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UNITED STATES
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTON 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT
For the transition period from ___________to __________
Commission File Number: 1-13290
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The Sports Club Company, Inc.
(Exact name of registrant as specified in its charter)
Delaware 95-4479735
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No:)
11100 Santa Monica Blvd., Suite 300
Los Angeles, California 90025
(Address of registrant's principal (Zip Code)
executive offices)
Registrant's telephone number,
including area code:
(310) 479-5200
Securities registered pursuant to Name of each exchange on which
Section 12(b) of the Act: registered
Title of each class
Common Stock $.01 par value American Stock Exchange
Securities registered pursuant to
Section 12(g) of the Act: None
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Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of
the registrant on June 15, 2004 was $7,184,586. The number of shares of the
Common Stock, par value $ .01 per share, outstanding (the only class of Common
Stock of the registrant outstanding) was 18,783,744 on June 15, 2004. Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes |_| No |X|
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1
PART I
ITEM 1. BUSINESS
General
We were incorporated in Deleware in 1994 to consolidate the ownership of
several sports and fitness clubs. We currently own and operate eight Clubs under
"The Sports Club/LA" name in Los Angeles, Beverly Hills, Orange County,
Washington D.C., Boston, San Francisco and at Rockefeller Center and the Upper
East Side in New York City. We also operate and own a majority interest in
Reebok Sports Club/NY, and operate The Sports Club/LA in Miami under a
management agreement. Our Clubs offer a wide range of fitness and recreation
options and amenities, and are marketed to affluent, health conscious
individuals who desire a service-oriented, state-of-the-art club. Our Clubs are
widely recognized as being among the finest sports and fitness clubs in the
country.
Our Clubs (hereinafter referred to as "Clubs" or "The Sports Club/LA") are
conveniently located and are spacious, modern facilities that typically include
spas, restaurants, fitness centers, swimming pools and basketball courts. The
Sports Club/LA sites are designed as "urban country clubs," and most Clubs range
in size from 90,000 to 140,000 square feet. Initiation fees and monthly
membership dues at The Sports Club/LA are higher than those charged by most
other sports and fitness clubs. Income from ancillary services and products,
including private training, food and beverage and spa services, also constitutes
a significant portion of our revenues. Our subsidiary, The SportsMed Company
("SportsMed"), operates physical therapy facilities in some Clubs and at other
locations.
According to the International Health, Racquet & Sportsclub Association
("IHRSA"), the industry's leading trade organization, it is estimated that 36.3
million Americans were members of more than 20,000 sports and fitness clubs in
2002. Revenues generated by the United States sports and fitness club industry
increased at a compound annual rate of 8.1% from $6.5 billion in 1993 to $13.1
billion in 2002. The industry has benefited from the general public's increasing
awareness of the importance of physical exercise. Among other groups, we target
members age 35 and older who, according to IHRSA, represent 54% of all
memberships and are the fastest growing segment of the industry.
Recent Events
On March 12, 2004, we completed a $6.5 million private placement of a newly
created series of Convertible Preferred Stock. We received $6.1 million in cash,
net of costs, and issued 65,000 shares of $.01 par value Series D Convertible
Preferred Stock at a price of $100 per share. Proceeds from the sale were
primarily used to make our March 15, 2004 interest payment on our Senior Secured
Notes.
In November 2003, we opened The Sports Club/LA - Miami. This 40,000 square
foot Club is located in the new Four Seasons Resort and Towers project in
downtown Miami. We manage this Club for which we receive a management fee based
upon both the gross revenue and net cash flow of the Club. We also license The
Sports Club/LA name to the owner. This management structure allows us to expand
our brand and receive an immediate earnings stream, with the potential for
additional profits, without making any capital investment.
In October 2003, we opened The Sports Club/LA - Beverly Hills. This 40,000
square foot Club is located in the heart of the Beverly Hills retail and
commercial district and is located approximately three miles east of our
flagship property The Sports Club/LA - Los Angeles. This Club may serve as the
prototype for smaller size Clubs to be built in locations near existing Sports
Club/LA sites.
On June 12, 2003, we replaced our Bank Credit Agreement with a new $20.0
million secured loan from Orange County's Credit Union. The new loan is
evidenced by a promissory note that bears interest at a fixed interest rate of
7.25% per annum; 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
2
owns The Sports Club/LA - Orange County; and is guaranteed by two of our major
shareholders. The note may be prepaid at any time without penalty and requires a
final principal payment of $18.3 million on July 1, 2008.
