UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 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 X No
--------- ----------
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 October 31, 2005
- ----------------------------------- ---------------------------------
Common Stock, 19,315,262
par value $.01 per share
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 2004 and September 30, 2005
(in thousands, except per share amounts)
ASSETS December 31, September 30,
2004 2005
---- ----
(Unaudited)
Current assets:
Cash and cash equivalents.......................................................... $ 7,559 $ 8,813
Accounts receivable, net of allowance for doubtful accounts of $396 and $391 at
December 31, 2004 and September 30, 2005, respectively........................... 2,030 1,523
Inventories........................................................................ 662 584
Prepaid expenses................................................................... 993 832
Assets held for sale............................................................... 143,408 143,845
--------- ---------
Total current assets.......................................................... 154,652 155,597
Property and equipment, net........................................................... 63,622 60,864
Goodwill............................................................................... 7,315 7,315
Restricted cash........................................................................ 3,403 1,367
Other assets........................................................................... 2,550 1,553
--------- ---------
$ 231,542 $ 226,696
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current installments of notes payable and equipment financing loans................ $ 65,444 $ 100,374
Accounts payable................................................................... 2,040 1,483
Accrued liabilities................................................................ 9,481 6,966
Deferred revenues.................................................................. 6,013 6,332
Liabilities related to assets held for sale........................................ 85,169 84,762
--------- ---------
Total current liabilities..................................................... 168,147 199,917
Notes payable and equipment financing loans, less current installments................. 54,286 19,008
Deferred lease obligations............................................................. 2,354 2,715
Deferred revenues...................................................................... 617 583
Minority interest...................................................................... 600 600
--------- ---------
Total liabilities............................................................. 226,004 222,823
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 $13,859
at December 31, 2004 and September 30, 2005, respectively)........................ 12,796 13,571
Redeemable Preferred Stock, Series E, $.01 par value, 20,000 shares authorized, issued
and outstanding.................................................................... 2,000 2,238
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 $6,376 at December
31, 2004 and September 30, 2005, respectively)................................. 6,040 6,376
Convertible Preferred Stock, Series D, $.01 par value, 65,000 shares authorized,
issued and outstanding (liquidation preference of $6,971 and $7,409 at December
31, 2004 and September 30, 2005, respectively)................................. 6,543 6,981
Common Stock, $.01 par value, 40,000,000 shares authorized;
21,074,717 shares issued ........................................................ 211 211
Additional paid-in capital......................................................... 98,392 96,605
Accumulated deficit................................................................ (106,974) (109,248)
Treasury Stock, at cost, 2,097,079 and 1,759,455 shares at
December 31, 2004 and September 30, 2005, respectively........................... (13,470) (12,861)
--------- ----------
Total Stockholders' equity (deficit).......................................... (9,258) (11,936)
--------- ----------
$ 231,542 $ 226,696
========= =========
See accompanying notes to consolidated financial statements.
1
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months and Nine Months Ended September 30, 2004 and 2005
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2005 2004 2005
---- ---- ---- ----
(Restated) (Restated)
Revenues:
Membership revenues....................................... $ 7,464 $ 8,125 $ 21,842 $ 24,053
Products and services..................................... 3,514 3,778 10,730 11,571
----------- ----------- ----------- ------------
Total revenue........................................ 10,978 11,903 32,572 35,624
Operating expenses:
Club operating costs...................................... 4,344 4,361 12,963 13,135
Cost of products and services............................. 3,218 3,231 9,431 9,836
Selling and marketing..................................... 385 333 1,172 998
General and administrative................................ 1,832 2,090 5,963 6,133
Pre-opening expenses...................................... -- -- 46 --
Depreciation and amortization............................. 1,098 1,272 3,253 3,775
Non-recurring items....................................... -- -- 1,104 --
----------- ----------- ----------- ------------
Total operating expenses............................. 10,877 11,287 33,932 33,877
----------- ----------- ----------- ------------
Income (loss) from operations.................... 101 616 (1,360) 1,747
Other income (expense):
Interest, net............................................. (1,622) (1,622) (4,900) (4,883)
Minority interests........................................ (38) (37) (113) (111)
------------ ------------ ------------ -------------
Loss from continuing operations before income
taxes and income (loss) from discontinued
operations......................................... (1,559) (1,043) (6,373) (3,247)
Provision (benefit) for income taxes.......................... -- -- -- --
------------ ------------ ------------ -------------
Loss from continuing operations before income
(loss) from discontinued operations................ (1,559) (1,043) (6,373) (3,247)
Income (loss) from discontinued operations.................... (3,790) 314 (9,998) 972
------------ ----------- ------------ ------------
Net loss........................................... (5,349) (729) (16,371) (2,275)
Dividends on Preferred Stock.................................. 508 556 1,384 1,657
----------- ----------- ----------- ------------
Net income (loss) attributable to common
stockholders....................................... $ (5,857) $ (1,285) $ (17,755) $ (3,932)
============ ============ ============ =============
Net income (loss) per share attributable to common stockholders
- - basic and diluted:
Discontinued operations................................. $ (0.20) $ 0.01 $ (0.53) $ 0.06
Continuing operations.................................... (0.11) (0.08) (0.42) (0.26)
------------ ------------- ------------ -------------
Net income (loss) per share.......................... $ (0.31) $ (0.07) $ (0.95) $ (0.20)
============ ============= ============ =============
Weighted average number of common shares outstanding:
Basic and diluted......................................... 18,784 19,308 18,682 19,197
=========== =========== =========== ============
See accompanying notes to consolidated financial statements.
