UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment 1)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2005
Commission File # 1-13290
THE SPORTS CLUB COMPANY, INC.
A Delaware corporation - I.R.S. No. 95-4479735
11100 Santa Monica Blvd., Suite 300, Los Angeles, CA 90025
(310) 479-5200
Indicate by check mark whether the Company (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
company was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
--------- ----------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--------- ----------
Indicate the number of shares outstanding of each of the issuer's classes
of Common Stock, as of the latest practicable date.
Shares
Outstanding at
Class September 30, 2005
---------------------------------- -----------------------------------
Common Stock, 19,315,262
par value $.01 per share
EXPLANATORY NOTE
This Amendment No. 1 on Form 10-Q/A (this "Amendment") to the Quarterly Report
of The Sports Club Company, Inc. on Form 10-Q for the fiscal quarter ended June
30, 2005, filed with the Securities and Exchange Commission (the "SEC") on
September 30, 2005 (the "Original Filing") is being filed as required by
Regulation S-X promulgated under the Securities Exchange Act of 1934.
Since the Original Filing, we have determined that our depreciation expense from
our discontinued operations has been overstated by $1,149,000 for the six months
ended June 30, 2005. Therefore, the accompanying condensed consolidated
financial statements reflect a reduction in our loss from discontinued
operations and net loss of $1,149,000. Several other drafting changes have been
made in the Form 10-Q/A to improve the disclosure.
In connection with the filing of this Amendment and pursuant to the rules of the
SEC, we are including with this Amendment a currently dated signature page and
certain currently dated certifications as Exhibits 31.1, 31.2, 32.1 and 32.2.
Except as described above, no other changes have been made to the Original
filing, however, for the convenience of the reader, we have restated the
Original filing in its entirety, as amended pursuant to the description above,
in this Amendment.
This Amendment continues to speak as of the date of the Original Filing, and we
have not updated the disclosures contained therein to reflect any events that
occurred at a date subsequent to the filing of the Original Filing. Accordingly,
this Amendment should be read in conjunction with our subsequent filings with
the SEC.
1
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 2004 and June 30, 2005
(in thousands, except per share amounts)
ASSETS Restated
December 31, June 30,
2004 2005
---- ----
(Unaudited)
Current assets:
Cash and cash equivalents.......................................................... $ 7,559 $ 8,894
Accounts receivable, net of allowance for doubtful accounts of $396 and $399 at
December 31, 2004 and June 30, 2005, respectively................................ 2,030 1,692
Inventories........................................................................ 662 651
Prepaid expenses................................................................... 993 758
Assets held for sale............................................................... 143,408 143,742
--------- ---------
Total current assets.......................................................... 154,652 155,737
Property and equipment, net............................................................ 63,622 61,785
Goodwill............................................................................... 7,315 7,315
Restricted cash........................................................................ 3,403 3,438
Other assets........................................................................... 2,550 1,805
--------- ---------
$ 231,542 $ 230,080
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current installments of notes payable and equipment financing loans................ $ 65,444 $ 100,389
Accounts payable................................................................... 2,040 1,577
Accrued liabilities................................................................ 9,481 9,449
Deferred revenues.................................................................. 6,013 6,522
Liabilities related to assets held for sale........................................ 85,169 85,091
--------- ---------
Total current liabilities..................................................... 168,147 203,028
Notes payable and equipment financing loans, less current installments................. 54,286 19,103
Deferred lease obligations............................................................. 2,354 2,599
Deferred revenues...................................................................... 617 442
Minority interest...................................................................... 600 600
--------- ---------
Total liabilities............................................................. 226,004 225,772
Commitments and contingencies
Redeemable Convertible Preferred Stock, Series B, $.01 par value, 10,500 shares authorized,
issued and outstanding (liquidation preference of $13,148 and $13,622
at December 31, 2004 and June 30, 2005, respectively)............................. 12,796 13,313
Redeemable Preferred Stock, Series E, $.01 par value, 20,000 shares authorized, issued
and outstanding.................................................................... 2,000 2,000
Stockholders' equity (deficit):
Preferred Stock, $.01 par value, 899,500 shares authorized; no shares issued or
outstanding...................................................................... -- --
Convertible Preferred Stock, Series C, $.01 par value, 5,000 shares authorized,
issued and outstanding (liquidation preference of $6,040 and $6,263 at December 31,
2004 and June 30, 2005, respectively)............................................ 6,040 6,263
Convertible Preferred Stock, Series D, $.01 par value, 65,000 shares authorized,
issued and outstanding (liquidation preference of $6,971 and $7,262 at December 31,
2004 and June 30, 2005, respectively)............................................ 6,543 6,834
Common Stock, $.01 par value, 40,000,000 shares authorized;
21,074,717 shares issued ........................................................ 211 211
Additional paid-in capital......................................................... 98,392 97,362
Accumulated deficit................................................................ (106,974) (108,521)
Treasury Stock, at cost, 2,097,079 and 1,924,401 shares at
December 31, 2004 and June 30, 2005, respectively................................ (13,470) (13,154)
--------- ---------
Total Stockholders' equity (deficit).......................................... (9,258) (11,005)
--------- ---------
$ 231,542 $ 230,080
========= =========
See accompanying notes to consolidated financial statements.
2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months and Six Months Ended June 30, 2004 and 2005
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2005 2004 2005
---- ---- ---- ----
(Restated) (Restated) (Restated) (Restated)
Revenues:
Membership revenues....................................... $ 7,291 $ 8,091 $ 14,378 $ 15,928
Products and services..................................... 3,625 3,979 7,216 7,793
----------- ----------- ----------- ------------
Total revenue........................................ 10,916 12,070 21,594 23,721
Operating expenses:
Club operating costs...................................... 4,315 4,343 8,619 8,774
Cost of products and services............................. 3,224 3,387 6,213 6,605
Selling and marketing..................................... 350 247 787 665
General and administrative................................ 2,146 1,995 4,131 4,043
Pre-opening expenses...................................... -- -- 46 --
Depreciation and amortization............................. 1,073 1,279 2,155 2,503
Non-recurring items....................................... -- -- 1,104 --
----------- ----------- ----------- ------------
Total operating expenses............................. 11,108 11,251 23,055 22,590
----------- ----------- ----------- ------------
Income (loss) from operations.................... (192) 819 (1,461) 1,131
Other income (expense):
Interest, net............................................. (1,639) (1,629) (3,278) (3,261)
Minority interests........................................ (37) (37) (75) (74)
------------ ------------ ------------ -------------
Loss from continuing operations before income
taxes and income (loss) from discontinued
operations......................................... (1,868) (847) (4,814) (2,204)
Provision (benefit) for income taxes.......................... -- -- -- --
------------ ------------ ------------ -------------
Loss from continuing operations before income
(loss) from discontinued operations................ (1,868) (847) (4,814) (2,204)
Income (loss) from discontinued operations.................... (2,840) 545 (6,208) 658
------------ ------------ ------------ ------------
Net loss........................................... (4,708) (302) (11,022) (1,546)
Dividends on Preferred Stock.................................. 495 495 876 988
----------- ----------- ----------- ------------
Net income (loss) attributable to common
stockholders....................................... $ (5,203) $ (797) $ (11,898) $ (2,534)
============ ============ ============ =============
Net income (loss) per share attributable to common stockholders - basic and
diluted:
Discontinued operations................................. $ (0.15) $ 0.03 $ (0.33) $ 0.04
Continuing operations.................................... (0.13) (0.07) (0.31) (0.17)
------------ ------------- ------------ -------------
Net income (loss) per share.......................... $ (0.28) $ (0.04) $ (0.64) $ (0.13)
============ ============= ============ =============
Weighted average number of common shares outstanding:
Basic and diluted......................................... 18,697 19,150 18,631 19,141
=========== =========== =========== ============
See accompanying notes to consolidated financial statements.
3
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2004 and 2005
(in thousands)
(unaudited)
Six Months Ended
June 30,
2004 2005
---- ----
(Restated) (Restated)
Cash flows provided from (used in) operating activities:
Net income (loss).................................................... $ (11,022) $ (1,546)
Adjustments to reconcile net income (loss) to cash used in operating
activities:
(Income) loss from discontinued operations...................... 6,208 (658)
Depreciation and amortization................................... 2,155 2,503
Related party costs settled with common stock................... 711 316
Minority interests expense...................................... 75 74
Distributions to minority interests............................. (75) (74)
(Increase) decrease in:
Accounts receivable, net.................................... (73) 338
Inventories................................................. (19) 11
Other current assets........................................ 888 235
Other assets, net........................................... 1,179 745
Increase (decrease) in:
Accounts payable............................................ (79) (463)
Accrued liabilities......................................... (1,575) (32)
Deferred revenues........................................... 431 334
Deferred lease obligations.................................. 266 245
--------- --------
Net cash provided from (used in) operating activities.... (930) 2,028
Cash flows (used in) investing activities:
Capital expenditures............................................ (1,688) (666)
(Increase) decrease in restricted cash.......................... 51 (35)
--------- ---------
Net cash (used in) investing activities.................. (1,637) (701)
Cash flows provided from (used in) financing activities:
Proceeds from issuance of Preferred Stock - net of costs........ 6,072 --
Repayments of notes payable and equipment financing loans....... (1,227) (238)
---------- ---------
Net cash provided from (used in) financing activities.... 4,845 (238)
Cash flows provided from (used in) discontinued operations:
Capital expenditures............................................ (668) (391)
Net cash from operating activities.............................. 181 637
--------- --------
Net cash provided from (used in) discontinued operations. (487) 246
---------- --------
Net increase (decrease) in cash and cash equivalents..... 1,791 1,335
Cash and cash equivalents at beginning of period......................... 1,932 7,559
--------- --------
Cash and cash equivalents at end of period............................... $ 3,723 $ 8,894
========= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest........................ $ 6,475 $ 6,405
======== ========
Cash paid during the period for income taxes.................... $ 590 $ 303
======== ========
See accompanying notes to consolidated financial statements.
4
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and June 30, 2005
(Unaudited)
1. Basis of Presentation
The unaudited, condensed consolidated financial statements, included
herein, have been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission ("SEC"). The condensed consolidated
financial statements should be read in conjunction with the Company's December
31, 2004, consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K (SEC File Number 1-13290). Certain
information and footnote disclosures, which are normally included in financial
statements prepared in accordance with United States generally accepted
accounting principles, have been condensed or omitted pursuant to SEC rules and
regulations for interim financial statements. The Company believes that the
disclosures made are adequate to make the information presented not misleading.