The Sports Club/LA
The Sports Club/LA ranges in size from 40,000 to 140,000 square feet and
typically includes the following features:
o large, fully equipped gyms with state-of-the-art fitness equipment,
including weight training, cardio- vascular equipment, flexibility
centers and functional performance areas,
o basketball, volleyball, racquetball, squash, tennis and paddle tennis
courts,
o group exercise studios featuring classes throughout the day and
evening, seven days a week, including aerobics, yoga, dance, muscle
conditioning, boxing, martial arts, pilates and bodymind,
o group cycling studios,
o rock climbing walls,
o boxing studios,
o swimming pools, sundecks, golf practice nets and running tracks,
o destination city spa offering massage, facials and full body
treatments,
o men's and women's locker rooms featuring wood lockers,
o steam rooms, saunas and jacuzzis,
o restaurants, sports bars, private dining/conference rooms and media
centers,
o valet parking, pro shops, hair salons and childcare services,
o sports medicine and physical therapy facilities,
o personal trainers to develop and supervise members' exercise routines,
o registered dietitians for nutritional consultations,
o FitLab assessment centers,
o PTS Private Trainer System nutritional programs and products,
o interactive children's' classes, as well as supervised age-specific
junior recreation rooms and junior programs such as gymnastics,
martial arts and dance,
o instruction in racquet sports, golf, swimming, boxing, martial arts
and rock climbing,
o full-time activities directors responsible for social and media events
for members, including organizing trips, lectures and charity events,
o sports instructors who present sports tournaments, leagues and
classes, and
o wellness protocols such as exercise regimens designed for specific
groups of members.
3
We currently have ten Sports Clubs in operation. The original Sports
Club/LA opened in 1987 in West Los Angeles, California, near the affluent
communities of Santa Monica, Brentwood, Beverly Hills, Bel Air, Westwood and
Century City. We opened The Sports Club/LA-Beverly Hills in October 2003. This
40,000 square foot Club is located in the heart of Beverly Hill's retail and
commercial district. The Sports Club/LA - Orange County opened in 1990 in
Irvine, California near Newport Beach.
We operate three Clubs in New York City. Reebok Sports Club/NY opened in
1995 on Manhattan's upper west side, and was developed in partnership with a
subsidiary of Reebok International, Ltd. ("Reebok") and Lincoln Metrocenter
Partners, L.P. (collectively with its affiliates "Millennium"). We manage the
operations and own a 60% interest in the partnership that owns this Club. Reebok
and Millennium have each retained an interest in the partnership. We opened The
Sports Club/LA at two locations in New York City in 2000. The Sports Club/LA -
New York at Rockefeller Center was opened in February 2000. This Club was
designed to service the executive business community in midtown Manhattan. The
Sports Club/LA - New York in New York City's Upper East Side was opened in
September 2000. This site is the location of the former Vertical Club, which was
closed in February 1999 for major renovation and conversion to The Sports
Club/LA and serves the affluent residential Upper East Side area of New York
City.
We also operate The Sports Club/LA at four other sites developed by
Millennium. The Sports Club/LA - Washington D.C. opened in October 2000. This
100,000 square foot Club is located at 22nd and M Streets between Washington
D.C.'s business district and Georgetown. The Sports Club/LA - Boston opened in
September 2001. This Club overlooks the historic Boston Common and is located a
short distance from the city's financial district. Both of these Clubs are
co-located with a Ritz Carlton Hotel. The Sports Club/LA - San Francisco has
been open since October 2001. This Club is located in the Four Seasons Hotel and
Residences in the emerging South of Market Area in San Francisco. The Sports
Club/LA - Miami opened in November 2004. We operate this Club pursuant to a
management agreement with Millennium, which has retained 100% ownership in the
Club's operations. We receive a management fee consisting of a flat percentage
of cash revenues plus a share of the Club's operating income.
The SportsMed Company, Inc.
Our SportsMed subsidiary operates physical therapy facilities within The
Sports Club/LA in Los Angeles and Orange County, the Spectrum Club - Valencia
and the Spectrum Club - Thousand Oaks. SportsMed also operates in a stand-alone
facility in Calabasas, California. The clinics are staffed by exercise
physiologists, physical therapists and registered dietitians who provide
services to members and others. We believe that SportsMed provides valuable
services, which are complementary to the other services provided by the Clubs,
and are considering placing physical therapy facilities in other Clubs in the
future.