2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2004 and 2005
(in thousands)
(unaudited)
Nine Months Ended
September 30,
2004 2005
---- ----
(Restated)
Cash flows provided from (used in) operating activities:
Net income (loss).................................................... $ (16,371) $ (2,275)
Adjustments to reconcile net income (loss) to cash used in operating
activities:
(Income) loss from discontinued operations...................... 9,998 (972)
Depreciation and amortization................................... 3,253 3,775
Related party costs settled with common stock................... 711 610
Minority interests expense...................................... 112 111
Distributions to minority interests............................. (112) (111)
(Increase) decrease in:
Accounts receivable, net.................................... (350) 507
Inventories................................................. (115) 78
Other current assets........................................ (1,647) 161
Other assets, net........................................... 4,769 997
Increase (decrease) in:
Accounts payable............................................ 709 (557)
Accrued liabilities......................................... (4,310) (2,515)
Deferred revenues........................................... 221 285
Deferred lease obligations.................................. 391 361
--------- --------
Net cash provided from (used in) operating activities.... (2,741) 455
Cash flows (used in) investing activities:
Capital expenditures............................................ (2,325) (1,017)
(Increase) decrease in restricted cash.......................... 1,041 2,036
--------- --------
Net cash provided by (used in) investing activities...... (1,284) 1,019
Cash flows provided from (used in) financing activities:
Proceeds from issuance of Preferred Stock - net of costs........ 8,072 --
Repayments of notes payable and equipment financing loans....... (1,669) (348)
---------- ---------
Net cash provided from (used in) financing activities.... 6,403 (348)
Cash flows provided from (used in) discontinued operations:
Capital expenditures............................................ (1,094) (643)
Net cash from operating activities.............................. (831) 771
---------- --------
Net cash provided from (used in) discontinued operations. (1,925) 128
---------- --------
Net increase (decrease) in cash and cash equivalents..... 453 1,254
Cash and cash equivalents at beginning of period......................... 1,932 7,559
--------- --------
Cash and cash equivalents at end of period............................... 2,385 $ 8,813
========= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest........................ 12,547 $ 12,697
======== ========
Cash paid during the period for income taxes.................... 702 $ 350
======== ========
See accompanying notes to consolidated financial statements.
3
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 (Audited) and September 30, 2005 (Unaudited)
1. Basis of Presentation
The unaudited, condensed consolidated financial statements and
condensed consolidated balance sheet as of December 31, 2004 derived from
audited 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 nine-month periods ended September 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 and on October 25, 2005, entered
into a definitive Asset Purchase Agreement 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 nine-month periods ended September 30, 2004 and 2005, the amount
of interest allocated to discontinued operations was $2,011,000 and $6,033,000,
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 offset the
deferred rent against the leasehold improvements. The 2004 condensed
consolidated financial statements have been adjusted to reflect this
reclassification.
4
The consolidated statements of operations for the three months and nine
months ended September 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 condensed
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 September 30, 2004 operating
statements to more properly account for initiation fees. During the nine months
ended September 30, 2004, the Company recognized a portion of its membership
initiation fees 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 September 30, 2004 have been
restated.
