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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
| þ | Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2005
| o | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from
Commission file number:333-114210
Town Sports International Holdings, Inc.
(Exact name of Registrant as specified in its charter)
| DELAWARE (State or other jurisdiction of incorporation or organization) | 20-0640002 (I.R.S. Employer Identification No.) |
888 SEVENTH AVENUE — 25TH FLOOR
NEW YORK, NEW YORK 10106
(212) 246-6700
(Address, including zip code and telephone number,
including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes þ No o
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part IV of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of Common Stock held by non-affiliates of the Registrant: Not applicable
As of March 28, 2006, there were 1,309,123 shares of Class A Common Stock of the Registrant outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC.
PART I
FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on our Form 10-K for the year ended December 31, 2005 are forward-looking statements within the meaning of Section 72A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding future financial results and performance, potential sales revenue, legal contingencies and tax benefits. These statements are subject to various risks, and uncertainties, many of which are outside our control, including the level of market demand for our services, competitive pressure, the ability to achieve reductions in operating costs and to continue to integrate acquisitions, environmental matters, the application of Federal and state tax laws and regulations, and other specific factors discussed herein and in other Securities and Exchange Commission (“SEC”) filings by us. The information contained herein represents our best judgment as of the data hereof based on information currently available; however, we do not intend to update this information except as required by law, to reflect developments or information obtained after the date hereof and disclaim any legal obligation to the contrary. Such statements also will be influenced by the factors described below in “Risk Factors”.
| Item 1. | Business |
General
We are one of the two leading owners and operators of fitness clubs in the Northeast and Mid-Atlantic regions of the United States and the third largest fitness club operator in the United States, in each case as measured by number of clubs. As of December 31, 2005, we owned and operated 139 fitness clubs and partly owned and operated two fitness clubs. These 141 clubs collectively served approximately 409,000 members. We have developed and refined our fitness club model through our clustering strategy, offering fitness clubs close to our members’ work and home. Our club model targets the “upper value” market segment, comprising individuals aged between 21 and 50 with income levels between $50,000 and $150,000 per year. We believe that the upper value segment is not only the broadest segment of the market, but also the segment with the greatest growth opportunities.
Our revenues, operating income, net income and EBITDA for the year ended December 31, 2005 were $388.6 million, $40.3 million, $1.8 million and $81.6 million, respectively. Our revenues, operating income, net loss and EBITDA for the year ended December 31, 2004 were $353.0 million, $34.3 million, ($3.9) million and $72.7 million, respectively.
Our goal is to be the most recognized health club network in each of the four major metropolitan regions we serve. We believe that our strategy of clustering clubs provides significant benefits to our members and allows us to achieve strategic operating advantages. In each of our markets, we have developed clusters by initially opening or acquiring clubs located in the more central urban markets of the region and then branching out from these urban centers to suburbs and neighboring communities. Capitalizing on this clustering of clubs, as of December 31, 2005, approximately 45% of our members participated in our passport membership plan that allows unlimited access to all of our clubs in our clusters for a higher monthly membership fee.
We have executed our clustering strategy successfully in the New York region through the network of fitness clubs we operate under our New York Sports Clubs brand name. We are the largest fitness club operator in Manhattan with 37 locations (more than twice as many as our nearest competitor) and operate a total of 95 clubs under the New York Sports Clubs brand name within a 50 mile radius of New York City. We operate 18 clubs in the Boston region under our Boston Sports Clubs brand name, 19 clubs in the Washington, D.C. region under our Washington Sports Clubs brand name and we are establishing a similar cluster in the Philadelphia region with six clubs under our Philadelphia Sports Clubs brand name. In addition, we operate three clubs in Switzerland. We employ localized brand names for our clubs to create an image and atmosphere consistent with the local community and to foster recognition as a local network of quality fitness clubs rather than a national chain.
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Over our32-year history, we have developed and refined a club format, that allows us to cost-effectively construct and efficiently operate our fitness clubs. Our model is flexible enough to adapt to the difficult real estate environments in the Company’s markets. It is designed to accommodate all relevant club sizes between 15,000 and 55,000 square feet necessary to operate the Company’s key club formats ranging from fitness-only to various multi-recreational formats. The average size of our clubs is approximately 24,000 square feet. Clubs typically have an open fitness area to accommodate cardiovascular and strength-training exercises, as well as special purpose rooms for group fitness class instruction and other exercise programs, as well as massage. Locker rooms generally include saunas and steam rooms, as well as daily and rental lockers. We seek to provide a broad array of high-quality exercise programs and equipment that are popular and effective, promoting the quality exercise experience that we strive to make available to our members. When developing clubs, we carefully examine the potential membership base and the likely demand for supplemental offerings such as swimming, basketball, children’s programs, tennis or squash and, provided suitable real estate is available, we will add one or more of these offerings to our fitness-only model. For example, a suburban club in a family market may include Sports Clubs for Kids programs, which can include swim lessons and sports camps.
Industry Overview
Total U.S. fitness club industry revenues increased at a compound annual growth rate, or CAGR, of 7.7% from $6.5 billion in 1993 to $14.8 billion in 2004, according to the International Health, Racquet and Sports Club Association, or IHRSA. Total U.S. fitness club memberships increased at a compound annual growth rate of 5.1% from 25.2 million in 1994 to 41.3 million in 2004, according to IHRSA.
U.S. Fitness Club Industry Revenues
($ in billions)
IHRSA Profiles of Success 2004, IHRSA Global Report 2005.
U.S. Fitness Club Memberships
(in millions)
IHRSA/ American Sports Data Health Club Trend Report.
Demographic trends have helped drive the growth experienced by the fitness industry over the past decade. The industry has benefited from the aging of the “baby boomer” generation and the coming of age of
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their offspring, the “echo boomers” (ages eight to 26). Government-sponsored reports, such as the Surgeon General’s Report on Physical Activity & Health (1996) and the Call to Action to Prevent and Decrease Overweight and Obesity (2001), have helped to increase the general awareness of the benefits of exercise to these demographic segments over those of prior generations. Membership penetration (defined as club members as a percentage of the total U.S. population over the age of six) has increased significantly from 7.4% in 1990 to 14.0% in 2003, according to the IHRSA American Sports Data Health Club Trend Report.
Notwithstanding these longstanding growth trends, the fitness club industry continues to be highly fragmented. Less than 10.0% of clubs in the United States are owned and operated by companies that own more than 25 clubs, and the two largest fitness club operators each generate less than 8.0% of total United States fitness club revenues, according to management estimates.
As a large operator with recognized brand names, leading regional market shares and an established operating history, we believe we are well positioned to benefit from these favorable industry dynamics.
We believe that the growth in fitness club memberships is attributable to several factors. Americans are focused on achieving a healthier, more active and less stressful lifestyle. Of the factors members consider very important in their decision to join a fitness club, the most commonly mentioned is health, closely followed by appearance-related factors including muscle tone, looking better and weight control. We believe that the increased emphasis on appearance and wellness in the media has heightened the focus on self-image and fitness and will continue to do so. We also believe that fitness clubs provide a more convenient venue for exercise than outdoor activities, particularly in densely populated metropolitan areas. According to published industry reports, convenience is a leading factor in choosing a fitness club.
We believe the industry can be segregated into three tiers based upon price, service and quality: (1) an upper tier consisting of clubs with monthly individual membership dues averaging in excess of $99 per month; (2) a middle tier consisting of clubs with monthly membership dues averaging between $35 and $99 per month; and (3) a lower tier consisting of clubs with monthly membership dues averaging less than $35 per month. We compete in the middle tier in terms of pricing, and because of our wide array of programs and services coupled with our commitment to customer service and our convenience to members’ work and home, we are positioned toward the upper end of this tier. Based upon the quality and service we provide to our members, we believe that we provide an attractive value to our members at the monthly membership dues we charge.
Competitive Strengths
We believe the following competitive strengths are instrumental to our success:
Strong market position with leading brands. We are the third largest fitness club operator in the United States, as measured by number of clubs. We are also one of the two leading owners and operators of fitness clubs in the Northeast and Mid-Atlantic regions of the United States. We are the largest fitness club owner and operator in the New York and Boston regions, and we believe we are the second largest owner and operator in the Washington, D.C. region and the third largest in the Philadelphia region. We attribute our leadership positions in these markets in part to the strength of our localized brand names, which foster recognition as a local network of quality fitness clubs.
Regional clustering strategy providing significant benefits to members. By operating a network of clubs in a concentrated geographic area, the value of our memberships is enhanced by our ability to offer members access to any of our clubs through our Passport Membership, which provides the convenience of having fitness clubs near a member’s work and home. Approximately half of our members have the Passport Membership plan, and because these memberships offer enhanced privileges and greater convenience, they generate higher monthly dues than single club memberships. Regional clustering also allows us to provide special facilities within a local area, such as swimming pools and squash, tennis and basketball courts, without offering them at every location. In addition, our regional clustering strategy is attractive to corporations seeking group memberships.
Regional clustering strategy designed to maximize revenues and achieve economies of scale. We believe our regional clustering strategy allows us to maximize revenue and earnings growth by providing high-quality, conveniently located fitness facilities on a cost-effective basis while making it more difficult for potential new
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entrants to come into our markets. Regional clustering has allowed us to create an extensive network of clubs in our core markets, in addition to a widely recognized brand with strong local identity. We believe that potential new entrants would need to establish or acquire a large number of clubs in a market to effectively compete with us. We believe that this would be difficult given the relative scarcity of suitable sites in our markets. Our clustering strategy also enables us to achieve economies of scale with regard to sales, marketing, purchasing, general operations and corporate administrative expenses, and to reduce our capital spending needs.
Expertise in site selection and development process. We believe that our expertise in site selection and development provides a significant advantage over our competitors given the real estate markets in the cities in which we operate and the relative scarcity of suitable sites. Before opening or acquiring a new club, we undertake a rigorous process involving demographic and competitive analysis, financial modeling, site selection and negotiation of lease and acquisition terms to ensure that a location meets our criteria for a model club. We believe our flexible club formats are well suited to the challenging real estate environments in our markets.
Experienced management team. We believe that our management team is one of the most experienced management teams in the industry. Our three most senior executives have 60 years of combined experience in the fitness club industry and have been working together at Town Sports since 1990. We believe that our management has the depth, experience and motivation to manage our growth. In the aggregate, our entire management team owns approximately 18.8% of our common stock.
Business Strategy
We intend to continue to grow our revenues, earnings and cash flows using the following strategies:
Drive comparable club revenue and profitability growth. For the year ended December 31, 2005, comparable club revenue growth was 6.9%. Our comparable club revenues increased as a result of our strategic initiatives, including our, commit membership plan and focus on growing ancillary revenues. The commit membership model that we implemented in 2003 encourages new members to commit to a one- or two-year membership at a discount to ourmonth-to-month plan. Since the implementation of the new membership model, attrition rates have declined dramatically and comparable club revenues have increased. We intend to capitalize on this momentum to drive revenue and profitability growth by increasing our membership base as well as the amount of revenue that we generate from each member. Our margins will also continue to improve as the positive comparable club revenue growth allows us to leverage our fixed-cost base.
Increase number of clubs by expanding within regional clusters. We intend to strengthen our market position and to increase revenues and earnings in our existing markets through the opening of new clubs and the acquisition of existing clubs. Our expertise in the site selection and development process combined with our proven and predictable club-level economic model enables us to generate significant returns from the opening of new clubs. We have currently identified over 100 urban and suburban locations in our existing markets that we believe possess the criteria for a model club. In addition, we have identified further growth opportunities in secondary markets located near our existing markets.
Grow ancillary and other non-membership revenues. We intend to grow our ancillary and other non-membership revenues through a continued focus on increasing the additional value-added services that we provide to our members as well as capitalizing on the opportunities for other non-membership revenues such as in-club advertising and retail sales. Non-membership revenues have increased from $42.0 million, or 15.0% of revenues for the year ended December 31, 2001, to $66.8 million, or 17.2% of revenues for the year ended December 31, 2005. We intend to continue to expand the current range of value-added services and programs that we offer to our members, such as personal training, massage, Sports Clubs for Kids and Group Exclusives. These sources of ancillary and other non-membership revenues generate incremental profits with minimal capital investment and assist in attracting and retaining members.
Realize benefits from maturation of recently opened clubs. From January 1, 2003 to December 31, 2005, we opened or acquired 18 clubs. We believe that our recent financial performance does not fully reflect
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the benefit of these clubs. Based on our experience, a new club tends to achieve significant increases in revenues during its first three years of operation as the number of members grows. Because there is relatively little incremental cost associated with such increasing revenues, there is a greater proportionate increase in profitability. We believe that the revenues and profitability of these 18 clubs will significantly improve as the clubs reach maturity.
Execute new business initiatives. We continually undertake initiatives to improve our business. For example, we have undertaken a significant study of various pricing and membership structure initiatives across our portfolio of clubs to seek to influence attrition and average length of membership. We have also improved the process surrounding the opening of newly constructed clubs to yield higher membership revenue in the first month of operation. In addition, we undertook a statistical multi-variable testing study and found a number initiatives that could be undertaken to improve our business. Of those, we tested 25 and have implemented seven initiatives in a combination that we believe will increase our membership and ancillary revenues and reduce attrition. Separately, we have a corporate sales division which targets or focuses on companies with more than 100 workers. In addition, we established an on-line corporate sales program to support the division in the first quarter of 2005. We believe these changes will lead to an increase in new corporate memberships in the future. Currently, 18.6% of our members have corporate memberships.
Marketing
Our marketing campaign, which we believe has increased awareness of our brand names, is directed by our marketing department, which is headed by the Chief Executive Officer and our Vice President of Marketing. This team develops advertising strategies to convey each of our regionally branded networks as the premier network of fitness clubs in its region. Our marketing team’s goal is to achieve broad awareness of our regional brand names primarily through radio, newspaper, billboard and direct mail advertising. We believe that clustering clubs creates economies in our marketing and advertising strategy that increase the efficiency and effectiveness of these campaigns.
Advertisements generally feature creative images or slogans that communicate the serious approach we take toward fitness in a provocative and/or humorous tone, rather than pictures of our clubs, pricing specials or members exercising. Promotional marketing campaigns will typically feature opportunities to participate in value-added services such as personal training for a limited time at a discount to the standard rate. We will also offer reduced initiation fees to encourage enrollment. Additionally, we frequently sponsor member referral incentive programs. Such incentive programs include personal training sessions or sports accessories.
We also engage in public relations and special events to promote our image in the local communities. We believe that these public relations efforts enhance our image and the image of our local brand names in the communities in which we operate. We also seek to build our community image through advertising campaigns with local and regional retailers.
Our principal web site,www.mysportsclubs.com, provides information about club locations, program offerings, exercise class schedules and on-line promotions. The site also allows our members to give us direct feedback on all of our services and offerings. We also use the site to promote career opportunities with us.
Sales
Sales of new memberships are generally handled at the club level. We employ approximately 420 “in-club” membership consultants who are responsible for new membership sales. Each club generally has two to four membership consultants. These consultants report directly to the club general manager, who in turn reports to a district manager. Membership consultants’ compensation consists of a base salary plus commission. Sales commissions range from $45 to $70 per new member enrolled. We provide additional incentive-based compensation in the form of bonuses contingent upon individual, club and company-wide enrollment goals. Membership consultants must successfully complete a 60 day in-house training program through which they learn our sales strategy. They are taught how to prospect for sales both through external
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activities and through existing member referrals. In making a sales presentation, membership consultants emphasize:
| • | the proximity of our clubs to concentrated commercial and residential areas convenient to where target members live and work; | |
| • | the obligation on the part of the enrollee; | |
| • | the price/value relationship of a Town Sports membership; and | |
| • | access to value-added services. |
A team of corporate membership consultants actively markets to larger corporations that have employees located in our markets. A separate corporate sales division was started in the fourth quarter of 2004 that currently has 20 full-time employees pursuing companies with more than 100 employees. In addition, a new on-line corporate sales program was established in the first quarter of 2005. We believe this focus will lead to significant new corporate participation in the future. Currently, 18.6% of members have corporate memberships.
We believe that clustering clubs allows us to sell memberships based upon the opportunity for members to utilize multiple club locations. We have a streamlined membership structure designed to simplify our sales process. In addition, our proprietary centralized computer software ensures consistency of pricing and controls enrollment processing at the club level. As of December 31, 2005, our existing members were enrolled under two principal types of memberships:
| • | The Passport Membership, ranging in price from $47 to $95 per month, is our higher priced membership and entitles members to use any of our clubs at any time. This membership is held by approximately 45% of our members. In addition, we have introduced a Passport Premium Membership at two select clubs, that includes a greater array of member services and facilities, at a price of $115 per month. | |
| • | The Gold Membership, ranging in price from $38 to $81 per month based on the market area of enrollment, enables members to use a specific club, or a group of specific clubs, at any time and any of our clubs during off-peak times. This membership is held by approximately 55% of our members. |
By operating a network of clubs in a concentrated geographic area, the value of our memberships is enhanced by our ability to offer members access to any of our clubs through a Passport Membership, which provides the convenience of having fitness clubs near a member’s work and home. Approximately 45% of our members have the Passport Membership plan, and because these memberships offer broader privileges and greater convenience, they generate higher monthly dues than single club memberships. Regional clustering also allows us to provide special facilities within a local area, such as squash, tennis, basketball programs and swimming pools, without offering them at each location.
Historically, we have soldmonth-to-month membership payment plans that are generally cancelable by our members at any time with 30 days’ notice. We implemented a commit membership model in October 2003 in an effort to improve our membership retention and to offer our members a wider range of membership types. The model encourages new members to commit to a one- or two-year membership, because these memberships are priced at a discount to themonth-to-month plan. During 2005, 90% of our newly enrolled members opted for a commit membership program. As of December 31, 2005, approximately 40% of our members originated under amonth-to-month non-commit membership plan and 60% originated under a commit membership plan. We believe members prefer to have the choice to commit for a year or two or to have the flexibility of themonth-to-month non-commit plan.
In joining a club, a new member signs a membership agreement that obligates the member to pay a one-time initiation fee, a one-time processing fee and monthly dues on an ongoing basis. Monthly electronic funds transfer, or EFT, of individual membership dues on a per-member basis averaged approximately $66.16 per month for the year ended December 31, 2005. Together, initiation fees and processing fees collected for new EFT members averaged approximately $68.35 for the year ended December 31, 2005. We collect approxi-
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mately 90% of all monthly membership dues through EFT and EFT revenue constituted over 74.4% of consolidated revenue for the year ended December 31, 2005. Substantially all other membership dues are paid in full in advance. Our membership agreements call for monthly dues to be collected by EFT based on credit card or bank account debit authorization contained in the agreement. During the first week of each month, we receive the EFT dues for that month after the payments are initiated by a third-party EFT processor. Discrepancies and insufficient funds incidents are researched and resolved by our in-house account services department. During 2005, we increased our collection efforts and retained a third-party collection agency, and have began to see a modest improvement in collections of our receivables. We believe that our EFT program of monthly dues collection provides a predictable and stable cash flow for us, reduces the traditional accounts receivable function and minimizes bad-debt write-offs while providing a significant competitive advantage in terms of the sales process, dues collection and working capital management. In addition, it enables us to increase our existing member dues in an efficient and consistent manner, which we typically do annually by between 1% and 3%, in line with increases in the cost of living.
| For the Month Ended December 31, (in $000s) | |||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | |||||||||||||||||
| Monthly consolidated net EFT revenue | $ | 18,321 | $ | 21,204 | $ | 21,303 | $ | 22,274 | $ | 25,190 | |||||||||||
| Increase over prior year | 19.3 | % | 15.7 | % | 0.5 | % | 4.6 | % | 13.1 | % | |||||||||||
Non-Membership Revenue
Over the past five years, we have expanded the level of ancillary club services provided to our members. Non-membership club revenue has increased by $24.8 million from $42.0 million in 2001 to $66.8 million in 2005. Increases in personal training revenue in particular have contributed $16.9 million of the increase in ancillary revenue during this period. In addition, we have added Sports Clubs for Kids and Group Exclusives (both additional fee for service programs) at selected clubs. Non-membership club revenue as a percentage of total revenue has increased from 15.0% for the year ended December 31, 2001 to 17.2% for the year ended December 31, 2005. Personal training revenue as a percentage of revenues increased from 9.0% of revenue in 2001 to 10.9% of revenue in 2005.
| For the Year Ended December 31, (in $000s) | ||||||||||||||||||||||||||||||||||||||||
| 2001 | % | 2002 | % | 2003 | % | 2004 | % | 2005 | % | |||||||||||||||||||||||||||||||
| Total revenue | $ | 280,381 | 100.0 | % | $ | 318,055 | 100.0 | % | $ | 341,172 | 100.0 | % | $ | 353,031 | 100.0 | % | $ | 388,556 | 100.0 | % | ||||||||||||||||||||
Non-Membership Revenue: | ||||||||||||||||||||||||||||||||||||||||
| Personal training revenue | 25,358 | 9.0 | % | 28,450 | 8.9 | % | 31,170 | 9.1 | % | 34,821 | 9.9 | % | 42,277 | 10.9 | % | |||||||||||||||||||||||||
| Other ancillary club revenue | 14,781 | 5.3 | % | 16,481 | 5.2 | % | 17,269 | 5.1 | % | 18,199 | 5.1 | % | 20,139 | 5.2 | % | |||||||||||||||||||||||||
| Fees and other revenue | 1,926 | 0.7 | % | 2,238 | 0.7 | % | 2,707 | 0.8 | % | 4,856 | 1.4 | % | 4,413 | 1.1 | % | |||||||||||||||||||||||||
| Total non-membership revenue | $ | 42,045 | 15.0 | % | $ | 47,169 | 14.8 | % | $ | 51,146 | 15.0 | % | $ | 57,876 | 16.4 | % | $ | 66,829 | 17.2 | % | ||||||||||||||||||||
Club Format and Locations
Our clubs are typically located in well-established, middle or upper-income residential, commercial or mixed urban neighborhoods within major metropolitan areas that are capable of supporting the development of a cluster of clubs. Our clubs generally have relatively high visibility in retail areas and are near transportation. In the New York City, Boston and Washington, D.C. markets, we have created clusters of clubs in urban areas and their commuter suburbs aligned with our operating strategy of offering our target members the convenience of multiple locations close to where they live and work, reciprocal use privileges and standardized facilities and services. We are establishing a similar cluster in Philadelphia.
Approximately half of the clubs we operate are urban clubs and the remainder are suburban. Our urban clubs generally range in size from 15,000 to 25,000 square feet and average approximately 20,000 square feet.
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Our suburban clubs vary in size from 15,000 square feet to 90,000 square feet, with one club being 200,000 square feet. Excluding this one large club, the average suburban club is 25,000 square feet. Membership for each club generally ranges from 2,000 to 4,500 members at maturity. Although club members represent a cross-section of the population in a given geographic market, our target member is college educated, between the ages of 21 and 50 and has an annual income of between $50,000 and $150,000.
We have experienced significant growth over the past five years through a combination of acquiring existing, privately owned, single and multi-club businesses, and developing and opening new club locations that we have constructed. From January 1, 2001 to December 31, 2005, we have acquired eleven existing clubs and opened 33 new clubs. In addition, during this period, we have relocated five clubs, sold one club, closed one club and temporarily closed one club for renovations to increase our total clubs under operation from 105 to 141.
We engage in detailed site analyses and selection processes based upon information provided by our development software to identify potential target areas for additional clubs based upon population demographics, psychographics, traffic and commuting patterns, availability of sites and competitive market information. In addition to our 141 locations, we opened three new clubs in January 2006 and two in February 2006. We also have 12 additional sites for which we entered into lease commitments, and have identified approximately 100 target areas in which we may add clubs under our New York Sports Clubs, Boston Sports Clubs, Washington Sports Clubs or Philadelphia Sports Clubs brand names. In addition, we have identified further growth opportunities in secondary markets located near our existing markets. In the future, we may explore expansion opportunities in other markets in the United States that share similar demographic characteristics to those in which we currently operate.
Our facilities include some of all of the followingstate-of-the-art cardiovascular equipment, including upright and recumbent bikes, steppers, treadmills and elliptical motion machines; strength equipment and free weights, including Cybex, Icarian, Nautilus, Free Motion and Hammer Strength equipment; group exercise and cycling studios; the Sportsclub Network entertainment system; locker rooms, including shower facilities, towel service and other amenities, such as saunas and steam rooms; babysitting; and a retail shop. Each of our clubs is equipped with automated external defibrillators. Personal training services are offered at all locations and massage is offered at most clubs, each at an additional charge. At certain locations, additional facilities are also offered, including swimming pools and racquet and basketball courts. Also, we have significantly expanded the availability of fee-based programming at many of our clubs, including programs targeted at children, members and non-member adult customers.
We also offer our Xpressline strength workout at all of our clubs. Xpressline is a trainer-supervised, eight-station total-body circuit workout designed to be used in 22 minutes and to accommodate all fitness levels. This service is provided for free to our members. We have also introduced FitMap, which is a visual tool that provides our members with guidance on how to use our equipment through safe progressions of difficulty.
We have over 5,000 Sportsclub Network personal entertainment units installed in our clubs. The units are typically mounted on cardiovascular equipment and are equipped with a color screen for television viewing; some also have a compact disc player or an audio cassette player. The Sportsclub Network also broadcasts our own personalized music video channel that provides us with a direct means of advertising products and services to our membership base.
Club Services and Operations
We emphasize consistency and quality in all of our club operations, including:
Management. We believe that our success is largely dependent on the selection and training of our staff and management. Our management structure is designed, therefore, to support the professional development of highly motivated managers who will execute our directives and support growth.
Our business is divided into regional operating lines in which our vice presidents of operations oversee the profit responsibility of a defined group, or cluster, of clubs. Reporting to these officers are regional functional departments as well as district managers. Reporting to these district managers are the individual club general
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managers. General managers are responsible for theday-to-day management of each club. Some general managers are designated as Cluster managers, and they assist the District managers in managing membership sales at their “home” club plus two others. At each level of responsibility, compensation is structured to align our goals for profitability with those of each region, district or club.
Corporate functional departments have been established to compliment each specific area of our clubs’ services, such as sales, training, group exercise programs, fitness equipment, programming, personal training, facility and equipment maintenance, procurement and laundry. We have also undertaken the establishment of a Learning and Development department to assume the management of existing sales and fitness training programs and to build training programs to support leadership training, operations management training, IT training and customer service training. The first modules of these programs are being introduced in the first quarter of 2006. This centralization allows local general managers at each club to focus on sales, customer service, club staffing and providing a high-quality exercise experience.
Our club support division acts as the coordinator for all departments, and ensures consistency of policies and procedures across the entire organization.
Personal Training. All of our fitness clubs offerone-on-one personal training, which is sold by the single session or in multi-session packages. We have implemented a comprehensive staff education curriculum, which progresses from basic knowledge and practical skills to advanced concepts and training techniques. Our education program provides professional guidelines to ensure that our trainers provide superior service and fitness expertise to our members. There are four levels of professional competency for which different levels of compensation are paid, with mandatory requirements trainers must meet in order to achieve and maintain such status. We believe the qualifications of the personal training staff help ensure that members receive a consistent level of quality service throughout our clubs. We believe that our personal training programs provide valuable guidance to our members and a significant source of incremental revenue. In addition, we believe that members who participate in personal training programs typically have a longer membership life.
Group Fitness. Our commitment to providing a quality workout experience to our members extends to the employment of program instructors, who teach aerobics, cycling, strength conditioning, boxing, yoga, Pilates and step aerobics classes, among others. All program instructors report to a centralized management structure, headed by the Director of Group Exercise whose department is responsible for overseeing auditions and providing in-house training to keep instructors current in the latest training techniques and program offerings. We also provide Group Exclusive offerings to our members, which are for-fee based programs that have smaller groups and provide more focused, and typically more advanced, training classes. Some examples of these offerings include Pilates, boxing camps and cycling camps.
Sports Clubs for Kids. During 2000, we began offering programs for children under the Sports Clubs for Kids brand. As of December 31, 2005, Sports Clubs for Kids was operating in 18 locations throughout our New York Sports Clubs, Boston Sports Clubs and Philadelphia Sports Clubs regions. In addition to extending fitness offerings to a demographic not previously served by us, we expect that Sports Clubs for Kids programming will help position our suburban clubs as family clubs, which we believe will provide us with a competitive advantage. Depending upon the facilities available at a location, Sports Clubs for Kids programming can include traditional youth offerings such as day camps, sports camps, swim lessons, hockey and soccer leagues, gymnastics, dance, martial arts and birthday parties. It also can include innovative and proprietary programming such as Kidspin Theater, a multi-media cycling experience, and non-competitive“learn-to-play” sports programs. In selected locations, we also offer laser tag.
Employee Compensation and Benefits. We provide performance-based incentives to our management. Senior management compensation, for example, is tied to our overall performance. Departmental directors, district managers and general managers can achieve bonuses tied to financial and member retention targets for a particular club or group of clubs. We offer our employees various benefits including health, dental and disability insurance; pre-tax healthcare, commuting and dependent care accounts; and a 401(k) plan. We believe the availability of employee benefits provides us with a strategic advantage in attracting and retaining quality managers, program instructors and professional personal trainers and that this strategic advantage in
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turn translates into a more consistent and higher-quality workout experience for those members who utilize such services.
Centralized Information Systems
We use a fully integrated information system to sell memberships, bill our members, track and analyze sales and membership statistics, the frequency and timing of member workouts, cross-club utilization, member life, value-added services and demographic profiles by member, which enables us to develop targeted direct marketing programs and to modify our broadcast and print advertising to improve consumer response. This system also assists us in evaluating staffing needs and program offerings. In addition, we rely on certain data gathered through our information systems to assist in the identification of new markets for clubs and site selection within those markets.
Information System Developments
We recognize the value of enhancing and extending the uses of information technology in virtually every area of our business. After developing an information technology strategy to support our business strategy, we developed a comprehensive multi-year plan to replace or upgrade key systems.
In 2003, we implemented a new, fully integrated club management system. This system incorporates browser-based technology and open architecture to allow for scalability to support our projected growth and diversification of services. This system provides enhanced functionality for member services, contract management, electronic billing, point of sale, scheduling resources and reservations. This club management system is continually enhanced to extend support for new business functionalities, new club models, and to integrate with other applications. Integration of the club management system with a customer relationship system is currently in test. During the year, we developed a new application utilizing business intelligence tools and data warehousing capabilities to enable enhanced managerial and analytical reporting of sales and operations.
We are in the process of implementing a human resource management system that provides enhanced capabilities for talent management from recruiting to employee and manager self service to evaluations and financial planning for staffing. The system will be merged with the existing timekeeping system and integrated with payroll and relevant financial applications for complete automation of compensation processing and management for all employees.
We re-launched our web site in 2005 utilizing new architecture to allow for flexibility in product offerings, on-line corporate sales, promotion and contest presentations, member self service, surveying and enhanced member options. We have built an intranet to provide a portal for the various browser-based applications that we utilize internally. Our intranet features support corporate communications, human resources programs and training.
We have implemented numerous infrastructure changes to accommodate our growth, provide network redundancy, better manage telecommunications and data costs, increase efficiencies in operations, and improve management of all components of our technical architecture. In 2005, we brought our disaster recovery site in Pennsylvania on-line. The disaster recovery facility utilizes replication tools to provide fail over capabilities for supporting our club operations and company communications.
Strategic Planning
During 2001, we began a strategic planning process. By 2004, our strategic plan had become an integral part of the decision-making process of our Executive Committee, which is now comprised of our Chief Executive Officer, President and Chief Development Officer, Chief Financial Officer, Chief Information Officer, Chief Operations Officer and our Senior Vice President of Strategic Planning. Reflecting our strategic plan’s role in the structural decisions being made, it is reviewed and refined quarterly. The execution of initiatives supporting each of the current six strategic objectives is the responsibility of the Executive Committee, with every member other than the Chairman responsible for at least one objective.
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Our strategic plan’s objectives have produced significant changes in our approach to our brand, our core business development process, our customer experience, our sales process and our technology strategy. Among these changes is a flattening of our club management structure, giving in-club management broader responsibility. This was coupled with a reduction of the span of control of district managers so that they can focus on fewer locations. Together with our information technology strategies, such changes reduced the administrative burden placed upon our club management staff and provided a platform for improved customer service. Additional objectives have resulted in, among other changes, the realignment of direct responsibility for the in-club membership sales process, a new division handling corporate sales activity and club-level responsibility for personal training sales and service delivery.
Our core business development initiatives have improved our ability to target markets and enhanced the accuracy of our business model. Finally, our information technology initiatives have resulted in an intranet platform that now serves as the portal through which employees access many enterprise-wide software systems. It also provides information about marketing promotions, details about clubs and services, corporate directories and resources related to the administration of human resources and procurement.
For 2006, we plan to drive the strategic planning process further into the organization. Selected divisions will develop strategy documents to improve the focus and efficiency of these groups. Because divisional strategy plans will support our overall strategic plan, they will improve the alignment of business processes with our high-level strategy.
Intellectual Property
We have registered various trademarks and service marks with the U.S. Patent and Trademark Office, includingNew York Sports Clubs, Washington Sports Clubs, Boston Sports Clubs, Philadelphia Sports Clubs, TSI andTown Sports International, Inc. We continue to register other trademarks and service marks as they are created.
Competition
The fitness club industry is competitive and continues to become more competitive. The number of health clubs in the U.S. has increased from 11,655 in 1993 to 28,449 in 2005. While we do not believe that we face any dominant competitors in our markets, we compete with other fitness clubs, physical fitness and recreational facilities established by local governments, hospitals and businesses for their employees, amenity and condominium clubs, the YMCA and similar organizations and, to a certain extent, with racquet and tennis and other athletic clubs, country clubs, weight reducing salons and the home-use fitness equipment industry.
The principal methods of competition include pricing and ease of payment, required level of members’ contractual commitment, level and quality of services, training and quality of supervisory staff, size and layout of facility and convenience of location with respect to access to transportation and pedestrian traffic.
We consider our service offerings to be in the mid-range of the value/service proposition and designed to appeal to a large portion of the population who attend fitness facilities. Competitors offering lower pricing and a lower level of service could compete effectively against our facilities if such operators are willing to accept operating margins that are lower than ours.
Furthermore, smaller and less expensive weight loss facilities present a competitive alternative for the de-conditioned market. We also face competition from club operators offering comparable or higher pricing with higher levels of service. The trend to larger outer-suburban family fitness centers, in areas where suitable real estate is more likely to be available, could also compete effectively against our suburban fitness-only models.
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Competitive Position Measured by Number of Clubs
| Number of | ||||||
| Market | Clubs | Position | ||||
| Boston metro | 18 | Leading operator | ||||
| New York metro | 95 | Leading operator | ||||
| Philadelphia metro | 6 | # 3 operator | ||||
| Washington, D.C. metro | 19 | # 2 operator, although leader in urban center | ||||
| Switzerland | 3 | Local operator only | ||||
We also compete with other entertainment and retail businesses for the discretionary income in our target demographics. There can be no assurance that we will be able to compete effectively in the future in the markets in which we operate. Competitors, which may include companies that are larger and have greater resources than us, may enter these markets to our detriment. These competitive conditions may limit our ability to increase dues without a material loss in membership, attract new members and attract and retain qualified personnel. Additionally, consolidation in the fitness club industry could result in increased competition among participants, particularly large multi-facility operators that are able to compete for attractive acquisition candidates and or newly constructed club locations, thereby increasing costs associated with expansion through both acquisitions and lease negotiation and real estate availability for newly constructed club locations.