Development of New Clubs
Recent New Club Developments. In October 2003, we opened The Sports Club/LA
- Beverly Hills. This 40,000 square foot Club is located in the heart of the
Beverly Hills retail and commercial district. This Club may serve as the
prototype for smaller size Clubs to be built in locations near existing Sports
Club/LA sites.
In 2000 and 2001, we completed the development of five new The Sports
Club/LA sites. Two of these Clubs are located in New York City and, when
combined with our Reebok Sports Club/NY site, form a trio of Clubs located in
residential areas on the East and West sides and the central midtown business
district. Three of the new The Sports Club/LA sites were developed with
Millennium, with whom we developed Reebok Sports Club/NY. Millennium is a
developer of premier multi-use projects and is funded by Quantum Realty Fund, a
member of the Quantum Group of Funds, which are off-shore investment funds
managed by Soros Fund Management, a management firm headed by George Soros;
Goldman Sachs' Whitehall Street Real Estate Limited Partnerships; and Millennium
Entertainment Partners L.P., a consortium of German insurance companies. These
Clubs are located in projects developed by Millennium
4
in prime, metropolitan locations that, like Reebok Sports Club/NY, include
commercial, retail, entertainment and residential space. In addition, each of
these developments includes either a Ritz Carlton or Four Seasons hotel. These
Clubs are approximately 100,000 square feet and offer services typically found
at other Sports Club/LA sites. We believe that such projects offer ideal
locations for The Sports Club/LA and would consider developing The Sports
Club/LA with Millennium or other developers in other major metropolitan areas.
Performance of Newly Developed and Acquired Clubs. Based on our experience,
a newly developed Club tends to achieve significant increases in revenues until
a mature membership level is reached. In the past, recently opened Clubs that
have not yet achieved mature membership levels have operated at a negative cash
flow or only a slight positive cash flow during the first two years of operation
as a result of fixed expenses that, together with variable operating expenses,
approximate or exceed membership fees and other revenues. This trend has
continued at The Sports Club/LA sites we opened since 2000. Three of these Clubs
are now operating at a positive cash flow level while three Clubs are still
building the membership base necessary to achieve this level. We believe that
our revenues from these Clubs will significantly increase as membership levels
mature.
Future New Club Developments
The completion of The Sports Club/LA at five new sites has required
significant financial resources. In addition, our current financing arrangements
and level of operating cash flow make it difficult to secure the required
financing to develop additional new sites. Therefore, our primary focus is now
on improving the operating performance of our existing Clubs. We are pursuing
The Sports Club/LA developments at new sites that are financially structured in
a way that will not require us to make a significant capital investment. We
would consider entering into joint ventures, partnership agreements or
management agreements for the purpose of developing new Clubs.
We currently operate The Sports Club/LA - Miami. Millennium is the owner of
this Club. They are responsible for providing all funds necessary to construct,
equip and operate the Club. We manage the Club's operations for which we receive
a management fee based upon both the gross revenues and net cash flow of the
Club. We also license The Sports Club/LA name to Millennium. This structure
allows us to expand our brand and receive an immediate earnings stream, with the
potential for additional profits, without making any capital investment. We
would consider entering into similarly structured agreements to manage other
Clubs for Millennium or other developers.
Sales and Marketing
Strategy. The Sports Club/LA is marketed as an "urban country club"
offering personalized attention and multiple amenities and services. We believe
that the image of The Sports Club/LA as the leader in the sports and fitness
industry justifies charging a premium. Our members include professionals, sports
and entertainment personalities and business people. The Sports Club/LA
emphasize personalized service and instruction and the creation of an "urban
country club" atmosphere in which members can relax and socialize. Our marketing
efforts at The Sports Club/LA emphasize retaining existing members, replacing
members who leave with new members and increasing ancillary revenues from
services such as private training and spa services. Our focus at the newer
Sports Club/LA locations is on attracting additional members.
Referrals, Endorsements and Advertising. Word-of-mouth referrals and
endorsements by existing members are The Sports Club/LA's most important source
of new members. In addition, The Sports Club/LA utilizes targeted marketing
programs which include advertisements, promotions, public relations and
community events. The principal marketing media for the Clubs are direct mail
and print advertisements. Special events and special membership programs
supplement the print advertisements. The Sports Club/LA hosts corporate parties
and charity benefits and often donates free or discounted memberships to
charitable organizations. We also conduct periodic membership drives whereby
referring members are entitled to receive special gifts and other incentives. We
believe that we will be able to continue to utilize these marketing strategies.