A reclassified restated condensed consolidated statement of operations
for the three months and nine months ended September 30, 2004, reflecting the
above reclassifications is presented below. The amounts are in thousands, except
per share amounts:
5
Condensed Consolidated Statement of Operations
Three Months Ended September 30, 2004
-------------------------------------
As Initiation Discontinued As
Reported Fees SFAS No. 13 Operations Reformat Restated
-------- ---- ----------- ---------- -------- --------
Revenues:
Membership revenues............................... $ 35,122 $ 100 $ -- $ (15,786) $ (11,972)$ 7,464
Reimbursed costs.................................. 1,267 -- -- (1,267) -- --
Products and services............................. -- (300) -- (8,082) 11,896 3,514
Management fees................................... -- -- -- (76) 76 --
----------- ---------- ---------- ------------- --------- -----------
Total revenue................................ 36,389 (200) -- (25,211) -- 10,978
Operating expenses:
Direct............................................ 29,504 -- -- -- (29,504) --
Reimbursed costs.................................. 1,267 -- -- (1,267) -- --
Club operating costs.............................. -- -- (597) (14,809) 19,750 4,344
Cost of products and services..................... -- -- -- (6,536) 9,754 3,218
Selling and marketing............................. 1,238 -- -- (853) -- 385
General and administrative........................ 1,898 -- -- (66) -- 1,832
Depreciation and amortization..................... 3,200 -- 597 (2,699) -- 1,098
Loss on assets held for sale...................... 527 -- -- (527) -- --
----------- ----------- ---------- ------------- --------- -----------
Total operating expenses..................... 37,634 -- -- (26,757) -- 10,877
----------- ----------- ---------- ------------- --------- -----------
Income (loss) from operations............ (1,245) (200) -- 1,546 -- 101
Other income (expense):
Interest, net..................................... (3,656) -- -- 2,034 -- (1,622)
Minority interests................................ (200) -- -- 162 -- (38)
------------ ---------- ---------- ------------ --------- ------------
Income (loss) before income taxes and loss
from discontinued operations............... (5,101) (200) -- 3,742 -- (1,559)
Provision (benefit) for income taxes.................. 48 -- -- (48) -- --
----------- ---------- ---------- ------------- --------- -----------
Income (loss) before loss from
discontinued operations...................... (5,149) (200) -- 3,790 -- (1,559)
----------- ---------- ---------- ------------- --------- -----------
Loss from discontinued operations................. -- -- -- (3,790) -- (3,790)
----------- ---------- ---------- ------------- --------- ------------
Net loss..................................... (5,149) (200) -- -- -- (5,349)
------------ ------------ ---------- ------------ --------- ------------
Dividends on Preferred Stock.......................... 508 -- -- -- -- 508
----------- ---------- ---------- ------------ --------- -----------
Net loss attributable to common stockholders. $ (5,657) $ (200) $ -- $ -- $ -- $ (5,857)
============ ============ ========== ============ ========= ============
Net loss per share attributable to common stockholders
- - basic and diluted:
Discontinued operations.......................... $ -- $ (0.20)
Continuing operations............................ (0.30) (0.11)
------------ ------------
Net income (loss) per share................. $ (0.30) $ (0.31)
=========== ============
Weighted average number of common shares outstanding:
Basic and diluted................................. 18,784 18,784
=========== ===========
6
Condensed Consolidated Statement of Operations
Nine Months Ended September 30, 2004
------------------------------------
As Initiation Discontinued As
Reported Fees SFAS No. 13 Operations Reformat Restated
-------- ---- ----------- ---------- -------- --------
Revenues:
Membership revenues..................................$ 107,529 $ 100 $ -- $ (47,713) $ (38,074) $ 21,842
Reimbursed costs..................................... 3,770 -- -- (3,770) -- --
Products and services................................ -- (1,600) -- (25,523) 37,853 10,730
Management fees...................................... -- -- -- (221) 221 --
---------- --------- ----------- ------------ ----------- ----------
Total revenue................................... 111,299 (1,500) -- (77,227) -- 32,572
Operating expenses:
Direct............................................... 89,376 -- -- -- (89,376) --
Reimbursed costs..................................... 3,770 -- -- (3,770) -- --
Club operating costs................................. -- (500) (1,792) (44,327) 59,582 12,963
Cost of products and services........................ -- -- -- (20,363) 29,794 9,431
Selling and marketing................................ 4,037 -- -- (2,864) (1) 1,172
