periods. And also I think just talk about some of the demographics of your membership and how you think of that?

Yes. This is a loaded question. I want to take it in 2 parts. Part 1, typically, in the past, all with the exception of great recession, 2008, whenever there was recessions, we lost a few members because the money was tight. We gained maybe just slightly more members because they had more time. They -- now they were getting severance pay, but they had extra time, the cheapest past time. So my expectation is that a mild recession won't impact our business, Planet Fitness or anybody else. Having said that, Life Time has a 4-year timetable. When we open a club, it takes year 1, year 2, year 3, year 4, we get to the full revenue and dues. In '19, right before we got shut down, about 81% of our clubs were mature and then about 6% or so per year, year 1, year 2, year 3, that they had time to ramp. Today about 80% of our clubs are in year 2 and 3 because we just started coming out of the closure. So whether there is a 1% or 2% impact from recession for retail businesses, I still expect significant growth for Life Time. If there was no recession, it would have been 18%. If it's recession, maybe 16%. We're going to grow regardless. We expect the headwind. We don't think there's not going to be any headwind, but even with that headwind, our numbers are going to significantly grow, revenue and EBITDA.

Do you see members pull back a little bit on what they're spending in club, maybe they don't give up their membership, but they pull back.

Yes. So our pricing strategy now puts us clearly as the top 5%, 10%, 20% of the population is coming to us. The rest of them are going to the middle level prices and then or to Planet Fitness like clubs. We haven't seen anything nor we have any excuse to tell you that if something is not working is because of the customer feeling pressure, we're not seeing that.

So you mentioned kind of margins. And last quarter, you discussed some rationalization of G&A, some rationalization of in-club expenses. And then you have a 30% to 35% EBITDA margin target that I think you talked about wanting to hit next year. So maybe just tell us more about what specifically you're kind of doing to get to that? And what reinforces your confidence in that?

So typically, every given year, I would challenge my executive team to come back and try to give me all of these things you want to do, what are the things you're not going to do anymore, right? But we didn't do that for the last 3 or 4 years. Last 3 or 4 years, I said no defense, just play offense. So there is 3 to 4 years' worth of opportunities to go back and see what are the things, there's no need for them to be done. They don't add any value. So we've been cleaning up, rewiring the business completely for more of an ownership mindset for our club managers and our department heads. And we have eliminated nothing from the clubs. It's actually added more classes, more services, and we have taken everything that was layers between the clubs and the corporate office, taken everything out. So there is just literally middle-level management stuff that has been taken out. And I'm not certain that those were adding any value other than, in my opinion, more confusion and just messages getting more diluted or convoluted as it was delivered. So we've been adjusting and cleaning and I expect to have a much, much more efficient machine coming into January of 2023.

And is that when you think those will be visible or are you mostly past those changes at this point?

Everything has been done. We chose deliberately not to try to take a onetime charge or something. Everything will be done through the pipe, all cleaned up by Jan 1. Jan 1 will be a clean slate going forward.

And have you made changes to staffing or class schedules in the clubs and all?

So class schedules or the number of classes are increasing. We're adding more small group training classes where -- because as many pack classes as you can. We are basically, again, most of the changes are in managerial roles, not in frontline. It's hardly nothing in the frontline.

Is there still anything you're concerned about just in terms of like labor inflation or any other inflationary cost pressures at this point?

I don't know how the world expects there is not going to be inflation when the governments around the world print 30% more money than ever existed. It's going to have to get washed out somehow and it's going to get washed out with higher prices. So the question is, it's a little bit spoiled behavior in U.S. because our dollars oil trades with it. So it's a delayed reaction. But if you printed 30% more money in any other country this month, next month, everything will be 30% higher. So I think it's going to settle. We have taken all of those hits. We've taken the payroll increases, the labor increases, the hourly -- we've taken all of that. And I think all of these things are taken into consideration in our forecast of what we're going to do next year.

Okay. Maybe just to talk about development a little bit. So you had targeted 10-plus new clubs per year at the time of the IPO. You'll do more than that this year, and it sounds like next year. So maybe just comment on what's driving some of that strength?