We believe that our market leadership, experience and operating efficiencies enable us to provide the consumer with a superior product in terms of convenience, quality service and affordability. We believe that there are significant barriers to entry in our urban markets, including restrictive zoning laws, lengthy permit processes and a shortage of appropriate real estate, which could discourage any large competitor from attempting to open a chain of clubs in these markets. However, such a competitor could enter these markets more easily through one, or a series of, acquisitions.
Government Regulation
Our operations and business practices are subject to federal, state and local government regulation in the various jurisdictions in which our clubs are located, including: (1) general rules and regulations of the Federal Trade Commission, state and local consumer protection agencies and state statutes that prescribe certain forms and provisions of membership contracts and that govern the advertising, sale, financing and collection of such memberships, (2) state and local health regulations, (3) federal regulation of health and nutritional supplements and (4) regulation of rehabilitation service providers.
Statutes and regulations affecting the fitness industry have been enacted in jurisdictions in which we conduct business; many others into which we may expand have adopted or likely will adopt similar legislation. Typically, these statutes and regulations prescribe certain forms and provisions of membership contracts, afford members the right to cancel the contract within a specified time period after signing, require an escrow of funds received from pre-opening sales or the posting of a bond or proof of financial responsibility, and may establish maximum prices for membership contracts and limitations on the term of contracts. In addition, we are subject to numerous other types of federal and state regulations governing the sale of memberships. These laws and regulations are subject to varying interpretations by a number of state and federal enforcement agencies and courts. We maintain internal review procedures in order to comply with these requirements, and believe that our activities are in substantial compliance with all applicable statutes, rules and decisions.
Under so-called state “cooling-off” statutes, a new member has the right to cancel his or her membership for a short period after joining set by the applicable law in the relevant jurisdiction and, in such event, is entitled to a refund of any initiation fee and dues paid. In addition, our membership contracts provide that a member may cancel his or her membership at any time for medical reasons or relocation a certain distance from the nearest club. The specific procedures and reasons for cancellation vary due to differing laws in the respective jurisdictions. In each instance, the canceling member is entitled to a refund of unused prepaid
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amounts only. Furthermore, where permitted by law, a fee is due upon cancellation and we may offset such amount against any refunds owed.
Employees
At December 31, 2005, we had approximately 8,200 employees, of whom approximately 3,100 were employed full-time. Approximately 370 employees were corporate personnel working in our Manhattan, Boston, Philadelphia or Washington, D.C. offices. We are not a party to any collective bargaining agreement with our employees. We have never experienced any significant labor shortages nor had any difficulty in obtaining adequate replacements for departing employees and consider our relations with our employees to be good.
| Item 1A. | Risk Factors |
| The risks described below could have a material and adverse impact on our business, results of operations and financial condition. |
Risks Related to Our Business
| We may be unable to attract and retain members, which could have a negative effect on our business. |
The performance of our clubs is dependent on our ability to attract and retain members, and we may not be successful in these efforts. Many of our members can cancel their club membership at any time upon 30 days’ notice. In addition, there are numerous factors that have in the past and could in the future lead to a decline in membership levels at established clubs or that could prevent us from increasing our membership at newer clubs, including harm to our reputation, a decline in our ability to deliver quality service at a competitive cost, the presence of direct and indirect competition in the areas in which the clubs are located, the public’s interest in sports and fitness clubs and general economic conditions. As a result of these factors, membership levels might not be adequate to maintain or permit the expansion of our operations. In addition, a decline in membership levels may have a material adverse effect on our performance, financial condition and results of operations.
| Our geographic concentration heightens our exposure to adverse regional developments. |
As of December 31, 2005, we operated 95 fitness clubs in the New York metropolitan market, 18 fitness clubs in the Boston market, 19 fitness clubs in the Washington, D.C. market, six fitness clubs in the Philadelphia market and three fitness clubs in Switzerland. Our geographic concentration in the Northeast and Mid-Atlantic regions and, in particular, the New York area, heightens our exposure to adverse developments related to competition, as well as, economic and demographic changes in these regions. Our geographic concentration might result in a material adverse effect on our business, financial condition or results of operations in the future.
| The level of competition in the fitness club industry could negatively impact our revenue growth rates and profits. |
The fitness club industry is competitive and continues to become more competitive. We compete with other fitness clubs, physical fitness and recreational facilities established by local governments, hospitals and businesses for their employees, amenity and condominium clubs, the YMCA and similar organizations and, to a certain extent, with racquet and tennis and other athletic clubs, country clubs, weight reducing salons and the home-use fitness equipment industry. We also compete with other entertainment and retail businesses for the discretionary income in our target demographics. We might not be able to compete effectively in the future in the markets in which we operate. Competitors, which may include companies that are larger and have greater resources than us, may enter these markets to our detriment. These competitive conditions may limit our ability to increase dues without a material loss in membership, attract new members and attract and retain qualified personnel. Additionally, consolidation in the fitness club industry could result in increased competition among participants, particularly large multi-facility operators that are able to compete for
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attractive acquisition candidates or newly constructed club locations, thereby increasing costs associated with expansion through both acquisitions, and lease negotiation and real estate availability for newly constructed club locations.
Competitors offering lower pricing and a lower level of service could compete effectively against our facilities if such operators are willing to accept operating margins that are lower than ours. Furthermore, smaller and less expensive weight loss facilities present a competitive alternative for the de-conditioned market. We also face competition from competitors offering comparable or higher pricing with higher levels of service. The trend to larger outer-suburban family fitness centers, in areas where suitable real estate is more likely to be available, could also compete effectively against our suburban fitness-only models.
In addition, large competitors could enter the urban markets in which we operate to attempt to open a chain of clubs in these markets through one, or a series of, acquisitions.
| If we are unable to identify and acquire suitable sites for new clubs, our revenue growth rate and profits may be negatively impacted. |
To successfully expand our business, we must identify and acquire sites that meet the site selection criteria we have established. In addition to finding sites with the right geographical, demographic and other measures we employ in our selection process, we also need to evaluate the penetration of our competitors in the market. We face competition from other health and fitness center operators for sites that meet our criteria, and as a result we may lose those sites, our competitors could copy our format or we could be forced to pay higher prices for those sites. If we are unable to identify and acquire sites for new clubs, our revenue growth rate and profits may be negatively impacted. Additionally, if our analysis of the suitability of a site is incorrect, we may not be able to recover our capital investment in developing and building the new club.
| We may experience prolonged periods of losses in our recently opened clubs. |
We have opened a total of ten new club locations that we have constructed in the24-month period ended December 31, 2005. Upon opening a club, we typically experience an initial period of club operating losses. Enrollment from pre-sold memberships typically generates insufficient revenue for the club to generate positive cash flow. As a result, a new club typically generates an operating loss in its first full year of operations and substantially lower margins in its second full year of operations than a mature club. These operating losses and lower margins will negatively impact our future results of operations. This negative impact will be increased by the initial expensing of pre-opening costs, which include legal and other costs associated with lease negotiations and permitting and zoning requirements, as well as increased depreciation and amortization expenses, which will further negatively impact net income. We may, at our discretion, accelerate or expand our plans to open new clubs, which may adversely affect results from operations temporarily.
| We could be subject to claims related to health or safety risks at our clubs. |
Use of our clubs poses some potential health or safety risks to members or guests through exertion and use of our services and facilities including exercise equipment. Claims against us for death or injury suffered by members or their guests while exercising at a club might be asserted. We might not be able to successfully defend such claims. Additionally, we might not be able to maintain our general liability insurance on acceptable terms in the future or maintain a level of insurance that would provide adequate coverage against potential claims.
| Loss of key personnel and/or failure to attract and retain highly qualified personnel could make it more difficult for us to generate cash flow from operations and service our debt. |
We are dependent on the continued services of our senior management team, particularly Robert J. Giardina, Chief Executive Officer; Alexander A. Alimanestianu, President and Chief Development Officer; Richard G. Pyle, Chief Financial Officer; and Randall C. Stephen, Chief Operating Officer. We believe the loss of such key personnel could have a material adverse effect on us and our financial performance. Currently,
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we do not have any long-term employment agreements with our executive officers, and we may not be able to attract and retain sufficient qualified personnel to meet our business needs.
| We are subject to extensive government regulation and changes in these regulations could have a negative effect on our financial condition. |
Our operations and business practices are subject to federal, state and local government regulation in the various jurisdictions in which our clubs are located, including: (1) general rules and regulations of the Federal Trade Commission, state and local consumer protection agencies and state statutes that prescribe certain forms and provisions of membership contracts and that govern the advertising, sale, financing and collection of such memberships, (2) state and local health regulations, (3) federal regulation of health and nutritional supplements and (4) regulation of rehabilitation service providers.
Statutes and regulations affecting the fitness industry have been enacted in jurisdictions in which we conduct business; many others into which we may expand have adopted or likely will adopt similar legislation. Typically, these statutes and regulations prescribe certain forms and provisions of membership contracts, afford members the right to cancel the contract within a specified time period after signing, require an escrow of funds received from pre-opening sales or the posting of a bond or proof of financial responsibility, and may establish maximum prices for membership contracts and limitations on the term of contracts. In addition, we are subject to numerous other types of federal and state regulations governing the sale of memberships. These laws and regulations are subject to varying interpretations by a number of state and federal enforcement agencies and courts. We maintain internal review procedures in order to comply with these requirements, and believe that our activities are in substantial compliance with all applicable statutes, rules and decisions.
Under so-called state “cooling-off” statutes, a new member has the right to cancel his or her membership for a short period after joining set by the applicable law in the relevant jurisdiction and, in such event, is entitled to a refund of any initiation fee and dues paid. In addition, our membership contracts provide that a member may cancel his or her membership at any time for medical reasons or relocation a certain distance from the nearest club. The specific procedures and reasons for cancellation vary due to differing laws in the respective jurisdictions. In each instance, the canceling member is entitled to a refund of unused prepaid amounts only. Furthermore, where permitted by law, a fee is due upon cancellation and we may offset such amount against any refunds owed.
Changes in any statutes, rules or regulations could have a material adverse effect on our financial condition and results of operations.
| Terrorism and the uncertainty of armed conflicts may have a material adverse effect on clubs and our operating results. |
Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, and other acts of violence or war may affect the markets in which we operate or our operating results. Our geographic concentration in the major cities in the Northeast and Mid-Atlantic regions and, in particular, the New York and Washington, D.C. areas, heightens our exposure to any such future terrorist attacks, which may adversely affect our clubs and result in a decrease in our revenues. The potential near-term and long-term effect these attacks may have for our members and the markets for our services are uncertain; however, their occurrence can be expected to further negatively affect the United States economy generally, and specifically the regional markets in which we operate. The consequences of any terrorist attacks or any armed conflicts are unpredictable; and we may not be able to foresee events that could have an adverse effect on our business.
| Disruptions and failures involving our proprietary information systems could cause customer dissatisfaction and adversely affect our billing and other administrative functions. |
The continuing and uninterrupted performance of our information systems is critical to our success. Our members may become dissatisfied by any systems disruption or failure that interrupts our ability to provide our services to them, including programs and adequate staffing. Disruptions or failures that affect our billing and other administrative functions could have an adverse affect on our operating results.
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We use a proprietary system developed internally to bill our members, track and analyze sales and membership statistics, the frequency and timing of member workouts, multi-club utilization, value-added services and demographic profiles by member. This system also assists us in evaluating staffing needs and program offerings. Correcting any disruptions or failures that affected our proprietary system could be difficult, time-consuming or expensive because we would need to use experts familiar with our system.
We have implemented numerous infrastructure changes to accommodate our growth, provide network redundancy, increase efficiencies in operations and improve management of all components of our technical architecture. In 2004, we constructed our disaster recovery site as well as a purpose-built member call center in a facility in Pennsylvania. The disaster recovery facility, including full network redundancy, was completely operational for key business systems in August of 2005. Fire, floods, earthquakes, power loss, telecommunications failures, break-ins, acts of terrorism and similar events could damage either our primary orback-up systems. In addition, computer viruses, electronic break-ins or other similar disruptive problems could also adversely affect our online sites. Any system disruption or failure, security breach or other damage that interrupts or delays our operations could cause us to lose members and adversely affect our business and results of operations.
| The opening of new clubs by us in existing locations may negatively impact our comparable club revenue increases and our operating margins. |
We currently operate clubs throughout the Northeast and Mid-Atlantic regions of the United States. We opened three clubs in January 2006, two in February 2006 and we have committed to open twelve additional clubs. Each of these twelve openings are in existing markets. With respect to existing markets, it has been our experience that opening new clubs may attract some memberships away from other clubs already operated by us in those markets and diminish their revenues. In addition, as a result of new club openings in existing markets, and because older clubs will represent an increasing proportion of our club base over time, our mature club revenue increases may be lower in future periods than in the past.
Another result of opening new clubs is that our club operating margins may be lower than they have been historically while the clubs build membership base. We expect both the addition of pre-opening expenses and the lower revenue volumes characteristic of newly opened clubs to affect our club operating margins at these new clubs.
| Our continued growth could place strains on our management, employees, information systems and internal controls, which may adversely impact our business and the value of your investment. |
Over the past five years, we have experienced significant growth in our business activities and operations, including an increase in the number of our clubs. Future expansion will place increased demands on our administrative, operational, financial and other resources. Any failure to manage growth effectively could seriously harm our business. To be successful, we will need to continue to improve management information systems and our operating, administrative, financial and accounting systems and controls. We will also need to train new employees and maintain close coordination among our executive, accounting, finance, marketing, sales and operations functions. These processes are time-consuming and expensive, increase management responsibilities and divert management attention.
| Our cash and cash equivalents are concentrated in one bank. |
Our cash and cash equivalents are held, primarily, in a single commercial bank. These deposits are not collateralized. In the event the bank becomes insolvent, we would be unable to recover most of our cash and cash equivalents deposited at the bank.
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Risks Related to Our Leverage
| Our substantial leverage may impair our financial condition and we may incur significant additional debt. |
We currently have a substantial amount of debt. As of December 31, 2005, our total consolidated debt was $411.2 million.
Our substantial debt could have important consequences, including:
| • | making it more difficult for us to satisfy our obligations with respect to our outstanding indebtedness; | |
| • | increasing our vulnerability to general adverse economic and industry conditions; | |
| • | limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions of clubs and other general corporate requirements; | |
| • | requiring a substantial portion of our cash flow from operations for the payment of interest on our debt and reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions of new clubs and general corporate requirements; and | |
| • | limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate. |
These limitations and consequences may place us at a competitive disadvantage to other less-leveraged competitors.
Subject to specified limitations, the indentures governing our senior discount notes and TSI, Inc.’s senior notes will permit us and our subsidiaries to incur substantial additional debt. In addition, as of December 31, 2005, we had $42.0 million of unutilized borrowings under our senior secured revolving credit facility, of which $34.6 million was available subject to certain limitations. If new debt is added to our and our subsidiaries’ current debt levels, the related risks that we and they now face could intensify.
| Servicing our debt will require, in aggregate, approximately $1,127 million (comprised of principal and interest) of cash, and our ability to generate sufficient cash flows depends upon many factors, some of which are beyond our control. |
Our ability to make payments on and refinance our debt and to fund planned capital expenditures depends on our ability to generate cash flows in the future. As of December 31, 2005, our total consolidated debt was $411.2 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual and Commitments Summary” for a description of our aggregate long-term debt and operating lease obligations as of December 31, 2005. To some extent, our ability to generate cash flows in the future is subject to general economic, financial, competitive, legislative and regulatory factors and other factors that are beyond our control. We may be unable to continue to generate cash flow from operations at current levels. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may have to refinance all or a portion of our existing debt or obtain additional financing. We cannot assure you that any refinancing of this kind would be possible or that any additional financing could be obtained.
The inability to obtain additional financing could have a material adverse effect on our financial condition and on our ability to meet our obligations under our debt.
| We may not have access to the cash flow and other assets of our subsidiaries that may be needed to make payments on our outstanding senior discount notes. |
Our operations are conducted through our subsidiaries and our ability to make payment on our outstanding senior discount notes is dependent on the earnings and the distribution of funds from our subsidiaries. However, none of our subsidiaries are obligated to make funds available to us for payment on our outstanding senior discount notes. In addition, the terms of the indenture governing TSI, Inc.’s existing senior
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notes and of TSI, Inc.’s senior secured revolving credit facility significantly restrict TSI, Inc. and its subsidiaries from paying dividends and otherwise transferring assets to us. Furthermore, our subsidiaries are permitted under the terms of TSI, Inc.’s senior secured revolving credit facility and other indebtedness (including under the indenture) to incur additional indebtedness that may severely restrict or prohibit the making of distributions, the payment of dividends or the making of loans by such subsidiaries to us.
We cannot assure you that the agreements governing the current and future indebtedness of our subsidiaries will permit our subsidiaries to provide TSI, Inc. with sufficient dividends, distributions or loans to fund scheduled interest and principal payments on TSI, Inc.’s senior notes when due.
| Covenant restrictions under our indebtedness may limit our ability to operate our business and, in such an event, we may not have sufficient assets to settle our indebtedness. |
The indentures governing our senior discount notes and TSI, Inc.’s senior notes and certain of our other agreements regarding our indebtedness contain, among other things, covenants that may restrict our ability to finance future operations or capital needs or to engage in other business activities. The indentures governing our senior discount notes and TSI, Inc.’s senior notes and certain of our other agreements regarding our indebtedness restrict, among other things, our ability and the ability of our restricted subsidiaries to:
| • | borrow money; | |
| • | pay dividends or make distributions; | |
| • | purchase or redeem stock; | |
| • | make investments and extend credit; | |
| • | engage in transactions with affiliates; | |
| • | engage in sale-leaseback transactions; | |
| • | consummate certain asset sales; | |
| • | effect a consolidation or merger or sell, transfer, lease or otherwise dispose of all or substantially all of our assets; and | |
| • | create liens on our assets. |
In addition, our senior secured revolving credit facility requires TSI, Inc. to maintain specified financial ratios and satisfy certain financial condition tests that may require us to take action to reduce our debt or to act in a manner contrary to our business objectives. Such ratios include:
| • | a ratio not less than ranging from 2.25:1.00 to 3.50:1.00, depending on the period, of EBITDA, as that term is defined in the credit agreement governing our senior secured revolving credit facility, to interest expense; | |
| • | a ratio not greater than ranging from 4.00:1.00 to 2.75:1.00, depending on the period, of indebtedness to EBITDA; and | |
| • | a ratio not greater than 1.00:1.00 of senior secured indebtedness to EBITDA. |
As of December 31, 2005, we are required to maintain an EBITDA to interest expense ratio of no less than 2.75:1.00, an indebtedness to EBITDA ratio of not greater than 3.50:1.00 and a senior secured indebtedness to EBITDA ratio of not greater than 1.00:1.00. As of December 31, 2005, we were in compliance with such ratios and our position relative to such ratios was 3.52:1.00, 3.13:1.00 and 0.16:1.00, respectively.
Events beyond our control, including changes in general economic and business conditions, may affect our ability to meet those financial ratios and financial condition tests. We may be unable to meet those tests and the lenders may decide not to waive any failure to meet those tests. A breach of any of these covenants would result in a default under the indenture governing our senior discount notes, TSI, Inc.’s senior secured revolving credit facility and the indenture governing the senior notes issued by TSI, Inc. If an event of default
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under TSI, Inc.’s senior secured revolving credit facility occurs, the lenders could elect to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. If an event of default occurs under the indenture governing our senior discount notes or the indenture governing the senior notes issued by TSI, Inc., the noteholders could elect to declare due all amounts outstanding thereunder, together with accrued interest. If any such event should occur, we might not have sufficient assets to pay our indebtedness.
| Item 1B. | Unresolved Staff Comments |
None
| Item 2. | Properties |
We own the 151 East 86th Street location, which houses a fitness club and a retail tenant that generated $1.1 million of rental income for us during the year ended December 31, 2005. We lease the remainder of our fitness clubs pursuant to long-term leases (generally 15 to 25 years, including options). In the next five years (ending December 31, 2010), the leases for only five locations will expire without any renewal options. In each case, we will endeavor to extend the lease or relocate the club or its membership base.
We lease approximately 40,000 square feet of office space in New York City, and have smaller regional offices in Fairfax, VA, East Brunswick, NJ, Old Bridge, NJ, Philadelphia, PA, Mamaroneck, NY and Wakefield, MA, for administrative and general corporate purposes. We also lease warehouse and commercial space in Brooklyn, NY, Queens, NY and Long Island City, NY for storage purposes and for the operation of a centralized laundry facility for certain of our clubs in the New York metropolitan area.
The following table provides information regarding our club locations:
| Date Opened or Management | |||||||
| Location | Address | Assumed | |||||
New York Sports Clubs: | |||||||
| Manhattan | 151 East 86th Street | January 1977 | |||||
| Manhattan | 61 West 62nd Street | July 1983 | |||||
| Manhattan | 614 Second Avenue | July 1986 | |||||
| Manhattan | 151 Reade Street | January 1990 | |||||
| Manhattan | 1601 Broadway | September 1991 | |||||
| Manhattan | 50 West 34th Street | August 1992 | |||||
| Manhattan | 349 East 76th Street | April 1994 | |||||
| Manhattan | 248 West 80th Street | May 1994 | |||||
| Manhattan | 502 Park Avenue | February 1995 | |||||
| Manhattan | 117 Seventh Avenue South | March 1995 | |||||
| Manhattan | 303 Park Avenue South | December 1995 | |||||
| Manhattan | 30 Wall Street | May 1996 | |||||
| Manhattan | 1635 Third Avenue | October 1996 | |||||
| Manhattan | 575 Lexington Avenue | November 1996 | |||||
| Manhattan | 278 Eighth Avenue | December 1996 | |||||
| Manhattan | 200 Madison Avenue | February 1997 | |||||
| Manhattan | 131 East 31st Street | February 1997 | |||||
| Manhattan | 2162 Broadway | November 1997 | |||||
| Manhattan | 633 Third Avenue | April 1998 | |||||
| Manhattan | 1657 Broadway | July 1998 | |||||
| Manhattan | 217 Broadway | March 1999 | |||||
| Manhattan | 23 West 73rd Street | April 1999 | |||||
| Manhattan | 34 West 14th Street | July 1999 | |||||
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| Date Opened or Management | ||||||
| Location | Address | Assumed | ||||
| Manhattan | 503-511 Broadway | July 1999 | ||||
| Manhattan | 1372 Broadway | October 1999 | ||||
| Manhattan | 300 West 125th Street | May 2000 | ||||
| Manhattan | 102 North End Avenue | May 2000 | ||||
| Manhattan | 14 West 44th Street | August 2000 | ||||
| Manhattan | 128 Eighth Avenue | December 2000 | ||||
| Manhattan | 2521-23 Broadway | August 2001 | ||||
| Manhattan | 3 Park Avenue | August 2001 | ||||
| Manhattan | 19 Irving Place | November 2001 | ||||
| Manhattan | 160 Water Street | November 2001 | ||||
| Manhattan | 230 West 41st Street | November 2001 | ||||
| Manhattan | 1221 Avenue of the Americas | January 2002 | ||||
| Manhattan | 200 Park Avenue | December 2002 | ||||
| Manhattan | 232 Mercer Street | September 2004 | ||||
| Manhattan | 225 Varick Stret | Future Opening | ||||
| Brooklyn, NY | 110 Boerum Place | October 1985 | ||||
| Brooklyn, NY | 1736 Shore Parkway | June 1998 | ||||
| Brooklyn, NY | 179 Remsen Street | May 2001 | ||||
| Brooklyn, NY | 453 Fifth Avenue | August 2003 | ||||
| Brooklyn, NY | 7118 Third Avenue | May 2004 | ||||
| Brooklyn, NY | 1609 Kings Highway | Future Opening | ||||
| Queens, NY | 69-33 Austin Street | April 1997 | ||||
| Queens, NY | 153-67 A Cross Island Parkway | June 1998 | ||||
| Queens, NY | 2856-2861 Steinway Street | February 2004 | ||||
| Queens, NY | 8000 Cooper Avenue | Future Opening | ||||
| Staten Island, NY | 300 West Service Road | June 1998 | ||||
| Scarsdale, NY | 696 White Plains Road | October 1995 | ||||
| Mamaroneck, NY | 124 Palmer Avenue | January 1997 | ||||
| Croton-on-Hudson, NY | 420 South Riverside Drive | January 1998 | ||||
| Larchmont, NY | 15 Madison Avenue | December 1998 | ||||
| Nanuet, NY | 58 Demarest Mill Road | May 1998 | ||||
| Great Neck, NY | 15 Barstow Road | July 1989 | ||||
| East Meadow, NY | 625 Merrick Avenue | January 1999 | ||||
| Commack, NY | 6136 Jericho Turnpike | January 1999 | ||||
| Oceanside, NY | 2909 Lincoln Avenue | May 1999 | ||||
| Long Beach, NY | 265 East Park Avenue | July 1999 | ||||
| Garden City, NY | 833 Franklin Avenue | May 2000 | ||||
| Huntington, NY | 350 New York Avenue | February 2001 | ||||
| Syosset, NY | 49 Ira Road | March 2001 | ||||
| West Nyack, NY | 3656 Palisades Center Drive | February 2002 | ||||
| Woodmere, NY | 158 Irving Street | March 2002 | ||||
| Hartsdale, NY | 208 E. Hartsdale Avenue | September 2004 | ||||
| Somers, NY | Somers Commons, 80 Route 6 | February 2005 | ||||
| White Plains, NY | 4 City Center | September 2005 | ||||
| Hawthorne, NY | 24 Saw Mill River Road | January 2006 | ||||
| Dobbs Ferry, NY | Lawrence Street | Future Opening | ||||
| Smithtown, NY | Browns Road | Future Opening | ||||
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| Date Opened or Management | ||||||
| Location | Address | Assumed | ||||
| Stamford, CT | 6 Landmark Square | December 1997 | ||||
| Stamford, CT | 16 Commerce Road | Reopened February 2006 | ||||
| Danbury, CT | 38 Mill Plain Road | January 1998 | ||||
| Stamford, CT | 1063 Hope Street | November 1998 | ||||
| Norwalk, CT | 250 Westport Avenue | March 1999 | ||||
| Greenwich, CT | 6 Liberty Way | May 1999 | ||||
| Westport, CT | 427 Post Road, East | January 2002 | ||||
| Greenwich, CT | 67 Mason Street | February 2004 | ||||
| East Brunswick, NJ | 8 Cornwall Court | January 1990 | ||||
| Princeton, NJ | 301 North Harrison Street | May 1997 | ||||
| Freehold, NJ | 200 Daniels Way | April 1998 | ||||
| Matawan, NJ | 163 Route 34 | April 1998 | ||||
| Old Bridge, NJ | Gaub Road and Route 516 | April 1998 | ||||
| Marlboro, NJ | 34 Route 9 North | April 1998 | ||||
| Fort Lee, NJ | 1355 15th Street | June 1998 | ||||
| Ramsey, NJ | 1100 Route 17 North | June 1998 | ||||
| Mahwah, NJ | 7 Leighton Place | June 1998 | ||||
| Parsippany, NJ | 2651 Route 10 | August 1998 | ||||
| Springfield, NJ | 215 Morris Avenue | August 1998 | ||||
| Colonia, NJ | 1250 Route 27 | August 1998 | ||||
| Franklin Park, NJ | 3911 Route 27 | August 1998 | ||||
| Plainsboro, NJ | 10 Schalks Crossing | August 1998 | ||||
| Somerset, NJ | 120 Cedar Grove Lane | August 1998 | ||||
| Hoboken, NJ | 221 Washington Street | October 1998 | ||||
| West Caldwell, NJ | 913 Bloomfield Avenue | April 1999 | ||||
| Jersey City, NJ | 147 Two Harborside Financial Center | June 2002 | ||||
| Newark, NJ | 1 Gateway Center | October 2002 | ||||
| Ridgewood, NJ | 129 S. Broad Street | June 2003 | ||||
| Westwood, NJ | 35 Jefferson Avenue | June 2004 | ||||
| Livingston, NJ | 39 W. North Field Rd. | February 2005 | ||||
| Princeton, NJ | 4250 Route 1 North | April 2005 | ||||
| Hoboken, NJ | 210 14th Street | Future Opening | ||||
| Montclair, NJ | 56 Church Street | Future Opening | ||||
| Englewood, NJ | 34-36 South Dean Street | Future Opening | ||||
Boston Sports Clubs: | ||||||
| Boston, MA | 561 Boylston Street | November 1991 | ||||
| Boston, MA | 1 Bulfinch Place | August 1998 | ||||
| Boston, MA | 201 Brookline Avenue | June 2000 | ||||
| Boston, MA | 361 Newbury Street | November 2001 | ||||
| Boston, MA | 350 Washington Street | February 2002 | ||||
| Boston, MA | 505 Boylston Street | January 2006 | ||||
| Boston, MA | 560 Harrison Avenue | February 2006 | ||||
| Boston, MA | 695 Atlantic Avenue | Future Opening | ||||
| Allston, MA | 15 Gorham Street | July 1997 | ||||
| Natick, MA | Sherwood Plaza, 124 Worcester Rd | September 1998 | ||||
| Weymouth, MA | 553 Washington Street | May 1999 | ||||
| Wellesley, MA | 140 Great Plain Avenue | July 2000 | ||||
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| Date Opened or Management | ||||||
| Location | Address | Assumed | ||||
| Andover, MA | 307 Lowell Street | July 2000 | ||||
| Lynnfield, MA | 425 Walnut Street | July 2000 | ||||
| Lexington, MA | 475 Bedford Avenue | July 2000 | ||||
| Franklin, MA | 750 Union Street | July 2000 | ||||
| Framingham, MA | 1657 Worcester Street | July 2000 | ||||
| Danvers, MA | 50 Ferncroft Road | July 2000 | ||||
| Cambridge, MA | 625 Massachusetts Avenue | January 2001 | ||||
| West Newton, MA | 1359 Washington Street | November 2001 | ||||
| Waltham, MA | 840 Winter Street | November 2002 | ||||
| Watertown, MA | 311 Arsenal Street | January 2006 | ||||
Washington Sports Clubs: | ||||||
| Washington, D.C. | 214 D Street, S.E. | January 1980 | ||||
| Washington, D.C. | 1835 Connecticut Avenue, N.W. | January 1990 | ||||
| Washington, D.C. | 1990 M Street, N.W. | February 1993 | ||||
| Washington, D.C. | 2251 Wisconsin Avenue, N.W. | May 1994 | ||||
| Washington, D.C. | 1211 Connecticut Avenue, N.W. | July 2000 | ||||
| Washington, D.C. | 1345 F Street, N.W. | August 2002 | ||||
| Washington, D.C. | 5346 Wisconsin Ave., N.W. | February 2002 | ||||
| Washington, D.C. | 1990 K Street, N.W. | February 2004 | ||||
| Washington, D.C. | 783 Seventh Street, N.W. | October 2004 | ||||
| Washington, D.C. | 3222 M Street, N.W. | February 2005 | ||||
| Washington, D.C. | 14th Street, NW | Future Opening | ||||
| Bethesda, MD | 4903 Elm Street | May 1994 | ||||
| North Bethesda, MD | 10400 Old Georgetown Road | June 1998 | ||||
| Germantown, MD | 12623 Wisteria Drive | July 1998 | ||||
| Silver Spring, MD | 8506 Fenton Street | November 2005 | ||||
| Bethesda, MD | 6800 Wisconsin Avenue | Future Opening | ||||
| Alexandria, VA | 3654 King Street | June 1999 | ||||
| Sterling, VA | 21800 Town Center Plaza | October 1999 | ||||
| Fairfax, VA | 11001 Lee Highway | October 1999 | ||||
| West Springfield, VA | 8430 Old Keene Mill | September 2000 | ||||
| Clarendon, VA | 2700 Clarendon Boulevard | November 2001 | ||||
Philadelphia Sports Clubs: | ||||||
| Philadelphia, PA | 220 South 5th Street | January 1999 | ||||
| Philadelphia, PA | 2000 Hamilton Street | July 1999 | ||||
| Chalfont, PA | One Highpoint Drive | January 2000 | ||||
| Cherry Hill, NJ | Route 70 and Kings Highway | April 2000 | ||||
| Philadelphia, PA | 1735 Market Street | October 2000 | ||||
| Ardmore, PA | 34 W. Lancaster Avenue | March 2002 | ||||
| Radnor, PA | 555 East Lancaster | Future Opening | ||||
Swiss Sports Clubs: | ||||||
| Basel, Switzerland | St. Johanns-Vorstadt 41 | August 1987 | ||||
| Zurich, Switzerland | Glarnischstrasse 35 | August 1987 | ||||
| Basel, Switzerland | Gellerstrasse 235 | August 2001 | ||||
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| Item 3. | Legal Proceedings |
In December 2005, we settled the action styledJoseph Anaya vs. Town Sports International, Inc. et al., brought by an individual against us in the Supreme Court of the State of New York, New York County, alleging that on January 14, 2003, he sustained serious bodily injury at one of our club locations. He filed an amended complaint on September 17, 2003, seeking $2 billion in damages. His cause of action seeking punitive damages, in the amount of $250 million, was dismissed on January 26, 2004. A Stipulation of Discontinuance was filed on January 27, 2006. The amount of the settlement was within the amount of our available insurance coverage for which payment was made in December 2005.
On March 1, 2005, in an action styledSarah Cruz, et ano v. Town Sports International, Inc., plaintiffs commenced a purported class action against us in the Supreme Court of the State of New York, New York County, seeking unpaid wages and alleging that we violated various overtime provisions of the New York State Labor Law with respect to the payment of wages to certain trainers and assistant fitness managers. We have yet to answer, move or otherwise respond to the complaint and the lawsuit is stayed upon agreement of the parties pending mediation. While we are unable to determine the ultimate outcome of the above actions, we intend to contest the case vigorously.
We and several other third parties have been named as defendants in an action styledCarlos Urbina et ano v 26 Court Street Associates, LLC et al,. filed in the Supreme Court, Kings County, on April 4, 2001, seeking damages for personal injuries. Following a trial, we received a directed verdict for indemnification against one of our contractors and the plaintiff received a jury verdict of approximately $8.9 million in his favor. Both of those verdicts are being appealed and we have filed an appeal bond in the amount of $1.8 million in connection with those appeals. We are vigorously opposing the appeal of the directed verdict and prosecuting the appeal of the jury verdict.
Depending upon the ultimate outcome, these matters may have a material effect on our consolidated financial position, results of operations or cash flows.