General and administrative........................... 6,150 -- -- (187) -- 5,963
Pre-opening expenses................................. 46 -- -- -- -- 46
Depreciation and amortization........................ 9,539 -- 1,792 (8,079) 1 3,253
Non-recurring items.................................. 1,104 -- -- -- -- 1,104
Loss on assets held for sale......................... 527 -- -- (527) -- --
---------- --------- ----------- ------------ ----------- ----------
Total operating expenses........................ 114,549 (500) -- (80,117) -- 33,932
---------- ---------- ----------- ------------ ----------- ----------
Income (loss) from operations................ (3,250) (1,000) -- 2,890 -- (1,360)
Other income (expense):
Interest, net........................................ (11,017) -- -- 6,116 1 (4,900)
Minority interests................................... (716) -- -- 604 (1) (113)
----------- --------- ----------- ----------- -----------------------
Income (loss) before income taxes and loss
from discontinued operations................. (14,983) (1,000) -- 9,610 -- (6,373)
Provision (benefit) for income taxes..................... 387 -- -- (388) 1 --
---------- --------- ----------- ------------ ----------- ----------
Income (loss) before loss from discontinued
operations................................ (15,370) (1,000) -- 9,998 (1) (6,373)
Loss from discontinued operations........................ -- -- -- (9,998) -- (9,998)
---------- --------- ----------- ------------ ----------- -----------
Net loss..................................... (15,370) (1,000) -- -- (1) (16,371)
Dividends on Preferred Stock............................. 1,384 -- -- -- -- 1,384
---------- --------- ----------- ----------- ----------- ----------
Net loss attributable to common stockholders.$ (16,754) $ (1,000) $ -- $ -- $ (1) $ (17,755)
=========== ========== =========== =========== =========== ===========
Net loss per share attributable to common stockholders -
basic and diluted:
Discontinued operations.............................$ -- $ (0.53)
Continuing operations............................... (0.90) (0.42)
----------- -----------
Net income (loss) per share.....................$ (0.90) $ (0.95)
=========== ===========
Weighted average number of common shares outstanding:
Basic and diluted.................................... 18,682 18,682
========== ----------
7
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. There were no options
granted in 2005. 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 Nine Months Ended
September 30, September 30,
------------ ------------
2004 2005 2004 2005
---- ---- ---- ----
Net loss attributable to common
stockholders, as reported..................... $ (5,857) $ (1,285) $ (17,755) $ (3,932)
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........................... $ (5,857) $ (1,285) $ (17,848) $ (3,932)
============= ============== ============= ==============
Net loss per share as reported basic and
diluted....................................... $ (0,31) $ (0.07) $ (0.95) $ (0.20)
============= ============== ============= ==============
Pro forma net loss per share basic and diluted $ (0.31) $ (0.07) $ (0.96) $ (0.20)
============= ============== ============= ==============
8
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 $2.3 million during the nine months ended
September 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 an Asset Purchase Agreement on October 28, 2005 to sell six of its
nine sports and fitness Clubs for $65.0 million to an affiliate of a significant
shareholder. The Company also believes it will be able to mortgage its property
in West Los Angeles, California and that the proceeds from the asset sale and
finaning will be sufficient to retire the entire $100.0 million of Senior
Secured Notes prior to their maturity date. The closing of the transaction is
expected to occur on or before December 31, 2005, however, because there is not
a commitment to refinance The Sports Club/LA and the closing of the Asset
Purchase Agreement is subject to a nubmer of conditions, there can be no
assurance that any of these transactions will be consummated.
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
9
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 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 and on October
28, 2005 entered into a definitive Asset Purchase Agreement. Accordingly, the
Company reported the assets of these Clubs as held for sale, the liabilities as
liabilities relating to assets held for sale and operations of these Clubs as
discontinued operations in accordance with SFAS No. 144.
In October 2004, the Company sold three SportsMed physical therapy
facilities for $600,000. The Company continues to own and operate two SportsMed
facilities that are located within The Sports Club/LA Clubs in Los Angeles and
Orange County.