Yes. So we aren't in a rush to start a new club, but we are more focused on making sure our pipeline for growth is packed, and we have nearly 100 deals in the pipeline. So there's no concern of us being able to produce the new growth for ongoing years to come. In our business, unlike some other smaller boutiques or retailers, the gestation time for our clubs are 4, 5, 6 years. So we have clear visibility for the future. However, as I mentioned earlier, we have so much dry powder in our growth coming out of our existing clubs that if 2024 we only open 8 clubs and open 14 clubs in 2025, none of that moves the needle [indiscernible] I'm saying to you. So our focus is balance sheet, my goal, his goal, our organization right now is to -- in my opinion, we have a first-class brand, we have a first class product, first-class experience. Our balance sheet needs to catch up. We need to get our EBITDA doubled from where it is today over the next year, 18 months. We need to get our debt-to-EBITDA adjusted and then considering the fact that we have near $3 billion worth of owned real estate still. We get to about $1.5 billion, $1.6 billion of debt, but EBITDA needs to be like I told you, double where it is today and the debt-to-EBITDA will be adjusted. That's the #1 focus for me right now to make sure next year we closed the year with balance sheet being as attractive as the brand and the experience at the Life Time at the same time.

Given that, do you think it would make sense to open slightly fewer clubs next year?

So it's naturally -- okay, so the clubs that are opening next year, they have been in the pipeline, under construction. They're largely funded already. It doesn't make any sense to slow those down. The clubs that would open in 2024, 2025, we own, in many cases, we own the land, we have the permits and we can start construction today, but we are deliberately taking more time to bid. And then like just today, I was talking to the construction team, where the results came back from one of the city's hot markets for real estate or 3 months ago, we took the numbers and the price is now flat for the first time. They haven't been going up, up, up every month. I think another 3 months, 4 months from now, you're going to see some construction prices starting to come down, and that's the time you make your purchase rather than rushing into them. So we're not in a tizzy to having to do a certain number of delivery. The most important thing I emphasize is managing our balance sheet to be in a much better position.

And where will -- you have had somewhat of a shift to newer markets here in New York now, for example, and you've continued to open in New York. Where will some of the focus be for those newer clubs? Will it continue to be in some of these newer markets?

So part of what we invented during the private time is the vertical model and partnership with the apartment builders, big real estate entities. So if you guys go to [ DUMBO ] that's a $1-plus billion building with CIM, and Life Time is basically the engine behind that whole resi and condo units. So we have lots of those deals in the pipeline. The nice thing about those things are they're pretty much already lease backed. I mean they're already leased upfront from the landlord. So they're lower capital investment and attractive deals because we are doing something for them, helping their business go faster. So we get an anchor treatment on our rents. So quite a bit of the deals in the future, probably 50% of our deals in a -- not in a given year because it could be lumpy, but in like a 5-year window, half of our deals are going to be either funded by apartment owners or malls.

Which is just repurposing real estate in existing mall?

Right, exactly.

Yes. Maybe just talk why you were talking about Life Time Living and Life Time Work, which was certainly part of the story you told at IPO? And what do you think about those businesses currently?

Same as we said in this and the Life Time living, we wanted to prove the concept. But when we build a Life Time Living brand, we get higher rent per square foot. We're getting about 180% rent per square foot in Las Vegas on the unit we built to demonstrate the model. People love living in that campus. It's different customers, it's not the same customers shopping for the last $100 cheaper apartment. They rent faster, they have a higher rent per square foot, and they have lower attrition. It's exactly what you want if you're building. We wanted to prove that. And as a result, the objective was to get the apartment builders to call us and say, "I want to build 1,200 apartments here in Florida. We want you to be the engine behind it". We have lots of those deals in the pipeline. And the mall deals, as I mentioned, we already have with constant work we're doing with them. Life Time Work, the results are exceptional when the Life Time Work is attached to the Life Time. Nobody can -- you get a Life Time Work membership as you would do in one of these co-working places. And then -- but you get the club membership also included. It's a no-brainer. So we have great economics. Our levered return because those are all leases, matches our levered return with our -- is better, slightly better than our core club. But it's never going to be like a WeWork. We're not going to do 100s of those. We're going to do them only when they make sense adjacent to one of our clubs. So there's going to be a few a year coming in, they just add to the overall growth. That's work. And the living is to get more locations.