We are engaged in other legal actions arising in the ordinary course of business and believe that the ultimate outcome of these actions will not have a material effect on consolidated financial position, results of operations or cash flows.
| Item 4. | Submission of Matters to a Vote of Security Holders |
Not applicable
PART II
| Item 5. | Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities |
Not applicable
| Item 6. | Selected Financial Data |
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(In thousands, except share, per share, club and membership data)
The selected consolidated balance sheet data as of December 31, 2004 and 2005 and the selected consolidated statement of operations and cash flow data for the years ended December 31, 2003, 2004 and 2005 have been derived from our audited consolidated financial statements included elsewhere herein. The selected consolidated balance sheet data as of December 31, 2001, 2002 and 2003 and the selected consolidated statement of operations and cash flow data for the years ended December 31, 2001 and 2002 have been derived from our audited consolidated financial statements not included herein. Other data and club and membership data for all periods presented have been derived from our unaudited books and records. Our historical results are not necessarily indicative of results for any future period. You should read these selected consolidated financial and other data, together with the accompanying notes, in conjunction with
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“Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this annual report and our consolidated financial statements and the related notes appearing at the end of this annual report.
| Year Ended December 31, | |||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | |||||||||||||||||
Statement of Operations Data: | |||||||||||||||||||||
| Revenues | $ | 280,382 | $ | 318,055 | $ | 341,172 | $ | 353,031 | $ | 388,556 | |||||||||||
| Operating expenses: | |||||||||||||||||||||
| Payroll and related | 112,766 | 129,105 | 130,585 | 138,302 | 151,920 | ||||||||||||||||
| Club operating | 88,941 | 99,113 | 111,069 | 116,847 | 130,219 | ||||||||||||||||
| General and administrative | 18,785 | 21,368 | 21,995 | 24,719 | 26,582 | ||||||||||||||||
| Depreciation and amortization(1) | 32,185 | 31,748 | 34,927 | 36,869 | 39,582 | ||||||||||||||||
| Goodwill impairment(2) | — | — | — | 2,002 | — | ||||||||||||||||
| Operating income | 27,705 | 36,721 | 42,596 | 34,292 | 40,253 | ||||||||||||||||
| Loss on extinguishment of debt(3) | — | — | 7,773 | — | — | ||||||||||||||||
| Interest expense, net of interest income | 14,527 | 16,421 | 23,226 | 38,600 | 39,208 | ||||||||||||||||
| Equity in the earnings of investees and rental income | (1,251 | ) | (1,372 | ) | (1,369 | ) | (1,493 | ) | (1,744 | ) | |||||||||||
| Income (loss) from continuing operations before provision for corporate income taxes | 14,429 | 21,672 | 12,966 | (2,815 | ) | 2,789 | |||||||||||||||
| Provision for corporate income taxes | 6,853 | 9,709 | 5,537 | 1,090 | 1,020 | ||||||||||||||||
| Income (loss) from continuing operations | 7,576 | 11,963 | 7,429 | (3,905 | ) | 1,769 | |||||||||||||||
| Loss from discontinued operations(4) (including loss on club closure of $996 in 2002), net of income tax benefit of $551 | (530 | ) | (767 | ) | — | — | — | ||||||||||||||
| Cumulative effect of change in accounting principle, net of income tax benefit of $612(5) | — | (689 | ) | — | — | — | |||||||||||||||
| Net income (loss) | 7,046 | 10,507 | 7,429 | (3,905 | ) | 1,769 | |||||||||||||||
| Accreted dividends on preferred stock | (10,201 | ) | (11,543 | ) | (10,984 | ) | (784 | ) | — | ||||||||||||
| Net income (loss) attributable to common stockholders | $ | (3,155 | ) | $ | (1,036 | ) | $ | (3,555 | ) | $ | (4,689 | ) | $ | 1,769 | |||||||
| As of December 31, | ||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
| Cash and cash equivalents | $ | 5,458 | $ | 5,551 | $ | 40,802 | $ | 57,506 | $ | 51,304 | ||||||||||
| Working capital (deficit) | (42,565 | ) | (43,192 | ) | (9,087 | ) | 7,039 | (2,262 | ) | |||||||||||
| Total assets | 296,005 | 314,250 | 362,199 | 390,956 | 433,771 | |||||||||||||||
| Long-term debt, including current installments | 163,979 | 160,943 | 261,877 | 396,461 | 411,162 | |||||||||||||||
| Redeemable senior preferred stock | 54,687 | 62,125 | — | — | — | |||||||||||||||
| Redeemable Series A preferred stock | 30,432 | 34,841 | 39,890 | — | — | |||||||||||||||
| Total stockholders’ deficit(6) | (32,797 | ) | (31,740 | ) | (34,294 | ) | (117,017 | ) | (115,683 | ) | ||||||||||
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| Year Ended December 31, | |||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | |||||||||||||||||
Cash Flow Data: | |||||||||||||||||||||
| Cash provided by (used in): | |||||||||||||||||||||
| Operating activities | $ | 45,073 | $ | 54,338 | $ | 58,870 | $ | 57,125 | $ | 63,256 | |||||||||||
| Investing activities | (59,083 | ) | (43,715 | ) | (43,351 | ) | (40,686 | ) | (66,338 | ) | |||||||||||
| Financing activities | 16,103 | (10,530 | ) | 19,732 | 265 | (3,120 | ) | ||||||||||||||
Other Data: | |||||||||||||||||||||
| Non-cash rental expense, net of non-cash rental income | 4,224 | 1,670 | 1,650 | 525 | 1,461 | ||||||||||||||||
| Non-cash compensation expense incurred in connection with stock options | 1,149 | 1,207 | 198 | 64 | 279 | ||||||||||||||||
| EBITDA(7) | 60,611 | 68,385 | 71,119 | 72,654 | 81,579 | ||||||||||||||||
| EBITDA margin(8) | 21.6 | % | 21.5 | % | 20.8 | % | 20.6 | % | 21.0 | % | |||||||||||
| Year Ended December 31, | ||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||
Club and Membership Data: | ||||||||||||||||||||
| New clubs opened | 12 | 8 | 3 | 5 | 5 | |||||||||||||||
| Clubs acquired | 2 | 4 | — | 3 | 2 | |||||||||||||||
| Clubs closed, relocated or sold | — | (2 | ) | (3 | ) | — | (3 | ) | ||||||||||||
| Wholly owned clubs operated at end of period | 117 | 127 | 127 | 135 | 139 | |||||||||||||||
| Total clubs operated at end of period(9) | 119 | 129 | 129 | 137 | 141 | |||||||||||||||
| Members at end of period(10) | 317,000 | 342,000 | 342,000 | 383,000 | 409,000 | |||||||||||||||
| Comparable club revenue increase (11) | 14.5% | 5.8% | 3.5% | 2.5% | 6.9% | |||||||||||||||
| Mature club revenue increase (12) | 12.3% | 4.1% | 1.6% | 2.1% | 5.8% | |||||||||||||||
| Revenue per weighted average club(13) | $ | 2,592 | $ | 2,581 | $ | 2,680 | $ | 2,680 | $ | 2,816 | ||||||||||
| Average revenue per member(14) | 937 | 964 | 987 | 960 | 968 | |||||||||||||||
| (1) | Effective January 1, 2002 we implemented Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” In connection with this implementation, we no longer amortize goodwill, but rather test it for impairment when circumstances indicate it is necessary, and at a minimum annually. The following table reconciles reported net income to net income adjusted for the pro forma implementation of SFAS No. 142 for the periods presented: |
| Year Ended | ||||
| December 31, | ||||
| 2001 | ||||
| Net income as reported | $ | 7,046 | ||
| Goodwill amortization | 4,436 | |||
| Deferred tax benefit | (1,344 | ) | ||
| Accreted dividends on preferred stock | (10,201 | ) | ||
| Net loss attributable to common stockholders as adjusted | $ | (63 | ) | |
| (2) | In the quarter ended March 31, 2004, we performed our annual impairment test. Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined based on purchase price allocation. As a result of this review, we determined that the goodwill at one of our remote clubs was not recoverable. The goodwill impairment associated with this |
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| underperforming club amounted to $2,002. A deferred tax benefit of $881 was recorded in connection with this impairment. Since this club is remote from one of our clusters, it does not benefit from the competitive advantage that our clustered clubs have, and as a result it is more susceptible to competition. We have reduced our projections of future cash flows of this club to take into account the impact of a recent opening of a competitor. | |
| (3) | The $7,773 loss on extinguishment of debt recorded in 2003 is a result of the refinancing of our debt on April 16, 2003. In connection with this refinancing, we wrote off $3,700 of deferred financing costs related to extinguished debt, paid a $3,000 call premium and incurred $1,000 of additional interest on TSI, Inc.’s 93/4% notes representing interest incurred during the30-day redemption notification period. |
| (4) | In the quarter ended December 31, 2002, we closed or sold two remote underperforming, wholly owned clubs. In connection with the closure of one of the clubs, we recorded club closure costs of $996 related to the write-off of fixed assets. We have accounted for these two clubs as discontinued operations and, accordingly, the results of their operations have been classified as discontinued in our consolidated statement of operations and prior periods have been reclassified in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” |
Revenues and loss from operations from these discontinued clubs was as follows for the periods presented:
| Year Ended | ||||||||
| December 31, | ||||||||
| 2001 | 2002 | |||||||
| Revenues | $ | 1,660 | $ | 1,607 | ||||
| Loss from operations of discontinued clubs (including loss on club closure of $996 in 2002) | (894 | ) | (1,318 | ) | ||||
| Benefit from corporate income tax | (364 | ) | (551 | ) | ||||
| Loss from discontinued operations | $ | (530 | ) | $ | (767 | ) | ||
| (5) | Effective January 1, 2002, we implemented SFAS No. 142. In connection with the SFAS No. 142 transitional impairment test, we recorded a $1,300 write-off of goodwill. A deferred tax benefit of $612 was recorded as a result of this goodwill write-off, resulting in a net cumulative effect of change in accounting principle of $689 in 2002. The write-off of goodwill related to four remote underperforming clubs. The impairment test was performed with discounted estimated future cash flows as the criteria for determining fair market value. The impairment loss recorded was measured by comparing the carrying value to the fair value of impaired goodwill. |
| (6) | In 2004, we paid a common stock distribution totaling $68,900, or $52.50 per share. |
| (7) | EBITDA consists of net income (loss) plus interest expense, net of interest income, provision for corporate income taxes and depreciation and amortization. This term, as we define it, may not be comparable to a similarly titled measure used by other companies and is not a measure of performance presented in accordance with generally accepted accounting principles or GAAP. We use EBITDA as a measure of operating performance. EBITDA should not be considered as a substitute for net income, operating income, cash flows provided by operating activities or other income or cash flow data prepared in accordance with GAAP. The funds depicted by EBITDA are not necessarily available for discretionary use if they are reserved for particular capital purposes, to maintain compliance with debt covenants, to service debt or to pay taxes. Additional details related to EBITDA are provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Non-GAAP Financial Measures.” |
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The following table reconciles net income (loss), the most directly comparable GAAP measure, to EBITDA:
| Year Ended December 31, | |||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | |||||||||||||||||
| Net income (loss) | $ | 7,046 | $ | 10,507 | $ | 7,429 | $ | (3,905 | ) | $ | 1,769 | ||||||||||
| Interest expense, net of interest income | 14,527 | 16,421 | 23,226 | 38,600 | 39,208 | ||||||||||||||||
| Provision for corporate income taxes | 6,853 | 9,709 | 5,537 | 1,090 | 1,020 | ||||||||||||||||
| Cumulative effect of change in accounting principle | — | 689 | — | — | — | ||||||||||||||||
| Loss from discontinued operations | 530 | 767 | — | — | — | ||||||||||||||||
| Equity in the earnings of investees and rental income | (1,251 | ) | (1,372 | ) | (1,369 | ) | (1,493 | ) | (1,744 | ) | |||||||||||
| Loss on extinguishment of debt | — | — | 7,773 | — | — | ||||||||||||||||
| Operating income | 27,705 | 36,721 | 42,596 | 34,292 | 40,253 | ||||||||||||||||
| Loss from discontinued operations | (530 | ) | (767 | ) | — | — | — | ||||||||||||||
| Equity in the earnings of investees and rental income | 1,251 | 1,372 | 1,369 | 1,493 | 1,744 | ||||||||||||||||
| Cumulative effect of change in accounting principle | — | (689 | ) | — | — | — | |||||||||||||||
| Loss on extinguishment of debt | — | — | (7,773 | ) | — | — | |||||||||||||||
| Depreciation and amortization | 32,185 | 31,748 | 34,927 | 36,869 | 39,582 | ||||||||||||||||
| EBITDA | $ | 60,611 | $ | 68,385 | $ | 71,119 | $ | 72,654 | $ | 81,579 | |||||||||||
| (8) | EBITDA margin is the ratio of EBITDA to total revenue. | |
| (9) | Includes wholly owned and partly owned clubs. In addition, as of December 31, 2005, we managed five university fitness clubs in which we did not have an equity interest. |
| (10) | Represents members at wholly owned and partly owned clubs. |
| (11) | Total revenue for a club is included in comparable club revenue increase beginning on the first day of the thirteenth full calendar month of the club’s operation. |
| (12) | We define mature club revenue as revenue from clubs operated by us for more than 24 months. |
| (13) | Revenue per weighted average club is calculated as total revenue divided by the product of the total number of clubs and their weighted average months in operation as a percentage of the period. |
| (14) | Average revenue per member is total revenue for the period divided by the average number of memberships for the period, where average number of memberships for the period is derived by dividing the sum of the total memberships at the end of each month during the period by the total number of months in the period. |
| Item 7. | Management’s Discussion and Analysis of Financial Condition & Results of Operations |
You should read the following discussion and analysis of our financial condition and consolidated results of operations in conjunction with the “Selected Consolidated Financial and Other Data” section of this annual report and our consolidated financial statements and the related notes appearing at the end of this annual report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth in the “Risk Factors” section and elsewhere in this annual report.
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Overview
We are one of the two leading owners and operators of fitness clubs in the Northeast and Mid-Atlantic regions of the United States and the third largest fitness club operator in the United States, in each case as measured by number of clubs. As of December 31, 2005, we owned and operated 139 fitness clubs and partly owned and operated two fitness clubs. These 141 clubs collectively served approximately 409,000 members. We have developed and refined our urban-commuter fitness club model through our clustering strategy, offering fitness clubs close to our members’ work and home. Our club model targets the “upper value” market segment, comprising individuals aged between 21 and 50 with income levels between $50,000 and $150,000 per year. We believe that the upper value segment is not only the broadest segment of the market, but also the segment with the greatest growth opportunities.
Our revenues, operating income, net income and EBITDA for the year ended December 31, 2005 were $388.6 million, $40.3 million, $1.8 million and $81.6 million, respectively. Our revenues, operating income, net loss and EBITDA for the year ended December 31, 2004 were $353.0 million, $34.3 million, $3.9 million and $72.7 million, respectively.
Our goal is to be the most recognized health club network in each of the four major metropolitan regions we serve. We believe that our strategy of clustering clubs provides significant benefits to our members and allows us to achieve strategic operating advantages. In each of our markets, we have developed clusters by initially opening or acquiring clubs located in the more central urban markets of the region and then branching out from these urban centers to suburbs and neighboring communities. Benefitting from the clustering of clubs, as of December 31, 2005, approximately 45% of our members participated in our passport membership plan that allows unlimited access to all of our clubs in our clusters for a higher monthly membership fee.
We have executed our clustering strategy successfully in the New York region through the network of fitness clubs we operate under our New York Sports Clubs brand name. We are the largest fitness club operator in Manhattan with 37 locations (more than twice as many as our nearest competitor) and operate a total of 95 clubs under the New York Sports Clubs brand name within a50-mile radius of New York City. We operate 18 clubs in the Boston region under our Boston Sports Clubs brand name, 19 clubs in the Washington, D.C. region under our Washington Sports Clubs brand name and are establishing a similar cluster in the Philadelphia region with six clubs under our Philadelphia Sports Clubs brand name. In addition, we operate three clubs in Switzerland. We employ localized brand names for our clubs to create an image and atmosphere consistent with the local community and to foster recognition as a local network of quality fitness clubs rather than a national chain.
We consider that we have two principal sources of revenues:
| • | Our largest sources of revenue are membership revenues consisting of dues and initiation fees paid by our members. This comprises 82.8% of our total revenue for the year ended December 31, 2005. We recognize revenue from membership dues in the month when the services are rendered. Approximately 93% of our members pay their monthly dues by electronic funds transfer, or EFT, while the remaining 7% of our members pay annually in advance. We recognize revenue from initiation fees over the expected average life of the membership. It is important therefore to operate facilities that are convenient, offer good price/value relationship and have a wide variety of fitness service offerings in order to attract and retain members at each facility. | |
| • | We generated 16.1% of our revenue for the year ended December 31, 2005 from ancillary club revenue. Ancillary club revenue consists of personal training, programming for children, group fitness training and other member activities, as well as sales of miscellaneous sports products. This total ancillary club revenue stream has increased as a percentage of total revenue more recently as we have focused on increasing revenue per member from our maturing club base. |
The balance of our revenue (approximately 1.1% in 2005) principally relates to rental of space in our facilities to operators who offer wellness-related offerings such as physical therapy. In addition, we generate management fees from certain club facilities that we do not wholly own and sell in-club advertising and sponsorships. We refer to this as Fees and Other revenue. Settlements from our business interruption
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insurance claim associated with the terrorist attacks of September 11, 2001 are separately disclosed. These settlements occurred in 2002 and 2003 and totaled $1.0 million and $2.8 million for the years ended December 31, 2002 and 2003, respectively.
Revenue consists of:
| Year Ended December 31, | ||||||||||||||
| 2003 | 2004 | 2005 | ||||||||||||
| (In thousands) | ||||||||||||||
| Membership dues | $ | 273,334 | $ | 282,716 | $ | 309,811 | ||||||||
| Initiation fees | 13,892 | 12,439 | 11,916 | |||||||||||
| Membership revenue | 287,226 | 295,155 | 321,727 | |||||||||||
| Personal training revenue | 31,170 | 34,821 | 42,277 | |||||||||||
| Other ancillary club revenue | 17,269 | 18,199 | 20,139 | |||||||||||
| Ancillary club revenue | 48,439 | 53,020 | 62,416 | |||||||||||
| Total club revenue | 335,665 | 348,175 | 384,143 | |||||||||||
| Fees and Other revenue | 2,707 | 4,856 | 4,413 | |||||||||||
| Business interruption insurance proceeds | 2,800 | — | — | |||||||||||
| Total revenue | $ | 341,172 | $ | 353,031 | $ | 388,556 | ||||||||
Our operating and selling expenses are comprised of both fixed and variable costs. Fixed costs include club and supervisory salary and related expenses, occupancy costs including certain elements of rent, housekeeping and contracted maintenance expenses, as well as depreciation. Variable costs are primarily related to payroll associated with ancillary club revenue, membership sales compensation, advertising, utilities, certain facility repairs, insurance and club supplies. As clubs mature and increase their membership base, fixed costs are typically spread over an increasing revenue base and our operating margins tend to improve.
General and administrative expenses include costs relating to our centralized support functions, such as accounting, information systems, purchasing and member relations, as well as consulting fees and real estate development expenses.
Our primary capital expenditures relate to the construction of new club facilities and upgrading and expanding our existing clubs. The construction and equipment costs for new clubs vary based on the costs of construction labor, as well as the planned service offerings and size and configuration of the facility. We perform routine improvements at our clubs and replacement of the fitness equipment each year for which we budget approximately 4.0% of annual revenue. Expansions of certain facilities are also performed from time to time, when incremental space becomes available on economic terms, and utilization and demand for the facility dictates. In this connection, facility remodeling is also considered where appropriate.
During the last several years, we have increased revenues, operating income, cash flows provided by operating activities and EBITDA by expanding our club base in New York, Boston, Washington, D.C. and Philadelphia. As a result of expanding our club base and the relatively fixed nature of our operating costs, our operating income has increased from $27.7 million for the year ended December 31, 2001 to $40.2 million for the year ended December 31, 2005. Cash flows provided by operating activities increased from $45.1 million in 2001 to $63.3 million in 2005. EBITDA increased from $60.6 million in 2001 to $81.6 million in 2005. Net income was $7.0 million in 2001 and $1.8 million in 2005. Net income decreased from 2001 to 2005
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principally due to the additional interest expense recorded in connection with the February 2004 Senior Discount Note offering.
| Year Ended December 31, | |||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | |||||||||||||||||
| Operating income | $ | 27,705 | $ | 36,721 | $ | 42,596 | $ | 34,292 | $ | 40,253 | |||||||||||
| Increase (decrease) over prior period | 24.3 | % | 32.5 | % | 16.0 | % | (19.5 | )% | 17.4 | % | |||||||||||
| Net income (loss) | $ | 7,046 | $ | 10,507 | $ | 7,429 | $ | (3,905 | ) | $ | 1,769 | ||||||||||
| Increase (decrease) over prior period | 45.8 | % | 49.1 | % | (29.3 | )% | (152.6 | )% | 145.3 | % | |||||||||||
| Cash flows provided by operating activities | $ | 45,073 | $ | 54,338 | $ | 58,870 | $ | 57,125 | $ | 63,256 | |||||||||||
| Increase (decrease) over prior period | 5.8 | % | 20.6 | % | 8.3 | % | (3.0 | )% | 10.7 | % | |||||||||||
| EBITDA | $ | 60,611 | $ | 68,385 | $ | 71,119 | $ | 72,654 | $ | 81,579 | |||||||||||
| Increase over prior period | 23.1 | % | 12.8 | % | 4.0 | % | 2.2 | % | 12.3 | % | |||||||||||
We have focused on building or acquiring club facilities in areas where we believe the market is underserved or where new clubs are intended to replace existing clubs at their lease expiration. Based on our historical experience, a new club tends to experience a significant increase in revenues during its first three years of operation as it reaches maturity. Because there is relatively little incremental cost associated with such increasing revenue, there is a greater proportionate increase in profitability. We believe that the revenues and operating income of our immature clubs will increase as they mature. As a result of our expansion, however, operating income margins may be negatively impacted in the near term, as further new clubs are added.
As of December 31, 2005, 139 of the existing fitness clubs were wholly owned by us and our consolidated financial statements include the operating results of all such clubs. Two locations in Washington, D.C. were managed and partly owned by us, with our profit sharing percentages approximating 20% (after priority distributions) and 45%, respectively, and are treated as unconsolidated affiliates. In addition, we provide management services at four university fitness clubs in which we have no equity interest.
Historical Club Growth
| Year Ended December 31, | ||||||||||||||||||||
| 2001 | 2002 | 2003 | 2004 | 2005 | ||||||||||||||||
| Wholly owned clubs operated at beginning of period | 103 | 117 | 127 | 127 | 135 | |||||||||||||||
| New clubs opened | 12 | 8 | 3 | 5 | 5 | |||||||||||||||
| Clubs acquired | 2 | 4 | — | 3 | 2 | |||||||||||||||
| Clubs closed, relocated or sold(1) | — | (2 | ) | (3 | ) | — | (3 | ) | ||||||||||||
| Wholly owned clubs operated at end of period | 117 | 127 | 127 | 135 | 139 | |||||||||||||||
| Total clubs operated at end of period(2) | 119 | 129 | 129 | 137 | 141 | |||||||||||||||
| (1) | In 2005, we temporarily closed a club for a renovation and expansion. This club reopened in February 2006. |
| (2) | Includes wholly owned and partly owned clubs. In addition, as of December 31, 2004 and 2005, we managed five university fitness clubs in which we did not have an equity interest. |
Existing Club Revenue
We define comparable club revenue as revenue at those clubs that were operated by us for over 12 months and comparable club revenue growth as revenue for the 13th month and thereafter as applicable as compared to the same period at the prior year. We define mature club revenue as revenue at those clubs that were operated by us for the entire period presented and that same entire period of the preceding year. Under this definition, mature clubs for periods shown are those clubs that were operated for more than 24 months.
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The following table depicts our comparable club and mature club revenue growth for each of the quarters and years beginning January 1, 2003 forward.
| Comparable Club | Mature Club | ||||||||||||||||
| Revenue | Revenue | ||||||||||||||||
| Quarter | Full Year | Quarter | Full Year | ||||||||||||||
2003 | |||||||||||||||||
| Q1 | 6.2 | % | 1.8 | % | |||||||||||||
| Q2 | 3.6 | % | (0.2 | )% | |||||||||||||
| Q3 | 2.2 | % | (0.5 | )% | |||||||||||||
| Q4 | 1.1 | % | 3.5 | % | (0.8 | )% | 1.6 | % | |||||||||
2004 | |||||||||||||||||
| Q1 | (0.1 | )% | (0.5 | )% | |||||||||||||
| Q2 | 1.6 | % | 1.3 | % | |||||||||||||
| Q3 | 4.1 | % | 2.8 | % | |||||||||||||
| Q4 | 4.6 | % | 2.5 | % | 3.8 | % | 2.1 | % | |||||||||
2005 | |||||||||||||||||
| Q1 | 6.0 | % | 4.8 | % | |||||||||||||
| Q2 | 7.0 | % | 5.7 | % | |||||||||||||
| Q3 | 6.1 | % | 5.1 | % | |||||||||||||
| Q4 | 8.5 | % | 6.9 | % | 7.1 | % | 5.8 | % | |||||||||
Key determinants of comparable club revenue growth are new memberships, member retention rates, pricing and ancillary revenue growth. The commit membership model that we implemented in 2003 encourages new members to commit to a one- or two-year membership at a discount to themonth-to-month plan and with a discounted initiation fee. Since the implementation of the new membership model, attrition rates have declined and comparable club revenues have increased.
Non-GAAP Financial Measures
We use the term “EBITDA” throughout this annual report, as well as “EBITDA margin.” EBITDA consists of net income (loss) plus interest expense, net of interest income, provision for (benefit from) corporate income taxes and depreciation and amortization. This term, as we define it, may not be comparable to a similarly titled measure used by other companies and is not a measure of performance presented in accordance with GAAP.
We use EBITDA and EBITDA margin as measures of operating performance. EBITDA should not be considered as a substitute for net income, operating income, cash flows provided by operating activities or other income or cash flow data prepared in accordance with GAAP. The funds depicted by EBITDA are not necessarily available for discretionary use if they are reserved for particular capital purposes, to maintain compliance with debt covenants, to service debt or to pay taxes.
We believe EBITDA is useful to an investor in evaluating our operating performance because:
| • | it is a widely accepted financial indicator of a company’s ability to service its debt and we are required to comply with certain covenants and borrowing limitations that are based on variations of EBITDA in certain of our financing documents; | |
| • | it is widely used to measure a company’s operating performance without regard to items such as depreciation and amortization, which can vary depending upon accounting methods and the book value of assets, and to present a meaningful measure of corporate performance exclusive of our capital structure and the method by which assets were acquired; and | |
| • | it helps investors to more meaningfully evaluate and compare the results of our operations from period to period by removing from our operating results the impact of our capital structure, primarily interest |
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| expense from our outstanding debt, and asset base, primarily depreciation and amortization of our properties. |
Our management uses EBITDA:
| • | as a measurement of operating performance because it assists us in comparing our performance on a consistent basis, as it removes from our operating results the impact of our capital structure, which includes interest expense from our outstanding debt, and our asset base, which includes depreciation and amortization of our properties; and | |
| • | in presentations to the members of our board of directors to enable our board to have the same consistent measurement basis of operating performance used by management. |
We have provided reconciliations of EBITDA to net income (loss), the most directly comparable GAAP measure, in footnote 8 under “Selected Consolidated Financial and Other Data.”
Results of Operations
The following table sets forth certain operating data as a percentage of revenue for the periods indicated:
| Year Ended December 31, | ||||||||||||
| 2003 | 2004 | 2005 | ||||||||||
| Revenues | 100.0% | 100.0 | % | 100.0% | ||||||||
| Operating expenses: | ||||||||||||
| Payroll and related | 38.3 | 39.2 | 39.1 | |||||||||
| Club operating | 32.6 | 33.1 | 33.5 | |||||||||
| General and administrative | 6.4 | 7.0 | 6.8 | |||||||||
| Depreciation and amortization | 10.2 | 10.4 | 10.2 | |||||||||
| Goodwill impairment | — | 0.6 | — | |||||||||
| Operating income | 12.5 | 9.7 | 10.4 | |||||||||
| Loss on extinguishment of debt | 2.3 | — | — | |||||||||
| Interest expense | 6.9 | 11.1 | 10.7 | |||||||||
| Interest income | (0.1 | ) | (0.2 | ) | (0.6 | ) | ||||||
| Equity in the earnings of investees and rental income | (0.4 | ) | (0.4 | ) | (0.4 | ) | ||||||
| Income (loss) before provision for corporate income taxes | 3.8 | (0.8 | ) | 0.7 | ||||||||
| Provision for corporate income taxes | 1.6 | 0.3 | 0.3 | |||||||||
| Net income (loss) | 2.2 | (1.1 | ) | 0.4 | ||||||||
| Accreted dividends on preferred stock | (3.2 | ) | (0.2 | ) | — | |||||||
| Net income (loss) attributable to common stockholders | (1.0 | )% | (1.3 | )% | 0.4% | |||||||
YEAR ENDED DECEMBER 31, 2005 COMPARED TO
YEAR ENDED DECEMBER 31, 2004
Revenues
Revenues increased $35.5 million, or 10.1%, to $388.6 million during the year ended December 31, 2005 from $353.0 million during the year ended December 31, 2004. Revenues increased during the twelve months by $19.8 million, or 5.8%, at our mature clubs (clubs owned and operated for at least 24 months). Revenues increased $8.2 million at the eight clubs opened during 2004 and $9.2 million at the seven clubs opened during 2005. These increases were offset by a decrease in revenue related to the three clubs that were closed or relocated during 2005.
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The 5.8% increase in mature club revenue is due to a 3.5% increase in membership, a 1.6% increase in ancillary revenue and a 0.7% increase in membership price.
Our mature club revenue increased 1.6%, 2.1% and 5.8% for the years ended December 31, 2003, 2004 and 2005 respectively.
Operating Expenses
Operating expenses increased $29.6 million, or 9.3%, to $348.3 million in the year ended December 31, 2005, from $318.7 million in the year ended December 31, 2004. The increase was due to the following increases in payroll and related expenses, club operating expenses, general and administrative expenses and depreciation and amortization:
Payroll and related. Payroll and related expenses increased by $13.6 million or 9.8% to $151.9 million in the year ended December 31, 2005, from $138.3 million in the year ended December 31, 2004. This increase was principally attributable to a 5.5% increase in the total months of club operations from 1,568 to 1,655, as well as the following:
| • | Payroll costs directly related to personal training, Group Exclusives and programming for children increased $5.5 million, or 23.6%, due to an increase in demand for these programs. | |
| • | An offset to the increases in payroll relate to a $1.1 million one-time bonus received by vested option holders in the first quarter of 2004 in connection with a common stock distribution, while no such bonus payment was made in 2005. |
Club operating. Club operating expenses increased by $13.4 million, or 11.4%, to $130.2 million in the year ended December 31, 2005, from $116.8 million in the year ended December 31, 2004. This increase was principally attributable to the following:
| • | A $7.6 million increase in rent expense. Rent expense related to our club base that has been open less than 24 months increased $5.2 million and rent expense at our clubs open over 24 months increased $2.4 million or 3.9%. | |
| • | Utility costs increased $2.6 million. Gas and electric costs increased by $2.6 million, or 19.9% from $13.0 million in 2004 to $15.6 million in 2005. While overall square footage under management increased by 4.8% during 2005, a significant portion of the increase was due to the increase in natural gas prices, principally in the fourth quarter, which is the underlying natural resource used for electricity generation in the north eastern United States. | |
| • | Advertising expense increased $1.3 million. Advertising expense, as a percent of revenue increased to 2.7% of total revenue for the year ended December 31, 2005 from 2.5% of total revenue during the same period in 2004. |
General and administrative. General and administrative expenses increased $1.8 million or 7.5% to $26.6 million in the year ended December 31, 2005 from $24.7 million during the same period in 2004. This increase was principally attributable to the following:
| • | Accounting and consulting fees and expenses increased by $468,000 principally due to increases in audit and consulting fees with respect to the Sarbanes- Oxley Act — Section 404 preparedness. | |
| • | Legal and related costs increased $1.0 million due to an increase in costs relating to new club leases, as well as increased litigation for both new and existing matters incurred in the normal course of business. | |
| • | Costs incurred in connection with the examination of financing alternatives totaled $928,000. | |
| • | These increases were offset by a $372,000 or 8.2% decrease in liability insurance costs. |
Depreciation and amortization. Depreciation and amortization increased by $2.7 million, or 7.4%, to $39.6 million in the year ended December 31, 2005, from $36.9 million in the same period in 2004 principally due to new and expanded clubs.
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Interest Expense
Interest expense increased $2.2 million to $41.6 million during the year period ended December 31, 2005 from $39.3 million during the same period in 2004. This increase is due to the issuance of the Discount Notes in February 2004.
Interest Income
Interest income increased $1.6 million to $2.3 million during the year ended December 31, 2005 from $743,000 during the same period in 2004. This increase is principally due to the increase in the rate of interest earned on invested cash.
Provision for Corporate Income Taxes
We have recorded an income tax provision of $1.0 million during the year ended December 31, 2005 compared to $1.1 million during the same period 2004.
Accreted Dividends on Preferred Stock
In connection with the February 2004 issuance of the Discount Notes, all outstanding preferred stock was redeemed. Therefore, we did not accrete dividends in 2005, while in 2004 dividends in an amount of $783,000 were accreted.
YEAR ENDED DECEMBER 31, 2004 COMPARED TO
YEAR ENDED DECEMBER 31, 2003
Revenues
Revenues increased $11.8 million, or 3.5%, to $353.0 million during 2004, from $341.2 million in 2003. This increase resulted from the three clubs opened or acquired in 2003 (approximately $4.9 million), and the eight clubs opened or acquired in 2004 (approximately $4.6 million). In addition, revenues increased during 2004 by approximately $6.8 million, or 2.1%, at our mature clubs. These increases were offset by a $2.5 million decrease in revenues related to the three clubs we relocated in 2003. Comparable club revenue increased during the year by 2.5%. In 2003, we received $2.8 million of insurance proceeds related to our business interruption insurance final settlement and such proceeds were classified as Fees and Other revenue. In 2004, no such business interruption proceeds were received.
The 2.1% increase in mature club revenue is due to a 2.8% increase in membership and a 1.4% increase in ancillary revenue, offset by a 2.1% decrease in membership price.
Our mature club revenue increased 4.1%, 1.6% and 2.1% for the years ended December 31, 2002, 2003 and 2004, respectively.