The information reflects all adjustments that, in the opinion of management, are
necessary for a fair presentation of the financial position and results of
operations for the interim periods set forth herein. All such adjustments are of
a normal and recurring nature. The results for the three-month and six-month
periods ended June 30, 2005, are not necessarily indicative of the results for
the fiscal year ending December 31, 2005.
In accordance with Emerging Issues Task Force Issue No. 87-24, "Allocation
of Interest to Discontinued Operations," interest was allocated to discontinued
operations based on the interest on debt that will be required to be repaid as a
result of the disposal transactions. On February 8, 2005, the Company entered
into a formal letter of intent to sell six of its nine sports and fitness Clubs
(see Note. 5). The proceeds of $65.0 million from the proposed sale are required
to be used to repay a portion of the $100.0 million of Senior Secured Notes.
Accordingly the Company has allocated to discontinued operations 65.0% of the
interest associated with the Senior Secured Notes. For the three-month and
six-month periods ended June 30, 2004 and 2005, the amount of interest allocated
to discontinued operations was $2,011,000 and $4,023,000, respectively.
2. Reclassification and Restatement
2004 Reclassification and Restatement
Statement of Financial Accounting Standards ("SFAS") No. 13, Accounting for
Leases, governs the Company's accounting for lease transactions. During the
first quarter of 2005, the Company determined that it was not properly
accounting for leasehold improvements that were funded by landlord allowances.
SFAS No. 13 requires that such improvements be recognized as assets and
amortized over the term of the lease and that the landlord allowance incentive
should be recorded as deferred rent and recognized, also over the term of the
lease, as a reduction of rent expense. Previously the Company netted the
deferred rent against the leasehold improvements. The 2004 consolidated
financial statements have been adjusted to reflect this reclassification.
5
The consolidated statements of operations for the three months and six
months ended June 30, 2004, have also been reclassified to increase depreciation
and amortization expense and to decrease rent expense by the same amount for
each period. There has been no change to net income (loss) as a result of this
reclassification.
Certain reclassifications have also been made to the 2004 consolidated
financial statements to reflect various assets and liabilities now held for sale
and to report the results of operations associated with those assets as
discontinued operations (See Note 5). The consolidated statements of operations
have also been reformatted to breakout product and services revenues and
expenses.
The Company has also restated its June 30, 2004 operating statement to more
properly account for initiation fees. During the six months ended June 30, 2004,
the Company recognized a portion of its membership initiation fess as private
training revenue since members were granted the opportunity to utilize private
training at no charge. In the fourth quarter of 2004, the Company determined it
was more appropriate to record this revenue as initiation fees and amortize it
over the estimated membership life. Accordingly, the operating statements for
the periods ended June 30, 2004 have been restated.
A reclassified restated condensed consolidated statement of operations for
the three months and six months ended June 30, 2004, reflecting the above
reclassifications is presented below. The amounts are in thousands, except per
share amounts:
6
Condensed Consolidated Statement of Operations
Three Months Ended June 30, 2004
--------------------------------
As Initiation Discontinued As
Reported Fees SFAS No. 13 Operations Reformat Restated
-------- ---- ----------- ---------- -------- --------
Revenues:
Membership revenues............................... $ 36,486 $ -- $ -- $ (16,067) $(13,128) $ 7,291
Reimbursed costs.................................. 1,246 -- -- (1,246) -- --
Products and services............................. -- (600) -- (8,828) 13,053 3,625
Management fees................................... -- -- -- (75) 75 --
----------- ---------- ---------- ------------- --------- -----------
Total revenue................................ 37,732 (600) -- (26,216) -- 10,916
Operating expenses:
Direct............................................ 29,830 -- -- -- (29,830) --
Reimbursed costs.................................. 1,246 -- -- (1,246) -- --
Club operating costs.............................. -- (200) (598) (14,534) 19,647 4,315
Cost of products and services..................... -- -- -- (6,959) 10,183 3,224
Selling and marketing............................. 1,267 -- -- (917) -- 350
General and administrative........................ 2,206 -- -- (60) -- 2,146
Pre-opening expenses.............................. -- -- -- -- -- --
Depreciation and amortization..................... 3,168 -- 598 (2,693) -- 1,073
----------- ---------- ---------- ------------- --------- -----------
Total operating expenses..................... 37,717 (200) -- (26,409) -- 11,108
----------- ----------- ---------- ------------- --------- -----------
Income (loss) from operations............ 15 (400) -- 193 -- (192)
Other income (expense):
Interest, net..................................... (3,672) -- -- 2,033 -- (1,639)
Minority interests................................ (479) -- -- 442 -- (37)
Non-recurring items............................... -- -- -- -- -- --
----------- ---------- ---------- ------------ --------- -----------
Income (loss) before income taxes and loss
from discontinued operations............... (4,136) (400) -- 2,668 -- (1,868)
Provision (benefit) for income taxes.................. 172 -- -- (172) -- --
----------- ---------- ---------- ------------- --------- -----------
Income (loss) before loss from
discontinued operations...................... (4,308) (400) -- 2,840 -- (1,868)
Loss from discontinued operations................. -- -- -- (2,840) -- (2,840)
------------ ------------ ---------- ------------- --------- ------------
Net loss..................................... (4,308) (400) -- -- -- (4,708)
------------ ------------ ---------- ------------ --------- ------------
Dividends on Preferred Stock.......................... 495 -- -- -- -- 495
----------- ---------- ---------- ------------ --------- -----------
Net loss attributable to common stockholders. $ (4,803) $ (400) $ -- $ -- $ -- $ (5,203)
============ ============ ========== ============ ========= ============
Net loss per share attributable to common stockholders - basic and diluted:
Discontinued operations.......................... $ -- $ (0.15)
Continuing operations............................ (0.26) (0.13)
------------ ------------
Net income (loss) per share................. $ (0.26) $ (0.28)
=========== ============
Weighted average number of common shares outstanding:
Basic and diluted................................. 18,697 18,697
=========== ===========
7
Condensed Consolidated Statement of Operations
Six Months Ended June 30, 2004
------------------------------
As Initiation Discontinued As
Reported Fees SFAS No. 13 Operations Reformat Restated
-------- ---- ----------- ---------- -------- --------
Revenues:
Membership revenues....................................$ 72,407 $ -- $ -- $ (31,927) $ (26,102) $ 14,378
Products and services.................................. -- (1,200) -- (17,541) 25,957 7,216
Management fees........................................ -- -- -- (145) 145 --
Reimbursed costs....................................... 2,503 -- -- (2,503) -- --
---------- --------- ----------- ------------ ----------- ----------
Total revenue..................................... 74,910 (1,200) -- (52,116) -- 21,594
Operating expenses:
Direct................................................. 59,872 -- -- -- (59,872) --
Club operating costs................................... -- (400) (1,195) (29,618) 39,832 8,619
Cost of products and services.......................... -- -- -- (13,827) 20,040 6,213
Selling and marketing.................................. 2,798 -- -- (2,011) -- 787
General and administrative............................. 4,252 -- -- (121) -- 4,131
Reimbursed costs....................................... 2,503 -- -- (2,503) -- --
Pre-opening expenses................................... 46 -- -- -- -- 46
Depreciation and amortization.......................... 6,340 -- 1,195 (5,380) -- 2,155
Non-recurring items.................................... 1,104 -- -- -- -- 1,104
---------- --------- ----------- ----------- ----------- ----------
Total operating expenses.......................... 76,915 (400) -- (53,460) -- 23,055
---------- ---------- ----------- ------------ ----------- ----------
Income (loss) from operations.................. (2,005) (800) -- 1,344 -- (1,461)
Other income (expense):
Interest, net.......................................... (7,360) -- -- 4,082 -- (3,278)
Minority interests..................................... (517) -- -- 442 -- (75)
----------- --------- ----------- ----------- ----------- -----------
Loss before income taxes and loss from
discontinued operations........................ (9,882) (800) -- 5,868 -- (4,814)
Provision (benefit) for income taxes....................... 340 -- -- (340) -- --
---------- --------- ----------- ------------ ----------- ----------
Loss before loss from discontinued operations.. (10,222) (800) -- 6,208 -- (4,814)
Loss from discontinued operations.......................... -- -- -- (6,208) -- (6,208)
---------- --------- ----------- ------------ ----------- -----------
Net loss....................................... (10,222) (800) -- -- -- (11,022)
Dividends on Preferred Stock............................... 876 -- -- -- -- 876
---------- --------- ----------- ----------- ----------- ----------
Net loss attributable to common stockholders...$ (11,098) $ (800) $ -- $ -- $ -- $ (11,898)
=========== ========== =========== =========== =========== ===========
Net loss per share attributable to common stockholders
- - basic and diluted:
Discontinued operations...............................$ -- $ (0.33)
Continuing operations................................. (0.60) (0.31)
----------- -----------
Net income (loss) per share.......................$ (0.60) $ (0.64)
=========== ===========
Weighted average number of common shares outstanding:
Basic and diluted...................................... 18,631 18,631
========== ----------
8
2005 Restatement
The June 30, 2005 condensed consolidated operating statement has been
restated from the statement presented in the Form 10-Q filed on September 30,
2005. The Company had previously recorded $1,149,000 of depreciation expense
through June 2005 related to assets held for sale. The Company has since
determined that the provision for deprecation expense on these assets should
have stopped in December 2004. Accordingly, the accompanying June 30, 2005
financial statements have been restated to eliminate this expense. The impact of
this restatement was to increase income from discontinued operations and to
reduce the net loss by $1,149,000 ($0.06 per basic and diluted share) for the
six months ended June 30, 2005 and to increase income from discontinued
operations and to reduce the net loss by $151,000 ($0.01 per basic and diluted
share) for the three months ended June 30, 2005.