5
Targeted Members. The largest segment of the membership base for The Sports
Club/LA consists of health-conscious individuals. We target four other groups in
order to expand membership: corporate members, medical referrals, families, and
seniors. Each of these groups requires specialized exercise/fitness programs and
we have developed specific programs to attract members of these groups.
Corporate Programs. We believe the corporate market is a significant source
of new members, due to the proximity of The Sports Club/LA to business centers.
Our members use the Clubs to conduct business and to develop and maintain
business contacts. We employ several Corporate Membership Directors whose
principal responsibilities are to solicit corporate memberships from businesses
operating in the vicinity of the Clubs. The Sports Club/LA offers corporate
group-discounted initiation fees depending upon the number of new members
involved. Our SportsMed subsidiary has developed several corporate wellness
programs to fit the needs of this particular market. We believe that
corporations are favorably disposed to The Sports Club/LA and The SportsMed
programs because of the positive impact regular exercise and overall fitness can
have on employee absenteeism, morale and productivity.
Medical Referrals. We target members from the medical referral market
through our SportsMed subsidiary by offering specific rehabilitation and
exercise protocols to complement other forms of physical therapy recommended by
a physician or medical group. We also offer a "next-step" program for SportsMed
patients who complete their physical therapy programs and are looking for an
option to complete their rehabilitation by becoming members at The Sports
Club/LA.
Family Programs. We believe that the family market has considerable
potential, as younger members grow older, marry and have children and seek
recreational activities in which the entire family can participate. To attract
the family market, we have implemented "Fun-N-Fit" programs that offer programs
to children between the ages of 6 months and 15 years and involve youth sports
camps and clinics, fitness programs, art classes and birthday parties. The
Sports Club/LA's weight-training, basketball and swimming pool facilities are
made available to children and their parents during Family Day, and
specially-designed movement classes utilizing a variety of fitness equipment are
offered to younger children. The Sports Club/LA provides individualized sports
instruction and offers multiple fitness activities such as gymnastics, martial
arts and dance that are age appropriate.
Senior Programs. We anticipate that as the current core membership group
ages, we will meet the changing fitness needs of seniors and attract additional
members from the senior population. We maintain training and exercise protocol
manuals for the senior market (that we generally define as members who are over
60 years old) that include a description of exercise and fitness programs
specifically designed for seniors. These manuals also contain discussions of the
biological, psychological and medical aspects of aging and the benefits of
regular exercise. We believe this market will expand as the "baby boomers"
mature.
Employee Training
We believe that a key component of our operating strategy is a well-trained
and knowledgeable staff. We have comprehensive training programs to enhance the
effectiveness of our personnel. All newly hired employees are required to attend
an orientation seminar that is led by members of our management staff and a
personnel instructor. Topics include our history and philosophy, The Sports
Club/LA policies and procedures, member service, interaction skills and product
knowledge. These orientation seminars are held weekly.
To aid in the development and continuing education of our management staff,
we offer a workshop entitled "Introduction to Management" for newly hired
management personnel and other employees demonstrating management skills. The
workshop is intended to educate managers in the areas of instilling our Company
philosophy, policies and procedures, safety, workers' compensation, managing
people, communication, group problem solving, training, coaching, motivation,
feedback, recognition, counseling, evaluations, as well as time and stress
management. Topics are added periodically to reflect new management techniques
or operating issues. These seminars, generally consisting of three eight-hour
sessions, are held six times a year or as needed for new employees.
Additionally, our management
6
personnel are required to participate in our Manager on Duty Program and other
management and sales seminars to maintain and develop their skills.
We provide additional seminars specifically designed for targeted employee
groups. Seminars providing specialized instruction for program directors,
private trainers, group exercise instructors and sales/marketing personnel are
offered at various times during the year, for which attendance on the part of
newly-hired personnel is mandatory. We place particular emphasis on our
sales/marketing training seminars that are given once every two months by a
personnel instructor. In these seminars, all new membership directors complete
20 hours of participation and all other membership directors are expected to
complete four hours of participation every two months. Our fitness instructors
are trained to assist in the sales function and to implement fitness testing and
individually-tailored exercise programs. Most instructors are college-educated
and all trainers are required to be certified by the National Academy of Sports
Medicine. Our group exercise instructors hold nationally recognized
certifications and must have at least one year of teaching experience before
they are permitted to teach at The Sports Club/LA. They are also required to
participate in ongoing training and periodic re-evaluation.