The operating results of the six Clubs to be sold and SportsMed
facilities (sold in 2004) have been classified as discontinued operations in the
accompanying condensed consolidated statements of operations. Summarized
financial data for these locations are as follows:
Statements of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2005 2004 2005
---- ---- ---- ----
(in thousands)
Revenues:
Membership revenues................................$ 15,786 $ 16,502 $ 47,713 $ 49,925
Products and services............................... 8,082 8,185 25,523 25,680
Management fees..................................... 76 92 221 276
Reimbursed costs.................................... 1,267 1,391 3,770 4,298
--------- ----------- ----------- -----------
Total revenue.................................... 25,211 26,170 77,227 80,179
Operating, expenses:
Club operating costs................................ 14,809 14,993 44,327 45,058
Costs of products and services...................... 6,536 6,293 20,363 19,863
Selling and marketing............................... 853 696 2,864 2,261
General and administrative.......................... 66 147 187 335
Depreciation and amortization....................... 2,699 -- 8,079 --
Reimbursed costs.................................... 1,267 1,391 3,770 4,298
--------- ----------- ----------- -----------
Total operating expenses......................... 26,230 23,520 79,590 71,815
--------- ----------- ----------- -----------
Income (loss) from operations................. (1,019) 2,650 (2,363) 8,364
Other income (expense):
Interest, net....................................... (2,034) (2,003) (6,116) (6,014)
Minority interests.................................. (162) (274) (604) (944)
---------- ------------- ------------ ------------
Income (loss) before income taxes............. (3,215) 373 (9,083) 1,406
Provision for income taxes.............................. 48 59 388 434
---------- ----------- ------------ -----------
Income (loss) from operations of
discontinued operations.................... (3,263) 314 (9,471) 972
(Gain) loss on disposal of assets....................... 527 -- 527 --
---------- ----------- ------------ ------------
Income (loss) from discontinued
operations................................$ (3,790) $ 314 $ (9,998) $ 972
=========== =========== ============ ===========
10
Assets and liabilities related to assets held for sale consist of the
following at:
December 31, September 30,
2004 2005
---- ----
(in thousands)
Assets held for sale:
Accounts receivable, net of allowance for doubtful accounts .. $ 1,320 $ 1,223
Inventories................................................... 442 492
Prepaid expenses.............................................. 433 275
Property and equipment, net................................... 141,015 141,659
Other assets.................................................. 198 196
---------------- -----------------
Total assets held for sale................................ $ 143,408 $ 143,845
================ =================
Liabilities related to assets held for sale:
Accrued liabilities........................................... $ 3,354 $ 3,556
Deferred revenues............................................. 15,178 15,560
Accrued lease obligations..................................... 65,774 64,239
Minority interest............................................. 863 1,407
---------------- -----------------
Total liabilities related to assets held for sale......... $ 85,169 $ 84,762
================ =================
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 September 30,
2005, cash and cash equivalents were $8.8 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
September 30, 2005, the Company had $1.4 million of restricted cash.
7. Notes Payable and Equipment Financing Loans
Notes payable and equipment financing loans are summarized as follows:
December 31, September 30,
2004 2005
---- ----
(in thousands)
Senior secured notes (a).......... $ 100,000 $ 100,000
Mortgage note (b)................. 19,550 19,306
Equipment financing loans (c)..... 180 76
-------------- --------------
119,730 119,382
Less current installments......... 65,444 100,374
-------------- --------------
$ 54,286 $ 19,008
============== ==============
---------
(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
11
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 September 30,
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 September 30, 2005, the
estimated fair value of the Senior Secured Notes was $98.0 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
September 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
7.1% and 13.1%.
8. Non-recurring Items
The non-recurring charge of $1.1 million during the nine months ended
September 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.
12
9. Income Tax Provision
The income tax provision recorded for the three-month and nine-month
periods ended September 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 Nine Months Ended
September 30, September 30,
2004 2005 2004 2005
---- ---- ---- ----
(in thousands)
Revenues:
Membership revenues:
Monthly dues................................ $ 6,794 $ 7,435 $ 19,999 $ 22,074
Initiation fees............................. 507 547 1,385 1,567
Other....................................... 163 143 458 412
----------- --------- --------- ---------
Total membership revenues.................. 7,464 8,125 21,842 24,053
----------- --------- --------- ---------
Products and Services:
Private training............................ 1,805 1,912 5,453 5,895
Food and beverage........................... 813 882 2,516 2,716
Spa services................................ 405 492 1,094 1,488
Physical therapy............................ 348 337 1,230 969
Other....................................... 143 155 437 503
----------- --------- --------- ---------
Total products and services................ 3,514 3,778 10,730 11,571
----------- --------- --------- ---------
Total revenue...................................... $ 10,978 $ 11,903 $ 32,572 $ 35,624
=========== ========= ========= =========
Operating expenses:
Club operating costs:
Payroll and benefits........................ $ 2,143 $ 2,121 $ 6,364 $ 6,435
Rent........................................ 471 464 1,421 1,404
Other operating costs....................... 1,730 1,776 5,178 5,296
----------- --------- --------- ---------
Total Club operating costs................. 4,344 4,361 12,963 13,135
----------- --------- --------- ---------
Costs of products and services:
Private training............................ 1,572 1,664 4,659 5,097
Food & beverage............................. 961 937 2,868 2,769
Spa services................................ 422 429 1,107 1,300
Physical therapy............................ 244 183 743 607
Other....................................... 19 18 54 63
----------- --------- --------- ---------
Total cost of products and services........ 3,218 3,231 9,431 9,836
----------- --------- --------- ---------
Sales and marketing........................... 385 333 1,172 998
General and administrative.................... 1,832 2,090 5,963 6,133
Pre-opening................................... -- -- 46 --
Depreciation and amortization................. 1,098 1,272 3,253 3,775
Non-recurring items........................... -- -- 1,104 --
----------- --------- --------- ---------
Total operating expenses........................... $ 10,877 $ 11,287 $ 33,932 $ 33,877
=========== ========= ========= =========
13
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 nine-months ended September
30, 2004, there were 4,035,250 and 3,536,184 anti-dilutive potential common
shares, respectively. For the three-months and nine-months ended September 30,
2005, there were 2,913,110 and 3,671,429 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 September 30, 2005, the Series B Preferred,
including accrued dividends of $3,359,000, was convertible into 4,800,319 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 $1,000
for each share of Series B Preferred then outstanding. Since this series of
Preferred Stock is conditionally redeemable, it has been classified between
stockholders' equity and total liabilities in the accompanying balance sheet.