3. Accounting for Stock-Based Compensation
The Company has elected to account for stock options granted to employees
and directors under the provisions of APB Opinion No. 25, using the intrinsic
value method. Entities electing to continue using the accounting prescribed by
APB Opinion No. 25 must make pro forma disclosures of net income and income per
share, as if the fair value based method of accounting defined in Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
("SFAS No. 123"), had been applied. In accordance with APB Opinion No. 25, no
compensation cost for employees, officers and non-employee directors, has been
recognized, as the fair value of the Company's stock was equal to the exercise
price of the options at the date of grant. Had compensation cost for the
Company's plan been determined consistent with SFAS No. 123, the Company's net
income (loss) attributable to common stockholders and income (loss) per share
would have been reduced to the pro-forma amounts indicated below:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2005 2004 2005
---- ---- ---- ----
Net loss attributable to common
stockholders, as reported..................... $ (5,203) $ (797) $ (11,898) $ (2,534)
Stock-based employee compensation expense
included in reported net loss................. -- -- -- --
Stock-based employee compensation expense
determined under fair value based method
for all awards................................ -- -- (93) --
------------- ------------- ------------- -------------
Pro forma net loss attributable to
Common stockholders........................... $ (5,203) $ (797) $ (11,991) $ (2,534)
============= ============== ============= ==============
Net loss per share as reported basic and
diluted....................................... $ (0.28) $ (0.04) $ (0.64) $ (0.13)
============= ============== ============= ==============
Pro forma net loss per share basic and diluted $ (0.28) $ (0.04) $ (0.64) $ (0.13)
============= ============== ============= ==============
9
4. Liquidity/Going Concern
The Company has experienced recurring net losses of $22.7 million, $18.4
million and $20.8 million during the years ended December 31, 2002, 2003 and
2004, respectively, and $2.5 million during the six months ended June 30, 2005.
The Company has also experienced net cash flows used in operating activities
(both continuing and discontinued operations) of $4.4 million and $3.5 million
during the years ended December 31, 2002 and 2003, respectively. During 2004 the
Company experienced net cash flows from operating activities of $1.7 million.
Additionally, the Company may suffer a significant loss during the year ending
December 31, 2005. On March 15, 2006, the Company is required to repay its
$100.0 million Senior Secured Notes (See Note 7). In the past the Company has
had to raise funds through the offering of equity securities in order to make
the interest payments due on its Senior Secured Notes. The above historical and
estimated future results of operations and cash flows in relation to the
Company's debt obligations raise substantial doubt about the Company's ability
to continue as a going concern.
The Company's continued existence is dependent upon its ability to satisfy
the interest and principal obligation of its Senior Secured Notes. The Company's
March 15, 2005 and September 15, 2005 interest payments were made using cash
balances on hand. In order to satisfy the $105.6 million principal and interest
payment due on March 15, 2006, the Company will be required to either issue new
equity securities, refinance all or a portion of the Senior Secured Notes, or
sell certain assets.
In order to generate funds for the March 2006 payment, the Company entered
into a letter of intent on February 8, 2005 to sell six of its nine sports and
fitness Clubs for $65.0 million to an affiliate of a significant shareholder.
The Company continues to negotiate this transaction and believes that it is
probable that the transaction will be completed, however, there can be no
assurance that the transaction will be completed. Proceeds from this transaction
would be used to reduce the Senior Secured Notes. In addition, the Company is
also seeking to refinance its West Los Angeles property to generate funds to
retire the remainder of the Senior Secured Notes.
If the Company is unable to sell certain of its assets and/or refinance the
West Los Angeles property it would be required to issue additional equity
securities. There can be no assurance that the Company will be able to sell
assets or raise capital by offering additional equity securities. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
5. Sale of Assets
In December 2004, the Company committed to a plan and came to an
understanding to sell six of its nine sports and fitness complexes to an
affiliate of Millennium Partners ("Millennium") for $65.0 million. Millennium is
the Company's largest stockholder and is the landlord at four of these Clubs.
The Clubs to be sold include three facilities located in New York City, and
single Clubs in Boston, Massachusetts, Washington D.C. and San Francisco,
California. In addition, the management agreement for the Club in Miami, Florida
will be assigned to Millennium. Based on the following (i) the Company has $100
million of
10
term loans which are due in March 2006, (ii) Millennium is the landlord at four
of the Clubs which are part of this transaction and they are the owner of the
Club in Miami and therefore have an interest in these Clubs and (iii) Millennium
has representation of the Board of Directors and has access to the financial
information relating to these Clubs, the Company concluded that, as of December
31, 2004, the sale was probable and is expected to occur prior to December 31,
2005. On February 8, 2005, the Company entered into a formal letter of intent
with Millennium. Accordingly, the Company reported the assets of the Clubs as
held for sale, the liabilities as liabilities relating to assets held for sale
and operations of the Clubs as discontinued operations in accordance with SFAS
No. 144.
In October 2004, the Company sold three SportsMed physical therapy
facilities for $600,000. The Company continues to own and operate two SportsMed
facilities that are located within The Sports Cub/LA Clubs in Los Angeles and
Orange County.
The operating results of the six Clubs to be sold and SportsMed facilities
have been classified as discontinued operations in the accompanying condensed
consolidated statements of operations. Summarized financial data for these
locations are as follows:
Statements of Operations
Three Months Ended Six Months Ended
June 30, June 30,
2004 2005 2004 2005
---- ---- ---- ----
(in thousands)
Revenues:
Membership revenues................................$ 16,067 $ 16,873 $ 31,927 $ 33,523
Products and services............................... 8,828 9,073 17,541 17,495
Management fees..................................... 75 92 145 184
Reimbursed costs.................................... 1,246 1,457 2,503 2,907
--------- ----------- ----------- -----------
Total revenue.................................... 26,216 27,495 52,116 54,109
Operating, expenses:
Club operating costs................................ 14,534 15,143 29,618 30,165
Costs of products and services...................... 6,959 6,962 13,827 13,570
Selling and marketing............................... 917 692 2,011 1,565
General and administrative.......................... 60 130 121 188
Depreciation and amortization....................... 2,693 -- 5,380 --
Reimbursed costs.................................... 1,246 1,457 2,503 2,907
--------- ----------- ----------- -----------
Total operating expenses......................... 26,409 24,384 53,460 48,395
--------- ----------- ----------- -----------
Income (loss) from operations................. (193) 3,111 (1,344) 5,714
Other income (expense):
Interest, net....................................... (2,033) (2,003) (4,082) (4,011)
Minority interests.................................. (442) (339) (442) (670)
---------- ------------- ------------ ------------
Income (loss) before income taxes............. (2,668) 769 (5,868) 1,033
Provision for income taxes.............................. 172 224 340 375
--------- ----------- ----------- -----------
Income (loss) from discontinued
operations................................$ (2,840) $ 545 $ (6,208) $ 658
=========== =========== ============ ===========
11
Assets and liabilities related to assets held for sale consist of the
following at:
December 31, June 30,
2004 2005
---- ----
(in thousands)
Assets held for sale:
Accounts receivable, net of allowance for doubtful accounts .. $ 1,320 $ 1,176
Inventories................................................... 442 450
Prepaid expenses.............................................. 433 512
Property and equipment, net................................... 141,015 141,405
Other assets.................................................. 198 199
---------------- -----------------
Total assets held for sale................................ $ 143,408 $ 143,742
================ =================
Liabilities related to assets held for sale:
Accrued liabilities........................................... $ 3,354 $ 3,663
Deferred revenues............................................. 15,178 15,576
Accrued lease obligations..................................... 65,774 64,719
Minority interest............................................. 863 1,133
---------------- -----------------
Total liabilities related to assets held for sale......... $ 85,169 $ 85,091
================ =================
6. Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. On June 30, 2005,
cash and cash equivalents were $8.9 million.
The Company considers cash, cash equivalents and other short-term
investments that are required to be held as deposits to satisfy certain
governmental regulatory or Club security deposits as restricted cash. At June
30, 2005, the Company had $3.4 million of restricted cash.
7. Notes Payable and Equipment Financing Loans
Notes payable and equipment financing loans are summarized as follows:
December 31, June 30,
2004 2005
---- ----
(in thousands)
Senior secured notes (a)......................... $ 100,000 $ 100,000
Mortgage note (b)................................ 19,550 19,389
Equipment financing loans (c).................... 180 103
-------------- --------------
119,730 119,492
Less current installments........................ 65,444 100,389
-------------- --------------
$ 54,286 $ 19,103
============== ==============
---------
(a) On April 1, 1999, the Company issued in a private placement $100.0
million of 11 3/8% Senior Secured Notes due in March 2006 (the "Senior
Notes") with interest due semi-annually. In May 1999, the Senior Notes
were exchanged for registered Series B Senior Secured Notes (the
"Senior Secured Notes"). The Senior Secured Notes are secured by
substantially all of the Company's assets, other than certain excluded
assets. In connection with the issuance of the Senior Secured Notes,
the Company entered into an indenture dated as of April 1, 1999 (the
"Indenture") that includes certain covenants, which as of June 30,
12
2005, restrict the Company's ability, subject to certain exceptions,
to: (i) incur additional indebtedness; (ii) pay dividends or other
distributions, or repurchase capital stock or other equity interests or
subordinated indebtedness; and (iii) make certain investments. The
Indenture also limits the Company's ability to: (i) enter into
transactions with affiliates, (ii) create liens on or sell certain
assets, and (iii) enter into mergers and consolidations. The Senior
Secured Notes may be repaid at any time at par.
The Company has classified $65.0 million of the Senior Secured
Notes as a current liability as of December 31, 2004 because the
Company expects to complete a transaction to sell six of its Clubs for
$65.0 million (See Note 5) before December 31, 2005 and the Indenture
requires that the proceeds from that transaction retire a portion of
the outstanding Senior Secured Notes. If for any reason the Company
were to be in default under any covenants or requirements of the
Indenture, the entire amount would be immediately due and payable.
If the Company undergoes a "change in control", as defined in
the Indenture, it must give holders of the Senior Secured Notes the
opportunity to sell their Senior Secured Notes to the Company at 101%
of their face amount, plus interest. At December 31, 2004, the
estimated fair value of the Senior Secured Notes was $94.0 million.
The Company did not file its 2004 annual report on Form 10-K
or its March 31, 2005 and June 30, 2005 quarterly reports on Form 10-Q
with the Securities and Exchange Commission on a timely basis and
therefore violated one of the provisions of the Indenture Agreement.
The trustee for the bondholders granted a waiver of this provision to
the Company and extended the allowable filing date to September 30,
2005 in exchange for a $250,000 consent fee. The Company filed the
required reports with the Securities and Exchange Commission on
September 30, 2005.