Right. Do you have a sense for how many of those you could do per year?

How many?

The living locations.

I think in the future, I think 3, 4 per year of our clubs opening up, will open in conjunction with a living arrangement. It will be lumpy for the next, like I said, 2, 3 years because gestation time is so long in these things. We're working on a lot of deals.

Yes. Okay. You alluded to this just from kind of a financing perspective. I guess the first question maybe just to ask is balance sheet. Where do you want to take your leverage to and maybe talk about how that will be a focus over the next couple of years?

Without any real estate owned, no real estate, which is in the picture for Life Time because we have so many assets that the value of the asset, the book value, it doesn't make sense for us to sell them. But if you had no real estate, I think 1x debt to EBITDA should be the target. With the amount of real estate we own, is we'd like to have that debt to EBITDA be under 3x. And we have a clear path to get that done.

And you have already announced a number of sale leasebacks to that point. But how many more could be feasibly done if you look at the existing ones?

So we halted the idea of selling the buildings that had a huge gain once we could see that over the next 3 years, we're going to generate enough pretax income to chew up all of the net loss carryover. But we're still going to do sale leasebacks and make sure our balance sheet stays where we want it as we want to do sale leaseback on newer clubs and the ones were going to be built. And that way, we're not going to take any gains, right, and then we end up having to pay taxes on our income. So it's just a shift of which assets we sell. We sell leaseback. But the idea for the company is capital light going forward. We went to a capital-light model when we were in private, and it's the plan to stay on capital light going forward.

And so your expectation, it sounds like, is that any new club where you own the land and building would be sold off?

Absolutely. Or better yet, and we hope to execute a couple of deals early next quarter, where they basically are the sale leasebacks are executed when we start construction.

And so as we look over the next few years, is it safe to say that you will fully self-fund new construction when you incorporate those proceeds and then there may be some access that you can reduce leverage with. Is that your intent?

That's correct.

Okay. Great. Maybe just let me ask about some of the newest clubs. I think curious about what you see there from a membership perspective, a revenue perspective and engagement perspective. How do those compare to some of your older clubs today?

Yes. So whether if it's Frisco or West Palm Beach, the new clubs that we are opening right now, the prototype clubs, they are basically beating any past records. The membership dollars are ramping the fastest because as I told you, we used to sell them too cheap. So we would get a lot of members, but we weren't getting as much dues as we could possibly get from them. But these clubs are ramping extremely fast. And the -- we are not seeing anything that says a new club opening is less attractive than it used to be before. It's more attractive.

And do they differ substantially though? Or do you think there's stuff that you've done deliberately to make this so successful and anything in terms of design or programming?

Yes. It's all of the above. I think the clubs are much more refined. The experience is more curated. The fact that it's not sold, it's just bought itself is dramatic, both economically for us, and it's a better experience for the customer and then all the programs. I mean, if you want the best tennis, it's Life Time, if you want the best pickleball, it's Life Time, if you want the best swimming. I mean it just we literally created a collection of the best experiences in health and athletics. And so they just -- the club sell themselves.

What markets would you -- I think you're in 26 states, maybe it's a little more today. What markets would you like to be in that you're not in today?

Yes. I mean it's an interesting question because we have one club in Salt Lake City. We need to have 5, 6. We have 14 clubs in Dallas, but we have -- with 6 million people, we have 20 clubs in Minneapolis with 2.5 million people. I mean if you look at across the country, the only market that we are close to saturation, the only market is Minneapolis. Every other market is wide open.

Okay. Great. I think that's all the questions I had. So I'll leave it there. And thank you, guys. We appreciate it.

Thank you so much.