The initial carrying value of the Series B Preferred was recorded at
its sale price less costs to issue on the date of issuance. The carrying value
of the Series B Preferred is periodically adjusted so that the carrying value
equals the redemption value on the redemption date. The carrying value of the
Series B Preferred will also be periodically adjusted for any accrued and unpaid
dividends. At December 31, 2004 and September 30, 2005, the Series B Preferred
carrying value consisted of the following ($ in thousands):
December 31, September 30,
2004 2005
---- ----
Initial fair value, sale price of $10,500
less costs to issue of $592..............$ 9,908 $ 9,908
Redemption value accretion.................... 240 304
Accrued and unpaid dividends accretion........ 2,648 3,359
---------------- -------------
Total carrying value......................$ 12,796 $ 13,571
================ =============
14
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 September 30, 2005, the Series C Preferred, including accrued dividends of
$1,376,000, was convertible into 2,208,444 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 $1,000 for
each share of Series C Convertible Preferred then outstanding, plus earned and
unpaid dividends.
The carrying value of the Series C Convertible Preferred is
periodically adjusted for any accrued and unpaid dividends. At December 31, 2004
and September 30, 2005, the Series C Convertible Preferred carrying value
consisted of the following (in thousands):
December 31, September 30,
2004 2005
---- ----
Initial fair value.......................$ 5,000 $ 5,000
Accrued and unpaid dividend accretion.... 1,040 1,376
--------------- --------------
Total carrying value.....................$ 6,040 $ 6,376
=============== ==============
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 September 30, 2005, the Series D Preferred,
including accrued
15
dividends of $909,000, was convertible into 3,704,000 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
$100 for each share of Series D Convertible Preferred then outstanding, plus any
earned and unpaid dividends. The holders of the Series D Convertible Preferred
are afforded protective rights that among other things restrict the Company's
ability to incur debt or lease obligations, make investments or acquisitions,
sell a Club leased from Millennium, issue any new class of equity securities,
repurchase or redeem any equity securities, hire or fire the Chief Executive
Officer, enter into any new line of business or change the primary line of
business and issue options under the Company's stock option plans. In addition,
Millennium is entitled to designate two directors (at least one of whom must be
independent) and the other two holders are each entitled to designate one
director, to serve on the Company's Board of Directors.
The carrying value of the Series D Convertible Preferred is
periodically adjusted for any accrued and unpaid dividends. At December 31, 2004
and September 30, 2005, the Series D Convertible Preferred carrying value
consisted of the following (in thousands):
December 31, September 30,
2004 2005
---- ----
Initial fair value.......................$ 6,500 $ 6,500
Issuance costs........................... (428) (428)
Accrued and unpaid dividend accretion.... 471 909
-------------- -------------
Total carrying value.....................$ 6,543 $ 6,981
============== =============
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
16
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.
Since this series of Preferred Stock is conditionally redeemable, it has been
classified between stockholders' equity and total liabilities in the
accompanying balance sheet.
This initial carrying value of the Series E Preferred was recorded at
its sales price. The carrying value of the Series E Preferred is periodically
adjusted for any accrued and unpaid dividends. At September 30, 2005, the Series
E Preferred carrying value consisted of the following (in thousands):
Initial fair value........................................ $ 2,000
Accrued and unpaid dividends accretion.................... 238
-------------
$ 2,238
=============
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.
17
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
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 initially operate 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 October 2005, we entered into a definitive Asset Purchase Agreement
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 assigned to the buyer. 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
18
Miami management 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 managing payroll
and other controllable 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 32.5% 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 27.5% is well below the normal in the industry.