(b) On June 12, 2003, the Company obtained mortgage financing in the
form of a secured five-year promissory loan in the amount of $20.0
million. The loan is evidenced by a promissory note that bears interest
at a fixed interest rate of 7.25%; requires monthly principal and
interest payments of $144,561; is secured by the common stock and all
the assets of Irvine Sports Club, Inc., the Company's wholly owned
subsidiary that owns The Sports Club/LA - Orange County; and is
guaranteed by the Company's Chairman and it's Chief Executive Officer.
The note requires The Sports Club/LA - Orange County to maintain a
minimum operating income, as defined, or the Company will be required
to establish a payment reserve account of up to $607,000. As of June
30, 2005, the Company has maintained the minimum operating income. The
note may be prepaid at any time without penalty or premium and requires
a final principal payment of $18.3 million on July 1, 2008.
(c)The equipment financing loans are secured by furniture, fixtures and
equipment. The amounts are generally repayable in monthly payments over
four or five years with effective interest rates between 7.12% and
13.1%.
8. Non-recurring Items
The non-recurring charge of $1.1 million during the six months ended June
30, 2004 represents various costs, primarily legal fees and investment banking
fees, related to an equity raising transaction that was initiated in April 2003
but abandoned in February 2004.
13
9. Income Tax Provision
The income tax provision recorded for the three-month and six-month periods
ended June 30, 2004 and 2005, are accruals for state and city income taxes
related to pre-tax profits at Reebok Sports Club/NY.
10. Consolidated Statements of Operations
Total revenue and total operating expenses consist of the following:
Three Months Ended Six Months Ended
June 30, June 30,
2004 2005 2004 2005
---- ---- ---- ----
(in thousands)
Revenues:
Membership revenues:
Monthly dues................................ $ 6,708 $ 7,452 $ 13,205 $ 14,639
Initiation fees............................. 449 510 878 1,020
Other....................................... 134 129 295 269
----------- --------- --------- ---------
Total membership revenues.................. 7,291 8,091 14,378 15,928
----------- --------- --------- ---------
Products and Services:
Private training............................ 1,841 2,058 3,648 3,983
Food and beverage........................... 876 921 1,703 1,834
Spa services................................ 315 504 689 996
Physical therapy............................ 438 318 882 632
Other....................................... 155 178 294 348
----------- --------- --------- ---------
Total products and services................ 3,625 3,979 7,216 7,793
----------- --------- --------- ---------
Total revenue...................................... $ 10,916 $ 12,070 $ 21,594 $ 23,721
=========== ========= ========= =========
Operating expenses:
Club operating costs:
Payroll and benefits........................ $ 2,110 $ 2,132 $ 4,221 $ 4,314
Rent........................................ 481 476 950 940
Other operating costs....................... 1,724 1,735 3,448 3,520
----------- --------- --------- ---------
Total Club operating costs................. 4,315 4,343 8,619 8,774
----------- --------- --------- ---------
Costs of products and services:
Private training............................ 1,573 1,743 3,087 3,433
Food & beverage............................. 1,045 986 1,907 1,832
Spa services................................ 325 429 685 871
Physical therapy............................ 260 207 499 424
Other....................................... 21 22 35 45
----------- --------- --------- ---------
Total cost of products and services........ 3,224 3,387 6,213 6,605
----------- --------- --------- ---------
Sales and marketing........................... 350 247 787 665
General and administrative.................... 2,146 1,995 4,131 4,043
Pre-opening................................... -- -- 46 --
Depreciation and amortization................. 1,073 1,279 2,155 2,503
Non-recurring items........................... -- -- 1,104 --
----------- --------- --------- ---------
Total operating expenses........................... $ 11,108 $ 11,251 $ 23,055 $ 22,590
=========== ========= ========= =========
14
11. Net Loss per Share
Basic and diluted loss per share represents the net loss less Preferred
Stock dividends divided by the weighted-average number of shares of Common Stock
outstanding for the period. Diluted loss per share excludes the dilutive effect
of potential common shares. For the three-months and six-months ended June 30,
2004, there were 3,610,479 and 3,301,518 anti-dilutive potential common shares,
respectively. For the three-months and six-months ended June 30, 2005, there
were 3,058,039 and 3,754,825 anti-dilutive potential common shares,
respectively.
12. Series B Redeemable Convertible Preferred Stock
On March 18, 2002, the Company completed a $10.5 million private placement
of a newly created series of its redeemable convertible Preferred Stock. The
Company received $9.9 million in cash, after issuance costs, and issued 10,500
shares of Series B Preferred Stock, $.01 par value ("Series B Preferred"), at a
price of $1,000 per share. The Company has the option to redeem any outstanding
shares of Series B Preferred at any time and the holders may require the
redemption of any outstanding shares of Series B Preferred on or after March 18,
2009 at a price of $1,000 per share plus accrued but unpaid dividends. Dividends
accrue at the annual rate of $90.00 per share. Such dividends are cumulative but
do not accrue interest and at the Company's option, may be paid in cash or in
additional shares of Series B Preferred. The Series B Preferred may, at the
option of the holder, be converted into shares of Common Stock at the rate of
$2.8871 per share, as adjusted for the issuance of Series D Preferred Stock in
March 2004. At June 30, 2005, the Series B Preferred, including accrued
dividends of $3,122,000, was convertible into 4,718,229 shares of Common Stock.
The conversion price will be adjusted downward in the event the Company issues
additional shares of Common Stock at a price below $2.8871 per share, subject to
certain exceptions; and any such downward adjustment is subject to the prior
approval of the American Stock Exchange. In the event of liquidation, the Series
B Preferred holders are entitled to receive, prior and in preference to any
distribution to common shareholders and pari passu with holders of the Series C
Convertible Preferred Stock, an amount equal to $1,000 for each share of Series
B Preferred then outstanding.
The initial carrying value of the Series B Preferred was recorded at its
sale price less costs to issue on the date of issuance. The carrying value of
the Series B Preferred is periodically adjusted so that the carrying value
equals the redemption value on the redemption date. The carrying value of the
Series B Preferred will also be periodically adjusted for any accrued and unpaid
dividends. At December 31, 2004 and June 30, 2005, the Series B Preferred
carrying value consisted of the following ($ in thousands):
December 31, June 30,
2004 2005
---- ----
Initial fair value, sale price of $10,500
less costs to issue of $592............................. $ 9,908 $ 9,908
Redemption value accretion................................... 240 283
Accrued and unpaid dividends accretion....................... 2,648 3,122
------------------ ----------------
Total carrying value..................................... $ 12,796 $ 13,313
================== ================
15
13. Series C Convertible Preferred Stock
On September 6, 2002, the Company completed a $5.0 million private
placement of a newly created series of convertible Preferred Stock. The Company
received $5.0 million in cash and issued 5,000 shares of Series C Convertible
Preferred Stock, $.01 par value ("Series C Convertible Preferred"), at a price
of $1,000 per share. Dividends accrue at an annual rate of $90.00 per share.
Dividends are payable when and as declared by the Board of Directors. Such
dividends are cumulative, but do not accrue interest and at the Company's
option, may be paid in cash or additional shares of Series C Convertible
Preferred. Dividends are paid pari passu with dividends on the Series B
Preferred. In addition, upon conversion any earned and unpaid dividends would
become payable. The Series C Convertible Preferred may, at the option of the
holder, be converted into shares of Common Stock at the rate of $2.8871 per
share, as adjusted for the issuance of Series D Preferred Stock in March 2004.
At June 30, 2005, the Series C Preferred, including accrued dividends of
$1,263,000, was convertible into 2,169,305 shares of Common Stock. Upon
conversion, any earned and unpaid dividends would become payable in cash or
additional shares of Series C Convertible Preferred, at the Company's option.
The conversion price will be adjusted downward in the event the Company issues
additional shares of Common Stock at a price below $2.8871 per share, subject to
certain exceptions; and any such downward adjustment is subject to the prior
approval of the American Stock Exchange. At the option of the Company, the
Series C Convertible Preferred may be redeemed in whole or in part by paying in
cash the sum of $1,000 per share plus any earned and unpaid dividends. In the
event of liquidation, the Series C Convertible Preferred holders are entitled to
receive, prior and in preference to any distribution to common shareholders, and
pari passu with holders of the Series B Preferred, an amount equal to $1,000 for
each share of Series C Convertible Preferred then outstanding, plus earned and
unpaid dividends.
The carrying value of the Series C Convertible Preferred is periodically
adjusted for any accrued and unpaid dividends. At December 31, 2004 and June 30,
2005, the Series C Convertible Preferred carrying value consisted of the
following (in thousands):
December 31, June 30,
2004 2005
---- ----
Initial fair value..................................$ 5,000 $ 5,000
Accrued and unpaid dividend accretion............... 1,040 1,263
----------------- -----------------
Total carrying value................................$ 6,040 $ 6,263
================= =================
14. Series D Convertible Preferred Stock
On March 12, 2004, the Company completed a $6.5 million private placement
of a newly created series of Convertible Preferred Stock. The Company received
$6.1 million in cash, after issuance costs of $428,000, and issued 65,000 shares
of $.01 par value Series D Convertible Preferred Stock ("Series D Convertible
Preferred"), at a price of $100 per share. The Series D Convertible Preferred
was purchased by three of the Company's principal shareholders. Dividends accrue
at an annual rate of $9.00 per share and shall be paid prior and in preference
to any dividends earned on the Series B Preferred, Series C Convertible
Preferred, Common Stock or any other class of equity security that is junior to
the Series D Convertible Preferred. Dividends are payable when and as declared
by the Board of Directors. Such dividends are cumulative, but do not accrue
interest and at the Company's option, may be paid in cash or additional shares
of Series D Convertible Preferred. The Series D Convertible Preferred may, at
the option of the holder, be converted into shares of Common Stock at the rate
of $2.00 per share. At June 30, 2005, the Series D Preferred, including accrued
dividends
16
of $762,000, was convertible into 3,631,000 shares of Common Stock. Each share
of Series D Convertible Preferred shall automatically be converted into shares
of Common Stock upon the consummation of a qualified public offering of Common
Stock of at least $50.0 million or if the closing price of the Common Stock for
a period of thirty consecutive trading days exceeds $6.00 per share and at least
150,000 shares of Common Stock have been traded during such applicable thirty
day period. Upon conversion, any earned and unpaid dividends would become
payable. The conversion price will be adjusted equitably in the event of any
combination, recapitalization, merger, reclassification or similar transaction
or issuance of Common Stock (or any instrument convertible into or exercisable
for Common Stock) at a price per share less than $2.00. Commencing on the sixth
anniversary of the issuance of the Series D Convertible Preferred, the Company
at its option may redeem the Series D Convertible Preferred in whole or in part
by paying in cash the sum of $100 per share plus any earned and unpaid
dividends. In the event of liquidation, the Series D Convertible Preferred
holders are entitled to receive, prior and in preference to any distribution to
common shareholders and holders of the Series B Preferred and Series C
Convertible Preferred, an amount equal to $100 for each share of Series D
Convertible Preferred then outstanding, plus any earned and unpaid dividends.