Lastly, all line staff can voluntarily participate in quarterly workshops
that are offered through our human resources department. Workshop topics include
conflict resolution, communication and member service; however, topics vary
depending on the Club's current training needs.
Membership Programs
Membership at The Sports Club/LA requires an initiation fee plus monthly
membership dues. Initiation fees are required to be paid upfront or during the
member's first year. Members are currently required to pay their dues on a
monthly basis by electronic funds transfer, by which each member is
automatically debited each month for dues either through a checking account or
credit card. At established Clubs, the average life of a membership is four to
five years.
The Sports Club/LA offers three types of memberships: executive, health and
racquet sports. The Sports Club/LA's initiation fees and monthly membership dues
vary depending on the location of the Club. The Sports Clubs' market rate for
initiation fees range from $400 to $2,900 and monthly membership dues range from
$110 to $300. Corporate, bicoastal and spousal memberships are also available.
We offer the following membership options:
Executive Membership. Executive membership offers the greatest number of
amenities and services, including unlimited use of all facilities, racquet
sports privileges, personal locker assignments within an executive locker room,
laundry service, free valet parking and charge privileges for dining and other
Club services. Executive membership entitles a member to use all The Sports
Club/LA locations.
Health Membership. Health membership is the basic membership offering
unlimited use of the facility excluding those privileges associated with a
racquet membership; courts are available to holders of health memberships for an
additional fee. We also offer a bi-coastal membership that entitles a member to
use all The Sports Club/LA locations throughout the country and both an Access
West and Access East membership that allows a member the ability to use all of
our Clubs located on either the west coast or east coast.
Racquet Sports Membership. Racquet sports memberships are currently offered
at The Sports Club/LA - Orange County, The Sports Club/LA - Boston and The
Sports Club/LA - Washington D.C. In addition to use of the Club's facilities,
this membership includes unlimited use of racquetball, squash, paddle tennis and
tennis courts, depending upon the individual Club's facilities.
Competition
Although the sports and fitness industry is still fragmented, the industry
has experienced significant consolidation in recent years and certain of our
competitors are significantly larger and have greater financial and operating
resources than we do. In addition, a number of individual and regional
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operators compete with us in our existing markets. Many of these sports and
fitness clubs attract the same types of members we target. We also compete with
recreational facilities established by governments and businesses, the YMCA and
YWCA, country clubs and weight-reducing salons, as well as products and services
that can be used in the home. As the general public becomes increasingly aware
of the benefits of regular exercise, we expect that additional sports and
fitness businesses will emerge. We believe that there will continue to exist a
market for The Sports Club/LA and that our operating experience, our highly
visible image, the professionalism of our staff and our state-of-the-art
equipment and exercise facilities afford us an advantage over our competitors.
However, we may be unable to maintain our membership fees or membership levels
in areas where another sports and fitness club offers competitive facilities and
services at a lower cost.
Trademarks and Trade Names
We have registered our "flying lady" logo as a stand-alone design and in
combination with "The Sports Club/LA" name under federal trademark laws.
Internationally, we have registered "The Sports Club/LA" name and logo in Japan,
Australia and throughout Europe under a joint "European Community" trademark.
We have also obtained federal protection for our food and nutritional
products that are marketed under the trade names of Private Trainer System and
PTS.
Additionally, we have received trademark approval for several of our
fitness programs, including BodyArt, REV and others. We have not been able to
obtain full protection under Federal trademark laws for our SportsMed subsidiary
name, Splash, the name of our spas, and For Kids Only, our child care and
children's fitness program; however, each of these have been granted "allowed"
status.
Government Regulation
Our operations and business practices are subject to regulation at the
federal, state and, in some cases, local levels. State and local consumer
protection laws and regulations govern our advertising, sales and other trade
practices.