Club operating costs consist primarily of payroll and employee
benefits, rent and other occupancy related costs, supplies, repairs 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 in the second quarter of 2005, the Company started amortizing
initiation fees over the
19
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 (determined by estimating future discounted cash flows)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 September 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 determined that our remaining goodwill was not impaired. No events
occurred in the nine months ended September 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
20
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 nine
months ended September 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 nine months ended September 30,
2005 to September 30, 2004 is after consideration of such reclassifications and
restatements.
Comparison of Three Months Ended September 30, 2005 to Three Months Ended
September 30, 2004.
Our total revenue from continuing operations for the three months ended
September 30, 2005, was $11.9 million, compared to $11.0 million for the same
period in 2004, an increase of $925,000 or 8.4%. Revenue increased by $585,000
as a result of membership growth at The Sports Club/LA-Beverly Hills, which
opened on October 7, 2003. Revenue increased by $351,000 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 due 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 $11,000 at our two SportsMed locations
primarily due to decreased patient visits.
Our club operating costs and cost of products and services remained
flat at $7.6 million for both the three months ended September 30, 2005 and
three months ended September 30, 2004.
Our selling and marketing expenses were $333,000 for the three months
ended September 30, 2005, versus $385,000 for the same period in 2004, a
decrease of $52,000 or 13.5%. Selling and marketing expenses were down at each
of our Clubs and in almost every category of expense due to expense control
measures we undertook.
General and administrative expenses were $2.1 million for the three
months ended September 30, 2005, versus $1.8 million for the same period in
2004, an increase of $258,000 or 14.1%. Payroll and payroll-related expenses for
the three months ended September 30, 2005, decreased by $285,000 primarily due
to headcount decreases. Rent decreased by $32,000 due to lower rent costs at the
corporate office. Legal fees increased by $584,000 primarily due to the
recording, in the third quarter of 2004, of a $600,000 reimbursement of certain
legal costs incurred and expensed in prior years related to litigation at one of
our Clubs. Accounting fees increased by $100,000 as a result of increased audit
fees necessary to complete our December 31, 2004 audit and first two quarterly
reviews in 2005. Other miscellaneous general administrative expenses decreased
by $109,000 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 September 30, 2005, versus $1.1 million for the same period
in 2004, an increase of $174,000 or 15.8%. Depreciation and amortization
expenses increased by $12,000, 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 $162,000
at the corporate office facility as a result of the decision to consolidate
21
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 September 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
September 30, 2005 and three months ended September 30, 2004.
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 September 30, 2005 and 2004.
Our income from discontinued operations was $314,000 for the three
months ended September 30, 2005, versus a loss of $3.8 million for the same
period in 2004, an increase of $4.1 million. Our income from discontinued
operations increased by $2.7 million because in 2005 we discontinued recording
depreciation expense 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 classified as held for sale.
Income from discontinued operations increased by approximately $1.0 million, as
the result of a 3.1 % increase in membership and to increases in dues and
ancillary services rates. Income from discontinued operations increased by
$527,000 due to a loss on the sale of three stand-alone SportsMed facilities
that occurred in the third quarter of 2004. Our income from discontinued
operations decreased by $112,000 as a result of an increase in the minority
interest expense at The Reebok Sport Club/NY during the three months ended
September 30, 2005 versus the same period in 2004.
After dividends on preferred stock of $556,000 during the three months
ended September 30, 2005 and $508,000 during the three months ended September
30, 2004, our consolidated net loss attributable to common stockholders was $1.3
million, or $0.07 per basic and diluted share for the three months ended
September 30, 2005, versus a loss of $5.9 million, or $0.31 per basic and
diluted share for the three months ended September 30, 2004.
Comparison of Nine Months Ended September 30, 2005 to Nine Months Ended
September 30, 2004.
Our total revenue from continuing operations for the nine months ended
September 30, 2005, was $35.6 million, compared to $32.6 million for the same
period in 2004, an increase of $3.0 million or 9.4%. Revenue increased by $2.1
million as a result of membership growth at The Sports Club/LA-Beverly Hills,
which opened on October 7, 2003. Revenue increased by $1.2 million 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 approximately $252,000 at our two SportsMed
locations primarily due to decreased patient visits.
Our club operating costs and cost of products and services increased by
$577,000, or 2.6% to $23.0 million for the nine months ended September 30, 2005,
versus $22.4 million for the same period in 2004. Club operating costs and cost
of products and services increased by approximately $448,000, 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
22
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 $1.0 million for the nine
months ended September 30, 2005, versus $1.2 million for the same period in
2004, a decrease of $174,000 or 14.8%. Selling and marketing expenses were down
at each of our Clubs and in almost every category of expense due to expense
control measures we undertook.