The holders of the Series D Convertible Preferred are afforded protective rights
that among other things restrict the Company's ability to incur debt or lease
obligations, make investments or acquisitions, sell a Club leased from
Millennium, issue any new class of equity securities, repurchase or redeem any
equity securities, hire or fire the Chief Executive Officer, enter into any new
line of business or change the primary line of business and issue options under
the Company's stock option plans. In addition, Millennium is entitled to
designate two directors (at least one of whom must be independent) and the other
two holders are each entitled to designate one director, to serve on the
Company's Board of Directors.
The carrying value of the Series D Convertible Preferred is periodically
adjusted for any accrued and unpaid dividends. At December 31, 2004 and June 30,
2005, the Series D Convertible Preferred carrying value consisted of the
following (in thousands):
December 31, June 30,
2004 2005
---- ----
Initial fair value..................................$ 6,500 $ 6,500
Issuance costs...................................... (428) (428)
Accrued and unpaid dividend accretion............... 471 762
--------------- --------------
Total carrying value................................$ 6,543 $ 6,834
=============== ==============
15. Series E Redeemable Preferred Stock
On September 14, 2004, the Company completed a $2.0 million private
placement of a newly created series of Redeemable Preferred Stock. The Company
received $2.0 million in cash and issued 20,000 shares of $.01 par value Series
E Preferred Stock ("Series E Preferred") at a price of $100 per share. The
Series E Preferred was purchased by three of the Company's principal
shareholders consisting of Kayne Anderson Capital Advisors, Rex Licklider and D.
Michael Talla. Dividends accrue at an annual rate of $11.375 per share.
Dividends are cumulative, do not accrue interest and, at the Company's option,
may be paid in additional shares of Series E Preferred. The Series E Preferred
is not convertible into shares of the Company's Common Stock and, except as
required by law, does not entitle the holder(s) to vote on matters brought
before the Company's stockholders. At any time after May 31, 2006, provided the
Company is legally able to do so, (i) the Company may, redeem all or part of the
Series E Preferred for cash at the redemption price of $100.00 per share,
together with all accrued but unpaid dividends or (ii) the holders of at least
50% of the Series E Preferred may
17
demand that the Company redeem all the shares of the Series E Preferred by
paying the redemption price in cash to each holder of the Series E Preferred.
Dividends are accrued on the Series E Preferred with any unpaid dividends
included in accrued liabilities on the accompanying condensed consolidated
balance sheet.
16. Litigation
The Company is involved in various claims and lawsuits incidental to its
business, including claims arising from accidents. However, in the opinion of
management, the Company is adequately insured against such claims and lawsuits
involving personal injuries, and any ultimate liability arising out of any such
proceedings, whether insured or not, will not have a material adverse effect on
the Company's consolidated financial condition, cash flows or results of
operations.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of our historical results of operations and our
liquidity and capital resources should be read in conjunction with the condensed
consolidated financial statements and related notes appearing elsewhere herein.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures. On an on-going basis, we evaluate our
estimates and judgments that are based on historical experience and other
assumptions that we believe to be reasonable under the circumstances. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements.
Overview
We are the operator of ten sports and fitness Clubs located in major
metropolitan markets across the United States, including one Club operated under
a management agreement. Our Clubs are spacious, modern facilities that typically
include spas, restaurants, fitness centers, swimming pools and basketball
courts. Our Clubs, which are usually named The Sports Club/LA, are recognized as
among the finest sports and fitness facilities in the United States. In 1999, we
decided to focus our efforts on the national development of The Sports Club/LA
brand. At that time, we sold all of our smaller sized Clubs. We also issued
$100.0 million of Senior Secured Notes due in March 2006. The proceeds from
these transactions were primarily utilized to develop five additional new Clubs
in New York City, Washington D.C., Boston and San Francisco. We have since
opened The Sports Club/LA in Beverly Hills and in Miami.
Most of our Clubs range in size from 90,000 to 140,000 square feet. Due to
the size of these facilities and the additional amenities included in our Clubs,
we spend significant amounts to construct a new facility. We compare the results
of our Clubs based upon how long the Clubs have been open at the most recent
measurement period. We categorize Clubs as either mature or recently opened.
Mature Clubs are those Clubs at which we believe the membership levels have
reached a stable level and based upon the amount of new membership sales and
attrition, or the size of the Club, we do not believe a significant additional
growth in the membership level will occur. Clubs are considered to be recently
opened while the membership level is increasing. Three of the Clubs that we own
are considered to be mature while the other six are considered to be recently
opened. Five of these Clubs were opened between 2000 and 2001 while The Sports
Club/LA - Beverly Hills was opened in October 2003. Newly developed Clubs tend
to achieve significant increases in revenues until a mature membership level is
reached. Recently opened Clubs that have not yet achieved mature membership
levels have operated at a loss or only a slight profit as a result of fixed
expenses that, together with variable operating expenses, approximate or exceed
membership fees and other revenues. Since 2000, we have invested significant
amounts of cash in the construction and operation of these new Clubs. Our
operating performances and our liquidity have been negatively impacted due to
the start up nature of these Clubs and the initial construction cost.
In February 2005, we entered into a letter of intent to sell six of our
nine sports and fitness complexes for $65.0 million. The Clubs to be sold
include our three New York facilities and single Clubs in Boston, Washington
D.C. and San Francisco. In addition, the management agreement for the Club in
Miami will be terminated. Following the sale, we will continue to own and
operate our three Southern California Clubs. The operating results from the six
Clubs to be sold and the fees and costs associated with the Miami management
19
agreement have been classified as Discontinued Operations in the accompanying
financial statements and in other parts of this Form 10-Q.
We measure performance using key operating statistics such as initiation
fees, monthly dues and ancillary revenues per member. We closely focus on new
membership sales and the level of membership attrition at each Club. We also
closely evaluate our expenses with an emphasis on controlling payroll costs. We
use Club operating income, before depreciation expenses and rent expense as a
means to evaluate the overall performance of an individual Club.
We have two primary sources of revenues. First, our largest source of
revenue is from membership dues and initiation fees. We recognize revenue from
dues in the month it is earned. Initiation fees are deferred and recognized as
revenue on a straight-line basis over the average life of a membership based
upon historical data for each individual Club. Secondly, we generate ancillary
revenue from our membership within each Club. The largest of these revenues
comes from individual private training. We also generate revenues from our spas,
restaurants, childcare, sports programs and guest fees. Our total ancillary
revenues represent 37.6% of total Club revenue and we believe that percentage is
among the highest in the industry. We believe that membership levels are the
primary indicator of a Clubs ability to generate revenue. Therefore, we are
consistently generating programs to market the Clubs to potential new members as
well as striving to reduce our membership attrition rates. We believe our
current attrition rate of 24.05% is well below the normal in the industry.
Our direct expenses include costs to operate our Clubs. These consist
primarily of payroll and employee benefits, rent and other occupancy related
costs, supplies, repairs, costs of products sold and various other operating
costs. A significant amount of these costs are fixed in nature.
General and administrative expenses include costs related to our
centralized support functions such as accounting, information technology,
development and our executive management. Costs associated with being a publicly
owned Company are also included in this category. Selling expenses include our
advertising, marketing department and promotional costs associated with the
generation of new memberships.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of the assets
and liabilities and disclosures of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. We base these estimates and assumptions upon
historical experience and existing known circumstances. Actual results could
differ from those estimates. Specifically, we must make estimates in the
following areas:
Revenue Recognition. We receive initiation fees and monthly membership dues
from our members. Substantially all of our members join on a month-to-month
basis and can therefore cancel their membership at any time. The transaction in
which the Company receives initiation fees may include free private training
sessions. Under Emerging Issues Task Force 00-21, "Revenue Arrangement with
Multiple Elements," the Company determined that the initiation fees and private
training sessions did not represent separate units of accounting. Accordingly,
initiation fees and related direct expenses, primarily sales commissions, are
deferred and recognized, on a straight line basis, over the average membership
life. Effective
20
in the second quarter of 2005, the Company started amortizing initiation fees
over the membership lives of each individual Club based on each individuals
Club's respective average membership life. Such average lives range from two and
a half years to five years. Dues that are received in advance are recognized on
a pro-rata basis over the periods in which services are to be provided. In
addition, payments of last months' dues are deferred. Revenues for services
including private training, spa treatments and physical therapy sessions are
recorded when such services are performed. Amounts received in advance are
recorded as deferred revenues. Revenues from our SportsMed subsidiary are
recognized based upon the estimated amount to be collected.
Allowance for doubtful accounts. We provide a reserve against our
receivables for estimated losses that may result from our members' inability to
pay. We determine the amount of the reserve by analyzing known uncollectible
accounts, economic conditions and historical losses and our members'
creditworthiness. The likelihood of a material loss from this area is minimal
due to our limited exposure to credit risk.
Lease Accounting. We record rent expense on facilities under operating
leases. The aggregate rental obligation is expensed on a straight line basis
over the lease term, commencing with the date when we take possession of the
property. If the lease imposes a significant economic penalty not to renew an
option period, we use the initial period plus the option period as the lease
term. Rent incurred before the facility is ready for use is capitalized as
leasehold improvements.
Impairment of long-lived assets. The carrying value of our long-lived
assets is reviewed annually and whenever events or changes in circumstances
indicate that such carrying values may not be recoverable. We consider a history
of consistent and significant operating losses to be our primary indicator of
potential impairment. Assets are grouped and evaluated for impairment at the
lowest level for which there are identifiable cash flows, which is generally at
an individual Club or a group of Clubs located in the same geographical area.