Statutes and regulations affecting the fitness industry have been enacted
or proposed in California, Florida and New York. Many other states into which we
may expand have or likely will adopt similar legislation. Typically, these
statutes and regulations prescribe certain forms and provisions of membership
contracts, limit the amount of prepaid revenues we can collect, afford members
the right to cancel the contract within a specified time period after signing,
require an escrow of funds received from pre-opening sales or the posting of a
bond or proof of financial responsibility and may impose numerous limitations on
the terms of membership contracts. In addition, we are subject to numerous other
types of federal and state regulations governing the sale of memberships. These
laws and regulations are subject to varying interpretations by a number of state
and federal enforcement agencies and courts. We maintain internal review
procedures in order to comply with these requirements and believe that our
activities are in substantial compliance with all applicable statutes, rules and
decisions.
Under so-called state "cooling-off" statutes, a member has the right to
cancel his or her membership for a period of three to ten days (depending on the
applicable state law) and, in such event, is entitled to a refund of any down
payment. In addition, our membership contracts provide that a member may cancel
his or her membership at any time upon death, disability or relocation beyond a
certain distance from our nearest Club. The specific procedures for cancellation
in these circumstances vary due to differing state laws. In each instance, the
canceling member is entitled to a refund of prepaid amounts only. Furthermore,
where permitted by law, a cancellation fee is due to us upon cancellation and we
may offset such amount against any refunds owed.
8
Employees
At May 31, 2004, we had 2,399 employees, most of whom are employed on a
part-time basis in Club operating activities such as aerobics, private training
and food and beverage services. At May 31, 2004, we employed 1,091 full-time
employees, 981 of whom were involved in The Sports Club/LA operations such as
sales, management, private training, food and beverage or support staff, 42 of
whom work for our SportsMed subsidiary and 68 of whom were in general and
administrative functions. We are not a party to any collective bargaining
agreement with our employees. Although we experience high turnover of
non-management personnel, we have never experienced any labor shortages nor had
any difficulty in obtaining adequate replacements for departing employees. We
consider our relations with our employees to be good.
Available Information
Quarterly and annual reports on Form 10-Q and Form 10-K can be accessed
through the SEC website at http://www.sec.gov/edgar/searchedgar/webusers.htm.
The website for the "Public Company Accounting Oversight Board" is
http://www.pcaobus.org/.
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ITEM 2. PROPERTIES
We own the real estate at The Sports Club/LA - Orange County and The Sports
Club/LA - Los Angeles (subject to a minority interest held by our Chairman D.
Michael Talla). All other premises on which the Clubs are located are leased.
The following table provides certain information concerning our Clubs:
Approximate Open Date Own or Lease
Club Square Feet (1) Expiration Date Renewal Option
---- ------------- ---------- --------------- --------------
The Sports Club/LA - Los Angeles (2)....... 100,000 1994 A Own N/A
The Sports Club/LA - Orange County......... 130,000 1994 A Own N/A
Reebok Sports Club/NY(3)................... 140,000 1995 O 4/17/15 Three 14-year options
The Sports Club/LA - Rockefeller Center.... 90,000 2000 O 1/31/13 Two 5-year options
The Sports Club/LA - Upper East Side....... 140,000 2000 O 12/31/20 Two 5-year options
The Sports Club/LA - Washington D.C.(4) 100,000 2000 O 10/31/20 Three 14-year options
The Sports Club/LA - Boston(4)............. 100,000 2001 O 8/31/21 Three 14-year options
The Sports Club/LA - San Francisco(5)...... 90,000 2001 O 9/30/21 Three 14-year options
The Sports Club/LA - Beverly Hills......... 40,000 2003 O 4/30/18 One 10-year option
-------------
(1) Date of acquisition ("A") or opening ("O").
(2) D. Michael Talla, our Chairman, has the right to 49.9% of the first
$300,000 of annual operating income from the partnership which owns The
Sports Club/LA - Los Angeles.
(3) We have entered into a lease agreement with Millennium with respect to this
property. We are entitled to certain priority distributions from the
partnership that owns this Club. After payment of such priority
distributions, we are entitled to 60% of all additional profits.
(4) We have entered into a lease agreement with Millennium for this Club. The
lease provides that Millennium is to receive 25% of cash flows as
additional rent after we earn certain priority distributions.
(5) We have entered into a lease agreement with Millennium for this Club. The
lease provides that Millennium is to receive 60% of cash flows as
additional rent after we earn certain priority distributions.
We remain obligated under lease agreements for seven of our former Spectrum
Club locations. We have subleased each of these properties to the buyer of these
Clubs under sublease agreements that provide for all operating costs of these
facilities to be assumed by the new owners.