Operating Expenses
Operating expenses increased $20.2 million, or 6.8%, to $318.8 million in 2004, from $298.6 million in 2003. The increase was due to increases in payroll and related expenses, club operating expenses, general and administrative expenses and depreciation and amortization:
Payroll and related. Payroll and related expenses increased by $7.7 million, or 5.9%, to $138.3 million in 2004, from $130.6 million in 2003. This increase was attributable to the following factors:
| • | In connection with the restructuring and distribution to common stockholders of TSI Holdings, vested common stock option holders, who did not exercise their options, were paid a one-time bonus recorded as payroll expense. This one-time payment totaled $1.1 million. See “— Liquidity and Capital Resources.” |
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| • | In an effort to increase membership satisfaction and improve our membership retention rates, we have increased the level of in-house training and club support personnel and have moved from third-party contracted equipment maintenance and housekeeping services to in-house supplied labor for these services. These customer service efforts resulted in a $2.4 million increase in payroll expense with a commensurate savings in club operating expenses. | |
| • | Personal training and Sports Clubs for Kids programming payroll expense increased $2.0 million, or 9.3%, to $23.2 million in 2004 from $21.2 million in 2003 to support increases in revenue generated by these programs and services. | |
| • | Payroll expense related to management in our legal, marketing, training and development and club operations departments increased a total of $486,000. | |
| • | Payroll taxes and benefits increased $1.5 million due to increases in total payroll and increases in healthcare costs. |
Club operating. Club operating expenses increased by $5.7 million, or 5.1%, to $116.8 million in 2004, from $111.1 million in 2003. This increase is principally attributable to the following:
| • | A $4.1 million increase in rent expense principally resulting from increases related to clubs that have opened since, or expanded after, December 2003. | |
| • | Facility repairs and maintenance costs increased $1.9 million, or 27.0%. Incremental costs to support our initiatives to increase member satisfaction and improve member retention contributed to this increase. | |
| • | In addition, we experienced a $611,000 increase in utilities due to increases in utility rates, and a 5.1% increase in square footage in operation. | |
| • | The aforementioned increases in club operating expense were partially offset by a $789,000 decrease in advertising costs as well as a $314,000 decrease in equipment maintenance costs that were predominately outsourced to third parties in 2003 and moved to in-house labor in 2004. |
General and administrative. General and administrative expenses increased by $2.7 million, or 12.3%, to $24.7 million in 2004, from $22.0 million in 2003:
| • | Liability insurance expense increased by $690,000. Premiums increased $327,000 coupled with a favorable adjustment of $363,000 recorded in the first quarter of 2003, where we had adjusted our reserves related to premium audits. | |
| • | We also experienced an increase of $700,000 in data communication lines costs. This related in part to the correction of our service provider’s billing errors in the first half of 2004 that amounted to a $429,000 increase. These costs also increased due to data-line redundancies created at our clubs to safeguard against single line outages. Furthermore, data-line traffic increased in 2004 due to the completion of our Club Network systems rollout that began in 2003. | |
| • | Accounting and tax consulting fees increased $622,000 principally due to an increase in accounting services related to our senior discount note offering in February 2004, and increases in consulting with respect to compliance with Section 404 of the Sarbanes-Oxley Act. | |
| • | Legal fees increased by $447,000 principally due to an increase in the number of new club leases and expansions executed. | |
| • | In an effort to increase member satisfaction and improve member retention rates, we have increased staff development and recruiting costs. These customer service efforts resulted in an increase of $292,000 over the prior year. |
Depreciation and amortization. Depreciation and amortization increased by $2.0 million, or 5.7%, to $36.9 million in 2004, from $34.9 million in 2003. This increase was principally attributable to increases in depreciation at new, expanded and remodeled clubs.
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| Goodwill Impairment |
In the quarter ended March 31, 2004, we performed our annual impairment test. Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered to be impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined based on purchase price allocation. As a result of this review, we determined that the goodwill at one of our remote clubs was not recoverable. The goodwill impairment associated with this under performing club amounted to $2.0 million. A deferred tax benefit of $881,000 has been recorded in connection with this impairment. Since this club is remote from one of our clusters, it does not benefit from the competitive advantage that our clustered clubs have, and as a result it is more susceptible to competition. We have reduced our projections of future cash flows of this club to take into account the impact of a recent opening of a competitor.
| Interest Expense |
Interest expense increased $15.6 million to $39.3 million in 2004 from $23.7 million in 2003. Interest expense increased $12.8 million due to the issuance of our senior discount notes in February 2004 while the remainder of the increase was principally due to the refinancing of our senior notes in April 2003 as discussed in “— Liquidity and Capital Resources.”
| Interest Income |
Interest income increased $299,000 to $743,000 in 2004 from $444,000 in 2003. This increase is due to increases in cash balances in 2004 compared to 2003. Average interest rates earned on cash balances also increased in 2004 when compared to 2003.
| Equity in the earnings of investees and rental income |
Equity in the earnings of investees and rental income increased from $1.4 million in 2003 to $1.5 million in 2004 principally due to increases in rent charged to our tenant.
| Provision for Income Tax |
The provision for corporate income taxes decreased $4.4 million from $5.5 million in 2003 to $1.1 million in 2004. In 2004 we recorded tax charges related to:
| • | A $597,000 increase in the deferred tax valuation allowance to reserve for state net operating losses that may not be utilized in future periods. | |
| • | Change in the allocation factors used in the computation of our New York State taxes, caused by revenue, payroll and asset growth outside of New York State, resulting in a deferred tax charge of approximately $340,000. | |
| • | Relief of our deferred tax asset totaling $1.1 million, associated with deferred compensation expense related to exercised stock options. |
| Accreted Dividends on Preferred Stock |
In connection with the February 4, 2004 senior discount note offering, all outstanding shares of Series A and Series B preferred stock were redeemed. After giving effect to these redemptions, our capital structure no longer has outstanding preferred stock and therefore no dividends have been accreted in periods subsequent to February 2004.
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| Liquidity and Capital Resources |
Historically, we have satisfied our liquidity needs through cash from operations and various borrowing arrangements. Principal liquidity needs have included the acquisition and development of new clubs, debt service requirements and other capital expenditures necessary to upgrade, expand and renovate existing clubs.
Operating Activities. Net cash provided by operating activities for the year ended December 31, 2005 was $63.3 million compared to $57.1 million during the year ended December 31, 2004. Net cash flows from operations have increased with profitability and due to a $6.1 million increase in cash provided by landlord contributions to tenant improvements, offset by a net increase of $9.0 million in cash paid for income taxes during the year ended December 31, 2005 when compared to 2004. The Jobs and Growth Tax Relief Reconciliation Act of 2003 permitted an acceleration of tax depreciation on 2004 capital improvements while no such acceleration was permitted in 2005. This resulted in an increase in cash paid for taxes when comparing the year 2005 to 2004.
Excluding the effects of cash and cash equivalent balances, we normally operate with a working capital deficit because we receive dues and program and services fees either (i) during the month services are rendered, or (ii) whenpaid-in-full, in advance. As a result, we typically do not have significant accounts receivable. We record deferred liabilities for revenue received in advance in connection with dues and servicespaid-in-full and for initiation fees paid at the time of enrollment. Initiation fees received and have been deferred and amortized over a24-month period, which represents the approximate life of a member. At the time a member joins our club we incur enrollment costs which have been deferred over 24 months. These costs typically offset the impact initiation fees have on working capital. We do not believe we will have to finance this working capital deficit in the foreseeable future, because as we increase the number of clubs open, we expect we will continue to have deferred revenue balances that reflect services and dues that arepaid-in-full in advance at levels similar to, or greater than, those currently maintained. The deferred revenue balances that give rise to this working capital deficit represent cash received in advance of services performed, and do not represent liabilities that must be funded with cash.
Investing Activities. We invested $66.3 million and $40.7 million in capital expenditures and club acquisitions during the year ended December 31, 2005 and 2004, respectively. For the year ended December 31, 2006, we estimate we will invest $63.6 million in capital expenditures which includes $15.5 million to continue to upgrade existing clubs and $2.8 to enhance our management information systems. The remainder of our 2006 capital expenditures will be committed to build or acquire clubs. These expenditures will be funded by cash flow provided by operations and available cash on hand.
Financing Activities. Net cash used in financing activities was $3.1 million for the year ended December 31, 2005 compared to net cash provided by financing activities of $265,000 in 2004.
February 4, 2004 Restructuring
On February 4, 2004, TSI, Inc. and affiliates and TSI Holdings, a newly formed company, entered into a restructuring agreement. We refer to the associated transactions as our restructuring. In connection with our restructuring, the holders of TSI, Inc.’s Series A preferred stock, Series B preferred stock and common stock contributed their shares of TSI, Inc. to TSI Holdings for an equal amount of newly issued shares of the same form in TSI Holdings. Immediately following this exchange, TSI Holdings contributed to TSI, Inc. the certificates representing all of TSI, Inc.’s shares contributed in the aforementioned exchange and in return TSI, Inc. issued 1,000 shares of common stock to TSI Holdings, and cancelled on its books and records the certificate representing TSI, Inc.’s shares contributed to it by TSI Holdings.
On February 4, 2004, TSI Holdings completed an offering of our 11.0% senior discount notes that will mature in February 2014. TSI Holdings received a total of $124.8 million in connection with this issuance. Fees and expenses related to this transaction totaled approximately $4.4 million. No cash interest is required to be paid prior to February 2009. The accreted value of each discount note will increase from the date of issuance until February 1, 2009, at a rate of 11.0% per annum compounded semi-annually such that on February 1, 2009 the accreted value will equal $213.0 million, the principal value due at maturity. Subsequent
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to February 1, 2009 cash interest on the discount notes will accrue and be payable semi-annually in arrears February 1 and August 1 of each year, commencing August 1, 2009. The discount notes are structurally subordinated and effectively rank junior to all indebtedness of TSI, Inc. The debt of TSI Holdings is not guaranteed by TSI, Inc. and TSI Holdings relies on the cash flows of TSI, Inc., subject to restrictions contained in the indenture governing the senior notes, to service its debt.
The use of proceeds from our senior discount note offering was as follows (in thousands):
| Redemption of Series A and Series B preferred stock | $ | 50,635 | ||
| Common stock distribution, net of option exercise proceeds | 68,404 | |||
| Underwriting fees and other closing costs | 4,378 | |||
| Bonus paid to employees in lieu of distribution | 1,144 | |||
| Available for general corporate purposes | 246 | |||
| Total use of funds | $ | 124,807 | ||
On February 6, 2004, all of TSI Holdings’ outstanding Series A preferred stock and Series B preferred stock was redeemed for a total of $50.6 million.
On March 12, 2004, 65,536 vested common stock options of TSI Holdings were exercised. TSI Holdings received $539,000 in cash related to these exercises.
On March 15, 2004, the Board of Directors of TSI Holdings approved a common stock distribution of $52.50 per share to all stockholders of record on March 15, 2004. This distribution totaled $68.9 million and was paid on March 17, 2004. Also, in lieu of a common stock distribution, vested common stock option holders were paid a total of $1.1 million recorded as payroll expense.
| April 16, 2003 Refinancing Transaction |
On April 16, 2003, TSI, Inc. completed a refinancing of its debt. This refinancing included an offering of $255.0 million of 95/8% senior notes that will mature April 15, 2011, and the entering into of a new $50.0 million senior secured revolving credit facility that will expire April 15, 2008. The senior notes accrue interest at 95/8% per annum and interest is payable semiannually on April 15 and October 15. In connection with this refinancing, we wrote off $3.7 million of deferred financing costs related to extinguished debt, paid a call premium of $3.0 million and incurred $1.0 million of interest on the senior notes representing the interest incurred during the30-day redemption notification period.
The use of proceeds from the notes offering was as follows (in thousands):
| Redemption of senior notes, principal and interest | $ | 126,049 | ||
| Call premium on senior notes | 3,048 | |||
| Redemption of senior preferred stock, at liquidation value | 66,977 | |||
| Repayment of line of credit principal borrowings and interest | 4,013 | |||
| Repayment of subordinated credit principal borrowings and interest | 9,060 | |||
| Underwriting fees and other closing costs | 9,578 | |||
| Available for general corporate purposes | 36,275 | |||
| Total use of funds | $ | 255,000 | ||
As of December 31, 2005, our total consolidated debt was $411.2 million. This substantial amount of debt could have significant consequences, including:
| • | making it more difficult to satisfy our obligations; | |
| • | increasing our vulnerability to general adverse economic and industry conditions; |
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| • | limiting our ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions of new clubs and other general corporate requirements; | |
| • | requiring cash flow from operations for the annual payment of $24.5 million interest on our Senior Notes and reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions of new clubs and general corporate requirements; and | |
| • | limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate. |
These limitations and consequences may place us at a competitive disadvantage to less-leveraged competitors.
As of December 31, 2005, we had $153.1 million of senior discount notes and $255.0 million of senior notes outstanding. Under the provisions of the senior note indenture, TSI, Inc. may not issue additional senior notes without modification of the indenture with the bondholders’ consent.
Senior Credit Facility
Our line of credit with our principal bank provides for direct borrowings and letters of credit of up to $50.0 million. The line of credit carries interest at our option based upon the Eurodollar borrowing rate plus 4.0% or the bank’s prime rate plus 3.0%, as defined, and we are required to pay a commitment fee of 0.75% per annum on the daily unutilized amount. As of December 31, 2004, and December 31, 2005, no borrowings were outstanding under this line. As of December 31, 2004 and December 31, 2005, outstanding letters of credit totaled $4.7 million and $8.0 million, respectively. As of December 31, 2004 and December 31, 2005, we had approximately $45.3 million and $42.0 million, respectively, unutilized under the line of credit, which matures in April 2008, and has no scheduled amortization requirements. In addition, as of December 31, 2004 and December 31, 2005 we had $57.5 million and $51.3 million, respectively, of cash and cash equivalents.
The senior secured revolving credit facility contains various covenants including limits on capital expenditures, the maintenance of a consolidated interest coverage ratio of not less than 2.75:1.00 and 3.00:1.00 during 2005 and 2006, respectively, and a maximum permitted total leverage ratio of 3.75:1.00 from December 31, 2004 through December 31, 2005 and 3.50:1.00 from December 31, 2005 through September 29, 2006 and 3.25:1.00 from September 30, 2006 through September 29, 2007. TSI’s interest coverage ratio and leverage ratios were 3.52 to 1.00 and 3.13 to 1.00, respectively, as of December 31, 2005. These covenants limit TSI, Inc.’s ability to incur additional debt, and as of December 31, 2005, permitted additional borrowing capacity under the senior secured revolving credit facility was limited to $34.6 million.
Notes payable were incurred upon the acquisition of various clubs and are subject to the right of offset for possible post-acquisition adjustments arising out of operations of the acquired clubs. These notes bear interest at rates between 5% and 9%, and are non-collateralized. The notes are due on various dates through 2009.
We believe that we have or will be able to obtain or generate sufficient funds to finance our current operating and growth plans through the end of 2007. Any material acceleration or expansion of that plan through additional new club locations that we have constructed or acquisitions (to the extent such acquisitions include cash payments) may require us to pursue additional sources of financing prior to the end of 2007. There can be no assurance that such financing will be available, or that it will be available on acceptable terms. Our line of credit accrues interest at variable rates based on market conditions. Therefore, future increases in interest rates could have a negative impact on net income should borrowings be required.
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Contractual Obligations and Commitments
The aggregate long-term debt and operating lease obligations as of December 31, 2005 were as follows:
| Payments Due by Period | |||||||||||||||||||||
| Less than | After | ||||||||||||||||||||
| Contractual Obligations | Total | 1 Year | 1-3 Years | 4-5 Years | 5 Years | ||||||||||||||||
| (In thousands) | |||||||||||||||||||||
| Long-term debt(1) | $ | 1,127,212 | $ | 25,811 | $ | 50,595 | $ | 94,306 | $ | 956,500 | |||||||||||
| Operating lease obligations(2) | 727,133 | 61,695 | 125,634 | 117,777 | 422,027 | ||||||||||||||||
| Total contractual cash obligations | $ | 1,854,345 | $ | 87,506 | $ | 176,229 | $ | 212,083 | $ | 1,378,527 | |||||||||||
| (1) | The long-term debt contractual cash obligations include principal and interest payment requirements. Interest on TSI, Inc.’s Senior Notes amounts to $24.5 million annually. |
| (2) | Operating lease obligations include base rent only. Certain leases provide for additional rent based on real estate taxes, common area maintenance and defined amounts based on the operating results of the lessee. |
Recent Changes in or Recently Issued Accounting Standards
In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees.” Among other items, SFAS No. 123R eliminates the use of APB Opinion No. 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee service received in exchange for awards of equity instruments, based on the grant-date fair value of those awards, in the financial statements. The effective date of SFAS No. 123R is the first reporting period beginning after December 15, 2005. SFAS No. 123R permits companies to adopt its requirements using either a “modified prospective” method, or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS No. 123R for all share-based payments granted after that date, and based on the requirements of SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but the “modified retrospective” method also permits entities to restate financial statements of previous periods on pro forma disclosures made in accordance with SFAS No. 123. We will implement SFAS No. 123R using the “modified prospective” method.
We currently utilize a standard option pricing model (Black-Scholes) to measure the fair value of stock options granted to employees. While SFAS No. 123R permits entities to continue to use such a model, the standard also permits the use of a “lattice” model. We will continue to use a standard pricing model to measure the fair value of employee stock options upon the adoption of SFAS No. 123R.
SFAS No. 123R also requires that the benefits associated with the tax deduction in excess of recognized compensation cost be reported as a financing cash flow, rather than an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. These future amounts cannot be estimated because they depend on, among other things, when employees exercise stock options.
We will adopt SFAS No. 123R effective January 1, 2006; and based on the stock options outstanding as of December 31, 2005 we do not believe SFAS No. 123R will have a material impact on our financial statements.
September 11, 2001 Events
The September 11 events resulted in a tremendous loss of life and property. Secondarily, those events interrupted the operations at four of our clubs located in downtown Manhattan. Three of the affected clubs were back in operation by October 2001, while the fourth club reopened in September 2002.
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We carry business interruption insurance to mitigate certain lost revenue and profits such as those experienced with the September 11 events. In this regard, in the third quarter of 2001 a $175,000 insurance receivable was recorded representing an estimate of costs incurred in September 2001. Such costs included rent, payroll benefits and other club operating costs incurred during the period of closure. In 2002, we collected this $175,000 receivable and received additional on-account payments of $1.0 million. In 2003, we received $2.8 million from our insurer and we entered into a final settlement agreement. These on-account and final payments were classified in Fees and Other revenue when received.
Use of Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Our most significant assumptions and estimates relate to the allocation and fair value ascribed to assets acquired in connection with the acquisition of clubs under the purchase method of accounting; the useful lives, recoverability and impairment of fixed and intangible assets; deferred income tax valuation; self-insurance reserves; valuation of, and expense incurred in connection with, stock options; legal contingencies; and the estimated membership life.
Our one-time member initiation fees and related direct expenses are deferred and recognized on a straight-line basis in operations over an estimated membership life of 24 months. This estimated membership life has been derived from actual membership retention experienced by us. Although the average membership life approximated 24 months over each of the past several years, this estimated life could increase or decrease in future periods. Consequently, the amount of initiation fees and direct expenses deferred by us would increase or decrease in similar proportion.
Fixed assets are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which are 30 years for building and improvements, five years for club equipment, furniture, fixtures and computer equipment, and three years for computer software. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining period of the lease. Expenditures for maintenance and repairs are charged to operations as incurred. The cost and related accumulated depreciation or amortization of assets retired or sold are removed from the respective accounts and any gain or loss is recognized in operations. The costs related to developing web applications, developing web pages and installing developed applications on the web servers are capitalized and classified as computer software. Web site hosting fees and maintenance costs are expensed as incurred.
Long-lived assets, such as fixed assets, and intangible assets are reviewed for impairment when events or circumstances indicate that the carrying value may not be recoverable. Estimated undiscounted expected future cash flows are used to determine if an asset is impaired, in which case the asset’s carrying value would be reduced to fair value. Actual cash flows realized could differ from those estimated and could result in asset impairments in the future.
Effective January 1, 2002, we implemented SFAS No. 142, “Goodwill and Other Intangible Assets.” There were no changes to the estimated useful lives of amortizable intangible assets due to the SFAS No. 142 implementation. In connection with the SFAS No. 142 transition impairment test, we recorded a $1.3 million write-off of goodwill. A deferred tax benefit of $612,000 was recorded as a result of this goodwill write-off, resulting in a net cumulative effect of change in accounting principle of $689,000 in the first quarter of 2002. The write-off of goodwill related to four remote underperforming clubs. The impairment test was performed with discounted estimated future cash flows as the criteria for determining fair market value. Goodwill has been allocated to reporting units that closely reflect the regions served by our four trade names: New York Sports Clubs, Boston Sports Clubs, Washington Sports Clubs and Philadelphia Sports Clubs, with certain more remote clubs that do not benefit from a regional cluster being considered single reporting units.
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We perform our annual impairment test in the first quarter of each year. Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered to be impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined based on purchase price allocation. As a result of the March 31, 2004 review, we determined that the goodwill at one of our remote clubs was not recoverable. The goodwill impairment associated with this under performing club amounted to $2.0 million. A deferred tax benefit of $881,000 has been recorded in connection with this impairment. Since this club is remote from one of our clusters, it does not benefit from the competitive advantage that our clustered clubs have, and as a result it is more susceptible to competition. We have reduced our projections of future cash flows of this club to take into account the impact of a recent opening of a competitor. In 2003 and 2005, no goodwill impairment charges were recorded.
As of December 31, 2005, our net deferred tax assets totaled $24.4 million. These net assets represent cumulative net “temporary differences” that will result in tax deductions in future years. The realizability of these assets greatly depends on our ability to generate sufficient future taxable income. Our pre-tax profit was $21.7 million and $13.0 million, and current tax liabilities were $10.3 million and $2.1 million, for the years ended December 31, 2002 and 2003, respectively. During the year ended December 31, 2004, our pre-tax loss was $2.8 million. During 2004, we incurred $12.7 million of additional interest expense related to our February 2004 issuance of the discount notes. In addition, we incurred $1.1 million of payroll expense related to a special bonus paid to common stockholders and we recorded a $2.0 million goodwill impairment charge. We believe that as our club base continues to expand, we will improve our profitability in years going forward and realize our deferred tax assets. For 2005, we generated pre-tax profit of $2.8 million. Given our profitability in past years and expected future profitability, the weight of available evidence indicates we will be able to realize these net deferred tax assets. If at some time in the future the weight of available evidence does not support the realizability of a portion of or the entire net deferred tax assets, the write-down of this asset could have a significant impact on our financial statements.
Inflation
Although we cannot accurately anticipate the effect of inflation on our operations, we believe that inflation has not had, and is not likely in the foreseeable future to have, a material impact on our results of operations.
Seasonality of Business
Seasonal trends have a limited effect on our overall business. Generally, we experience greater membership growth at the beginning of each year and experience an increased rate of membership attrition during the summer months. In addition, during the summer months, we experience a slight increase in operating expenses due to our outdoor pool and summer camp operations, matched by seasonal revenue recognition from season pool memberships and camp revenue.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
We do not believe that we have any significant risk related to interest rate fluctuations since we currently only carry fixed-rate debt. We invest our excess cash in highly liquid short-term investments. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our cash equivalents and, therefore impact our cash flows and results of operations. If short-term interest rates were to have increased by 100 basis points during 2005, our interest income from cash equivalents would have increased by approximately $632,000. These amounts are determined by considering the impact of the hypothetical interest rates on our cash equivalents balance during 2005.
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| Item 8. | Financial Statements and Supplementary Data |
Our Financial Statements appear elsewhere herein and are listed in the index appearing under Item 15.
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None
| Item 9A. | Controls and Procedures |
(a) At the end of the period, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 and15d-15). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2005, our disclosure controls and procedures were effective in ensuring that material information was properly disclosed by us in the reports filed or submitted by the us under the Exchange Act.
(b) There have been no changes in our internal controls over financial reporting during the year ended December 31, 2005 that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.
| Item 9B. | Other Information |
None
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PART III
| Item 10. | Directors and Executive Officers of the Registrant |
Our executive officers and directors are listed below:
| Name | Age | Position | ||||
| Robert J. Giardina | 48 | Chief Executive Officer and Director | ||||
| Alexander A. Alimanestianu | 47 | President and Chief Development Officer | ||||
| Richard G. Pyle | 47 | Chief Financial Officer | ||||
| Randall C. Stephen | 49 | Chief Operating Officer | ||||
| Keith E. Alessi(1) | 51 | Director | ||||
| Paul N. Arnold(2) | 59 | Director | ||||
| Bruce C. Bruckmann(2) | 52 | Director | ||||
| J. Rice Edmonds(1) | 35 | Director | ||||
| Jason M. Fish(1) | 48 | Director | ||||
| (1) | Member of the Audit Committee |
| (2) | Member of the Compensation Committee |
Robert J. Giardinajoined us in 1981 and has served as President and Chief Operating Officer from 1992 to 2001, and became Chief Executive Officer in January 2002. He was elected to serve as our director in March 2006. With over 30 years of experience in the club industry, Mr. Giardina has expertise in virtually every aspect of facility management and club operations. In addition to operations, Mr. Giardina has primary responsibility for sales and marketing.
Alexander A. Alimanestianujoined us in 1990 and became Executive Vice President, Development in 1995 and Chief Development Officer in January 2002. He became President and Chief Development Officer in March 2006. From 1990 to 1995, Mr. Alimanestianu served as Vice President and Senior Vice President. Before joining us, he worked as a corporate attorney for six years with one of our outside law firms. Mr. Alimanestianu has been involved in the development or acquisition of over 100 of our clubs.
Richard G. Pyle, a British chartered accountant, joined us in 1987 and has been chiefly responsible for our financial matters since that time, as a Vice President beginning in 1988, Senior Vice President and Chief Financial Officer beginning in 1992 and Executive Vice President and Chief Financial Officer beginning in 1995, successively. Before joining us, Mr. Pyle worked in public accounting (in the United States, Bermuda, Spain and England) specializing in the hospitality industry, and as the corporate controller for a British public company in the leisure industry.
Randall C. Stephenjoined us in 2002 as Chief Operating Officer. Prior to joining us and since 1987, Mr. Stephen held various positions with Circuit City Stores, including Director of Human Resources, General Manager and Assistant Vice President. In 1995, he was appointed Circuit City Stores’ Vice President, Corporate Operations, focusing on operating, marketing, promotions and business process re-engineering and in 1996 he became the Northeast Division President. Prior to 1987, Mr. Stephen worked with several premier retailers including Eastern Mountain Sports, Eddie Bauer, Keeger & Sons and Britches of Georgetown.
Keith E. Alessihas served as a director of Town Sports since April 1997 and is currently serving pursuant to the stockholders agreement discussed in “Related Party Transactions.” Mr. Alessi is an adjunct professor of Law at Washington and Lee University School of Law. Mr. Alessi served as President, Chief Executive Officer and a director of Telespectrum Worldwide, Inc. from March 1998 to April 2000. From May 1996 to March 1998, Mr. Alessi served as Chairman, President and Chief Executive Officer of Jackson Hewitt, Inc. Mr. Alessi currently serves as director and chairman of the audit committees for MWI Veterinary Supply of Boise, ID, H&E Equipment Services, Inc of Baton Rouge, LA, Nanocerox, Inc, of Ann Arbor, MI and O’ Sullivan Industries of Atlanta, GA, he is also an adjunct lecturer of business and The University of Michigan.
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Paul N. Arnoldhas served as a director of Town Sports since April 1997 and is currently serving pursuant to the stockholders agreement. Mr. Arnold has served as Chairman and Chief Executive Officer of Cort Business Services, Inc., a Berkshire Hathaway company, since 2000. From 1992 to 2000, Mr. Arnold served as President, Chief Executive Officer and Director of Cort Business Services. Prior to 1992, Mr. Arnold held various positions over a24-year period within Cort Furniture Rental, a division of Mohasco Industries. Mr. Arnold is currently a director of Penhall International Corp.
Bruce C. Bruckmannhas served as a director of Town Sports since December 1996 and is currently serving as a director designated by Bruckmann, Rosser, Sherrill & Co., LP, which we refer to as BRS, pursuant to the stockholders agreement. Since 1994, Mr. Bruckmann has served as Managing Director of BRS. From 1983 until 1994, Mr. Bruckmann served as an officer and subsequently a Managing Director of Citicorp Venture Capital, Ltd. Mr. Bruckmann is currently a director of Mohawk Industries, Inc., H&E Equipment Services L.L.C. and Anvil Knitwear, Inc. and several private companies.
J. Rice Edmondshas served as a director of Town Sports since July 2002 and is currently serving as a director designated by BRS pursuant to the stockholders agreement. Mr. Edmonds is a Principal of BRS. Prior to joining BRS in 1996, Mr. Edmonds worked in the high yield finance group of Bankers Trust. Mr. Edmonds is currently a director of Real Mex Restaurants, Inc., McCormick & Schmick’s Seafood Restaurants, Inc., The Sheridan Group, Inc., and several private companies.
Jason M. Fishhas been a director of Town Sports since December 1996 and is currently serving as a director designated by the Farallon Entities (as defined in footnote 2 to the Principal and Selling Stockholders table) pursuant to the stockholders agreement. Mr. Fish is a co-founder and President of CapitalSource Inc., and a member of CapitalSource’s board of directors, a position he has held since September 2000. Prior to founding CapitalSource, Mr. Fish was employed from 1990 to 2000 by Farallon Capital Management, L.L.C., serving as a managing member from 1992 to 2000. Before joining Farallon, Mr. Fish worked at Lehman Brothers Inc., where he was a Senior Vice President responsible for its financial institution investment banking coverage on the West Coast.
Code of Ethics
The Company has adopted a written Code of Ethics and Business Conduct, which applies to all officers, directors and employees, including our principal executive officer, principal financial officer and principal accounting officer or controller. Interested person may obtain a copy of our Code of Ethics and Business Conduct either by visiting our web site www.mysportsclubs.com in the investor relations section or without charge by writing to Town Sports International Holdings Inc., Attention: Robert S. Herbst, Vice President and General Counsel, 888 Seventh Avenue, New York, New York 10106.
Board Committees
Our board of directors has an audit committee and a compensation committee. The board of directors may also establish other committees to assist in the discharge of its responsibilities.
Audit Committee. The audit committee is currently composed of Messrs. Alessi, Edmonds and Fish. Mr. Alessi is our Audit Committee Financial Expert. The audit committee appoints our independent registered public accounting firm, subject to ratification by our stockholders, reviews the plan for and the results of the independent audit, approves the fees of our independent registered public accounting firm, reviews with management and the independent registered public accounting firm our quarterly and annual financial statements and our internal accounting, financial and disclosure controls, reviews and approves transactions between TSI and its officers, directors and affiliates and performs other duties and responsibilities as set forth in a charter approved by our board.
Compensation Committee. The compensation committee is currently composed of Messrs. Giardina, Arnold, and Bruckmann. The compensation committee evaluates performance and establishes and oversees executive compensation policy and makes decisions about base pay, incentive pay and any supplemental benefits for our executive officers. The compensation committee also administers our stock incentive plans and
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approves the grant of stock options, the timing of the grants, the price at which the options are to be offered and the number of shares for which options are to be granted to our executive officers, directors and other employees. The compensation committee also performs other duties and responsibilities as set forth in a charter approved by our board.
| Item 11. | Executive Compensation |
The following table summarizes the compensation paid to or earned for all services rendered to us in all capacities during 2005, 2004 and 2003 by our Chief Executive Officer and the other four highest compensated executive officers. The table below includes compensation paid by TSI Holdings, Inc. and its predecessor, TSI, Inc., for services rendered on our behalf. We refer to the officers listed in the following table in this Form 10-K as our named executive officers.
Summary Compensation Table
| Long-Term | |||||||||||||||||||||
| Compensation | |||||||||||||||||||||
| Other Annual | Awards Common Stock | ||||||||||||||||||||
| Salary | Bonus(1) | Compensation(2) | Underlying Options/SARs | ||||||||||||||||||
| Name and Principal Position | Year | ($) | ($) | ($) | (#) | ||||||||||||||||
| Mark N. Smith(3) | 2005 | 452,152 | 448,565 | — | — | ||||||||||||||||
| Chairman | 2004 | 443,286 | 429,000 | — | 4,800 | ||||||||||||||||
| 2003 | 434,594 | 511,133 | — | 1,200 | |||||||||||||||||
| Robert J. Giardina | 2005 | 428,831 | 354,701 | — | — | ||||||||||||||||
| Chief Executive Officer | 2004 | 420,423 | 349,710 | — | 4,800 | ||||||||||||||||
| 2003 | 412,179 | 406,227 | — | 1,200 | |||||||||||||||||
| Richard G. Pyle | 2005 | 318,643 | 212,181 | — | — | ||||||||||||||||
| Chief Financial Officer | 2004 | 312,395 | 212,474 | — | 4,000 | ||||||||||||||||
| 2003 | 306,270 | 251,746 | — | 1,000 | |||||||||||||||||
| Alexander A. Alimanestianu | 2005 | 318,643 | 212,181 | — | — | ||||||||||||||||
| President and Chief Development Officer | 2004 | 312,395 | 212,474 | — | 4,000 | ||||||||||||||||
| 2003 | 306,270 | 251,746 | — | 1,000 | |||||||||||||||||
| Randall C. Stephen | 2005 | 245,565 | 97,520 | — | 4,000 | (4) | |||||||||||||||
| Chief Operating Officer | 2004 | 229,500 | 116,413 | — | 3,200 | ||||||||||||||||
| 2003 | 225,000 | 95,755 | 800 | ||||||||||||||||||
| (1) | Includes annual bonus payments under our Annual Bonus Plan. |
| (2) | The aggregate amount of perquisites and other personal benefits did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus reported for each named executive officer and has therefore been omitted. |
| (3) | Effective March 23, 2006, Mr. Smith resigned, and he is no longer an employee, executive officer or director. |
| (4) | See discussion on Option Grants in the Year Ended December 31, 2005, below. |
Option/ SAR Grants During the Year Ended December 31, 2005
In 2005, the Company granted the following options to a named executive:
| Number | ||||||||||||||
| of Options | Length of | |||||||||||||
| Granted | Exercise Price(1) | Option Term | ||||||||||||
| Name | Date | (#) | ($) | at Grant Date | ||||||||||
| Randall C. Stephen | April 1, 2005 | 4,000 | $ | 91.50 | 120 months | |||||||||
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| (1) | The exercise price exceeds the fair market value of $33.00 per share on the grant date. Fair market value was based on an independent valuation. |
Aggregated Option/ SAR Exercises During the Year Ended December 31, 2005 and 2005 Year-End Option/ SAR Values
The following summarizes exercises of stock options by the named executive officers during the year ended December 31, 2005 as well as the number and value of all unexercised options held by the named executive officers as of December 31, 2005.
| Value of Unexercised | ||||||||||||||||
| Common | In-the-Money | |||||||||||||||
| Shares | Value | Number of Securities | Options/SARs at | |||||||||||||
| Acquired on | Realized | Options/SARs at FY-End (#) | FY-End ($)(1) | |||||||||||||
| Name | Exercise (#) | ($) | Exercisable/Unexercisable | Exercisable/Unexercisable | ||||||||||||
| Mark N. Smith(2) | — | — | 1,200/4,800 | $ | 0/$60,349 | |||||||||||
| Robert J. Giardina | — | — | 1,200/4,800 | $ | 0/$60,349 | |||||||||||
| Richard G. Pyle | — | — | 1,000/4,000 | $ | 0/$50,291 | |||||||||||
| Alexander A. Alimanestianu | — | — | 1,000/4,000 | $ | 0/$50,291 | |||||||||||
| Randall C. Stephen | — | — | 1,600/6,400 | $ | 10,058/$80,466 | |||||||||||
| (1) | Value is based upon the fair market value of the stock minus the exercise price. The fair market value was determined by to be $104.07 per share of common stock and was based upon the historical and projected financial performance of the Company. |
| (2) | Effective March 23, 2006, Mr. Smith resigned, and he is no longer an employee, executive officer or director of the Company. |
Town Sports International Holdings, Inc. Stock Option Plan
Our board of directors has adopted a stock option plan, which provides for the grant to our key employees and/or directors of stock options. The compensation committee of our board of directors administers the stock option plan. The compensation committee has broad powers under the stock option plan, including exclusive authority (except as otherwise provided in the stock option plan) to determine:
(1) who will receive awards,
(2) the type, size and terms of awards,
(3) the time when awards will be granted, and
(4) vesting criteria, if any, of the awards.
If we undergo a re-organization, recapitalization, stock dividend or stock split or other change in shares of our common stock, the compensation committee may make adjustments to the plan in order to prevent dilution of outstanding options. The compensation committee may also cause options awarded under the plan to become immediately exercisable if we undergo specific types of changes in the control of our company.
Compensation of Directors
Our two independent directors receive $3,000 for attending board of director meetings in person and $1,000 when attending telephonically. When our Audit or Compensation Committees meet, our independent directors receive $1,000 when attending in person and $500 when attending telephonically on days when there is no board meeting.