The determination of whether an impairment has occurred is based on an estimate
of undiscounted future cash flows directly related to that Club or group of
Clubs compared to the carrying value of the assets. If an impairment has
occurred, the amount of impairment recognized is determined by estimating the
fair value of the assets and recording a loss if the carrying value is greater
than the fair value. There was no impairment of long-lived assets at December
31, 2004 or June 30, 2005.
Valuation of goodwill. We recorded goodwill in connection with our
acquisitions of The Sports Club/LA in Los Angeles and Orange County, Reebok
Sports Club/NY and SportsMed. In January 2002, we adopted SFAS No. 142, Goodwill
and Other Intangible Assets, and as a result have ceased to amortize goodwill.
Instead, we were required to perform a transitional impairment review of our
goodwill as of January 1, 2002. We performed the transitional impairment test
and determined that goodwill was impaired as of January 1, 2002 by $5,134,000.
We are also required to evaluate goodwill on an annual basis or when events
require us to reevaluate our goodwill. We performed the analysis, as of December
31, 2004 and June 30, 2005, and determined that our remaining goodwill was not
impaired. No events occurred in the six months ended June 30, 2005, that
required the Company to re-evaluate its goodwill.
Valuation of deferred income taxes. Valuation allowances are established to
reduce deferred tax assets to the amount expected to be realized. The likelihood
of material change in our expected realization of these assets depends on future
taxable income, our ability to deduct tax loss carry forwards against future
taxable income, the effectiveness of our tax planning and
21
strategies among the various tax jurisdictions in which we operate and any
significant changes in the tax laws.
Results of Operations
Several reclassifications and restatements have been made to the condensed
consolidated statement of operations for the three months and six months ended
June 30, 2004 as discussed in Note 2 to the condensed consolidated financial
statements. The following discussion that compares our results of operations of
the three months and six months ended June 30, 2005 to June 30, 204 is after
consideration of such reclassifications and restatements.
Comparison of Three Months Ended June 30, 2005 to Three Months Ended
June 30, 2004.
Our total revenue from continuing operations for the three months ended
June 30, 2005, was $12.1 million, compared to $10.9 million for the same period
in 2004, an increase of $1.2 million or 9.6%. Revenue increased by $725,000 as a
result of membership growth at The Sports Club/LA-Beverly Hills, which opened on
October 7, 2003. Revenue increased by $540,000 at The Sports Club/LA-Los Angeles
and The Sports Club/LA-Orange County as a result of dues increases and higher
ancillary revenues and to the reopening of the Spa at The Sports Club/LA - Los
Angeles which was closed for remodeling during part of 2004. There was a
decrease in revenue of $111,000 at our two SportsMed locations primarily due to
decreased patient visits.
Our club operating costs and cost of products and services increased by
$191,000 (2.5%) to $7.7 million for the three months ended June 30, 2005, versus
$7.5 million for the same period in 2004. Club operating costs and cost of
products and services increased by approximately $149,000, as a result of the
increases in variable costs (mostly payroll and payroll related) associated with
the increase in membership and revenues at The Sports Club/LA-Beverly Hills.
Club operating costs and cost of products and services increased by
approximately $95,000 at The Sports Club/LA-Los Angeles and The Sports
Club/LA-Orange County primarily due to increased payroll and payroll related
costs. There was a decrease in cost of products and services of approximately
$53,000 at our two SportsMed facilities.
Our selling and marketing expenses were $247,000 for the three months ended
June 30, 2005, versus $350,000 for the same period in 2004, a decrease of
$103,000 or 29.4%. Selling and marketing expenses were down at each of our Clubs
and in almost every category of expense. We expect our selling and marketing
expenses to be about flat for the year and this quarterly variance is due to the
timing of our direct mail and promotional campaigns.
General and administrative expenses were $2.0 million for the three months
ended June 30, 2005, versus $2.1 million for the same period in 2004, a decrease
of $151,000 or 7.0%. Payroll and payroll-related expenses for the three months
ended June 30, 2005, decreased by $120,000, primarily due to headcount
decreases. Outside service fees increased by approximately $118,000 primarily
due to costs incurred as a result of the retention of an investment bank to
assist us in evaluating alternatives to restructure our debt. Rent decreased by
$30,000 primarily due to lower rent negotiated at the west coast corporate
office. Other miscellaneous general administrative expenses decreased by
$119,000 mostly as a result of cost cutting measures taken by management to
reduce our general and administrative expenses.
Our depreciation and amortization expenses were $1.3 million for the three
months ended June 30, 2005, versus $1.1 million for the same period in 2004, an
increase of $206,000 or 19.2%. Depreciation and amortization expenses increased
by $36,000, primarily due to
22
capital additions made at The Sports Club/LA-Los Angeles, The Sports
Club/LA-Orange County and The Sports Club/LA-Beverly Hills during 2004 and 2005.
Depreciation increased by $170,000 at the corporate office facility as a result
of the decision to consolidate this leased office space into other facilities.
We decreased the amortization period of the corporate office fixed assets from
their original estimated useful lives to the projected move date of December 31,
2005.
For the three months ended June 30, 2005 and 2004, we allocated $2.0
million of interest expense to discontinued operations. Our remaining net
interest expense was flat at $1.6 million for both the three months ended June
30, 2005 and three months ended June 30, 2004. A minor decrease in equipment
financing interest costs of $10,000 resulting from the pay down of these
balances accounts for the small net change.
We did not record any federal or state deferred tax benefit related to our
consolidated pre-tax losses from continuing operations for the three months
ended June 30, 2005 and 2004.
Our income from discontinued operations was $545,000 for the three months
ended June 30, 2005, versus a loss of 2.8 million for the same period in 2004,
an increase of $3.4 million. Our income from discontinued operations increased
by $2.7 million because in 2005 we discontinued depreciation on assets held for
sale. Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets, requires that depreciation cease on
assets once they are classified as held for sale. Income from discontinued
operations increased by approximately $600,000, as the result of a 2.3 %
increase in membership and to increases in dues and ancillary services rates.
Our income from discontinued operations increased by $103,000 as a result of a
decrease in the minority interest expense at The Reebok Sport Club/NY during the
three months ended June 30, 2005 versus the same period in 2004.
After the income (loss) from discontinued operations and dividends on
preferred stock of $495,000 during the three months ended June 30, 2005 and
three months ended June 30, 2004, our consolidated net loss attributable to
common stockholders was $797,000, or $0.04 per basic and diluted share for the
three months ended June 30, 2005, versus a loss of $5.2 million, or $0.28 per
basic and diluted share for the three months ended June 30, 2004.
Comparison of Six Months Ended June 30, 2005 to Six Months Ended June 30, 2004.
Our total revenue from continuing operations for the six months ended June
30, 2005, was $23.7 million, compared to $21.6 million for the same period in
2004, an increase of $2.1 million or 9.8%. Revenue increased by $1.5 million as
a result of membership growth at The Sports Club/LA-Beverly Hills, which opened
on October 7, 2003. Revenue increased by $813,000 at The Sports Club/LA-Los
Angeles and The Sports Club/LA-Orange County as a result of dues increases and
higher ancillary revenues and to the reopening of the Spa at The Sports Club/LA
- - Los Angeles which was closed for remodeling during part of 2004. There was a
decrease in revenue of $241,000 at our two SportsMed locations primarily due to
decreased patient visits.
Our club operating costs and cost of products and services increased by
$547,000 (3.7%) to $15.4 million for the six months ended June 30, 2005, versus
$14.8 million for the same period in 2004. Club operating costs and cost of
products and services increased by approximately $418,000, as a result of the
increases in variable costs (mostly payroll and payroll related) associated with
the increase in membership and revenues at The Sports Club/LA-Beverly Hills.
Club operating costs and cost of products and services increased by
23
approximately $200,000 at The Sports Club/LA-Los Angeles and The Sports
Club/LA-Orange County primarily due to increased payroll and payroll related
costs. There was a decrease in cost of products and services of approximately
$71,000 at our two SportsMed facilities.
Our selling and marketing expenses were $665,000 for the six months ended
June 30, 2005, versus $787,000 for the same period in 2004, a decrease of
$122,000 or 15.5%. Selling and marketing expenses were down at each of our Clubs
and in almost every category of expense. We expect our selling and marketing
expenses to be about flat for the year and this six-month variance is due to the
timing of our direct mail and promotional campaigns.
Our general and administrative expenses were $4.0 million for the six
months ended June 30, 2005, versus $4.1 million for the same period in 2004, a
decrease of $88,000 or 2.1%. Payroll and payroll-related expenses for the six
months ended June 30, 2005, decreased by $220,000, primarily due to headcount
decreases. Outside service fees increased by approximately $281,000 primarily
due to costs incurred as a result of the retention of an investment bank to
assist us in evaluating alternatives to restructure our debt. Rent decreased by
$26,000 primarily due to lower rent negotiated at the west coast corporate
office. Other miscellaneous general administrative expenses decreased by
$123,000 mostly as a result of cost cutting measures taken by management to
reduce our general and administrative expenses.
Pre-opening expenses of $46,000 for the six months ended June 30, 2004
consisted of expenses related to The Sports Club/LA-Beverly Hills, which opened
on October 7, 2003.
Our depreciation and amortization expenses were $2.5 million for the six
months ended June 30, 2005, versus $2.2 million for the same period in 2004, an
increase of $348,000 or 16.1%. Depreciation and amortization expenses increased
by $60,000, primarily due to capital additions made at The Sports Club/LA-Los
Angeles, The Sports Club/LA-Orange County and The Sports Club/LA-Beverly Hills
during 2004 and 2005. Depreciation increased by $288,000 at the corporate office
facility as a result of the decision to consolidate this leased office space
into other facilities. We decreased the amortization period of the corporate
office fixed assets from their original estimated useful lives to the projected
move date of December 31, 2005.
We recorded a non-recurring charge of $1.1 million during the six months
ended June 30, 2004. This charge is comprised of various costs, primarily legal
fees and investment banking fees, related to a proposed restructuring
transaction that was initiated in April 2003 and abandoned in February 2004.
For the six months ended June 30, 2005 and 2004, we allocated $4.0 million
of interest expense to discontinued operations. Our remaining net interest
expense was flat at $3.3 million for both the six months ended June 30, 2005 and
six months ended June 30, 2004. A minor decrease in equipment financing interest
costs resulting from the pay down of these balances accounted for the decrease
of $17,000 in interest expense for the period.