Our general and administrative expenses were $6.1 million for the nine
months ended September 30, 2005, versus $6.0 million for the same period in
2004, an increase of $170,000 or 2.9%. Payroll and payroll-related expenses for
the nine months ended September 30, 2005, decreased by approximately $500,000,
primarily due to headcount decreases. Outside service fees increased by
approximately $300,000 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 $58,000 due to lower rent costs at the
corporate office. Legal fees increased by approximately $550,000 primarily due
to the recording, in the third quarter of 2004, of a $600,000 reimbursement of
certain legal costs incurred and expensed in prior years related to litigation
at one of our Clubs. Accounting fees increased by approximately $100,000 as a
result of increased audit fees necessary to complete our December 31, 2004 audit
and first two quarterly reviews in 2005. Other miscellaneous general
administrative expenses decreased by approximately $222,000 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 nine months ended September 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 $3.8 million for the
nine months ended September 30, 2005, versus $3.3 million for the same period in
2004, an increase of $522,000 or 16.0%. Depreciation and amortization expenses
increased by $82,000, 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 $440,000
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 nine
months ended September 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 nine months ended September 30, 2005 and 2004, we allocated
$6.0 million of interest expense to discontinued operations. Our remaining net
interest expense was flat at $4.9 million for both the nine months ended
September 30, 2005 and nine months ended September 30, 2004.
We did not record any federal or state deferred tax benefit related to
our consolidated pre-tax losses from continuing operations for the nine months
ended September 30, 2005 and 2004.
23
Our income from discontinued operations was $1.0 million for the nine
months ended September 30, 2005, versus a loss of $10.0 million for the same
period in 2004, an increase of $11.0 million. Our income from discontinued
operations increased by $8.1 million because we discontinued recording
depreciation expense 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 classified as held for sale.
Our income from discontinued operations increased by approximately $2.7 million,
as the result of an increase in membership and to increases in dues and
ancillary services rates. Our income from discontinued operations increased by
$527,000 due to a loss on the sale of three stand-alone SportsMed facilities
that occurred in the third quarter of 2004. Our income from discontinued
operations decreased by $340,000 as a result of an increase in the minority
interest expense at The Reebok Sport Club/NY during the nine months ended
September 30, 2005 versus the same period in 2004.
After dividends on preferred stock of $1.7 million during the nine
months ended September 30, 2005 and $1.4 million during the nine months ended
September 30, 2004, our consolidated net loss attributable to common
stockholders was $3.9 million, or $0.20 per basic and diluted share for the nine
months ended September 30, 2005, versus a loss of $17.8 million, or $0.95 per
basic and diluted share for the nine months ended September 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. On October 28, 2005, we entered into a definitive Asset
Purchase Agreement for the sale of these Clubs. We also 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. The closing
of the transactions is expected to occur on or before December 31, 2005,
however, because we do not have a commitment for the refinance of The Sports
Club/LA and the closing of the Asset Purchase Agreement is subject to a number
of conditions, 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
24
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 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 September 30, 2005, our cash balance was $8.8 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 2005, we received back $2.5 million of such
deposits.
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 $500,000 to relocate our corporate office and
$600,000 during the next year to upgrade our management information systems and
enhance our disaster recovery capabilities. In addition, if we successfully
complete the asset sale and financing of The Sports Club/LA-Los Angeles, we plan
on investing several million dollars back into the Club to maintain its
condition.
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.
25
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.
On June 12, 2003, we 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 September 30,
2006, are estimated to be as follows (amounts in thousands):
Indenture interest (assuming refinancing)........... $ 9,513
Corporate office relocation......................... 500
Information system upgrades......................... 600
Principal payments on long-term debt................ 100,389
Retirement of Series E Preferred Stock.............. 2,389
-------------
$ 113,391
=============
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.
26
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 during the vacation season.
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. 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.
27
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 September 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 $19.3 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 September 30, 2005
is estimated as follows (in thousands):
Senior Secured Notes....................... $ 98,000
First Mortgage Notes....................... 19,300
-------------------
$ 117,300
===================
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: November 21, 2005 by /s/ Rex A. Licklider
----------------------------------------
Rex A. Licklider
Chief Executive Officer
(Principal Executive Officer)
Date: November 21, 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 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 third 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, November 21, 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 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 third 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, November 21, 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 for the period ended September 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
November 21, 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 for the period ended September 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
November 21, 2005
37