We reimburse directors for anyout-of-pocket expenses incurred by them in connection with services provided in such capacity.
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Compensation Committee Interlocks and Insider Participation
The current members of our compensation committee are Bruce Bruckmann and Paul Arnold. Bruce Bruckmann and Paul Arnold are non-employee directors. See “Certain Relationships and Related Party Transactions” for additional information concerning our relationships with BRS, with which Mr. Bruckmann is affiliated.
Management Equity Agreements
We have entered into executive stock agreements with our named executive officers. Pursuant to these executive stock agreements, certain of our named executive officers each have purchased shares of our common stock in December 1996 at a purchase price of $1.00 per share of common stock. In addition, our named executive officers have acquired options to purchase shares of our common stock.
These agreements contain no minimum purchase requirements. Upon termination of the employment by the Company of those named executive officers, the Company, BRS and the Farallon Entities have a right, but not an obligation, to repurchase all of the shares of stock then held by such terminated named executive officer for fair market value. Fair market value is determined based on the price of publicly traded shares or, if the shares are not publicly traded, then on a formula based on TSI Holding’s earnings over the previous four fiscal quarters, and its capitalization for the quarter most recently ended. The named executive officers do not have a right or obligation under the executive stock agreements to purchase additional shares of TSI Holdings.
The table below sets out the number of shares of our common stock purchased by each of our named executive officers pursuant to their respective executive stock purchase agreement and which would be subject to repurchase by the Company at the termination of their employment, as well as the total number of shares that each named executive may be able to purchase pursuant to the options granted under the executive stock purchase agreements.
| Number of Shares of | Number of Shares of | |||||||
| Common Stock | Common Stock Underlying | |||||||
| Currently Held | the Options | |||||||
| Mark N. Smith | 74,955 | 6,000 | (1) | |||||
| Robert J. Giardina | 59,480 | 6,000 | (1) | |||||
| Richard G. Pyle | 51,410 | 5,000 | (2) | |||||
| Alexander A. Alimanestianu | 50,839 | 5,000 | (2) | |||||
| Randall C. Stephen | — | 8,000 | (3) | |||||
| (1) | The exercise price for 1,200 options, each to purchase one underlying share of our common stock, is $144.00 and the exercise price for 4,800 options, each to purchase one underlying share of our common stock, is $91.50. |
| (2) | The exercise price for 1,000 options, each to purchase one underlying share of our common stock, is $144.00 and the exercise price for 4,000 options, each to purchase one share of underlying share of our common stock, is $91.50. |
| (3) | The exercise price for 800 options, each to purchase one underlying share of our common stock, is $144.00 and the exercise price for 7,200 options, each to purchase one underlying share of our common stock, is $91.50. |
Other Benefit Plans
We maintain a 401(k) defined contribution plan and are subject to the provisions of the Employee Retirement Income Security Act of 1974, known as ERISA. The plan provides for us to make discretionary contributions. The plan was amended, effective January 1, 2001, to provide for an employer matching contribution in an amount equal to 25% of the participant’s contribution with a limit of $500 per annum. In February 2004, 2005 and March 2006, employer matching contributions totaling $195,000, $191,000,$180,000 were made for the plan years ended December 31, 2003, 2004 and 2005 respectively.
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Limitation of Liability and Indemnification of Officers and Directors
Our certificate of incorporation and bylaws provide that our directors and officers shall be indemnified to the fullest extent permitted by Delaware law, as it now exists or may in the future be amended, against all expenses and liabilities reasonably incurred in connection with their service for us or on our behalf. We also intend to enter into agreements with our directors and officers that provide for such indemnification and expenses and liability reimbursement. In addition, our certificate of incorporation provides that our directors will not be personally liable for monetary damages for breaches of their fiduciary duty as directors, unless they violate their duty of loyalty to us or our stockholders, act in bad faith, knowingly or intentionally violate the law, authorize illegal dividends or redemptions or derive an improper personal benefit from their action as directors. We maintain insurance that insures our directors and officers against certain losses and that insures us against our obligations to indemnify the directors and officers.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management |
The following table sets forth (as of March 28, 2006) certain information with respect to the beneficial ownership of the common stock by: (i) each person or entity who owns of record or beneficially more than 5% or more of any class of our voting securities; (ii) each named executive officer and director of TSI Holdings; and (iii) all directors and executive officers as a group.
| Common | |||||||||
| Stock | Percentage of | ||||||||
| Beneficially | Common Stock | ||||||||
| Name | Owned(1) | Outstanding(1) | |||||||
| Bruckmann, Rosser, Sherrill (“BRS”)(2) | 504,456 | 38.5 | % | ||||||
| The Farallon Entities(3) | 270,091 | 20.6 | % | ||||||
| The Canterbury Entities(4) | 139,437 | 10.7 | % | ||||||
| Named Executive Officers and Directors: | |||||||||
| Mark N. Smith(5) | 76,155 | 5.8 | % | ||||||
| Robert J. Giardina(5) | 60,680 | 4.6 | % | ||||||
| Richard G. Pyle(5) | 52,410 | 4.0 | % | ||||||
| Alexander A. Alimanestianu(5) | 51,839 | 4.0 | % | ||||||
| Randall C. Stephen(5) | * | * | |||||||
| Bruce C. Bruckmann(6) | 517,642 | 39.5 | % | ||||||
| J. Rice Edmonds(7) | 504,456 | 38.5 | % | ||||||
| Jason M. Fish(8) | 23,000 | 1.8 | % | ||||||
| Paul N. Arnold | * | * | |||||||
| Keith E. Alessi | * | * | |||||||
| All Executive Officers and Directors as a Group: | |||||||||
| 26 Persons(9) | 1,089,376 | 82.1 | % | ||||||
| * | Represents less than 1%. |
| (1) | Beneficial ownership is determined in accordance with Rule 13d-3 under the Exchange Act. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of March 15, 2006 are deemed outstanding. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. |
| (2) | Excludes shares held individually by Mr. Bruckmann and other individuals (and affiliates and family members thereof), each of whom are employed by BRS. Bruce Bruckmann, Hal Rosser, Stephen Sherrill and Stephen Edwards, as individuals are the sole shareholders of BRSE Associates, Inc., which is the General Partner of BRS Partners, LP, which is the General Partner of Bruckmann, Rosser, Sherrill & |
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| Co., LP. All major investment and other decisions of Bruckmann, Rosser, Sherrill & Co., LP are vested in BRS Partners, LP. | |
| (3) | Includes approximately 94,532 shares held by Farallon Capital Partners, L.P. (“FCP”), approximately 108,037 shares held by Farallon Capital Institutional Partners, L.P. (“FCIP”), approximately 54,018 shares by Farallon Capital Institutional Partners II, L.P. (“FCIPII”) and approximately 13,504 shares held by RR Capital Partners, L.P. (collectively with FCP, FCIP, FCIPII, the “Farallon Entities”), directly hold, in aggregate, the shares listed above. As the general partner of each of the Farallon Entities, Farallon Partners, L.L.C. (“FPLLC”), may, for purposes of Rule 13d-3 under the Exchange Act, be deemed to own beneficially the shares held by the Farallon Entities. As the managing members of FPLLC, Chun R. Ding, Joseph F. Downes, William F. Duhamel, Charles E. Ellwein, Richard B. Fried, Monica R. Landry, William F. Mellin, Stephen L. Millham, Rajiv A. Patel, Derek C. Schrier, Thomas F. Steyer and Mark C. Wehrly may each, for purposes of Rule 13d-3 under the Exchange Act, be deemed to own beneficially the shares owned by the Farallon Entities. Each of FPLLC and each of its managing members disclaim any beneficial ownership of such shares. All of the above-mentioned entities and individuals disclaim group attribution. |
| (4) | Includes approximately 121,529 shares held by Canterbury Mezzanine Capital, L.P. (“CMC”) and approximately 17,908 shares held by Canterbury Detroit Partners, L.P. (“CDP”), and together with CMC, the “Canterbury Entities”). For purposes of Rule 13d-3, Patrick N.W. Turner and Nicholas B. Dunphy, may be deemed to own beneficially all shares held by the Canterbury Entities. Messrs. Turner and Dunphy disclaim beneficial ownership of such shares. |
| (5) | Includes options to acquire common stock, options exercisable within 60 days, pursuant to the option plan. Messrs. Smith, Giardina, Pyle, Alimanestianu and Stephen each hold such options on 1,200, 1,200, 1,000, 1,000 and 1,600 shares of common stock, respectively. The address for each of these named executive officers is the same as the address of our principal executive offices. Effective March 23, 2006, Mr. Smith resigned, and is no longer a director or an executive officer. |
| (6) | Includes 504,456 shares held by BRS, and approximately 2,971 shares held by certain other family members and partnership investments of Mr. Bruckmann. Mr. Bruckmann disclaims beneficial ownership of such shares held by BRS. |
| (7) | Includes shares held by BRS. Mr. Edmonds disclaims beneficial ownership of such shares. |
| (8) | All 23,000 shares are held by CS Equity, LLC. Mr. Fish is a co-founder, president and director of CapitalSource Inc., the 100% owner of CS Equity, LLC. Mr. Fish disclaims beneficial ownership of such shares. |
| (9) | Includes (i) shares held by BRS, which may be deemed to be owned beneficially by Messrs. Bruckmann and Edmonds, and (ii) shares held by CS Equity, LLC, which may be deemed to be owned beneficially by Mr. Fish. |
Excluding the shares beneficially owned by BRS and CS Equity, LLC, the directors and named executive officers as a group beneficially own 518,489 shares of common stock (which represents approximately 39.4% of the common stock on a fully diluted basis).
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Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information with respect to compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance to employees as of December 31, 2005:
| Number of Securities | ||||||||||||
| Number of Securities | Remaining Available for | |||||||||||
| to be Issued Upon | Weight-Average | Future Insurance Under | ||||||||||
| Exercise of | Exercise Price of | Equity Compensation Plans | ||||||||||
| Outstanding Options, | Outstanding Options, | (Excluding Securities | ||||||||||
| Warrants and Rights | Warrants and Rights | Reflected in Column(a)) | ||||||||||
| Plan Category | (a) | (b) | (c) | |||||||||
| Equity compensation plans approved by security holders | 88,366 | $ | 86.26 | 4,177 | ||||||||
| Equity compensation plans not approved by security holders | — | — | — | |||||||||
| Total | 88,366 | 86.26 | 4,177 | |||||||||
| Item 13. | Certain Relationships and Related Party Transactions |
Other than compensation agreements and other arrangements that are described in the “Executive Compensation” section of this annual report on Form 10-K and the transactions described below, since January 1, 2003, there has not been, and there is not currently proposed, any transaction or series of similar transactions to which we were or will be a party in which the amount involved exceeded or will exceed $60,000 and in which any of our directors, executive officers, holders of more than five percent of any class of our voting securities or any member of the immediate family of the foregoing persons had or will have a direct or indirect material interest.
We believe that we have executed all of the transactions set forth below on terms no less favorable to us than we could have obtained from unaffiliated third parties. It is our intention to ensure that all future transactions between us and our officers, directors and principal stockholders and their affiliates are approved by a majority of our board of directors, including a majority of the independent and disinterested members of the board of directors, and are on terms no less favorable to us than those that we could obtain from unaffiliated third parties.
Restructuring Agreement
In connection with our 2004 restructuring, the TSI, Inc. equity holders, TSI Holdings and TSI, Inc. entered into an agreement, dated February 4, 2004, whereby the TSI, Inc. equity holders contributed all their equity holdings in TSI, Inc. to TSI Holdings in exchange for equity shares of TSI Holdings on the same terms and in the same proportions as they held in TSI, Inc.
Stockholders Agreement
In connection with our restructuring, TSI Holdings, TSI, Inc., BRS, the Farallon Entities, the Canterbury Entities, Rosewood Capital, L.P., Rosewood Capital IV, L.P., Rosewood Capital IV Associates, L.P., CS Equity LLC, Keith E. Alessi, Paul N. Arnold and certain of our other stockholders, whom we refer to as the TSI Holdings equity holders, entered into a stockholders agreement dated February 4, 2004, which was amended as of March 23, 2006. Pursuant to the stockholders agreement, the TSI Holdings equity holders agreed to terminate the existing stockholders agreement between the TSI, Inc. equity holders and TSI, Inc.
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and to vote to fill the six positions on the Board of Directors of TSI Holdings so that, as of the date of the stockholders agreement, it consisted of the following:
| • | Two members designated by BRS — currently, Bruce C. Bruckmann and J. Rice Edmonds; | |
| • | One member designated by the Farallon Entities — currently, Jason M. Fish; | |
| • | Mark N. Smith (for so long as he is the Chairman of TSI Holdings); and | |
| • | Two members designated by holders of the common stock of TSI Holdings — currently, Keith E. Alessi and Paul N. Arnold. |
Pursuant to the stockholders agreement, BRS will have the right to designate two directors for as long as it holds approximately 4% of the common stock of TSI Holdings and the Farallon Entities will have the right to designate one director as long as it holds approximately 2% of the common stock of TSI Holdings. Pursuant to the March 23, 2006 Amendment, the parties consented to the election of Robert Giardina to the Board to fill the vacancy created by Mark Smith’s resignation. Under the stockholders agreement, the rights described in this paragraph will terminate upon consummation of an initial public offering.
Each party to the stockholders agreement has the right, subject to certain exceptions, to purchase its pro rata portion of any shares of stock that TSI Holdings issues in the future. Furthermore, the stockholders agreement provides that TSI Holdings will have a right of first refusal to purchase all or a part of any shares of stock proposed to be transferred by any certain stockholder. To the extent TSI Holdings does not exercise this right, BRS and the Farallon Entities would have the right to purchase such shares. If BRS proposes to transfer any shares of stock, the other stockholders could elect to participate in such transfer on a pro rata basis. Finally, in the event of a sale by BRS of its interest of TSI Holdings to an unaffiliated third party, each stockholder will be obligated to sell their shares in connection with such transaction. Under the stockholders agreement, the rights described in this paragraph will terminate upon consummation of an initial public offering.
Registration Rights Agreement
In connection with our restructuring, TSI Holdings, TSI, Inc. and the TSI Holdings equity holders agreed to terminate the existing registration rights agreements among the TSI, Inc. equity holders and TSI, Inc. and entered into a new registration rights agreement dated February 4, 2004, which was amended as of March 23, 2006. Pursuant to the terms of the registration rights agreement, BRS, the Farallon Entities and the Canterbury Entities have the right to require TSI Holdings, at its expense and subject to certain limitations, to register under the Securities Act all or part of the shares of common stock held by them, which we refer to as the registrable securities. BRS is entitled to demand up to three long-form registrations at any time and unlimited short-form registrations. Farallon is entitled to demand one long-form registration (but only one year after we have consummated an initial registered public offering of our common stock) and up to three short-form registrations. The Canterbury Entities are entitled to demand up to two short-form registrations. CapitalSource is entitled to demand one short-form registration.
All holders of registrable securities are entitled to an unlimited number of “piggyback” registrations, with TSI Holdings paying all expenses of the offering, whenever TSI Holdings proposes to register its common stock under the Securities Act. Each such holder is subject to certain limitations on its ability to participate in such a “piggyback” registration. In addition, pursuant to the registration rights agreement, TSI Holdings has agreed to indemnify all holders of registrable securities against certain liabilities, including certain liabilities under the Securities Act.
Professional Services Agreement
In connection with our recapitalization in 1996, Bruckmann, Rosser, Sherrill & Co., Inc., an affiliate of BRS that we refer to as BRS Inc., and TSI Holdings and its predecessor TSI, Inc. entered into a professional services agreement, whereby BRS Inc. agreed to provide us certain strategic and financial consulting services.
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In exchange for such services, BRS Inc. receives an annual fee of $250,000 per calendar year while it owns, directly or indirectly, at least 3.66% of our outstanding common stock.
Agreements with Mark N. Smith
In connection with Mark N. Smith’s resignation from his position as our Chairman and as one of our directors, we negotiated and entered into a Separation Agreement and General Release and an Equity Rights Letter, each dated as of March 23, 2006, based on the circumstances that led to his resignation and taking into account his more than 20 years of service for TSI (and its predecessors). Under the Separation Agreement and General Release, provided Mr. Smith first delivers (and does not revoke) a general release of claims, we agreed (i) to continue to pay Mr. Smith his current base salary, $465,716 annually, in equal installments every two weeks through March 31, 2007, (ii) to pay Mr. Smith a bonus for calendar year 2006 at the time such bonuses are generally paid, in an amount ranging between $200,000 and $645,000, based on TSI’s performance, (iii) to pay for continued health care benefits for Mr. Smith and his eligible dependents through March 31, 2007, (iv) to continue to pay Mr. Smith on a bi-weekly basis an amount equal to his automobile allowance, $9,217 annually, through March 31, 2007, (v) to provide Mr. Smith, his spouse and their children, a Lifetime Family Premium Passport Membership or its equivalent and (vi) to let Mr. Smith keep his office computer equipment. Mr. Smith will serve as a consultant for us through March 31, 2007 without additional compensation. Mr. Smith remains subject to non-disparagement, cooperation, non-competition, non-solicitation, confidentiality and similar covenants for specified periods following his resignation, and the breach of these obligations may entitle us to cease any ongoing payments and benefits and to recoup all prior payments and benefits under the agreement, among other remedies.
The Equity Rights Letter sets forth certain rights and restrictions with respect to Mr. Smith’s outstanding common stock and his outstanding stock options. In particular, under the Equity Rights Letter, we agreed (i) to extend the period during which the outstanding, vested portion of Mr. Smith’s stock option may be exercised until December 31, 2006, (ii) to grant a new option to purchase 4,800 shares of our common stock with an exercise price equal to the fair market value on the date of grant, which stock option vests on December 31, 2012, subject to acceleration upon the occurrence of certain events, and expires on July 23, 2013, (iii) to pay a lump sum cash amount equal to $44,448 if (x) prior to December 31, 2007, there is a sale of the company and the aggregate gross consideration equals or exceeds specified amounts or (y) our achieved equity value as of December 31, 2007 equals or exceeds specified amounts and (iv) to not exercise our repurchase rights with respect to his common stock.
Other Related Party Transactions
We paid approximately $848,000 in 2003, $862,000 in 2004 and $888,000 in 2005 to an entity of which Mr. Frank Napolitano, one of our non-executive officers, is currently a 25% owner, for rent for a multi-recreational club facility that we acquired in 1999. We expect to pay $690,000 in annual base rent and a pro rata share of operating expenses and property taxes on the facility during the term of the lease, which expires in 2015. Pursuant to the lease, we are also obligated to pay percentage rent based upon the revenue of the facility in the future.
Our certificate of incorporation eliminates, subject to certain exceptions, directors’ personal liability to TSI or our stockholders for monetary damages for breaches of fiduciary duties. Our certificate of incorporation does not, however, eliminate or limit the personal liability of a director for (i) any breach of the director’s duty of loyalty to TSI or our stockholders, (ii) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived an improper personal benefit.
Our bylaws provide that we shall indemnify our directors and executive officers to the fullest extent permitted under the Delaware General Corporation Law, and may indemnify our other officers, employees and other agents as set forth in the Delaware General Corporation Law. In addition, we intend to enter into
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indemnification agreements with our directors and officers. These indemnification agreements will contain provisions that require us, among other things, to indemnify our directors and executive officers against certain liabilities (other than liabilities arising from intentional or knowing and culpable violations of law) that may arise by reason of their status or service as our directors or executive officers or other entities to which they provide service at our request and to advance expenses they may incur as a result of any proceeding against them as to which they could be indemnified. We believe that these provisions and agreements are necessary to attract and retain qualified directors and officers. We have obtained an insurance policy covering our directors and officers for claims that such directors and officers may otherwise be required to pay or for which we are required to indemnify them, subject to certain exclusions.
| Item 14. | Principal Accountant Fees and Services |
Town Sports International Holdings, Inc. was billed for the following services provided by PricewaterhouseCoopers LLP, the company’s Independent Registered Public Accounting Firm during December 31, 2004 and 2005:
| 2004 | 2005 | |||||||
| Audit fees(1) | $ | 512,000 | $ | 646,750 | ||||
| Audit related fees(2) | 34,000 | 90,938 | ||||||
| Tax consulting fees(3) | 101,500 | 115,000 | ||||||
| All other fees(4) | 20,150 | — | ||||||
| Total | $ | 667,650 | $ | 852,688 | ||||
| (1) | Audit fees include fees for (i) the audit of our consolidated financial statements, including services related to statutory audits of certain of our subsidiaries, (ii) review of the unaudited condensed consolidated interim financial statements included in quarterly reports and (iii) the review of debt and equity offerings and issuance of comfort letters and SEC filings. |
| (2) | Audit related fees include fees for audit of our employee benefit plan and readiness assessment in compliance with Section 404 of the Sarbanes Oxley Act of 2002 and fees for other audit related services. |
| (3) | Tax consulting fees include fees for tax advice on state related matters as well as assistance with the American Jobs Creaction Act of 2004. |
| (4) | All other fees related to consultations regarding insurance claims, establishment of a captive insurance company, and consulting related to stock options. |
The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services provided by the Independent Registered Public Accounting Firm. These services may include audit services, audit-related services, tax services, and other services. Pre-approval is generally provided for up to one year and is detailed as to the particular services on a case-by-case basis. The Audit Committee pre-approved 100% of the audit fees, audit-related fees, and all other fees for the fiscal years ended December 31, 2004 and 2005.
The Audit Committee determined that the provision of services discussed above is compatible with maintaining the independence of PricewaterhouseCoopers LLP from the Company.
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| Item 15. | Exhibits, Financial Statement Schedules |
(a)(1) Financial statements filed as part of this report:
| Page | |||||
| Number | |||||
| Consolidated Annual Financial Statements of Town Sports International Holdings, Inc. | |||||
| Report of Independent Registered Public Accounting Firm | F-2 | ||||
| Consolidated balance sheets at December 31, 2004 and December 31, 2005 | F-3 | ||||
| Consolidated statements of operations for the years ended December 31, 2003, 2004 and 2005 | F-4 | ||||
| Consolidated statements of stockholders’ deficit for the years ended December 31, 2003, 2004 and 2005 | F-5 | ||||
| Consolidated statements of cash flows for the years ended December 31, 2003, 2004 and 2005 | F-6 | ||||
| Notes to consolidated financial statements | F-7 | ||||
| Consolidated Annual Financial Statements of Kalorama Sports Management Associates | |||||
| Independent Auditors’ Report | F-37 | ||||
| Consolidated balance sheets at December 31, 2005 and December 31, 2004 | F-38 | ||||
| Consolidated statements of income and expense for the years ended December 31, 2005, 2004 and 2003 | F-39 | ||||
| Consolidated statements of partners’ capital for the years ended December 31, 2005, 2004 and 2003 | F-40 | ||||
| Consolidated statements of cash flows for the years ended December 31, 2005, 2004 and 2003 | F-41 | ||||
| Notes to consolidated financial statements | F-42 | ||||
(a)(2) Financial Statements Schedules
Not applicable
| (a)(3) | Exhibits |
Exhibits identified in parentheses below are on file with the SEC and are incorporated herein by reference to such previous filings.
| Exhibit | ||||
| No. | Description of Exhibit | |||
| 3 | .1 | Certificate of Incorporation of Town Sports International Holdings, Inc. (Incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 3 | .2 | Amended Certificate of Incorporation of Town Sports International Holdings, Inc. (Incorporated by reference to Exhibit 3.2 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 3 | .3 | By-laws of Town Sports International Holdings, Inc. (Incorporated by reference to Exhibit 3.3 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 4 | .1 | Indenture dated as of February 4, 2004 by and among Town Sports International Holdings, Inc. and The Bank of New York. (Incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 4 | .2 | Registration Rights Agreement, dated as of February 4, 2004, by and between Town Sports International Holdings, Inc. and Deutsche Bank Securities Inc. (Incorporated by reference to Exhibit 4.3 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 4 | .3 | Form of Class A Common Stock Certificate | ||
| 10 | .1 | Credit Agreement dated as of April 16, 2003 by and among Town Sports International, Inc., the financial institutions referred to therein and Deutsche Bank Trust Company Americas ((Incorporated by reference to Exhibit 10.1 to Form S-4 of Town Sports International, Inc. (File No. 333-82607)). | ||
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| Exhibit | ||||
| No. | Description of Exhibit | |||
| 10 | .2 | First Amendment, dated as of January 27, 2004, to Credit Agreement by and among Town Sports International, Inc., the financial institutions referred to therein and Deutsche Bank Trust Company Americas. (Incorporated by reference to Exhibit 10.2 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .3 | Restructuring Agreement, dated as of February 4, 2004, by and among Town Sports International, Inc., Town Sports International Holdings, Inc. Bruckmann, Rosser, Sherril & Co., L.P. the individuals and entities listed on the BRS Co-Investor Signature Pages thereto, Farallon Capital Partners, L.P., Farralon Capital Institutional Partners, L.P., RR Capital Partners, L.P., and Farallon Capital Institutional Partners II, L.P., Canterbury Detroit Partners, L.P., Canterbury Mezzanine Capital, L.P., Rosewood Capital, L.P., Rosewood Capital IV, L.P., Rosewood Capital IV Associates, L.P., CapitalSource Holdings LLC, Keith Alessi, Paul Arnold, and certain stockholders of the Company listed on the Executive Signature Pages thereto. (Incorporated by reference to Exhibit 10.3 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .4 | Stockholders Agreement, dated as of February 4, 2004, by and among Town Sports International Holdings, Inc., Town Sports International, Inc., Bruckmann, Rosser, Sherril & Co., L.P. the individuals and entities listed on the BRS Co-Investor Signature Pages thereto, Farallon Capital Partners, L.P., Farralon Capital Institutional Partners, L.P., RR Capital Partners, L.P., and Farallon Capital Institutional Partners II, L.P., Canterbury Detroit Partners, L.P., Canterbury Mezzanine Capital, L.P., Rosewood Capital, L.P., Rosewood Capital IV, L.P., Rosewood Capital IV Associates, L.P., CapitalSource Holdings LLC, Keith Alessi, Paul Arnold, and certain stockholders of the Company listed on the Executive Signature Pages thereto. (Incorporated by reference to Exhibit 10.4 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .5 | Registration Rights Agreement, dated as of February 4, 2004, by and among Town Sports International Holdings, Inc., Town Sports International, Inc., Bruckmann, Rosser, Sherril & Co., L.P. the individuals and entities listed on the BRS Co-Investor Signature Pages thereto, Farallon Capital Partners, L.P., Farralon Capital Institutional Partners, L.P., RR Capital Partners, L.P., and Farallon Capital Institutional Partners II, L.P., Canterbury Detroit Partners, L.P., Canterbury Mezzanine Capital, L.P., Rosewood Capital, L.P., Rosewood Capital IV, L.P., Rosewood Capital IV Associates, L.P., CapitalSource Holdings LLC, Keith Alessi, Paul Arnold, and certain stockholders of the Company listed on the Executive Signature Pages thereto. (Incorporated by reference to Exhibit 10.5 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .6 | Tax Sharing Agreement, dated as of February 4, 2004, by and among Town Sports International Holdings, Inc., Town Sports International, Inc., and the other signatories thereto. (Incorporated by reference to Exhibit 10.6 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .7 | The 2004 Common Stock Option Plan of Town Sports International Holdings, Inc. (Incorporated by reference to Exhibit 10.7 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .8 | Pledge Agreement, dated as of February 4, 2004, between Town Sports International Holdings, Inc. and Deutsche Bank Trust Company Americas, as collateral agent, for the benefit of the Secured Creditors (as defined therein). (Incorporated by reference to Exhibit 10.8 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .9 | Security Agreement, dated as of February 4, 2004, made by Town Sports International Holdings, Inc., in favor of Deutsche Bank Trust Company Americas, as collateral agent, for the benefit of the Secured Creditors (as defined therein). (Incorporated by reference to Exhibit 10.9 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .10 | Holdco Guaranty, dated as of February 4, 2004, made by Town Sports International Holdings, Inc. (Incorporated by reference to Exhibit 10.10 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
56
Table of Contents
| Exhibit | ||||
| No. | Description of Exhibit | |||
| 10 | .11 | Professional Services Agreement, dated as of December 10, 1996, by and among TSI, Inc. and Bruckmann, Rosser, Sherrill & Co., L.P. (‘BRS‘). (Incorporated by reference to Exhibit 10.11 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .12 | First Amendment to Professional Services Agreement, dated June 1, 2004, by and between Town Sports International Inc., and Bruckmann, Rosser, Sherrill and Co. (Incorporated by reference to Exhibit 10.12 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004). | ||
| 10 | .13 | 2003 Executive Stock Agreement, dated July 23, 2003, among TSI, Inc., BRS, the Farallon Entities and Randy Stephen. (Incorporated by reference to Exhibit 10.12 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| 10 | .16 | Purchase Agreement dated as of January 28, 2004 by and among Town Sports International Holdings, Inc. and Deutsche Bank Securities Inc. (Incorporated by reference to Exhibit 10.17 of the Company’s Registration Statement on Form S-4, Reg. No 333-114210) | ||
| **10 | .17 | Form of Executive Stock Agreement, dated as of February 4, 2004, between Town Sports International Holdings, Inc., BRS, the Farallon Entities and each of Mark Smith, Robert Giardina, Richard Pyle, Alex Alimanestianu, and Randall Stephen, respectively. | ||
| **10 | .18 | Separation Agreement and General Release between Mark Smith and Town Sports International Holdings, Inc. dated March 23, 2006. | ||
| **10 | .19 | Equity Agreement between Mark Smith and Town Sports International Holdings, Inc. dated March 23, 2006. | ||
| **10 | .20 | Amendment No. 1 to the Stockholders Agreement and Consent Agreement dated March 23, 2006 | ||
| **10 | .21 | Amendment No. 1 to the Registration Rights Agreement dated as of March 23, 2006 | ||
| **12 | Ratio of Earnings to Fixed Charges. | |||
| **14 | Code of Ethics and Business Conduct. | |||
| **21 | Subsidiaries of the Registrant. | |||
| **31 | .1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. | ||
| **31 | .2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. | ||
| **32 | .1 | Section 1350 Certification. | ||
| **32 | .2 | Section 1350 Certification. | ||
| ** | Filed herewith |
57
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 29, 2006.
| Town Sports International Holdings, Inc. |
| By: | /s/Robert Giardina |
| Robert Giardina | |
| Chief Executive Officer | |
| (principal executive officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature | Title | Date | ||||
| By: /s/Robert Giardina Robert Giardina | Chief Executive Officer (principal executive officer) | March 29, 2006 | ||||
| By: /s/Richard Pyle Richard Pyle | Chief Financial Officer (principal financial and accounting officer) | March 29, 2006 | ||||
| By: /s/Keith Alessi Keith Alessi | Director | March 29, 2006 | ||||
| By: /s/Paul Arnold Paul Arnold | Director | March 29, 2006 | ||||
| By: /s/Bruce Bruckmann Bruce Bruckmann | Director | March 29, 2006 | ||||
| By: /s/Rice Edmonds Rice Edmonds | Director | March 29, 2006 | ||||
| By: /s/Jason Fish Jason Fish | Director | March 29, 2006 | ||||
58
Table of Contents
INDEX TO FINANCIAL STATEMENTS
| Page | |||||
| Consolidated Annual Financial Statements of Town Sports International Holdings, Inc.: | |||||
| F-2 | |||||
| F-3 | |||||
| F-4 | |||||
| F-5 | |||||
| F-6 | |||||
| F-7 | |||||
| Consolidated Annual Financial Statements of Kalorama Sports Management Associates: | |||||
| F-37 | |||||
| F-38 | |||||
| F-39 | |||||
| F-40 | |||||
| F-41 | |||||
| F-42 | |||||
F-1
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Town Sports International Holdings, Inc:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ deficit and cash flows present fairly, in all material respects, the financial position of Town Sports International Holdings, Inc and Subsidiaries (the “Company”) at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
| /s/Pricewaterhousecoopers LLP |
New York, New York
March 28, 2006
F-2
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2005
| 2004 | 2005 | |||||||||
| (All figures in $’000s, except | ||||||||||
| share and per share data) | ||||||||||
| ASSETS | ||||||||||
| Current assets: | ||||||||||
| Cash and cash equivalents | $ | 57,506 | $ | 51,304 | ||||||
| Accounts receivable (less allowance for doubtful accounts of $2,647 and $1,984 in 2004 and 2005, respectively) | 1,955 | 7,103 | ||||||||
| Inventory | 655 | 421 | ||||||||
| Prepaid corporate income taxes | 5,645 | 4,518 | ||||||||
| Prepaid expenses and other current assets | 8,971 | 13,907 | ||||||||
| Total current assets | 74,732 | 77,253 | ||||||||
| Fixed assets, net | 226,253 | 253,131 | ||||||||
| Goodwill | 47,494 | 49,974 | ||||||||
| Intangible assets, net | 931 | 741 | ||||||||
| Deferred tax assets, net | 12,735 | 24,378 | ||||||||
| Deferred membership costs | 12,017 | 11,522 | ||||||||
| Other assets | 16,794 | 16,772 | ||||||||
| Total assets | $ | 390,956 | $ | 433,771 | ||||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||||
| Current liabilities: | ||||||||||
| Current portion of long-term debt and capital lease obligations | $ | 1,225 | $ | 1,267 | ||||||
| Accounts payable | 10,555 | 8,333 | ||||||||
| Accrued expenses | 22,402 | 31,620 | ||||||||
| Accrued interest | 5,217 | 5,267 | ||||||||
| Deferred revenue | 28,294 | 33,028 | ||||||||
| Total current liabilities | 67,693 | 79,515 | ||||||||
| Long-term debt and capital lease obligations | 395,236 | 409,895 | ||||||||
| Deferred lease liabilities | 36,009 | 48,898 | ||||||||
| Deferred revenue | 3,298 | 2,905 | ||||||||
| Other liabilities | 5,737 | 8,241 | ||||||||
| Total liabilities | 507,973 | 549,454 | ||||||||
| Commitments and contingencies (Note 15) | ||||||||||
| Stockholders’ deficit: | ||||||||||
| Class A voting common stock, $.001 par value; issued and outstanding 1,312,289 and 1,309,123 shares at December 31, 2004 and 2005, respectively | 1 | 1 | ||||||||
| Paid-in capital | (113,900 | ) | (113,588 | ) | ||||||
| Unearned compensation | (292 | ) | (509 | ) | ||||||
| Accumulated other comprehensive income (currency translation adjustment) | 916 | 386 | ||||||||
| Retained earnings (accumulated deficit) | (3,742 | ) | (1,973 | ) | ||||||
| Total stockholders’ deficit | (117,017 | ) | (115,683 | ) | ||||||
| Total liabilities and stockholders’ deficit | $ | 390,956 | $ | 433,771 | ||||||
See notes to consolidated financial statements.