We did not record any federal or state deferred tax benefit related to our
consolidated pre-tax losses from continuing operations for the six months ended
June 30, 2005 and 2004.
Our income from discontinued operations was $658,000 for the six months
ended June 30, 2005, versus a loss of $6.2 million for the same period in 2004,
an increase of $6.9 million. Our net loss from discontinued operations decreased
by $5.4 million because we discontinued depreciation on assets held for sale.
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets, requires that depreciation cease on
assets once they are classified as held for sale. Our loss from discontinued
operations
24
decreased by approximately $1.7 million, as the result of an increase in
membership and to increases in dues and ancillary services rates. Our loss from
discontinued operations increased by $228,000 as a result of an increase in the
minority interest expense at The Reebok Sport Club/NY during the six months
ended June 30, 2005 versus the same period in 2004.
After the loss from discontinued operations and dividends on preferred
stock of $988,000 during the six months ended June 30, 2005 and $876,000 during
the six months ended June 30, 2004, our consolidated net loss attributable to
common stockholders was $2.5 million, or $0.13 per basic and diluted share for
the six months ended June 30, 2005, versus a loss of $11.9 million, or $0.64 per
basic and diluted share for the six months ended June 30, 2004.
Liquidity and Capital Resources
Liquidity
Historically, we have satisfied our liquidity needs through various debt
arrangements, sales of Common or Preferred Stock and cash from operations. Our
primary liquidity needs during the past several years have been from the
development of new Clubs and the interest cost associated with our $100.0
million Senior Secured Notes.
In order to make our March 15, 2004 interest payment on the Senior Secured
Notes, we issued $6.5 million of a newly created class of Series D Convertible
Preferred Stock. In order to make our September 15, 2004 interest payment, we
issued $2.0 million of a newly created class of Series E Preferred Stock. During
the nine months ended September 30, 2005, we generated cash flows from
operations and received $2,500,000 of deposits back as cash. These amounts
allowed us to make our March 15, 2005 and September 15, 2005, interest payments
without raising any additional capital.
On March 15, 2006, our entire $100.0 million principal amount of the Senior
Secured Notes are due along with $5.6 million of interest. We do not have the
cash to make these payments and therefore we have decided to sell six of our
Clubs for $65.0 million. We believe we will be able to mortgage our property in
West Los Angeles, California and that the proceeds from the asset sale and
financing will be sufficient for us to retire the entire $100.0 million of
Senior Secured Notes prior to their maturity date. However, there can be no
assurance that we will be able to consummate any of these transactions. If we
are unable to sell these assets or finance the West Los Angeles property, we
would be required to raise additional capital by issuing equity if the
bondholders are not be willing to extend the due date of the Senior Secured
Notes. If those events would not occur, we would probably default on the
principal payment of the Senior Secured Notes and the holders of the Senior
Secured Notes could elect to foreclose on our assets.
If we complete the sale of six Clubs and therefore continue to own and
operate three Clubs, we will implement a plan to significantly reduce our
general and administrative expenses. If we consummate the sale of the six clubs,
refinance of our West Los Angeles Club as described above and reduce general and
administrative expenses, we believe that we will be able to operate the
remaining three Clubs without the infusion of additional funds, although there
can be no assurance that we would be able to do so.
Following the sale of the six Clubs, additional funds will be required to
undertake any future acquisitions or the development of additional new Clubs. We
would consider entering into joint ventures, partnership agreements or
management agreements (subject to the
25
restrictions and limitations on such transactions in the Indenture) for the
purpose of developing new Clubs, but only if such arrangements would generate
additional cash flow or further enhance The Sports Club/LA brand name in the
market place.
Operating Activities
At June 30, 2005, our cash balance was $8.9 million. During 2004, we
generated cash flows from operating activities; both continuing and
discontinued, of $1.7 million. We believe we will continue to generate positive
cash flows in the future. We had various deposits that secured our performance
under several contracts. In the first quarter of 2005, we received back $500,000
of such deposits and we received $2.0 million back in the third quarter of 2005.
Investing Activities
Investing activities consist of new Club development and expenditures to
maintain and update our existing Clubs. Our Clubs are upscale and capital
improvements are regularly needed to retain the upscale nature and presentation
of the Clubs. A deterioration of the quality of the Clubs can lead to reduction
in membership levels and lower revenues. Capital expenditures to maintain and
update our Clubs, including costs to complete construction of The Sports Club/LA
- - Beverly Hills were $4.1 million in 2004. We estimate that expenditures of
between 2% and 4% of revenues, depending on the age of the Club, will be
necessary to maintain the quality of the Clubs to our satisfaction. We also
expect to spend approximately $600,000 during the next year to upgrade our
management information systems and enhance our disaster recovery capabilities.
We currently have no other plans for new Club developments that would
require our own capital.
In February 2005, we entered into a letter of intent to sell six of our
nine Clubs to an affiliate of Millennium for $65.0 million. Proceeds from this
transaction would be used to retire long-term debt. The letter of intent is
nonbinding on the Company and Millennium and is subject to the execution of a
definitive agreement and the satisfaction of a number of conditions.
Accordingly, we can give no assurances that the proposed sale will be completed.
Financing Activities
On April 1, 1999, we issued in a private placement $100.0 million of 11
3/8% Senior Secured Notes (the "Senior Secured Notes") due in March 2006, with
interest due semi-annually. The Senior Secured Notes were issued pursuant to the
terms of an indenture agreement dated April 1, 1999 (the "Indenture"). The
Senior Secured Notes are secured by substantially all of our assets, other than
certain excluded assets. The Indenture includes certain covenants that restrict
our ability to: (i) incur additional indebtedness; (ii) pay dividends or other
distributions, or repurchase capital stock or other equity interests or
subordinated indebtedness; and (iii) make certain investments. The Indenture
also limits our ability to: (i) enter into transactions with affiliates; (ii)
create liens on or sell certain assets; and (iii) enter into mergers and
consolidations. The Indenture requires us to make an offer to retire the Senior
Secured Notes if the net proceeds of any asset sale are not reinvested in assets
related to our business, unless the remaining net proceeds are less than $10.0
million. The Indenture requires us to make semi-annual interest payments of $5.7
million on March 15th and September 15th of each year.
26
On June 12, 2003, we $ 11,375 obtained financing in the form of a secured
five-year promissory loan in the amount of $20.0 million. The new loan is
evidenced by a promissory note that bears interest at a fixed interest rate of
7.25%; requires monthly principal and interest payments of $144,561; is secured
by the common stock and all the assets of Irvine Sports Club, Inc., our wholly
owned subsidiary that owns The Sports Club/LA - Orange County; and is guaranteed
by two of our major stockholders. The note may be prepaid at any time without
penalty and requires a final payment of $18.3 million on July 1, 2008.
In March 2004, three of our principal shareholders purchased $6.5 million
of a newly created class of Series D Convertible Preferred Stock in a private
placement offering. The proceeds were used to pay the March 15, 2004 interest
payment on our Senior Secured Notes and to provide additional working capital.
In September 2004, three of our principal shareholders purchased $2.0 million of
a newly created class of Series E Preferred Stock in another private placement
offering. The proceeds were used to pay the September 15, 2004 interest payment
on our Senior Secured Notes.
Other than our normal operating activities and capital expenditures, our
total cash requirements for our existing operations through June 30, 2006, are
estimated to be as follows (amounts in thousands):
Indenture interest.............................. $ 11,375
Information system upgrades..................... 600
Principal payments on long-term debt............ 100,389
-------------
$ 112,364
Impact of Inflation
We do not believe inflation has had a material impact on our consolidated
results of operations. We cannot provide assurance that future inflation will
not have an adverse impact on our consolidated operating results and financial
condition.
Seasonality of Business
Seasonal trends have a limited impact on our operations. We typically
experience a slight increase in membership sales in the first quarter.
Additionally, we normally experience a slight decrease in our ancillary revenues
during the summer months at our east coast Clubs due to lower membership
attendance.
Forward Looking Statements
From time to time we make "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements include the words "may,"
"will," "estimate," "continue," "believe," "expect" or "anticipate" and other
similar words. The forward-looking statements generally appear in the material
set forth under the heading "Management's Discussion and Analysis of Financial
Condition and Results of Operations" but may be found in other locations as
well. Forward-looking statements may also be found in our other reports filed
with the Securities and Exchange Commission and in our press releases and other
public disclosures. These forward-looking statements generally relate to our
plans and objectives for future operations and are based upon management's
reasonable estimates of future results or trends. Although we believe that our
plans and objectives reflected in or suggested by such forward-looking
statements are reasonable, such plans or objectives may not be achieved.
27
Actual results may differ from projected results due to unforeseen developments,
including developments relating to the following:
o the availability and adequacy of our cash flow and financing
facilities for our requirements, including payment of the Senior
Secured Notes and mortgage note,
o our ability to attract and retain members, which depends on
competition, market acceptance of new and existing sports and fitness
clubs and services, demand for sports and fitness club services
generally and competitive pricing trends in the sports and fitness
market,
o our ability to successfully develop Clubs,
o disputes or other problems arising with our development partners or
landlords,
o changes in economic, competitive, demographic and other conditions in
the geographic areas in which we operate, including business
interruptions resulting from earthquakes or other causes,
o competition,
o changes in personnel or compensation, and
o changes in statutes and regulations or legal proceedings and rulings.
We will not update forward-looking statements even though our situation may
change in the future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are also exposed to risk from a change in interest rates to the extent
we are required to refinance existing fixed rate indebtedness at rates higher
than those prevailing at the time the existing indebtedness was incurred. As of
June 30, 2005, we had Senior Secured Notes totaling $100.0 million due in March
2006. Annual interest of $11.4 million is payable semi-annually in March and
September. We also have a $19.4 million loan with a fixed interest rate of 7.25%
that matures and requires a final principal payment of $18.3 million on July 1,
2008. A change in interest rates of 1% would impact our interest expense by
approximately $1.2 million per year.