F-3
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2003, 2004 and 2005
| 2003 | 2004 | 2005 | |||||||||||
| (All figures in $’000s) | |||||||||||||
Revenues: | |||||||||||||
| Club operations | $ | 335,665 | $ | 348,175 | $ | 384,143 | |||||||
| Fees and Other | 5,507 | 4,856 | 4,413 | ||||||||||
| 341,172 | 353,031 | 388,556 | |||||||||||
Operating expenses: | |||||||||||||
| Payroll and related | 130,585 | 138,302 | 151,920 | ||||||||||
| Club operating | 111,069 | 116,847 | 130,219 | ||||||||||
| General and administrative | 21,995 | 24,719 | 26,582 | ||||||||||
| Depreciation and amortization | 34,927 | 36,869 | 39,582 | ||||||||||
| Goodwill impairment | — | 2,002 | — | ||||||||||
| 298,576 | 318,739 | 348,303 | |||||||||||
| Operating income | 42,596 | 34,292 | 40,253 | ||||||||||
| Loss on extinguishment of debt | 7,773 | — | — | ||||||||||
| Interest expense | 23,670 | 39,343 | 41,550 | ||||||||||
| Interest income | (444 | ) | (743 | ) | (2,342 | ) | |||||||
| Equity in the earnings of investees and rental income | (1,369 | ) | (1,493 | ) | (1,744 | ) | |||||||
| Income (loss) before provision for corporate income taxes | 12,966 | (2,815 | ) | 2,789 | |||||||||
| Provision for corporate income taxes | 5,537 | 1,090 | 1,020 | ||||||||||
| Net income (loss) | 7,429 | (3,905 | ) | 1,769 | |||||||||
| Accreted dividends on preferred stock | (10,984 | ) | (784 | ) | — | ||||||||
| Net income (loss) attributable to common stockholders | $ | (3,555 | ) | $ | (4,689 | ) | $ | 1,769 | |||||
See notes to consolidated financial statements.
F-4
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
Years Ended December 31, 2003, 2004 and 2005
| Preferred Stock | Common Stock | |||||||||||||||||||||||||||||||||||||
| Series B | Class A | Accumulated | Accumulated | |||||||||||||||||||||||||||||||||||
| ($1.00 par) | ($.001 par) | Other | (Deficit)/ | Total | ||||||||||||||||||||||||||||||||||
| Paid-in | Unearned | Comprehensive | Retained | Stockholders’ | ||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Compensation | Income | Earnings | Deficit | ||||||||||||||||||||||||||||||
| (All figures in $’000s) | ||||||||||||||||||||||||||||||||||||||
Balance at January 1, 2003 | 3,822 | $ | 303 | 1,176,043 | $ | 1 | $ | (32,149 | ) | $ | (278 | ) | $ | 293 | $ | 90 | $ | (31,740 | ) | |||||||||||||||||||
| Series B preferred stock issued in connection with the exercise of stock options | 106,267 | 8,618 | (8,618 | ) | — | |||||||||||||||||||||||||||||||||
| Repurchase of stock | (549 | ) | (43 | ) | (540 | ) | (583 | ) | ||||||||||||||||||||||||||||||
| Compensation expense incurred in connection with Series B Preferred stock options | 177 | 177 | ||||||||||||||||||||||||||||||||||||
| Amortization of unearned compensation | 21 | 21 | ||||||||||||||||||||||||||||||||||||
| Accretion of Series B preferred stock dividend ($9.84 per share) | 1,083 | (305 | ) | (778 | ) | — | ||||||||||||||||||||||||||||||||
| Accretion of Series A redeemable preferred stock dividend ($32.86 per share) | (1,219 | ) | (3,830 | ) | (5,049 | ) | ||||||||||||||||||||||||||||||||
| Accretion of redeemable senior preferred stock dividend ($121.30 per share plus accretion to liquidation value) | (2,888 | ) | (1,964 | ) | (4,852 | ) | ||||||||||||||||||||||||||||||||
| Forfeiture of unvested options | (85 | ) | 85 | — | ||||||||||||||||||||||||||||||||||
| Other comprehensive income,: | ||||||||||||||||||||||||||||||||||||||
| Net income | 7,429 | 7,429 | ||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | 303 | 303 | ||||||||||||||||||||||||||||||||||||
| Total comprehensive income | 7,732 | |||||||||||||||||||||||||||||||||||||
Balance at December 31, 2003 | 109,540 | 9,961 | 1,176,043 | 1 | (45,627 | ) | (172 | ) | 596 | 947 | (34,294 | ) | ||||||||||||||||||||||||||
| Exercise of common stock warrants | 71,631 | — | — | — | ||||||||||||||||||||||||||||||||||
| Exercise of common stock options | 65,936 | 539 | 539 | |||||||||||||||||||||||||||||||||||
| Common stock distribution | (68,943 | ) | (68,943 | ) | ||||||||||||||||||||||||||||||||||
| Repurchase of common stock | (1,321 | ) | (53 | ) | (53 | ) | ||||||||||||||||||||||||||||||||
| Deferred compensation issued in connection with the issuance of common stock options | 184 | (184 | ) | — | ||||||||||||||||||||||||||||||||||
| Amortization of unearned compensation | 64 | 64 | ||||||||||||||||||||||||||||||||||||
| Accretion of Series B preferred stock dividend ($1.43 per share) | 157 | (157 | ) | — | ||||||||||||||||||||||||||||||||||
| Accretion of Series A redeemable preferred stock dividend ($15.69 per share) | (627 | ) | (627 | ) | ||||||||||||||||||||||||||||||||||
| Series B preferred stock redemption | (109,540 | ) | (10,118 | ) | (10,118 | ) | ||||||||||||||||||||||||||||||||
| Other comprehensive income,: | ||||||||||||||||||||||||||||||||||||||
| Net loss | (3,905 | ) | (3,905 | ) | ||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | 320 | 320 | ||||||||||||||||||||||||||||||||||||
| Total comprehensive loss | (3,585 | ) | ||||||||||||||||||||||||||||||||||||
Balance at December 31, 2004 | — | — | 1,312,289 | 1 | (113,900 | ) | (292 | ) | 916 | (3,742 | ) | (117,017 | ) | |||||||||||||||||||||||||
| Repurchase of common stock | (3,166 | ) | (184 | ) | (184 | ) | ||||||||||||||||||||||||||||||||
| Amortization of unearned compensation | (3 | ) | 282 | 279 | ||||||||||||||||||||||||||||||||||
| Deferred compensation charges related to outstanding stock options | 499 | (499 | ) | |||||||||||||||||||||||||||||||||||
| Other comprehensive income,: | ||||||||||||||||||||||||||||||||||||||
| Net income | 1,769 | 1,769 | ||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | (530 | ) | (530 | ) | ||||||||||||||||||||||||||||||||||
| Total comprehensive income | 1,239 | |||||||||||||||||||||||||||||||||||||
Balance at December 31, 2005 | — | $ | — | 1,309,123 | $ | 1 | $ | (113,588 | ) | $ | (509 | ) | $ | 386 | $ | (1,973 | ) | $ | (115,683 | ) | ||||||||||||||||||
See notes to consolidated financial statements.
F-5
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2004 and 2005
| 2003 | 2004 | 2005 | ||||||||||||
| (All figures in $’000s) | ||||||||||||||
Cash flows from operating activities: | ||||||||||||||
| Net income (loss) | $ | 7,429 | $ | (3,905 | ) | $ | 1,769 | |||||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities | ||||||||||||||
| Depreciation and amortization | 34,927 | 36,869 | 39,582 | |||||||||||
| Goodwill impairment | — | 2,002 | — | |||||||||||
| Fixed asset impairment charge | — | 406 | — | |||||||||||
| Non cash interest expense on Senior Discount Notes | — | 12,758 | 15,505 | |||||||||||
| Amortization of debt issuance costs | 1,627 | 1,584 | 1,644 | |||||||||||
| Loss on extinguishment of debt | 7,773 | — | — | |||||||||||
| Noncash rental expense, net of noncash rental income | 1,650 | 525 | 1,461 | |||||||||||
| Compensation expense incurred in connection with stock options | 198 | 64 | 279 | |||||||||||
| Net change in certain working capital components | (227 | ) | (1,292 | ) | 4,221 | |||||||||
| Decrease (increase) in deferred tax asset | 3,483 | 4,036 | (11,623 | ) | ||||||||||
| Decrease in deferred membership costs | 1,370 | 1,021 | 495 | |||||||||||
| Landlord contributions to tenant improvements | 617 | 2,508 | 8,590 | |||||||||||
| Increase in insurance reserves | — | 1,399 | 1,837 | |||||||||||
| Other | 23 | (850 | ) | (504 | ) | |||||||||
| Total adjustments | 51,441 | 61,030 | 61,487 | |||||||||||
| Net cash provided by operating activities | 58,870 | 57,125 | 63,256 | |||||||||||
Cash flows from investing activities: | ||||||||||||||
| Capital expenditures, net of effect of acquired businesses | (43,397 | ) | (36,816 | ) | (62,393 | ) | ||||||||
| Proceeds from sale of equipment | 176 | 7 | — | |||||||||||
| Acquisition of businesses, net of cash acquired | (130 | ) | (3,877 | ) | (3,945 | ) | ||||||||
| Net cash used in investing activities | (43,351 | ) | (40,686 | ) | (66,338 | ) | ||||||||
| Cash flows from financing activities: | ||||||||||||||
| Change in book overdraft | — | 2,778 | (1,792 | ) | ||||||||||
| Proceeds from 11.0% Senior Discount Note Offering | — | 120,487 | — | |||||||||||
| Redemption of Series A and Series B preferred stock | — | (50,635 | ) | — | ||||||||||
| Common stock distribution | — | (68,943 | ) | — | ||||||||||
| Repurchase of common stock | — | (53 | ) | (184 | ) | |||||||||
| Proceeds from stock option exercises | — | 539 | — | |||||||||||
| Repayments of other borrowings | (5,566 | ) | (3,908 | ) | (1,144 | ) | ||||||||
Proceeds from 95/8% Senior Note Offering | 255,000 | — | — | |||||||||||
Repayment of 93/4% Senior Notes | (125,000 | ) | — | — | ||||||||||
| Premium paid on extinguishment of debt and other costs | (4,064 | ) | — | — | ||||||||||
| Redemption of redeemable senior preferred stock | (66,977 | ) | — | — | ||||||||||
Transaction costs related to 95/8% Senior Notes | (9,578 | ) | — | — | ||||||||||
| Net line of credit repayments | (14,500 | ) | — | — | ||||||||||
| Net subordinated credit repayments | (9,000 | ) | — | — | ||||||||||
| Repurchase of Series B preferred stock | (583 | ) | — | — | ||||||||||
| Net cash provided by (used in) financing activities | 19,732 | 265 | (3,120 | ) | ||||||||||
| Net increase (decrease) in cash and cash equivalents | 35,251 | 16,704 | (6,202 | ) | ||||||||||
Cash and cash equivalents beginning of period | 5,551 | 40,802 | 57,506 | |||||||||||
| Cash and cash equivalents end of period | $ | 40,802 | $ | 57,506 | $ | 51,304 | ||||||||
Summary of the change in certain working capital components, net of effects of acquired businesses | ||||||||||||||
| Increase in accounts receivable | $ | (136 | ) | $ | (486 | ) | $ | (2,334 | ) | |||||
| Decrease in inventory | 382 | 95 | 230 | |||||||||||
| Increase in prepaid expenses and other current assets | (137 | ) | (845 | ) | (3,774 | ) | ||||||||
| (Increase) decrease in prepaid corporate income taxes | (1,050 | ) | (1,583 | ) | 1,127 | |||||||||
| Increase in accounts payable and accrued expenses | 1,036 | 515 | 4,920 | |||||||||||
| (Decrease) increase in deferred revenue | (322 | ) | 1,012 | 4,052 | ||||||||||
| Net change in certain working capital components | $ | (227 | ) | $ | (1,292 | ) | $ | 4,221 | ||||||
See notes to consolidated financial statements.
F-6
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2004 and 2005
(In $000s, except share data)
| 1. | The Company and Summary of Significant Accounting Policies |
Town Sports International Holdings, Inc. and Subsidiaries (the “Company” or “TSI Holdings”) owns and operates 139 fitness clubs (“clubs”) and partly owns and operates two additional clubs as of December 31, 2005. The Company operates in a single segment. The Company operates 95 clubs in the New York metropolitan market, 18 clubs in the Boston market, 19 clubs in the Washington, D.C. market, six in the Philadelphia market and three clubs in Switzerland. The Company’s geographic concentration in the New York metropolitan market may expose the Company to adverse developments related to competition, demographic changes, real estate costs, acts of terrorism and economic down turns.
| Principles of Consolidation |
The accompanying consolidated financial statements include the accounts of Town Sports International Holdings, Inc. and all wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications were made to the reported amounts at December 31, 2003 and 2004 to conform to the presentation at December 31, 2005
| Revenue Recognition |
The Company receives a one-time non-refundable initiation fee and monthly dues from its members. The Company’s members have the option to join on amonth-to-month basis or to commit to a one or two year membership.Month-to-month members can cancel their membership at any time with 30 days notice. Initiation fees and related direct expenses, primarily a percentage of salaries and sales commissions payable to membership consultants, are deferred and recognized, on a straight-line basis, in operations over an estimated membership life of twenty four (24) months. The amount of costs deferred do not exceed the related deferred revenue for the periods presented. Dues that are received in advance are recognized on a pro-rata basis over the periods in which services are to be provided. Revenues from ancillary services are recognized as services are performed. Management fees earned for services rendered are recognized at the time the related services are performed.
The Company recognizes revenue from merchandise sales upon delivery to the member.
In connection with advance receipts of fees or dues, the Company is required to maintain surety bonds totaling $3,427 and $3,766 as of December 31, 2004 and 2005, respectively, pursuant to various state consumer protection laws.
| Inventory |
Inventory consists of athletic equipment, supplies, headsets for the club entertainment system and clothing for sale to members. Inventories are valued at the lower of cost or market by thefirst-in, first-out method.
| Accounts Receivable and Allowance for Doubtful Accounts |
Accounts receivable principally consists of amounts due from the Company’s membership base. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s members to make required payments. The Company considers factors such as: historical collection experience, the age of the receivable balance, and general economic conditions that may effect our members ability to pay.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Receivables and Allowance for Doubtful Accounts |
Receivables consist of the following at December 31, 2004 and 2005:
| 2004 | 2005 | |||||||
| Membership receivables | $ | 3,645 | $ | 4,426 | ||||
| Landlord receivables | 412 | 3,241 | ||||||
| Other | 545 | 1,420 | ||||||
| $ | 4,602 | $ | 9,087 | |||||
Following are the changes in the allowance for doubtful accounts during the years December 31, 2003, 2004 and 2005:
| Balance Beginning | Write-offs Net of | Balance at | ||||||||||||||
| of the Year | Additions | Recoveries | End of Year | |||||||||||||
| December 31, 2005 | $ | 2,647 | $ | 6,165 | $ | (6,828 | ) | $ | 1,984 | |||||||
| December 31, 2004 | 822 | 5,497 | (3,672 | ) | 2,647 | |||||||||||
| December 31, 2003 | 120 | 1,537 | (835 | ) | 822 | |||||||||||
| Fixed Assets |
Fixed assets are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which are thirty years for building and improvements, five years for club equipment, furniture, fixtures and computer equipment, and three years for computer software. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining period of the related lease. Payroll costs directly related to the construction or expansion of the Company’s club base are capitalized with leasehold improvements. Expenditures for maintenance and repairs are charged to operations as incurred. The cost and related accumulated depreciation or amortization of assets retired or sold are removed from the respective accounts and any gain or loss is recognized in operations. The costs related to developing web applications, developing web pages and installing developed applications on the web servers are capitalized and classified as computer software. Web site hosting fees and maintenance costs are expensed as incurred.
| Advertising and Club Preopening Costs |
Advertising costs and club preopening costs are charged to operations during the period in which they are incurred, except for production costs related to television and radio advertisements, which are expensed when the related commercials are first aired. Total advertising costs incurred by the Company during the years ended December 31, 2003, 2004 and 2005 totaled $9,783, $8,994 and $10,337 respectively, and are included in club operations.
| Insurance |
The Company obtains insurance coverage for significant exposures as well as those risks required to be insured by law or contract. The Company retains a portion of risk internally related to general liability losses. Where the Company retains risk, provisions are recorded based upon the Company’s estimates of its ultimate exposure for claims. The provisions are estimated based on claims experience, an estimate of claims incurred but not yet reported and other relevant factors. In this connection, under the provision of the Deductible Agreement related to the payment and administration the Company’s insurance claims, we are required to maintain an irrevocable letter of credit, which amounts to $3,000 as of December 31, 2005.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
The most significant assumptions and estimates relate to the allocation and fair value ascribed to assets acquired in connection with the acquisition of clubs under the purchase method of accounting, the useful lives, recoverability and impairment of fixed and intangible assets, deferred income tax valuation, valuation of and expense incurred in connection with stock options, insurance reserves, legal contingencies and the estimated membership life.
| Corporate Income Taxes |
Deferred tax liabilities and assets are recognized for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined on the basis of the difference between the financial statement and tax basis of assets and liabilities (“temporary differences”) at enacted tax rates in effect for the years in which the temporary differences are expected to reverse. A valuation allowance is recorded to reduce deferred tax assets to the amount that is more likely than not to be realized.
| Statements of Cash Flows |
Supplemental disclosure of cash flow information:
| Year Ended December 31, | |||||||||||||
| 2003 | 2004 | 2005 | |||||||||||
| Cash paid | |||||||||||||
| Interest (net of amounts capitalized) | $ | 24,004 | $ | 25,399 | $ | 25,251 | |||||||
| Income taxes | 3,104 | 1,706 | 10,718 | ||||||||||
| Noncash investing and financing activities | |||||||||||||
| Acquisition of fixed assets included in accounts payable and accrued expenses | 7,287 | 8,372 | 10,479 | ||||||||||
| See Notes 6, 9, 10 and 11 for additional non-cash investing and financing activities | |||||||||||||
| Cash and Cash Equivalents |
The Company considers all highly liquid instruments which have original maturities of three months or less when acquired to be cash equivalents. The carrying amounts reported in the balance sheets for cash and cash equivalents approximate fair value. The Company owns and operates a captive insurance company in the State of New York. Under the insurance laws of the State of New York, this captive insurance company is required to maintain a cash balance of at least $250. At December 31, 2004 and December 31, 2005, $254, and $256 respectively, of cash related to this wholly owned subsidiary was included in cash and cash equivalents.
| Deferred Lease Liabilities and Noncash Rental Expense |
The Company recognizes rental expense for leases with scheduled rent increases on the straight-line basis over the life of the lease beginning upon the commencement of the lease.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Foreign Currency |
At December 31, 2005, the Company owned three Swiss clubs, which use the local currency as their functional currency. Assets and liabilities are translated into U.S. dollars at year-end exchange rates, while income and expense items are translated into U.S. dollars at the average exchange rate for the period. For all periods presented foreign exchange transaction gains and losses were not material. Adjustments resulting from the translation of foreign functional currency financial statements into U.S. dollars are included in the currency translation adjustment in stockholders’ deficit. The difference between the Company’s net income (loss) and comprehensive income (loss) is the effect of foreign exchange translation adjustments, which was $303, $320 and $(530) for 2003, 2004 and 2005 respectively.
| Comprehensive Income |
Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including foreign currency translation adjustments. The Company presents comprehensive income in its consolidated statements of stockholders’ deficit.
| Investments in Affiliated Companies |
The Company has investments in Capitol Hill Squash Club Associates (“CHSCA”) and Kalorama Sports Management Associates (“KSMA”) (collectively referred to as the “Affiliates”). The Company has a limited partnership interest in CHSCA, which provides the Company with approximately 20% of the CHSCA profits, as defined. The Company has a co-general partnership and limited partnership interests in KSMA, which entitles it to receive approximately 45% of the KSMA profits, as defined. The Affiliates have operations, which are similar, and related to, those of the Company. The Company accounts for these Affiliates in accordance with the equity method. The assets, liabilities, equity and operating results of the CHSCA and the Company’s pro rata share of the CHSCA’s net assets and operating results were not material for all periods presented. The financial statements of KSMA have been included with the Company’s Annual Report on Form 10-K. The KSMA balance sheets for the periods presented are not material to the Company’s balance sheets for these respective periods. Total revenue, income from operations and net income of KSMA for the years ending December 31, 2003, 2004 and 2005 are as follows:
| Year Ended December 31, | ||||||||||||
| 2003 | 2004 | 2005 | ||||||||||
| Revenue | $ | 3,657 | $ | 3,560 | $ | 3,526 | ||||||
| Income from operations | 1,634 | 1,563 | 1,452 | |||||||||
| Net income | 1,526 | 1,459 | 1,373 | |||||||||
| Intangible Assets, Goodwill and Debt Issuance Costs |
Intangible assets consist of membership lists, a beneficial lease and covenants-not-to-compete. These assets are stated at cost and are being amortized by the straight-line method over their estimated lives. Membership lists are amortized over 24 months and covenants-not-to-compete are amortized over the contractual life, generally five years. The beneficial lease is being amortized over the remaining life of the underlying club lease.
In accordance with the Statement on Financial Accounting Standards (“SFAS”) No. 142 (“SFAS 142”),Goodwill and Other Intangible Assets, goodwill has not been amortized subsequent to December 31, 2001.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Debt issuance costs are classified within other assets and are being amortized as additional interest expense over the life of the underlying debt, five to ten years, using the interest method. Amortization of debt issue costs was $1,627, $1,584 and $1,644 for December 31, 2003, 2004 and 2005 and respectively.
| Accounting for the Impairment of Long-Lived Assets |
Long-lived assets, such as fixed assets and intangible assets are reviewed for impairment when events or circumstances indicate that their carrying value may not be recoverable. Estimated undiscounted expected future cash flows are used to determine if an asset is impaired, in which case the asset’s carrying value would be reduced to fair value.
| Concentrations of Credit Risk |
Financial instruments which potentially subject the Company to concentrations of credit risk are cash and cash equivalents. Such amounts are held, primarily, in a single commercial bank. The Company holds no collateral for these financial instruments.
| Stock-Based Employee Compensation |
For financial reporting purposes, the Company accounts for stock-based compensation in accordance with the intrinsic value method (“APB No. 25”). In accordance with this method, no compensation expense is recognized in the accompanying financial statements in connection with the awarding of stock option grants to employees provided that, as of the grant date, all terms associated with the award are fixed and the fair value of the Company’s stock is not greater than the amount an employee must pay to acquire the stock as defined; however, to the extent that stock options are granted to employees with variable terms or if the fair value of the Company’s stock as of the measurement date is greater than the amount an employee must pay to acquire the stock, then the Company will recognize compensation expense. The fair value of warrants granted to non-employees for financing were recorded as deferred financing costs and amortized into interest expense using the interest method. See Note 10 for further discussion on stock options and warrants.
The following table illustrates the effect on net income (loss) attributed to common stockholders if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board issued Statement No. 123, (“SFAS 123”)Accounting for Stock-Based Compensation, to stock-based employee compensation.
| Year Ended December 31, | |||||||||||||
| 2003 | 2004 | 2005 | |||||||||||
| Net income (loss) attributed to common stockholders, as reported | $ | (3,555 | ) | $ | (4,689 | ) | $ | 1,769 | |||||
| Add | |||||||||||||
| Stock-based employee compensation expense included in reported net loss attributed to common stockholders, net of related tax effects | 12 | 37 | 177 | ||||||||||
| Deduct | |||||||||||||
| Total stock-based employee compensation expense determined under fair value based method for all stock option awards, net of related tax effects | (167 | ) | (99 | ) | (128 | ) | |||||||
| Pro forma net income (loss) attributed to common stockholders | $ | (3,710 | ) | $ | (4,751 | ) | $ | 1,818 | |||||
Since option grants vest over several years and additional grants are expected in the future, the pro forma results noted above are not likely to be representative of the effects on future years of the application of the fair value based method.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
For the purposes of the above pro forma information, the fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model and the following assumptions:
| Weighted | ||||||||||||||||||||
| Risk-Free | Average | Expected | Fair Value | |||||||||||||||||
| Interest | Expected | Expected | Dividend | at Date | ||||||||||||||||
| Class A Common | Rate | Life | Volatility | Yield | of Grant | |||||||||||||||
| 1999 Grants | 5.7 | % | 5 years | 60 | % | — | $ | 30.10 | ||||||||||||
| 2000 Grants | 6.6 | 5 years | 69 | — | 47.11 | |||||||||||||||
| 2001 Grants | 4.6 | 5 years | 72 | — | 111.89 | |||||||||||||||
| 2003 Grants | 3.8 | 6 years | 55 | — | 14.50 | |||||||||||||||
| 2005 Grants | 4.1 | 6 years | 49 | — | 8.00 | |||||||||||||||
Expected volatility percentages were derived from the volatility of publicly traded companies considered to have businesses similar to the Company.
| 2. | Recent Accounting Pronouncements |
In December 2004, the FASB issued SFAS No. 123R,“Shared-Based Payments.” SFAS No. 123R is a revision of SFAS No. 123,“Accounting for Stock Based Compensation,”and supersedes APB 25. Among other items, SFAS 123R eliminates the use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The effective date of SFAS 123R is the first reporting period beginning after December 15, 2005, which is first quarter 2006 for calendar year companies, although early adoption is allowed. SFAS 123R permits companies to adopt its requirements using either a “modified prospective” method, or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements of SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, requirements are the same as under the “modified prospective” method, but also permits entities to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. The Company will implement SFAS 123R using the “modified prospective” method.
SFAS 123R also requires that the benefits associated with the tax deduction in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. These future amounts cannot be estimated, because they depend on, among other things, when employees exercise stock options.
We currently utilized a standard option pricing model (i.e, Black-Scholes) to measure the fair value of stock options granted to employees. While SFAS 123R permits entities to continue to use such a model, the standard also permits the use of a “lattice” model. We will continue to use a standard pricing model to measure the fair value of employee stock options upon the adoption of SFAS 123R.
We will adopt SFAS 123R effective January 1, 2006; and based on the stock options outstanding as of December 31, 2005 we do not believe SFAS 123R will have a material impact on our financial statements.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| 3. | Fixed Assets |
Fixed assets as of December 31, 2004 and 2005, are shown at cost, less accumulated depreciation and amortization, and are summarized below:
| December 31, | |||||||||
| 2004 | 2005 | ||||||||
| Leasehold improvements | $ | 257,552 | $ | 287,171 | |||||
| Club equipment | 62,172 | 68,420 | |||||||
| Furniture, fixtures and computer equipment | 39,912 | 45,338 | |||||||
| Computer software | 9,893 | 11,261 | |||||||
| Building and improvements | 4,995 | 4,995 | |||||||
| Land | 986 | 986 | |||||||
| Construction in progress | 14,479 | 29,045 | |||||||
| 389,989 | 447,216 | ||||||||
| Less: Accumulated depreciation and amortization | (163,736 | ) | (194,085 | ) | |||||
| $ | 226,253 | $ | 253,131 | ||||||
Depreciation and leasehold amortization expense for the years ended December 31, 2003, 2004 and 2005, was $33,987, $36,092 and $38,950 respectively.
| 4. | Goodwill and Intangible Assets |
The Company is required to conduct at a minimum an annual review of goodwill for potential impairment. Goodwill impairment testing requires a comparison between the carrying value and fair value of reportable goodwill. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of the impairment loss is measured as the difference between the carrying value and the implied fair value of goodwill, which is determined using discounted cash flows. In the quarter ended March 31, 2004, the Company determined that the goodwill at one if its remote clubs was not recoverable. The goodwill impairment associated with this under performing club amounted to $2,002. A deferred tax benefit of $881 has been recorded in connection with this impairment. Since the club is remote from one of the Company’s clusters, it does not benefit from the competitive advantage that our clustered clubs have, and as a result is more susceptible to competition. In 2003 and 2005, the Company did not have to record a charge to earnings for an impairment of goodwill as a result of its annual review conducted during the first quarter.
The change in the carrying amount of goodwill from January 1, 2004 through December 31, 2005 is as follows:
Balance at January 1, 2004 | $ | 45,864 | |||
| Goodwill impairment | (2,002 | ) | |||
| Currency translation adjustments | 69 | ||||
| Acquisitions | 3,563 | ||||
Balance at December 31, 2004 | $ | 47,494 | |||
| Other | (15 | ) | |||
| Currency translation adjustments | (114 | ) | |||
| Acquisitions | 2,609 | ||||
Balance at December 31, 2005 | $ | 49,974 | |||
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
A summary of our acquired amortizable intangible assets as of December 31, 2004 and 2005 is as follows:
| December 31, 2004 | ||||||||||||
| Gross | ||||||||||||
| Carrying | Accumulated | Net | ||||||||||
| Amount | Amortization | Intangibles | ||||||||||
Acquired intangible assets | ||||||||||||
| Membership lists | $ | 11,008 | $ | (10,372 | ) | $ | 636 | |||||
| Covenants-not-to-compete | 1,151 | (895 | ) | 256 | ||||||||
| Beneficial lease | 223 | (184 | ) | 39 | ||||||||
| $ | 12,382 | $ | (11,451 | ) | $ | 931 | ||||||
| December 31, 2005 | ||||||||||||
| Gross | ||||||||||||
| Carrying | Accumulated | Net | ||||||||||
| Amount | Amortization | Intangibles | ||||||||||
Acquired intangible assets | ||||||||||||
| Membership lists | 11,450 | (10,939 | ) | 511 | ||||||||
| Covenants-not-to-compete | 1,151 | (949 | ) | 202 | ||||||||
| Beneficial lease | 223 | (195 | ) | 28 | ||||||||
| $ | 12,824 | $ | (12,083 | ) | $ | 741 | ||||||
The amortization expense of the above acquired intangible assets for each of the five years ending December 31, 2010 will be as follows:
| Amortization | ||||
| Expense | ||||
Year Ending December 31, | ||||
| 2006 | $ | 521 | ||
| 2007 | 120 | |||
| 2008 | 64 | |||
| 2009 | 36 | |||
| 2010 | — | |||
| $ | 741 | |||
Amortization expense of intangible assets for the years ended December 31, 2003, 2004 and 2005 was $940, $777 and $632 respectively.
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Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| 5. | Accrued Expenses |
Accrued expenses as of December 31, 2004 and 2005 consist of the following:
| December 31, | ||||||||
| 2004 | 2005 | |||||||
| Accrued payroll | $ | 5,472 | $ | 6,447 | ||||
| Accrued construction in progress and equipment | 3,200 | 7,848 | ||||||
| Accrued occupancy costs | 4,621 | 5,783 | ||||||
| Accrued insurance claims | 2,319 | 4,091 | ||||||
| Accrued other | 6,790 | 7,451 | ||||||
| $ | 22,402 | $ | 31,620 | |||||
| 6. | Long-Term Debt and Capital Lease Obligations |
Long-term debt and capital lease obligations consist of the following:
| December 31, | |||||||||
| 2004 | 2005 | ||||||||
Senior Notes 95/8% | $ | 255,000 | $ | 255,000 | |||||
| Senior Discount Notes 11% | 137,572 | 153,077 | |||||||
| Notes payable for acquired businesses | 3,874 | 3,085 | |||||||
| Capital lease obligations | 15 | — | |||||||
| 396,461 | 411,162 | ||||||||
| Less: Current portion due within one year | 1,225 | 1,267 | |||||||
| Long-term portion | $ | 395,236 | $ | 409,895 | |||||
The aggregate long-term debt obligations maturing during the next five years and thereafter is as follows:
| Amount Due | ||||
Year Ending December 31, | ||||
| 2006 | $ | 1,267 | ||
| 2007 | 775 | |||
| 2008 | 732 | |||
| 2009 | 311 | |||
| 2010 | — | |||
| Thereafter | 408,077 | |||
| $ | 411,162 | |||
In October 1997, the Company issued $85,000 of Series B 93/4% Senior Notes due October 2004. The net proceeds from the Senior Notes totaled approximately $81,700. The transaction fees of approximately $3,300, were accounted for as deferred financing costs. In June 1999, the Company issued $40,000 of Senior Notes at a price of 98.75%, providing the Company with $39,500 of proceeds before expenses relating to the issuance. The Senior Notes bear interest at an annual rate of 93/4%, payable semi-annually. The Senior Notes are redeemable at the option of the Company on or after October 15, 2001. For redemption prior to October 15, 2004, the Company would be required to pay a premium as defined. The $85,000 and $40,000 issuances are
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
collectively referred to as the “Senior Notes.” The Senior Notes were redeemed on April 16, 2003. See the April 16, 2003 Refinancing Transactions discussed below.
In November 2000, the Company entered into a Subordinated Credit Agreement (the “Subordinated Agreement”) with an affiliate of a stockholder of the Company. This Subordinated Agreement provided for up to $20,000 of principal borrowings and would have expired December 31, 2004. Interest on principal borrowings accrued at 12.75% per annum; 9.75% of which was payable on a monthly basis and the remaining 3% was accruable and payable, at the option of the Company, through maturity. The Company was charged a fee of 0.083% per month based on the portion of the facility not utilized. In connection with the April 16, 2003 refinancing transactions, this Subordinated Agreement was terminated.
Notes payable were incurred upon the acquisition of various clubs and are subject to the Company’s right of offset for possible post acquisition adjustments arising out of operations of the acquired clubs. These notes are stated at rates of between 5% and 9%, and are non-collateralized. The notes are due on various dates through 2009.
| April 16, 2003 Refinancing Transactions |
On April 16, 2003 the Company successfully completed a refinancing of its debt. This refinancing included an offering of $255,000 of 95/8% Senior Notes (“Notes”) that will mature April 15, 2011, and the entering into of a new $50,000 senior secured revolving credit facility (the “Senior Credit Facility”) that will expire April 15, 2008. The transaction fees of approximately $9,600 have been accounted for as deferred financing costs. The Notes accrue interest at 95/8% per annum and interest is payable semiannually on April 15 and October 15. In connection with this refinancing in 2003, the Company wrote-off $3,709 of deferred financing costs related to extinguished debt, paid a call premium of $3,048 and incurred $1,016 of interest on the 93/4% Notes representing the interest incurred during the 30 day redemption notification period.
| Senior Credit Facility |
The Company’s Senior Credit Facility contains various covenants including limits on capital expenditures, the maintenance of a consolidated interest coverage ratio of not less than 2.75 and 3.00:1.00 during 2005 and 2006 respectively, and a maximum permitted total leverage ratio of 3.75:1.00 from December 31, 2004 through December 30, 2005 and 3.50:1.00 from December 31, 2005 through September 29, 2006 and 3.25:1.00 from September 30, 2006 through September 29, 2007. TSI’s interest coverage and leverage rates were 3.52 to 1.00 and 3.13 to 1.00, respectively as of December 31, 2005. These covenants limit the Company’s ability to incur additional debt, and as of December 31, 2005, permitted additional borrowing capacity under the Senior Credit Facility was limited to $34,606. For the year ended December 31, 2005 the company was in compliance with its debt covenants.