The fair value of our financial instruments as of June 30, 2005 is
estimated as follows (in thousands):
Senior Secured Notes....................... $ 94,000
First Mortgage Notes....................... 19,400
-------------------
$ 113,400
===================
28
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our reports under the Securities
Exchange Act of 1934, as amended, are recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's ("SEC") rules and forms, and that such information is accumulated
and communicated to management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosures. Our internal control system is designed to provide reasonable
assurance regarding the preparation and fair presentation of published financial
statements. All internal control systems are designed based in part upon certain
assumptions about the likelihood of future events, and, no matter how well
designed, have inherent limitations. Therefore, even those systems determined to
be effective can provide only reasonable assurance with respect to financial
statement preparation and presentation and may not prevent or detect all
misstatements. Our management, including our Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"), has evaluated the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
Quarterly Report on Form 10-Q. This evaluation included a review of the steps
management undertook in an effort to ensure that information required to be
disclosed in its Exchange Act filings is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC. In
light of certain material weaknesses in our controls and procedures described
below, the CEO and CFO concluded that, as of the end of such period, these
deficiencies have caused our disclosure controls and procedures not to be
effective to enable us to record, process, summarize, and report information
required to be included in our SEC filings within the required time period, and
to ensure that such information is accumulated and communicated to our
management, including our CEO and CFO, to allow timely decisions regarding
required disclosure. As described below, we are taking steps to remediate the
deficiencies in our control over the financial reporting process.
In performing its audit of our Consolidated Financial Statements for the
year ended December 31, 2003, KPMG LLP ("KPMG") noted a matter involving our
internal controls that it considered to be a "reportable condition," as defined
under standards established by the American Institute of Certified Public
Accountants. In performing its audit of our Consolidated Financial Statements
for the year ended December 31, 2004, Stonefield Josephson, Inc. ("Stonefield")
also noted a matter involving our internal controls that it considered to be a
"reportable condition." A "reportable condition," which may or may not be deemed
a material weakness, involves matters relating to significant deficiencies in
the design or operation of internal controls that, in the auditor's judgment,
could adversely affect our ability to record, process, summarize and report
financial data consistent with the assertions of management in the financial
statements.
The reportable condition, that KPMG considered to be a material weakness,
was that the Company does not have adequate internal controls over the
application of new accounting principles or the application of existing
accounting principles to new transactions. In this regard, KPMG noted that,
during their review of our financial statements for the quarter ended March 31,
2003, the Company had not properly accounted for private training revenues. In
addition, in connection with their audit of our financial statements for the
year ended December 31, 2003, KPMG determined that we were not properly
accounting for our management arrangement with The Sports Club/LA-Miami; that we
had not properly followed Financial Accounting Standard No. 142 relating to
goodwill; and that we had not properly
29
accounted for the accretion of dividends on our Series C Convertible Preferred
Stock. Finally, KPMG suggested that we needed to consider additional staffing in
our accounting department, and take other action (such as attending training
seminars on new accounting rules and pronouncements) to ensure that we have the
expertise and resources to implement new accounting standards and apply existing
accounting standards to new transactions. KPMG's observations were summarized in
its letter dated June 16, 2004, to the Audit Committee of the Board of
Directors.
The reportable condition, that Stonefield considered to be a material
weakness, was that the Company was unable to process its financial information
and present financial statements within a timely fashion. Stonefield's
observation was summarized in its letter dated September 30, 2005 to the Audit
Committee of the Board of Directors.
In connection with the completion of the 2003 audit, the Company's
accounting personnel worked with, and considered the recommendations of, KPMG in
accounting for private training revenues, goodwill, management fees and dividend
accrual on our Series C Convertible Preferred Stock. They conducted detailed
validation work on these accounts to substantiate the accuracy of the financial
information and related disclosures contained in our Form 10-K. The accounting
personnel reviewed the requirements of Financial Accounting Standards No. 142 to
understand the methodology underlying the accounting treatment of goodwill and
continue to monitor any new developments or changes in accounting treatment or
policies for these assets to ensure that they are accurately disclosed in our
financial statements.
In December 2004, the Company received a comment letter relating to the
Company's Form 10-K/A for the year ended December 31, 2003 and Form 10-Q for the
quarter ended September 30, 2004 from the staff of the SEC. One of the issues
dealt with accounting for initiation fees under the provision of Emerging Issues
Task Force ("EITF") No. 00-21. The eventual resolution of this issue contributed
to the untimely filing of the Company's financial statements for the year ended
December 31, 2004 and quarterly periods ended March 31, 2005 and June 30, 2005.
The Audit Committee has authorized and directed management to devise and
implement actions to address these deficiencies and to enhance the reliability
and effectiveness of the Company's internal controls over financial reporting
and to provide reasonable assurance that our disclosure controls and procedures
allow for the accurate presentation and timely filing of our financial
statements. The Company's accounting personnel have reviewed their reporting and
certification obligations under the Exchange Act and the Sarbanes Oxley Act of
2002, and have consulted with the Company's outside counsel with respect to
those obligations. We are now performing regular analyses of revenues
attributable to private training and management fees. In addition, our
accounting personnel have determined that if there should occur any changes in
existing accounting rules or policies, or if accounting principles are adopted,
which apply to the Company's financial accounts (particularly with respect to
the manner in which private training revenues, management fees, goodwill and
dividend accrual is accounted for), such matters will be brought to the
attention of our independent auditor and, if necessary, outside counsel to
ensure that all required disclosures are accurate and complete and are made in a
timely fashion. We have assigned a high priority to both the short-term and
long-term strengthening of these controls and have identified certain additional
measures, which we believe will address the conditions identified by our
auditors as a material weakness, including the following:
30
o engaging an accounting or financial consulting firm (other than the
Company's independent auditor) to consult with the Company on accounting issues,
including the interpretation of new accounting rules and releases promulgated by
the SEC, the Financial Accounting Standards Board and other organizations, and
the application of accounting principles to new transactions in which the
Company engages;
o creating and maintaining a written "log" in which new FASB, EITF, SOP and
other accounting rules and pronouncements are recorded. The log will include a
description of the new rule or pronouncement; whether or not it amends or
modifies an existing rule or pronouncement; its applicability to the Company or
any transactions in which the Company has engaged, or proposes to engage; and
the appropriate accounting ramifications of the new rule or pronouncement.
Management intends to submit this log to the Audit Committee and its independent
auditors on a quarterly basis, as part of their respective financial statement
review;
o subscribing to selected professional publications that discuss new
accounting rules and regulations applicable to reporting companies, and sending
our senior accounting personnel to seminars and other presentations which focus
on new accounting and financial disclosure rules and pronouncements; and
o establishing an internal audit procedure to ensure that transactional
recording, transactional review and adherence to applicable accounting policies
and principles are observed.
Management believes that the foregoing measures will address the conditions
identified as material weaknesses by KPMG and Stonefield. We will continue to
monitor and evaluate the effectiveness of our disclosure controls and procedures
and our internal controls over financial reporting on an ongoing basis, and are
committed to taking further action and implementing additional enhancements or
improvements, as necessary. We believe that these measures are reasonably likely
to have a material impact on both our internal controls over financial reporting
and disclosure controls and procedures in future periods.
(b) Changes in internal controls.
During the reporting period, the following changes occurred in the
Company's internal controls over financial reporting (as those terms are defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially
affected, or are reasonably likely to materially affect, its internal controls
over financial reporting:
o the Company has worked with an accounting firm (other than Company's
independent auditor) to consult with on accounting issues;
o the Company has reviewed new accounting pronouncements to determine
the applicability to the Company;
o the Company has subscribed to professional publications that discuss
new accounting rules and regulations.
31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in various claims and lawsuits incidental to our business,
including claims arising from accidents. However, in the opinion of management,
we are adequately insured against such claims and lawsuits involving personal
injuries, and any ultimate liability, whether insured or not, arising out of any
such proceedings will not have a material adverse effect on our consolidated
financial condition, cash flows or results of operations.
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
Item 6. Exhibits
31.1 Certification of Rex A. Licklider pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Timothy O'Brien pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Rex A. Licklider pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Timothy O'Brien pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SPORTS CLUB COMPANY, INC.
Date: October 13, 2005 by /s/ Rex A. Licklider
-------------------------------------
Rex A. Licklider
Chief Executive Officer
(Principal Executive Officer)
Date: October 13, 2005 by /s/ Timothy M. O'Brien
-------------------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and Accounting
Officer)
33
EXHIBIT 31.1
CERTIFICATIONS
I, Rex A. Licklider, Chief Executive Officer of The Sports Club Company, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The Sports
Club Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information
relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those
entities, particularly during the period in which this
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures (as of the end of the period covered
by this report based on such evaluation); and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's second fiscal quarter in the case of this
quarterly report) that has materially affected, or is
reasonably likely to materially affect, the registrant's
internal control over financial reporting; and;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls over financial reporting.
Dated, October 13, 2005
/s/ Rex A. Licklider
- --------------------------------------
Rex A. Licklider
Chief Executive Officer
34
EXHIBIT 31.2
CERTIFICATIONS
I, Timothy O'Brien, Chief Financial Officer of The Sports Club Company, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The Sports
Club Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information
relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those
entities, particularly during the period in which this
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures (as of the end of the period covered
by this report based on such evaluation); and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's second fiscal quarter in the case of this
quarterly report) that has materially affected, or is
reasonably likely to materially affect, the registrant's
internal control over financial reporting; and;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls over financial reporting.
Dated, October 13, 2005
/s/ Timothy O'Brien
- --------------------------------------
Timothy O'Brien
Chief Financial Officer
35
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of The Sports Club Company, Inc. (the
"Company") on Form 10-Q/A for the period ended June 30, 2005 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Rex A.
Licklider, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. (Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act
of 2002, that to my knowledge:
(i) The Report fully complies with the requirements
of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(ii) The information contained in the Report fairly
represents, in all material respects, the financial condition and result of
operations of the Company.
/s/ Rex A. Licklider
- --------------------------------------
The Sports Club Company, Inc.
Chief Executive Officer
October 13, 2005
36
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of The Sports Club Company, Inc. (the
"Company") on Form 10-Q/A for the period ended June 30, 2005 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Timothy
O'Brien, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
(Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of
2002, that to my knowledge:
(i) The Report fully complies with the requirements
of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(ii) The information contained in the Report fairly
represents, in all material respects, the financial condition and result of
operations of the Company.
/s/ Timothy O'Brien
- --------------------------------------
The Sports Club Company, Inc.
Chief Financial Officer
October 13, 2005
37