Loans under the Senior Credit Facility will, at our option, bear interest at either the bank’s prime rate plus 3.0% or the Eurodollar rate plus 4.0%, as defined. There were no borrowings outstanding at December 31, 2004 and 2005. Outstanding letters of credit issued totaled $4,746 and $7,693 at December 31, 2004 and December 31, 2005 respectively, and the unutilized portion of the Senior Credit Facility was $45,254 and $42,037 as of December 31, 2004 and December 31, 2005 respectively. The Company is required to pay a commitment fee of 0.75% per annum on the daily unutilized amount.
| February 4, 2004 Restructuring |
On February 4, 2004 TSI Holdings, successfully completed an offering of 11.0% Senior Discount Notes (the “Discount Notes”) that will mature in February 2014. TSI Holdings received a total of $124,807 in connection with this issuance. Fees and expenses related to this transaction totaled approximately $4,378. No cash interest is required to be paid prior to February 2009. The accreted value of each Discount Note will increase from the date of issuance until February 1, 2009, at a rate of 11.0% per annum compounded semi-
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
annually such that on February 1, 2009 the accreted value will equal $213,000, the principal value due at maturity. Subsequent to February 1, 2009 cash interest on the Discount Notes will accrue and be payable semi-annually in arrears February 1 and August 1 of each year, commencing August 1, 2009. The Discount Notes are structurally subordinated and effectively rank junior to all indebtedness of the Company.
| Fair Market Value |
The carrying value of long-term debt, other than the Notes and the Discount Notes, approximates fair market value as of December 31, 2004 and 2005. Based on quoted market prices, the Discount Notes have a fair value of approximately $120,089 and $146,970 at December 31, 2004 and December 31, 2005 respectively. The Notes have a fair value of approximately $268,324 and $267,113 at December 31, 2004 and 2005 respectively.
| Interest Expense |
The Company’s interest expense and capitalized interest related to funds borrowed to finance club facilities under construction for the years ended December 31, 2003, 2004 and 2005 are as follows:
| Year Ended December 31, | ||||||||||||
| 2003 | 2004 | 2005 | ||||||||||
| Interest costs expensed | $ | 23,670 | $ | 39,343 | $ | 41,550 | ||||||
| Interest costs capitalized | 322 | 429 | 899 | |||||||||
| Total interest expense and amounts capitalized | $ | 23,992 | $ | 39,772 | $ | 42,449 | ||||||
| 7. | Related Party Transactions |
The Company entered into a professional service agreement with Bruckmann, Rosser, Sherrill & Co., Inc. (“BRS”), a stockholder of the Company for strategic and financial advisory services on December 10, 1996. As of December 31, 2005, BRS owned 38.5% of the Company’s outstanding common stock and has the ability to elect a majority of the board of directors and generally to control the affairs and policies of the Company. Fees for such services, which are included in General and administrative expenses, are $250 per annum, and are payable while BRS owns 3.66% or more of the outstanding Common stock of the Company. No amounts were due BRS at December 31, 2004 and 2005.
We paid approximately $848 in 2003, $862 in 2004 and $888 in 2005 to an entity of which Mr. Frank Napolitano, one of our officers, is currently a 25% owner, for rent for a multi-recreational club facility that we acquired in 1999. We expect to pay $690 in annual base rent and a pro rata share of operating expenses and property taxes on the facility during the term of the lease, which expires in 2015. Pursuant to the lease, we are also obligated to pay percentage rent based upon the revenue of the facility in the future.
| 8. | Leases |
The Company leases office, warehouse and multi-recreational facilities and certain equipment under non-cancelable operating leases. In addition to base rent, the facility leases generally provide for additional rent based on increases in real estate taxes and other costs. Certain leases give the Company the right to acquire the leased facility at defined prices based on fair value and provide for additional rent based upon defined formulas of revenue, cash flow or operating results of the respective facilities. Under the provisions of certain of these leases, the Company is required to maintain irrevocable letters of credit, which amount to $1,297 as of December 31, 2005.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The leases expire at various times through April 30, 2028, and certain leases may be extended at the Company’s option.
Future minimum rental payments under non-cancelable operating leases are as follows:
| Minimum | ||||
| Annual Rental | ||||
Year Ending December 31, | ||||
| 2006 | $ | 61,695 | ||
| 2007 | 63,279 | |||
| 2008 | 62,355 | |||
| 2009 | 60,373 | |||
| 2010 | 57,404 | |||
| Aggregate thereafter | 422,027 | |||
Rent expense, including the effect of deferred lease liabilities, for the years ended December 31, 2003, 2004 and 2005 was $59,575, $64,742 and $71,034 respectively. Such amounts include additional rent of $10,643, $11,653 and $13,399 respectively.
The Company, as landlord, leases space to third party tenants under non-cancelable operating leases and licenses. In addition to base rent, certain leases provide for additional rent based on increases in real estate taxes, indexation, utilities and defined amounts based on the operating results of the lessee. The leases expire at various times through June 30, 2018. Future minimum rentals receivable under noncancelable leases are as follows:
| Minimum | ||||
| Annual Rental | ||||
Year Ending December 31, | ||||
| 2006 | $ | 3,308 | ||
| 2007 | 3,056 | |||
| 2008 | 2,324 | |||
| 2009 | 2,028 | |||
| 2010 | 1,909 | |||
| Aggregate thereafter | 9,998 | |||
Rental income, including non-cash rental income, for the years ended December 31, 2003, 2004 and 2005 was $2,434, $2,416 and $3,035 respectively. Such amounts include additional rental charges above the base rent of $386, $218 and $35 respectively. We own the building at one of our club locations which houses a rental tenant that generated $613, $788 and $1,059 of rental income for the years ended December 31, 2003, 2004 and 2005 respectively.
| 9. | Redeemable Preferred Stock |
| Redeemable Senior Preferred Stock |
During November 1998, the Company issued 40,000 shares of mandatorily redeemable Senior stock and 143,261 warrants. During 2002, 71,630 of these warrants were exercised and in January 2004 the remaining 71,631 warrants were exercised. The Senior stock had no voting rights except as required by law. The warrants had an exercise price of $0.01. After payment of fees and expenses of approximately $365, the Company received net proceeds of $39,635. Upon issuance, a $3,416 value was ascribed to the warrants. The initial fair value of the Senior stock ($36,219) was being accreted to its liquidation value using the interest method. The
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Senior stock was redeemable in November 2008. The Company, at its option, could redeem the Senior stock at any time without premium.
The Senior stock had a liquidation value of $1,000 per share plus cumulative unpaid dividends of $26,977 as of April 16, 2003. The Senior stock holders were entitled to a cumulative 12% annual dividend, based on the share price of $1,000. During 2003, the Company recorded $4,852 of accretion, which was comprised of stock dividend accretion of $2,465 and the remaining warrant accretion to liquidation value of $2,387. On April 16, 2003, in connection with the refinancing transaction discussed in Note 6, all of the Senior stock was redeemed at a liquidation value of $66,977.
| Series A Redeemable Preferred Stock |
During fiscal years 1997 and 1998, the Company issued 152,455 and 1,182 shares, respectively, of Series A redeemable preferred stock. As of December 31, 2002 and 2003, 153,637 shares of Series A stock were outstanding. Series A stock had liquidation preferences over Common Stock in the event of a liquidation, dissolution or winding up of the Company. Series A stock had no conversion features or voting rights except as required by law, and rank“pari passu.”Series A stock had a liquidation value of $100 per share plus cumulative unpaid dividends of $24,526 as of December 31, 2003. Series A stockholders were entitled to a cumulative 14% annual dividend based upon the per share price of $100. In connection with the issuance of the 11% Senior Discount Notes discussed in Note 6 all of the 153,637 outstanding shares were redeemed in February 2004 for a total of $40,517.
| 10. | Stockholders’ Deficit |
| a. Capitalization |
The Company’s certificate of incorporation, provides for the issuance of up to 3,500,000 shares of capital stock, consisting of 2,500,000 shares of Class A Voting Common Stock (“Class A”), par value $0.001 per share; 500,000 shares of Class B Non-voting Common Stock (“Class B”), par value of $0.001 per share, (Class A and Class B are collectively referred to herein as “Common Stock”); and 200,000 shares of Series B Preferred Stock (“Series B”) par value $1.00 per share. This also includes the redeemable preferred stock discussed in Note 9, 100,000 shares Senior stock, par value $1.00 per share and 200,000 shares of Series A stock, par value $1.00 per share.
All stockholders have preemptive rights to purchase a pro-rata share of any future sales of securities, as defined.
| Common Stock |
Class A stock and Class B stock each have identical terms with the exception that Class A stock is entitled to one vote per share, while Class B stock has no voting rights, except as required by law. In addition, Class B stock is convertible into an equal number of Class A shares, at the option of the holder of the majority of the Class B stock. To date, the Company has not issued Class B stock.
On January 26, 2004 warrants to purchase 71,631 shares of Class A common stock were exercised.
| Series B Preferred Stock |
During December 1996, the Company issued 3,857 shares of Series B preferred stock, 3,273 shares of which were outstanding as of December 31, 2003, respectively. Series B stock had liquidation preferences over Common Stock in the event of a liquidation, dissolution or winding up of the Company. Series B stock has no voting rights except as required by law, and rank“pari passu.”Series B stock had a liquidation value of $35 per share plus cumulative unpaid dividends of $6,127 as of December 31, 2003. Series B stockholders
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
were entitled to a cumulative 14% annual dividend based upon the per share price of $35. In connection with the issuance of the 11% Discount Notes discussed in Note 6 all of the 109,540 outstanding shares were redeemed in February 2004 for a total of $10,118.
| Restructuring |
On February 4, 2004 Town Sports International, Inc. (“TSI Inc.”) and affiliates and TSI Holdings, a newly formed company, entered into a Restructuring Agreement. In connection with this Restructuring, the holders of TSI Inc.’s Series A Preferred Stock, Series B Preferred Stock and Class A Common stock contributed their shares of TSI Inc. to TSI Holdings for an equal amount of newly issued shares of the same form in TSI Holdings. Immediately following this exchange TSI Holdings contributed to TSI Inc. the certificates representing all of TSI Inc.’s shares contributed in the aforementioned exchange and in return TSI Inc. issued 1,000 shares of common stock to TSI Holdings, and cancelled on its books and records the certificate representing TSI Inc.’s shares contributed to it by TSI Holdings.
On February 6, 2004 all of TSI Holdings’ outstanding Series A stock and Series B stock were redeemed for a total of $50,635.
On March 12, 2004 65,536 vested common stock options of TSI Holdings were exercised. TSI Holdings received $539 in cash related to these exercises.
On March 15, 2004 the Board of Directors of TSI Holdings approved a common stock distribution of $52.50 per share to all shareholders of record on March 15, 2004. This dividend totaling $68,943 was paid on March 17, 2004. Also, in lieu of a common stock distribution, vested common option holders were paid a total of $1,144 recorded as payroll expense
b. Stock Options
| Series B Preferred Stock Options |
During the year ended December 31, 1996, the Company granted 164,783 options (“Series B Options”) to certain employees which entitle the holders to purchase an equal number of shares of Series B stock at an exercise price of $10.00 per share. Series B Options were fully vested on the date of grant and expire on December 31, 2021. The terms of the Series B Options also contained provisions whereby the exercise price would be reduced, or in certain cases, the option holder would receive cash in accordance with a formula as defined. The aggregate value of, either a reduction in exercise price, or the distribution of cash is deemed compensatory and, accordingly, is recorded as a compensation expense. The provisions of the Series B Preferred Stock Option Plan provide for a Special Accrual (“the Special Accrual”) equal to a 14% compounded annual return on the difference between the liquidation value for the shares subject to option, less the $10 per share exercise price. For the year ended December 31, 2003, compensation expense recognized in connection with Series B Options’ Special Accrual totaled $177. All Series B Preferred stock options were exercisable upon grant. There are no shares of Series B Preferred Stock reserved for future option grants.
In January 2003, an executive officer of the Company exercised 9,530 Series B Options, and in turn these newly issues shares were repurchased by the Company for $540 and were retired. In February 2003, certain executives of the Company exercised and converted the remaining 148,775 Series B Options in to 106,267 shares of Series B preferred stock. The difference between the 148,775 options exercised and the 106,267 shares issued is due to the remittance of these shares to the Company to cover the purchase price of the stock. The remitted shares were subsequently retired by the Company.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Class A Common Stock Options |
During the year ended December 31, 1996, the Company adopted the Town Sports International Inc. Common Stock Option Plan (the “Plan”). The provisions of the Plan, as amended and restated, provide for the Company’s Board of Directors to grant to executives and key employees options to acquire 162,754 shares of Class A stock.
Grants vest in full at various dates between December 2007 and 2015. The vesting of these grants will be accelerated in the event that certain defined events occur including the achievement of annual equity values or the sale or an Initial Public Offering of the Company. The term of each of these grants is ten or eleven years.
In accordance with APB No. 25,Accounting for Stock Issued to Employees, the Company recorded unearned compensation in connection with the 2001 Grants. Such amount is included within stockholders’ deficit and represented the difference between the estimated fair value of the Class A stock on the date of amendment or grant, respectively, and the exercise price. The Company utilized a third-party valuation as of June 30, 2000 together with consideration of events occurring since that date in determining the value of the Company’s stock at the date of grant of the 2001 options. Unearned compensation is amortized as compensation expense over the vesting period. During the years ended December 31, 2003, 2004 and 2005 amortization of unearned compensation totaled $21, $64 and $279 respectively.
As of December 31, 2005, there were 4,177 shares reserved for future option awards.
As of December 31, 2003, 2004 and 2005, a total of 80,294, 19,508 and 23,268 Class A Common stock options were exercisable, respectively.
The following table summarizes the stock option activity for the years ended December 31, 2003, 2004 and 2005:
| Weighted | Weighted | |||||||||||||||
| Average | Average | |||||||||||||||
| Class A | Exercise | Series B | Exercise | |||||||||||||
| Common | Price | Preferred | Price | |||||||||||||
| Balance at January 1, 2003 | 93,482 | $ | 28.23 | 158,306 | $ | 10.00 | ||||||||||
| Granted | 46,400 | 144.00 | (i) | — | ||||||||||||
| Exercised | (1,740 | ) | 36.14 | (158,306 | ) | 10.00 | ||||||||||
| Forfeited | (7,610 | ) | 24.48 | — | ||||||||||||
| Balance at December 31, 2003 | 130,532 | 69.49 | — | — | ||||||||||||
| Reinstated (ii) | 5,750 | 2.15 | ||||||||||||||
| Exercised | (65,936 | ) | 8.22 | |||||||||||||
| Forfeited | (1,460 | ) | 48.22 | |||||||||||||
| Balance at December 31, 2004(iii) | 68,886 | 84.42 | ||||||||||||||
| Granted | 20,000 | 91.50 | (i) | |||||||||||||
| Exercised (iv) | (240 | ) | 75.00 | |||||||||||||
| Forfeited | (280 | ) | 19.36 | |||||||||||||
| Balance at December 31, 2005 | 88,366 | 86.26 | ||||||||||||||
| (i) | Option exercise price was greater than market price on the grant date. | |
| (ii) | Option reinstated as a result of inadvertent forfeiture on behalf of TSI. |
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| (iii) | In connection with the restructuring of the Company’s capitalization, a total of 50,238 vested common stock options with a weighted average exercise price of $127.42 were amended to decrease the exercise price by $52.50, equivalent to the distribution that common stock holders received in March 2004. As of December 31, 2004, the 50,238 outstanding common stock options have a weighted average exercise price of $74.92. | |
| (iv) | The shares related to the exercise of these options were immediately repurchased and retired by the company. |
The following table summarizes stock option information as of December 31, 2005:
| Options Outstanding | |||||||||||||||||||||
| Options Exercisable | |||||||||||||||||||||
| Weighted- | |||||||||||||||||||||
| Average | Weighted- | Weighted- | |||||||||||||||||||
| Remaining | Average | Average | |||||||||||||||||||
| Number | Contractual | Exercise | Number | Exercise | |||||||||||||||||
| Outstanding | Life | Price | Exercisable | Price | |||||||||||||||||
| Class A Common | |||||||||||||||||||||
| 1999 grants | 880 | 36 months | $ | 53.00 | 880 | $ | 53.00 | ||||||||||||||
| 2000 grants | 9,148 | 48 months | $ | 75.00 | 9,148 | $ | 75.00 | ||||||||||||||
| 2003 grants | 9,240 | 84 months | $ | 144.00 | 9,240 | $ | 144.00 | ||||||||||||||
| 2004 amended and repriced 1999 grants | 1,640 | 36 months | $ | 0.50 | — | $ | 0.50 | ||||||||||||||
| 2004 amended and repriced 2000 grants | 6,098 | 48 months | $ | 22.50 | — | $ | 22.50 | ||||||||||||||
| 2004 amended and repriced 2001 grants | 4,400 | 77 months | $ | 47.50 | — | $ | 47.50 | ||||||||||||||
| 2004 amended and repriced 2003 grants | 36,960 | 84 months | $ | 91.50 | — | $ | 91.50 | ||||||||||||||
| 2005 grants | 20,000 | 108 months | $ | 91.50 | 4,000 | $ | 91.50 | ||||||||||||||
| Total Grants | 88,366 | $ | 86.26 | 23,268 | $ | 104.41 | |||||||||||||||
In connection with the issuance of the Discount Notes the Company’s Board of Directors approved a $52.50 common stock distribution payable to shareholders of record on March 15, 2004. The Board also approved the re-pricing of outstanding options such that the exercise price was reduced by the $52.50 distribution equivalent. These represent the 2004 amended and repriced grants.
| 11. | Asset Acquisitions |
During the years ended December 31, 2004 and 2005, the Company completed the acquisition the assets of certain existing fitness clubs. There were no club acquisitions during the year ended December 31, 2003. None of the individual acquisitions were material to the financial position, results of operations or cash flows
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
of the Company. The table below summarizes the aggregate purchase price and the purchase price allocation to assets acquired:
| Years Ended | |||||||||
| December 31, | |||||||||
| 2004 | 2005 | ||||||||
| Number of clubs acquired | 3 | 2 | |||||||
| Purchase prices payable in cash at closing | $ | 3,877 | $ | 3,945 | |||||
| Issuance and assumption of notes payable | 920 | 340 | |||||||
Total purchase prices | $ | 4,797 | $ | 4,285 | |||||
| Years Ended | |||||||||
| December 31, | |||||||||
| 2004 | 2005 | ||||||||
| Allocation of purchase prices | |||||||||
| Goodwill | $ | 3,563 | $ | 2,609 | |||||
| Fixed assets | 1,155 | 1,483 | |||||||
| Membership lists | 803 | 442 | |||||||
| Non-compete agreement | 275 | — | |||||||
| Other net liabilities acquired | (42 | ) | — | ||||||
| Other net assets acquired | — | 40 | |||||||
| Deferred revenue | (957 | ) | (289 | ) | |||||
Total allocation of purchase prices | $ | 4,797 | $ | 4,285 | |||||
For financial reporting purposes, these acquisitions have been accounted for under the purchase method and, accordingly, the purchase prices have been assigned to the assets and liabilities acquired on the basis of their respective fair values on the date of acquisition. The excess of purchase prices over the net assets acquired has been allocated to goodwill. The results of operations of the clubs have been included in the Company’s consolidated financial statements from the respective dates of acquisition. The impact of these acquisitions on the consolidated financial statements of the Company was not material.
| 12. | Revenue from Club Operations |
Revenues from club operations for the years ended December 31, 2003, 2004 and 2005 are summarized below:
| Years Ended December 31, | ||||||||||||
| 2003 | 2004 | 2005 | ||||||||||
| Membership dues | $ | 273,334 | $ | 282,716 | $ | 309,811 | ||||||
| Initiation fees | 13,892 | 12,439 | 11,916 | |||||||||
| Personal training revenue | 31,170 | 34,821 | 42,277 | |||||||||
| Other club ancillary revenue | 17,269 | 18,199 | 20,139 | |||||||||
| Total club revenue | 335,665 | 348,175 | 384,143 | |||||||||
| Other Revenue | 2,707 | 4,856 | 4,413 | |||||||||
| Business interruption insurance proceeds | 2,800 | — | — | |||||||||
| Total revenue | $ | 341,172 | $ | 353,031 | $ | 388,556 | ||||||
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| 13. | Corporate Income Taxes |
The provision (benefit) for income taxes for the years ended December 31, 2002, 2003 and 2004 consisted of the following:
| Year Ended December 31, 2003 | ||||||||||||
| State and | ||||||||||||
| Federal | Local | Total | ||||||||||
| Current | $ | 463 | $ | 1,591 | $ | 2,054 | ||||||
| Deferred | 3,017 | 466 | 3,483 | |||||||||
| $ | 3,480 | $ | 2,057 | $ | 5,537 | |||||||
| Year Ended December 31, 2004 | ||||||||||||||||
| State and | ||||||||||||||||
| Federal | Foreign | Local | Total | |||||||||||||
| Current | $ | (5,468 | ) | $ | 247 | $ | 2,275 | $ | (2,946 | ) | ||||||
| Deferred | 4,956 | — | (920 | ) | 4,036 | |||||||||||
| $ | (512 | ) | $ | 247 | $ | 1,355 | $ | 1,090 | ||||||||
| Year Ended December 31, 2005 | ||||||||||||||||
| State and | ||||||||||||||||
| Federal | Foreign | Local | Total | |||||||||||||
| Current | $ | 9,761 | $ | 318 | $ | 2,584 | $ | 12,663 | ||||||||
| Deferred | (8,557 | ) | — | (3,086 | ) | (11,643 | ) | |||||||||
| $ | 1,204 | $ | 318 | $ | (502 | ) | $ | 1,020 | ||||||||
| December 31, | |||||||||
| 2004 | 2005 | ||||||||
Deferred tax assets | |||||||||
| Deferred lease liabilities | $ | 8,781 | $ | 10,973 | |||||
| Deferred revenue | 4,367 | 5,697 | |||||||
| Deferred compensation expense incurred in connection with stock options | 42 | 149 | |||||||
| State net operating loss carry-forwards | 1,684 | 1,835 | |||||||
| Interest accretion | 4,051 | 10,198 | |||||||
| Accruals, reserves and other | 1,766 | 2,277 | |||||||
| 20,691 | 31,129 | ||||||||
Deferred tax liabilities | |||||||||
| Fixed assets and intangible assets | (2,735 | ) | (496 | ) | |||||
| Deferred costs | (4,240 | ) | (4,548 | ) | |||||
| (6,975 | ) | (5,044 | ) | ||||||
| Net deferred tax assets, prior to valuation allowance | 13,716 | 26,085 | |||||||
| Valuation allowance | (981 | ) | (1,707 | ) | |||||
| Net deferred tax assets | $ | 12,735 | $ | 24,378 | |||||
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
As of December 31, 2005, the Company has state net operating loss (“NOL”) carry-forwards of approximately $18,889. Such amounts expire between December 31, 2006 and December 31, 2024. The Company’s $1,707 valuation allowance principally relates to NOL carryforwards which may not be realizable due to the lack of future profitability in the respective states to which it applies.
In 2005, our foreign pre-tax earnings related to our Swiss entity was $863 and the related current tax provision was $318.
The differences between the U.S. federal statutory income tax rate and the Company’s effective tax rate were as follows for the years ended December 31, 2003, 2004 and 2005:
| Years Ended | ||||||||||||
| December 31, | ||||||||||||
| 2003 | 2004 | 2005 | ||||||||||
| Federal statutory tax rate | 35 | % | (35 | )% | 35 | % | ||||||
| State and local income taxes, net of federal tax benefit | 8 | 7 | 17 | |||||||||
| Change in state effective income tax rate | — | 12 | (11 | ) | ||||||||
| Deferred compensation | — | 41 | — | |||||||||
| State tax benefit related to self insurance | — | (8 | ) | (22 | ) | |||||||
| Foreign rate differential | — | (3 | ) | (3 | ) | |||||||
| Valuation allowance | — | 21 | 13 | |||||||||
| Swiss repatriation cost | — | — | 4 | |||||||||
| Other permanent differences | — | 4 | 4 | |||||||||
| 43 | % | 39 | % | 37 | % | |||||||
We have not provided for U.S. federal income and foreign withholding taxes on the undistributed earnings of ournon-U.S. subsidiary as calculated for income tax purposes, because, in accordance with the provisions of Accounting Principles Board Opinion No. 23, Accounting for Income Taxes -Special Areas (“APB 23”) we intend to reinvest these earnings outside the U.S. indefinitely.
Earnings from our foreign subsidiary are indefinitely reinvested outside of our home tax jurisdiction and thus pursuant to Accounting Principles Board Opinion No. 23, “Accounting for Income Taxes — Special Areas.” We do not recognize a deferred tax liability for the tax effect of the excess of the book over tax basis of our investments in our foreign subsidiary.
| The American Jobs Creation Act of 2004 |
The American Jobs Creation Act of 2004 (the “Act”) was signed into law on October 22, 2004. The Act provides for a special one-time elective dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer. In 2005 the Company elected to do a one-time dividend totaling $1,700. This dividend resulted in additional taxes of $119.
| 15. | Contingencies |
In December 2005, the Company settled the action styledJoseph Anaya vs. Town Sports International, Inc. et al., brought by an individual against us in the Supreme Court, New York County, alleging that on January 14, 2003, he sustained serious bodily injury at one of our club locations. He filed an amended complaint on September 17, 2003 seeking $2 billion dollars in damages for personal injuries. His cause of action seeking punitive damages in the amount of $250 million dollars was dismissed on January 26, 2004. A Stipulation of Discontinuance was filed on January 27, 2006. The amount of the settlement was within the amount of the Company’s available insurance coverage for which payment was made in December 2005.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
On March 1, 2005, in an action styledSarah Cruz, et ano v. Town Sports International, Inc.,, plaintiffs commenced a purported class action against us in the Supreme Court, New York County seeking unpaid wages and alleging that the Company violated various overtime provisions of the New York State Labor Law with respect to the payment of wages to certain trainers and Assistant Fitness Managers. The Company has yet to answer, move or otherwise respond to the complaint and the lawsuit is stayed upon agreement of the parties pending mediation. While we are unable to determine the ultimate outcome of the above actions, we intend to contest the case vigorously. Depending upon the ultimate outcome, this matter may have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
The Company and several other third parties have been named as defendants in an action styledCarlos Urbina et ano v 26 Court Street Associates, LLC et al., filed in the Supreme Court, Kings County, on April 4, 2001, seeking damages for personal injuries. Following a trial, the Company received a directed verdict for indemnification against one of the Company’s contractors and the plaintiff received a jury verdict of approximately $8,900 in his favor. Both of those verdicts are being appealed and the Company has filed an appeal bond in the amount of $1,812 in connection with those appeals. The Company is vigorously opposing the appeal of the directed verdict and prosecuting the appeal of the jury verdict. Depending on the ultimate outcome, this matter may have a material effect on the Company’s results of operation.
| 16. | Employee Benefit Plan |
The Company maintains a 401(k) defined contribution plan and is subject to the provisions of the Employee Retirement Income Security Act of 1974 (“ERISA”). The Plan provides for the Company to make discretionary contributions. The Plan was amended, effective January 1, 2001, to provide for an employer matching contribution in an amount equal to 25% of the participant’s contribution with a limit of five hundred dollars per individual, per annum. Employer matching contributions totaling $195, $191 and $180 were made in February 2004 and 2005 and March 2006 respectively, for the Plan years ended December 31, 2003, 2004 and 2005 respectively.
| 17. | Subsequent Event |
Effective March 23, 2006 Mark Smith, Chairman and Director of the Company resigned from his positions and is no longer an employee, executive officer or director of the Company. In connection with this resignation payments totaling approximately $1,035 will be made to Mr. Smith from March 2006 through March 2007. The $1,035 will be expensed in the three months ended March 31, 2006.
| 18. | Guarantors |
TSI Holdings has unconditionally guaranteed the 11.0% Discount Notes. TSI Holdings, TSI and all of TSI’s domestic subsidiaries have unconditionally guaranteed the $255,000 95/8% Senior Notes discussed in Note 6. However, TSI’s foreign subsidiaries have not provided guarantees for these Notes.
Except for TSI Holdings (TSI’s parent) each guarantor of the Senior Notes is a wholly owned subsidiary of TSI. The guarantees are full and unconditional and joint and severable. In January 2004, TSI Holdings was incorporated solely for the purpose of issuing the Discount Notes. The following schedules set forth condensed consolidating financial information as required by Rule 3-10d of Securities and Exchange Commission Regulation S-X at December 31, 2004, and December 31, 2005 and for the years ending December 31, 2003, 2004 and 2005. The financial information illustrates the composition of the combined guarantors.
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TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Balance Sheet
December 31, 2004
| Non- | ||||||||||||||||||||||||||
| Subsidiary | Guarantor | |||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiary | Eliminations | Consolidated | |||||||||||||||||||||
| (All figures in $’000s) | ||||||||||||||||||||||||||
| ASSETS | ||||||||||||||||||||||||||
| Current assets | ||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 274 | $ | 3,425 | $ | 51,327 | $ | 2,480 | $ | — | $ | 57,506 | ||||||||||||||
| Accounts receivable | — | 3,199 | 1,121 | 114 | (2,479 | ) | 1,955 | |||||||||||||||||||
| Inventory | — | — | 623 | 32 | — | 655 | ||||||||||||||||||||
| Prepaid corporate income taxes | — | 5,645 | — | — | — | 5,645 | ||||||||||||||||||||
| Intercompany receivable (payable) | 1,075 | 8,636 | (8,083 | ) | (1,628 | ) | — | — | ||||||||||||||||||
| Prepaid expenses and other current assets | — | 7,740 | 4,731 | — | (3,500 | ) | 8,971 | |||||||||||||||||||
| Total current assets | 1,349 | 28,645 | 49,719 | 998 | (5,979 | ) | 74,732 | |||||||||||||||||||
| Investment in subsidiaries | 8,862 | 267,350 | — | — | (276,212 | ) | — | |||||||||||||||||||
| Fixed assets, net of accumulated depreciation | — | 11,478 | 213,464 | 1,311 | — | 226,253 | ||||||||||||||||||||
| Goodwill | — | — | 46,619 | 875 | — | 47,494 | ||||||||||||||||||||
| Intangible assets, net | — | — | 931 | — | — | 931 | ||||||||||||||||||||
| Deferred tax assets | 6,266 | 7,108 | (491 | ) | (148 | ) | — | 12,735 | ||||||||||||||||||
| Deferred membership costs | — | — | 12,017 | — | — | 12,017 | ||||||||||||||||||||
| Other assets | 4,106 | 7,519 | 5,169 | — | — | 16,794 | ||||||||||||||||||||
| Total assets | $ | 20,583 | $ | 322,100 | $ | 327,428 | $ | 3,036 | $ | (282,191 | ) | $ | 390,956 | |||||||||||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||||||||||||||||||||
| Current liabilities | ||||||||||||||||||||||||||
| Current portion of long-term debt and capital lease obligations | $ | — | $ | — | $ | 1,225 | $ | — | $ | — | 1,225 | |||||||||||||||
| Accounts payable | — | 3,732 | 6,823 | — | — | 10,555 | ||||||||||||||||||||
| Accrued expenses and corporate income taxes payable | 28 | 6,353 | 15,509 | 512 | — | 22,402 | ||||||||||||||||||||
| Accrued interest | — | 5,215 | 2,481 | — | (2,479 | ) | 5,217 | |||||||||||||||||||
| Deferred revenue | — | — | 28,294 | — | — | 28,294 | ||||||||||||||||||||
| Total current liabilities | 28 | 15,300 | 54,332 | 512 | (2,479 | ) | 67,693 | |||||||||||||||||||
| Long-term debt and capital lease obligations | 137,572 | 295,865 | (34,701 | ) | — | (3,500 | ) | 395,236 | ||||||||||||||||||
| Deferred lease liabilities | — | 485 | 35,524 | — | — | 36,009 | ||||||||||||||||||||
| Deferred revenue | — | 60 | 3,137 | 101 | — | 3,298 | ||||||||||||||||||||
| Other liabilities | — | 1,528 | 4,209 | — | — | 5,737 | ||||||||||||||||||||
| Total liabilities | 137,600 | 313,238 | 62,501 | 613 | (5,979 | ) | 507,973 | |||||||||||||||||||
| Stockholders’ deficit: | ||||||||||||||||||||||||||
| Common Stockholder’s deficit | (117,933 | ) | 7,946 | 264,919 | 1,515 | (274,380 | ) | (117,933 | ) | |||||||||||||||||
| Accumulated other comprehensive income | 916 | 916 | 8 | 908 | (1,832 | ) | 916 | |||||||||||||||||||
| Other | — | — | — | — | — | — | ||||||||||||||||||||
| Total Stockholder’s deficit | (117,017 | ) | 8,862 | 264,927 | 2,423 | (276,212 | ) | (117,017 | ) | |||||||||||||||||
| Total liabilities and Stockholder’s deficit | $ | 20,583 | $ | 322,100 | $ | 327,428 | $ | 3,036 | $ | (282,191 | ) | $ | 390,956 | |||||||||||||
F-27
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Balance Sheet
December 31, 2005
| Non- | ||||||||||||||||||||||||||
| Subsidiary | Guarantor | |||||||||||||||||||||||||
| TSI Holding | TSI | Guarantors | Subsidiary | Eliminations | Consolidated | |||||||||||||||||||||
| (All figures in $’000s) | ||||||||||||||||||||||||||
| ASSETS | ||||||||||||||||||||||||||
| Current assets: | ||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 1 | $ | 1,359 | $ | 48,682 | $ | 1,262 | $ | — | $ | 51,304 | ||||||||||||||
| Accounts receivable | — | 3,664 | 6,144 | 133 | (2,838 | ) | 7,103 | |||||||||||||||||||
| Inventory | — | — | 395 | 26 | — | 421 | ||||||||||||||||||||
| Prepaid corporate income taxes | — | 4,550 | (32 | ) | — | — | 4,518 | |||||||||||||||||||
| Intercompany receivable (payable) | 1,137 | (1,137 | ) | — | — | — | — | |||||||||||||||||||
| Prepaid expenses and other current assets | — | 5,425 | 10,195 | (1,713 | ) | — | 13,907 | |||||||||||||||||||
| Total current assets | 1,138 | 13,861 | 65,384 | (292 | ) | (2,838 | ) | 77,253 | ||||||||||||||||||
| Investment in subsidiaries | 18,941 | 253,703 | — | — | (272,644 | ) | — | |||||||||||||||||||
| Fixed assets, net | — | 10,114 | 242,149 | 868 | — | 253,131 | ||||||||||||||||||||
| Goodwill | — | — | 49,215 | 759 | — | 49,974 | ||||||||||||||||||||
| Intangible assets | — | — | 741 | — | — | 741 | ||||||||||||||||||||
| Deferred tax assets | 13,560 | 11,354 | (492 | ) | (44 | ) | — | 24,378 | ||||||||||||||||||
| Deferred membership costs | — | 94 | 11,428 | — | — | 11,522 | ||||||||||||||||||||
| Other assets | 3,755 | 11,833 | 1,184 | — | — | 16,772 | ||||||||||||||||||||
| Total assets | 37,394 | 300,959 | 369,609 | 1,291 | (275,482 | ) | 433,771 | |||||||||||||||||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||||||||||||||||||||
| Current liabilities: | ||||||||||||||||||||||||||
| Current portion of long-term debt and capital lease obligations | — | — | 1,267 | — | — | 1,267 | ||||||||||||||||||||
| Accounts payable | — | (82 | ) | 8,415 | — | — | 8,333 | |||||||||||||||||||
| Accrued expenses | — | 13,364 | 17,864 | 392 | — | 31,620 | ||||||||||||||||||||
| Accrued Interest | — | 5,265 | 2,840 | — | (2,838 | ) | 5,267 | |||||||||||||||||||
| Deferred revenue | — | — | 32,940 | 88 | — | 33,028 | ||||||||||||||||||||
| Total current liabilities | — | 18,545 | 63,327 | 480 | (2,837 | ) | 79,515 | |||||||||||||||||||
| Long-term debt and capital lease obligations | 153,077 | 255,000 | 1,818 | — | — | 409,895 | ||||||||||||||||||||
| Deferred lease liabilities | — | 452 | 48,446 | — | — | 48,898 | ||||||||||||||||||||
| Deferred revenue | — | — | 2,905 | — | — | 2,905 | ||||||||||||||||||||
| Other liabilities | — | 8,019 | 222 | — | — | 8,241 | ||||||||||||||||||||
| Total liabilities | 153,077 | 282,018 | 116,717 | 480 | (2,838 | ) | 549,454 | |||||||||||||||||||
| Stockholders’ deficit: | ||||||||||||||||||||||||||
| Common Stockholders’ deficit | (116,069 | ) | 18,941 | 252,882 | 435 | (272,258 | ) | (116,069 | ) | |||||||||||||||||
| Accumulated other Comprehensive income | 386 | — | 10 | 376 | (386 | ) | 386 | |||||||||||||||||||
| Total stockholders’ deficit | (115,683 | ) | (18,941 | ) | 252,892 | 811 | (272,644 | ) | (115,683 | ) | ||||||||||||||||
| Total liabilities and stockholders’ deficit | $ | 37,394 | $ | 300,959 | $ | 369,609 | $ | 1,291 | $ | (275,482 | ) | $ | 433,771 | |||||||||||||
F-28
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Statement of Operations
For Twelve Months Ended December 31, 2003
| Non- | |||||||||||||||||||||||||
| Subsidiary | Guarantor | ||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiary | Eliminations | Consolidated | ||||||||||||||||||||
| All figures in $’000s | |||||||||||||||||||||||||
Revenue: | |||||||||||||||||||||||||
| Club operations | $ | — | $ | 427 | $ | 330,627 | $ | 4,611 | $ | — | $ | 335,665 | |||||||||||||
| Fees and other | 3,376 | 6,306 | — | (4,175 | ) | 5,507 | |||||||||||||||||||
| — | 3,803 | 336,933 | 4,611 | (4,175 | ) | 341,172 | |||||||||||||||||||
Operations expense: | |||||||||||||||||||||||||
| Payroll and related | — | 21,439 | 107,364 | 1,782 | — | 130,585 | |||||||||||||||||||
| Club operating | — | 772 | 112,800 | 1,112 | (3,615 | ) | 111,069 | ||||||||||||||||||
| General and administrative | — | (123 | ) | 22,291 | 387 | (560 | ) | 21,995 | |||||||||||||||||
| Depreciation and amortization | — | 3,890 | 30,661 | 376 | — | 34,927 | |||||||||||||||||||
| — | 25,978 | 273,116 | 3,657 | (4,175 | ) | 298,576 | |||||||||||||||||||
| Operating Income | — | (22,175 | ) | 63,817 | 954 | — | 42,596 | ||||||||||||||||||
| Loss of extinguishment of debt | — | 7,773 | — | — | — | 7,773 | |||||||||||||||||||
| Interest expense | — | 23,891 | 130 | (1 | ) | (350 | ) | 23,670 | |||||||||||||||||
| Interest Income | — | (794 | ) | — | — | 350 | (444 | ) | |||||||||||||||||
| Equity in the earnings of investees and rental income | — | (614 | ) | (755 | ) | — | — | (1,369 | ) | ||||||||||||||||
| Income(Loss) before provision (benefit) For corporate income taxes | — | (52,431 | ) | 64,442 | 955 | — | 12,966 | ||||||||||||||||||
| Provision (benefit) for corporate income taxes | — | (24,100 | ) | 29,401 | 236 | — | 5,537 | ||||||||||||||||||
| Income (loss) before equity earnings | — | (28,331 | ) | 35,041 | 719 | — | 7,429 | ||||||||||||||||||
| Equity earnings from subsidiaries | — | 35,760 | — | — | (35,760 | ) | — | ||||||||||||||||||
| Net Income (Loss) | $ | — | $ | 7,429 | $ | 35,041 | $ | 719 | $ | (35,760 | ) | $ | 7,429 | ||||||||||||
F-29
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Statements of Operations
For Twelve Months Ended December 31, 2004
| Non- | |||||||||||||||||||||||||
| Subsidiary | Guarantor | ||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiary | Eliminations | Consolidated | ||||||||||||||||||||
| �� | |||||||||||||||||||||||||
| All figures in $’000s | |||||||||||||||||||||||||
Revenues: | |||||||||||||||||||||||||
| Club operations | $ | — | $ | 19 | $ | 343,244 | $ | 4,912 | $ | — | $ | 348,175 | |||||||||||||
| Fees and other | — | 1,710 | 6,901 | 8 | (3,763 | ) | 4,856 | ||||||||||||||||||
| — | 1,729 | 350,145 | 4,920 | (3,763 | ) | 353,031 | |||||||||||||||||||
Operating Expenses: | |||||||||||||||||||||||||
| Payroll and related | — | 21,709 | 114,649 | 1,944 | — | 138,302 | |||||||||||||||||||
| Club operating | — | 1,368 | 117,546 | 1,136 | (3,203 | ) | 116,847 | ||||||||||||||||||
| General and administrative | 50 | 609 | 24,210 | 410 | (560 | ) | 24,719 | ||||||||||||||||||
| Depreciation and amortization | — | 3,994 | 32,478 | 397 | — | 36,869 | |||||||||||||||||||
| Goodwill impairment | — | — | 2,002 | — | — | 2,002 | |||||||||||||||||||
| 50 | 27,680 | 290,885 | 3,887 | (3,763 | ) | 318,739 | |||||||||||||||||||
| Operating Income (loss) | (50 | ) | (25,951 | ) | 59,260 | 1,033 | — | 34,292 | |||||||||||||||||
| Interest expense | 13,037 | 27,629 | (969 | ) | (4 | ) | (350 | ) | 39,343 | ||||||||||||||||
| Interest income | (60 | ) | (1,031 | ) | (2 | ) | — | 350 | (743 | ) | |||||||||||||||
| Equity in the earnings of investees and rental income | — | (788 | ) | (705 | ) | — | — | (1,493 | ) | ||||||||||||||||
| Income(loss) before provision (benefit) For corporate income taxes | (13,027 | ) | (51,761 | ) | 60,936 | 1,037 | — | (2,815 | ) | ||||||||||||||||
| Provision (benefit) for corporate income taxes | (6,267 | ) | (18,140 | ) | 25,250 | 247 | — | 1,090 | |||||||||||||||||
| Income (loss) before equity earnings | (6,760 | ) | (33,621 | ) | 35,686 | 790 | — | (3,905 | ) | ||||||||||||||||
| Equity earnings from subsidiaries | 2,855 | 36,476 | — | — | (39,331 | ) | — | ||||||||||||||||||
| Net Income (loss) | $ | (3,905 | ) | $ | 2,855 | $ | 35,686 | $ | 790 | $ | (39,331 | ) | $ | (3,905 | ) | ||||||||||
F-30
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Statement of Operations
For Twelve Months Ended December 31, 2005
| Non- | |||||||||||||||||||||||||
| Subsidiary | Guarantor | ||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiary | Eliminations | Consolidated | ||||||||||||||||||||
| All figures in $’000s | |||||||||||||||||||||||||
Revenues: | |||||||||||||||||||||||||
| Club operations | $ | — | $ | — | $ | 379,539 | $ | 4,604 | $ | — | $ | 384,143 | |||||||||||||
| Fees and other | — | 1,009 | 8,509 | — | (5,105 | ) | 4,413 | ||||||||||||||||||
| — | 1,009 | 388,048 | 4,604 | (5,105 | ) | 388,556 | |||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||
| Payroll and related | — | 22,780 | 127,624 | 1,879 | (363 | ) | 151,920 | ||||||||||||||||||
| Club operating | — | 1,304 | 131,944 | 1,153 | (4,182 | ) | 130,219 | ||||||||||||||||||
| General and administrative | 22 | 1,335 | 25,442 | 343 | (560 | ) | 26,582 | ||||||||||||||||||
| Depreciation and amortization | — | 4,334 | 34,876 | 372 | — | 39,582 | |||||||||||||||||||
| 22 | 29,753 | 319,886 | 3,747 | (5,105 | ) | 348,303 | |||||||||||||||||||
| Operating income (loss) | (22 | ) | (28,744 | ) | 68,162 | 857 | — | 40,253 | |||||||||||||||||
| Interest expense | 15,836 | 22,742 | 3,299 | — | (326 | ) | 41,550 | ||||||||||||||||||
| Interest income | (6 | ) | (2,652 | ) | (10 | ) | — | 326 | (2,342 | ) | |||||||||||||||
| Equity in the earnings of investees and rental income | — | (1,059 | ) | (685 | ) | — | — | (1,744 | ) | ||||||||||||||||
| Income (loss) before provision (benefit) for corporate income taxes | (15,852 | ) | (47,775 | ) | 65,558 | 857 | — | 2,789 | |||||||||||||||||
| Provision (benefit) for corporate income taxes | (7,828 | ) | (15,719 | ) | 24,256 | 311 | — | 1,020 | |||||||||||||||||
| Net Income before extraordinary items | (8,024 | ) | (32,055 | ) | 41,302 | 546 | — | 1,769 | |||||||||||||||||
| Equity earnings from Subsidiaries | 9,793 | 41,848 | — | — | (51,641 | ) | — | ||||||||||||||||||
| Net income (loss) | $ | 1,769 | $ | 9,793 | $ | 41,302 | $ | 546 | $ | (51,641 | ) | $ | 1,769 | ||||||||||||
F-31
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Statement of Cash Flow
For Twelve Months Ended December 31, 2003
| Non- | ||||||||||||||||||||||||||
| Subsidiary | Guarantor | |||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||
| (All figures in $’000s) | ||||||||||||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||||||||
| Net income | $ | — | $ | 7,429 | $ | 35,041 | $ | 719 | $ | (35,760 | ) | $ | 7,429 | |||||||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||||||||||||
| Depreciation and amortization | — | 3,890 | 30,661 | 376 | — | 34,927 | ||||||||||||||||||||
| Goodwill impairment write-off and club closure costs | — | 198 | — | — | — | 198 | ||||||||||||||||||||
| Compensation expense in connection with stock options | — | (84 | ) | 1,734 | — | — | 1,650 | |||||||||||||||||||
| Noncash rental expense, net of noncash rental income | — | 7,773 | — | — | — | 7,773 | ||||||||||||||||||||
| Amortization of debt issuance costs | — | 1,627 | — | — | — | 1,627 | ||||||||||||||||||||
| Changes in operating assets and liabilities | — | 4,011 | 1,166 | 66 | — | 5,243 | ||||||||||||||||||||
| Other | — | (36,277 | ) | 485 | 55 | 35,760 | 23 | |||||||||||||||||||
| Total adjustments | — | (18,862 | ) | 34,046 | 497 | 35,760 | 51,441 | |||||||||||||||||||
| Net cash provided by operating activities | — | (11,433 | ) | 69,087 | 1,216 | — | 58,870 | |||||||||||||||||||
Net cash used in investing activities | — | (4,288 | ) | (38,737 | ) | (326 | ) | — | (43,351 | ) | ||||||||||||||||
Net cash used in financing activities | — | 14,566 | 5,021 | 145 | — | 19,732 | ||||||||||||||||||||
| Net Increase in cash and cash equivalents | — | (1,155 | ) | 35,371 | 1,035 | — | 35,251 | |||||||||||||||||||
| Cash and cash equivalents at beginning of period | — | 1,575 | 3,635 | 341 | — | 5,551 | ||||||||||||||||||||
| Cash and cash equivalents at end of period | $ | — | $ | 420 | $ | 39,006 | $ | 1,376 | $ | — | $ | 40,802 | ||||||||||||||
F-32
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Statement of Cash Flow
For Twelve Months Ended December 31, 2004
| Non- | ||||||||||||||||||||||||||
| Subsidiary | Guarantor | |||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||
| (All figures in $’000s) | ||||||||||||||||||||||||||
Cash flows from operating activities: | $ | (3,905 | ) | $ | 2,855 | $ | 35,686 | $ | 790 | $ | (39,331 | ) | $ | (3,905 | ) | |||||||||||
| Net income | ||||||||||||||||||||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | — | 3,994 | 32,478 | 397 | — | 36,869 | ||||||||||||||||||||
| Depreciation and amortization | — | — | 2,002 | — | — | 2,002 | ||||||||||||||||||||
| Goodwill impairment write-off | — | 406 | — | — | — | 406 | ||||||||||||||||||||
| Fixed Asset impairment charges | — | 64 | — | — | — | 64 | ||||||||||||||||||||
| Compensation expense in connection with stock options | ||||||||||||||||||||||||||
| Noncash rental expense, net of noncash rental income | — | (99 | ) | 624 | — | — | 525 | |||||||||||||||||||
| Loss on extinguishment of debt | 12,758 | — | — | — | — | 12,758 | ||||||||||||||||||||
| Amortization of debt issuance costs | 272 | 1,312 | — | — | — | 1,584 | ||||||||||||||||||||
| Changes in operating assets and liabilities | (7,340 | ) | 9,412 | 4,270 | (69 | ) | — | 6,273 | ||||||||||||||||||
| Other | (2,885 | ) | (37,590 | ) | 1,552 | 141 | 39,331 | 549 | ||||||||||||||||||
| Total adjustments | 2,805 | (22,501 | ) | 40,926 | 469 | 39,331 | 61,030 | |||||||||||||||||||
| Net cash provided by operating activities | (1,100 | ) | (19,646 | ) | 76,612 | 1,259 | — | 57,125 | ||||||||||||||||||
Net cash used in investing activities | — | (3,800 | ) | (36,731 | ) | (155 | ) | — | (40,686 | ) | ||||||||||||||||
Net cash provided by financing activities | 1,374 | 26,451 | (27,560 | ) | — | — | 265 | |||||||||||||||||||
| Net Increase in cash and cash equivalents | 274 | 3,005 | 12,321 | 1,104 | — | 16,704 | ||||||||||||||||||||
Cash and cash equivalents at beginning of period | — | 420 | 39,006 | 1,376 | — | 40,802 | ||||||||||||||||||||
| Cash and cash equivalents at end of period | $ | 274 | $ | 3,425 | $ | 51,327 | $ | 2,480 | $ | — | $ | 57,506 | ||||||||||||||
F-33
Table of Contents
TOWN SPORTS INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Condensed Consolidating Statement of Cash Flow
For Twelve Months Ended December 31, 2005
| Non- | ||||||||||||||||||||||||||
| Subsidiary | Guarantor | |||||||||||||||||||||||||
| TSI Holdings | TSI | Guarantors | Subsidiary | Eliminations | Consolidated | |||||||||||||||||||||
| (All figures in $’000s) | ||||||||||||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||||||||
| Net income | $ | 1,769 | $ | 9,793 | $ | 41,302 | $ | 546 | $ | (51,641 | ) | $ | 1,769 | |||||||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||||||||||||
| Depreciation and amortization | — | 4,334 | 34,876 | 372 | — | 39,582 | ||||||||||||||||||||
| Compensation expense in connection with stock options | — | 279 | — | — | — | 279 | ||||||||||||||||||||
| Noncash rental expense, net of noncash rental income | — | (162 | ) | 1,623 | — | — | 1,461 | |||||||||||||||||||
| Noncash interest expense | 15,505 | — | — | — | — | 15,505 | ||||||||||||||||||||
| Amortization of debt issuance costs | 331 | 1,313 | — | — | — | 1,644 | ||||||||||||||||||||
| Increase in insurance reserves | — | 1,837 | — | — | — | 1,837 | ||||||||||||||||||||
| Landlord Contributions | — | — | 8,590 | — | — | 8,590 | ||||||||||||||||||||
| Changes in operating assets and liabilities | (93 | ) | 4,314 | — | — | — | 4,221 | |||||||||||||||||||
| Other | (17,601 | ) | 45,500 | (89,036 | ) | (2,136 | ) | 51,641 | (11,632 | ) | ||||||||||||||||
| Total adjustments | (1,858 | ) | 57,415 | (43,947 | ) | (1,764 | ) | 51,641 | 61,487 | |||||||||||||||||
| Net cash provided by operating activities | (89 | ) | 67,208 | (2,645 | ) | (1,218 | ) | — | 63,256 | |||||||||||||||||
Net cash used in investing activities | — | (66,338 | ) | — | — | — | (66,338 | ) | ||||||||||||||||||
Net cash provided by financing activities | (184 | ) | (2,936 | ) | — | — | — | (3,120 | ) | |||||||||||||||||
| Net increase (decrease) in cash and cash equivalents | (273 | ) | (2,066 | ) | (2,645 | ) | (1,218 | ) | — | (6,202 | ) | |||||||||||||||
Cash and cash equivalents at beginning of period | 274 | 3,425 | 51,327 | 2,480 | — | 57,506 | ||||||||||||||||||||
| Cash and cash equivalents at end of period | $ | 1 | $ | 1,359 | $ | 48,682 | $ | 1,262 | $ | — | $ | 51,304 | ||||||||||||||
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Table of Contents
KALORAMA SPORTS
MANAGEMENT ASSOCIATES
AND SUBSIDIARY
DECEMBER 31, 2005, 2004 AND 2003
F-35
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TABLE OF CONTENTS
| Page | |||
| Independent Auditors’ Report | F-37 | ||
| Financial Statements: | |||
| Consolidated Balance Sheets | F-38 | ||
| Consolidated Statements of Income and Expenses | F-39 | ||
| Consolidated Statements of Partners’ Capital | F-40 | ||
| Consolidated Statements of Cash Flows | F-41 | ||
| Notes to Consolidated Financial Statements | F-42 — 45 | ||
F-36
Table of Contents
INDEPENDENT AUDITORS’ REPORT
Partners
Kalorama Sports Management Associates
Washington, D.C.
We have audited the accompanying consolidated balance sheets of Kalorama Sports Management Associates (A Limited Partnership) and Subsidiary as of December 31, 2005 and 2004, and the related consolidated statements of income and expenses, partners’ capital, and cash flows for each of the three years in the period ended December 31, 2005. These consolidated financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kalorama Sports Management Associates and Subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.
January 28, 2006
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Table of Contents
KALORAMA SPORTS MANAGEMENT ASSOCIATES
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
| December 31, | ||||||||||
| 2005 | 2004 | |||||||||
| (In thousands of | ||||||||||
| dollars) | ||||||||||
| ASSETS | ||||||||||
CURRENT ASSETS: | ||||||||||
| Accounts receivable | $ | 142 | $ | 163 | ||||||
| Inventory | 1 | 4 | ||||||||
| Prepaid expenses and other | 31 | 33 | ||||||||
| Deposits and other | — | 20 | ||||||||
TOTAL CURRENT ASSETS | 174 | 220 | ||||||||
PROPERTY, PLANT AND EQUIPMENT | 158 | 255 | ||||||||
OTHER ASSETS: | ||||||||||
| Prepaid rent | 11 | 12 | ||||||||
| Deferred member costs | 73 | 99 | ||||||||
| Deferred tax benefit | 105 | 64 | ||||||||
| Deposits and other deferred charges | 57 | 28 | ||||||||
TOTAL OTHER ASSETS | 246 | 203 | ||||||||
TOTAL ASSETS | $ | 578 | $ | 678 | ||||||
| LIABILITIES AND PARTNERS’ CAPITAL | ||||||||||
CURRENT LIABILITIES: | ||||||||||
| Bank overdraft | $ | 6 | $ | 9 | ||||||
| Accounts payable and accrued expenses | 249 | 259 | ||||||||
| Deferred revenue | 195 | 194 | ||||||||
| Deferred lease benefit | — | 21 | ||||||||
TOTAL CURRENT LIABILITIES | 450 | 483 | ||||||||
OTHER LIABILITIES: | ||||||||||
| Deferred revenue | 42 | 32 | ||||||||
| Deferred lease benefit | 300 | — | ||||||||
TOTAL OTHER LIABILITIES | 342 | 32 | ||||||||
TOTAL LIABILITIES | 792 | 515 | ||||||||
COMMITMENTS AND CONTINGENCIES | ||||||||||
PARTNERS’ CAPITAL | (214 | ) | 163 | |||||||
TOTAL LIABILITIES AND PARTNERS’ CAPITAL | $ | 578 | $ | 678 | ||||||
The accompanying notes are an integral part of these financial statements.
F-38
Table of Contents
KALORAMA SPORTS MANAGEMENT ASSOCIATES
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND EXPENSES
| For the Years Ended | ||||||||||||||
| December 31, | ||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||
| (In thousands of dollars) | ||||||||||||||
INCOME: | ||||||||||||||
| Membership and facility fees | $ | 3,508 | $ | 3,527 | $ | 3,634 | ||||||||
| Pro shop sales | 8 | 15 | 23 | |||||||||||
| Advertising and other income | 10 | 18 | 4 | |||||||||||
TOTAL INCOME | 3,526 | 3,560 | 3,661 | |||||||||||
EXPENSES: | ||||||||||||||
| Personnel and related costs | 779 | 794 | 857 | |||||||||||
| Occupancy | 683 | 410 | 384 | |||||||||||
| Other operating expenses | 367 | 377 | 340 | |||||||||||
| Depreciation and amortization | 156 | 319 | 323 | |||||||||||
| Advertising | 84 | 94 | 108 | |||||||||||
| Cost of sales — pro shop | 6 | 3 | 12 | |||||||||||
TOTAL EXPENSES | 2,075 | 1,997 | 2,024 | |||||||||||
NET INCOME BEFORE INCOME TAXES | 1,451 | 1,563 | 1,637 | |||||||||||
| State income taxes | (78 | ) | (104 | ) | (111 | ) | ||||||||
NET INCOME | $ | 1,373 | $ | 1,459 | $ | 1,526 | ||||||||
The accompanying notes are an integral part of these financial statements.
F-39
Table of Contents
KALORAMA SPORTS MANAGEMENT ASSOCIATES
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
| General | ||||||||||||||||||
| Partners | ||||||||||||||||||
| and | ||||||||||||||||||
| Class I | Class II | Class III | ||||||||||||||||
| Limited | Limited | Limited | ||||||||||||||||
| Totals | Partners | Partners | Partners | |||||||||||||||
| (In thousands of dollars) | ||||||||||||||||||
BALANCE | ||||||||||||||||||
DECEMBER 31, 2002 | $ | 428 | $ | 8 | $ | 372 | $ | 48 | ||||||||||
| NET INCOME | 1,526 | 175 | 266 | 1,085 | ||||||||||||||
| DISTRIBUTIONS | (1,700 | ) | (192 | ) | (293 | ) | (1,215 | ) | ||||||||||
BALANCE | ||||||||||||||||||
DECEMBER 31, 2003 | 254 | (9 | ) | 345 | (82 | ) | ||||||||||||
| NET INCOME | 1,459 | 169 | 256 | 1,034 | ||||||||||||||
| DISTRIBUTIONS | (1,550 | ) | (178 | ) | (269 | ) | (1,103 | ) | ||||||||||
BALANCE | ||||||||||||||||||
DECEMBER 31, 2004 | 163 | (18 | ) | 332 | (151 | ) | ||||||||||||
| NET INCOME | 1,373 | 160 | 243 | 970 | ||||||||||||||
| DISTRIBUTIONS | (1,750 | ) | (198 | ) | (300 | ) | (1,252 | ) | ||||||||||
BALANCE | ||||||||||||||||||
DECEMBER 31, 2005 | $ | (214 | ) | $ | (56 | ) | $ | 275 | $ | (433 | ) | |||||||
The accompanying notes are an integral part of these financial statements.
F-40
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KALORAMA SPORTS MANAGEMENT ASSOCIATES
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Years Ended December 31, | ||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||
| (In thousands of dollars) | ||||||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||||||
| Cash received from members and guests | $ | 3,572 | $ | 3,480 | $ | 3,690 | ||||||||||
| Cash paid to suppliers and employees | (1,686 | ) | (1,757 | ) | (1,770 | ) | ||||||||||
| Interest received | 1 | 1 | 3 | |||||||||||||
| Income taxes paid | (76 | ) | (102 | ) | (139 | ) | ||||||||||
NET CASH PROVIDED BY OPERATING ACTIVITIES | 1,811 | 1,622 | 1,784 | |||||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||||||
| Purchases of property, plant and equipment | (58 | ) | (63 | ) | (104 | ) | ||||||||||
| Proceeds from sale of fixed assets | — | 5 | — | |||||||||||||
NET CASH USED IN INVESTING ACTIVITIES | (58 | ) | (58 | ) | (104 | ) | ||||||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||||||
| Distributions to partners | (1,750 | ) | (1,550 | ) | (1,700 | ) | ||||||||||
| Change in bank overdraft | (3 | ) | (14 | ) | 20 | |||||||||||
NET CASH USED IN FINANCING ACTIVITIES | (1,753 | ) | (1,564 | ) | (1,680 | ) | ||||||||||
NET INCREASE IN CASH | — | — | — | |||||||||||||
CASH, BEGINNING OF YEAR | — | — | — | |||||||||||||
CASH, END OF YEAR | $ | — | $ | — | $ | — | ||||||||||
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: | ||||||||||||||||
| Net income | $ | 1,373 | $ | 1,459 | $ | 1,526 | ||||||||||
| Adjustments: | ||||||||||||||||
| Depreciation and amortization | 156 | 319 | 323 | |||||||||||||
| Loss on disposal of assets | — | 1 | — | |||||||||||||
| Changes in assets and liabilities: | ||||||||||||||||
| Accounts receivable | 21 | (111 | ) | 21 | ||||||||||||
| Inventory, prepaid expenses and other | 5 | 4 | (25 | ) | ||||||||||||
| Deposits and other deferred charges | (9 | ) | (1 | ) | — | |||||||||||
| Deferred member costs | 26 | 33 | 11 | |||||||||||||
| Deferred tax benefit | (41 | ) | (15 | ) | — | |||||||||||
| Accounts payable and accrued expenses | (10 | ) | (7 | ) | 31 | |||||||||||
| Deferred liabilities | 290 | (60 | ) | (103 | ) | |||||||||||
NET CASH PROVIDED BY OPERATING ACTIVITIES | $ | 1,811 | $ | 1,622 | $ | 1,784 | ||||||||||
The accompanying notes are an integral part of these financial statements.
F-41
Table of Contents
KALORAMA SPORTS MANAGEMENT ASSOCIATES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004 and 2003
(amounts in thousands of dollars)
| Note 1. | Organization and Significant Accounting Policies |
Organization — Kalorama Sports Management Associates (the Partnership) was organized as a limited partnership during the years 1989 and 1990 for the purpose of operating a multi-recreational health and fitness facility in Washington, D.C. Operations of the facility commenced in February 1991.
The capital structure of the Partnership consists of General Partners, Class I Limited Partners, Class II Limited Partners, and Class III Limited Partners. The General Partners have exclusive charge and control over the management and operation of the business and property of the Partnership.
The Partnership owns a substantial and controlling interest in its subsidiary Kalorama Down Under, LLC (a limited liability company). This subsidiary was formed to build and own a health and fitness club. As of December 31, 2005 this club had not been constructed and management was negotiating to terminate or restructure its lease at that site (Note 5).
Principles of Consolidation — The consolidated financial statements include the accounts of the Partnership and its subsidiary. All material intercompany accounts and transactions have been eliminated.
Accounting Method — The Partnership uses the accrual method of accounting for both financial and income tax reporting purposes. Under this method, revenue is recognized when earned and expenses are recognized when incurred.
Cash and Cash Equivalents — For purposes of the statements of cash flows, the Partnership considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Accounts Receivable — Accounts receivable are net of an allowance for uncollectible accounts. The allowance for uncollectible accounts at December 31, 2005 and 2004 was $15 and $19, respectively.
Inventory — The inventory of athletic equipment and supplies is valued at the lower of cost or market value, using thefirst-in, first-out (FIFO) method.
Property, Plant and Equipment — The operational facility is located at 1825 and 1875 Connecticut Avenue, N.W., Washington, D.C. and is housed in leased premises (Note 5) which have been renovated. The leasehold improvements are recorded at cost of construction and are being amortized over the lease term. The equipment and fixtures are recorded at cost and are being depreciated using accelerated methods over predetermined lives of five to seven years.
Revenue Recognition — In addition to monthly dues, the Partnership receives a one-time initiation fee, and, in certain cases, an annual fee from its members. The initiation fees are recognized on a pro rata basis over a two-year period commencing concurrently with the start of the membership period, as are the related costs. The annual fees are recognized on a pro rata basis over a twelve-month period commencing concurrently with the start of the membership period. In this connection, the Partnership is required to maintain a $50 surety bond pursuant to District of Columbia law.
Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications — Certain accounts in the prior-year financial statements have been reclassified for comparative purposes to conform to the presentation in the current-year financial statements.
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KALORAMA SPORTS MANAGEMENT ASSOCIATES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Note 2. | Concentration of Credit Risk |
Financial instruments which potentially subject the Partnership to concentrations of credit risk include cash deposits with commercial banks. The Partnership’s cash management policies limit its exposure to concentrations of credit risk by maintaining cash accounts at financial institutions whose deposits are insured by the Federal Deposit Insurance Corporation (FDIC). Cash deposits may, however, exceed the FDIC insurable limits of $100 at times throughout the year. Management does not consider this a significant concentration of credit risk.
| Note 3. | Property, Plant and Equipment |
Fixed assets consist of the following:
| December 31, | |||||||||
| 2005 | 2004 | ||||||||
| Leasehold improvements | $ | 1,792 | $ | 1,777 | |||||
| Equipment and fixtures | 979 | 954 | |||||||
| Totals | $ | 2,771 | $ | 2,731 | |||||
| Less; Accumulated depreciation and amortization | 2,613 | 2,476 | |||||||
| Totals | $ | 158 | $ | 255 | |||||
Depreciation and amortization expense was $156, $319 and $323 for the years ended December 31, 2005, 2004 and 2003, respectively.
| Note 4. | Income Taxes |
Pursuant to the Internal Revenue Code, all income and losses generated by the Partnership flow directly to the Partners and are reported separately on each partner’s individual income tax return. Accordingly, no provision for federal income taxes has been provided. The District of Columbia requires the filing of an Unincorporated Business Franchise Tax Return, which assesses tax on the taxable income earned in its jurisdiction. The 2005, 2004 and 2003 provision for Unincorporated Business Franchise Taxes has been included in the accompanying statements.
The components of income taxes at December 31 are as follows:
| 2005 | 2004 | 2003 | |||||||||||
| Current | $ | 120 | $ | 119 | $ | 128 | |||||||
| Deferred | (42 | ) | (15 | ) | (17 | ) | |||||||
| Totals | $ | 78 | $ | 104 | $ | 111 | |||||||
The Partnership’s total deferred tax assets, deferred tax liabilities, and deferred tax allowances at December 31, were as follows:
| 2005 | 2004 | ||||||||
| Deferred tax assets | $ | 110 | $ | 71 | |||||
| Less, valuation allowance | — | — | |||||||
| Totals | $ | 110 | $ | 71 | |||||
| Deferred tax liabilities | (5 | ) | (7 | ) | |||||
| Totals | $ | 105 | $ | 64 | |||||
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KALORAMA SPORTS MANAGEMENT ASSOCIATES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
These amounts are included in the accompanying financial statements under other assets.
Rent concessions granted to the Partnership as described in Note 5 are being recognized for financial statement purposes over the life of the sublease. For income tax purposes, rent expense will be recognized as payments are made under the payment schedule contained in the sublease agreement. Depreciation methods used for tax purposes differ from those used under U.S. Generally Accepted Accounting Principles.
| Note 5. | Commitments and Contingencies |
The Partnership operates under a long-term sublease agreement for its facility. On April 18, 2005, the Partnership agreed to a lease extension for an additional fifteen years, commencing on April 20, 2005 and ending on April 30, 2020. Under the lease extension, the partnership is leasing 32,838 square feet, an additional 11,886 square feet more than was leased under the previous lease agreements. The terms of the lease agreement provide the Partnership with rent abatement of five months on the portion of the space totaling 21,101 square feet and rent abatement of three months on the remaining space. The rent abatement and payment concessions are being amortized on a straight-line basis over the term of the sublease.
Monthly rent under the terms of the agreement is approximately $45 for the first year of the lease, increasing approximately 2% each year for the remainder of the lease. In addition, the Partnership bears the cost of its proportionate share of all utility charges imposed upon the building.
As part of the new lease agreement the landlord agreed to provide a build out allowance of approximately $163 to cover the costs associated with improving the new and existing space. The lease agreement also provides the Partnership with an option to renew the existing lease agreement for an additional five-year period.
Rent expense, including common area maintenance, was $579, $300 and $287 for the years ended December 31, 2005, 2004, and 2003, respectively. In accordance with accounting principles generally accepted in the United States of America, the Partnership records monthly rent expense equal to the total of the payments due over the lease term, divided by the total number of months of the lease term. The difference between rent expense recorded and the amount paid is credited or charged to the deferred lease benefit, which is reflected as a separate line item in the accompanying consolidated balance sheets. The deferred lease benefit at December 31, 2005 and 2004 was $300 and $21, respectively.
At December 31, 2005, future minimum annual rents under subleases for the operating facility are as follows, exclusive of Kalorama Down Under’s liability described above:
| Year | Amount | ||||
| 2006 | $ | 551 | |||
| 2007 | 564 | ||||
| 2008 | 576 | ||||
| 2009 | 590 | ||||
| 2010 | 627 | ||||
| Thereafter | 6,868 | ||||
| Total | $ | 9,776 | |||
During 1994 the Partnership’s subsidiary, Kalorama Down Under, LLC, entered into a sublease agreement for 14,000 square feet of space at Dupont Circle in Washington, DC. The sublease commenced July 1, 1995. The terms of the sublease provided for scheduled rent increases which resulted in a deferred lease benefit. This benefit was to be amortized over the life of the sublease. In addition to monthly rentals, the
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KALORAMA SPORTS MANAGEMENT ASSOCIATES AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
sublease required the payment of utility charges, and it also provided for two five-year renewal options, not to exceed the underlying lease expiration date of October 24, 2013.
During 1997, because of problems of the developer in completing improvements and delivering the leased space, the construction costs associated with the space, which totaled approximately $106, were charged to earnings since it was anticipated the space would never be occupied. At that time, a determination was made to begin negotiations regarding the early termination or possible restructuring of this lease.
As a result of the continuing difficulties of the developer, during the year ended December 31, 2000, Kalorama Down Under, LLC ceased making payments of rent in anticipation of negotiating a settlement. In 2002, it adjusted its accrued lease liability to $150 representing its estimate of any amount which might be due.
| Note 6. | Related Party Transactions |
Kalorama Sports Management Associates is primarily owned by LEL, Inc., TSI Dupont Circle, Inc., and various partners of Capitol Hill Squash Club Associates Limited Partnership (CHSC). TSI Dupont Circle, Inc. is a subsidiary of Town Sports International, Inc. which is a limited partner of CHSC through a subsidiary, TSI Washington, Inc. Paul London is owner of LEL, Inc. and is a limited partner of CHSC and the owner of PL, Inc., the general partner of CHSC.
The Partnership had outstanding net receivables at December 31, 2005 and 2004 of $46 and $100, respectively, from related parties. These amounts arise from the allocation of certain costs among clubs operating in the Washington, D.C. area that are managed, affiliated with, or owned by Town Sports International, Inc. The centralization of certain management functions is aimed at achieving economies of scale.
| Note 7. | Partners’ Allocations |
Partnership net income and distributions are allocated as follows: the first $150 is allocated twenty-five percent to Class I Limited Partners, forty percent to Class II Limited Partners, and thirty-five percent to General and Class III Limited Partners. Any amounts above $150 are allocated ten percent to Class I Limited Partners, fifteen percent to Class II Limited Partners, and seventy-five percent to General and Class III Limited Partners in proportion to their respective percentage of partnership interest.
F-45