All of the Clubs maintain comprehensive casualty, liability and business
interruption insurance. In March 2003, we secured insurance against acts of
terrorism. Clubs located in California maintain a blanket $35.0 million
earthquake insurance policy. We believe that our insurance coverage is in
accordance with or above industry standards. There are, however, certain types
of losses that may be either uninsurable or not economically insurable, and
insurance proceeds may not adequately compensate us for all economic
consequences of any loss. Should a loss occur, we could lose both our invested
capital and our anticipated profits from the affected Clubs. Any such event
could have a material adverse effect on our operations.
ITEM 3. 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 arising out of any such proceedings will
not have a material adverse effect on our financial condition, cash flow or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Not applicable
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED MATTERS
Our Common Stock is traded on the American Stock Exchange ("AMEX") under
the symbol "SCY". The following table sets forth the quarterly high and low sale
prices for the Common Stock for the periods indicated, as reported by the AMEX.
Price Range of Common Stock
---------------------------
Calendar Quarter High Low
---------------- ---- ---
Year Ended December 31, 2002:
First Quarter ............................................. $ 2.90 $ 2.45
Second Quarter............................................. 2.60 2.10
Third Quarter.............................................. 2.45 1.00
Fourth Quarter............................................. 3.45 1.72
Year Ended December 31, 2003:
First Quarter.............................................. 2.50 2.15
Second Quarter............................................. 2.87 2.40
Third Quarter.............................................. 3.00 2.50
Fourth Quarter............................................. 2.70 1.65
Year Ending December 31, 2004:
First Quarter.............................................. 2.35 1.80
Second Quarter (through June 15th)......................... 1.98 1.45
As of June 15, 2004, we had 63 stockholders of record and approximately 600
beneficial owners. The closing price of our Common Stock as reported by the
American Stock Exchange ("AMEX") on June 15, 2004, was $1.61.
On April 15, 2004, AMEX notified us that we had not met certain of the AMEX
continued listing standards as set forth in Section 1003(d) of the AMEX Company
Guide. We were afforded an opportunity to respond and on April 30th, submitted a
plan to comply with the AMEX listing standards. The plan was amended on May 19,
2004. On May 25, 2004, AMEX approved our amended plan. We have an extension
until June 21, 2004, to complete the filing of our Form 10-K for the year ended
December 31, 2003 and Form 10-Q for the quarter ended March 31, 2004 with the
Securities and Exchange Commission. We are subject to periodic AMEX review and
our failure to regain compliance with the continued listing standards by the end
of the extension period could result in our Common Stock being delisted from the
AMEX.
Dividend Policy
We have never declared or paid any dividends on our Common Stock or
Preferred Stock and we do not anticipate doing so in the foreseeable future. It
is our present policy to retain earnings for use in our operations, debt service
and the expansion of our business. In addition, our ability to pay cash
dividends is limited by our current financing agreements and may be similarly
limited by future financing agreements.
11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents our summary financial and operating data for
the fiscal years ended December 31, 1999 through 2003 and has been derived from
our consolidated financial statements. Such consolidated financial statements
and summary financial and operating data have been restated as described in Note
2 to the consolidated financial statements. The summary financial and operating
data should be read in conjunction with, and is qualified in its entirety by
reference to, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and our consolidated financial statements and the notes
thereto appearing elsewhere in this Form 10-K.
Fiscal Year Ended December 31,
------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
(Restated)
(Dollars in thousands, except per share data)
Statement of Operations Data:
Revenues:
Membership revenues.............................. $ 86,787 $ 75,217 $ 100,165 $ 120,853 $ 130,988
Reimbursed costs................................. -- -- -- -- 2,383
--------- --------- --------- --------- ---------
Total revenues................................. 86,787 75,217 100,165 120,853 133,371
Operating expenses:
Direct........................................... 60,065 58,575 87,560 100,973 107,925
Reimbursed costs................................. -- -- -- -- 2,383
General and administrative....................... 6,810 7,326 8,468 7,414 7,840
Selling.......................................... 2,608 2,915 3,880 4,907 4,902
Depreciation and amortization.................... 6,147 7,428 11,883 11,909 12,052
Pre-opening expenses............................. 3,090 9,589 5,884 130 2,258
Impairment charge................................ -- -- 5,044 -- --
--------- --------- --------- --------- ---------
Total operating expenses................... 78,720 85,833 122,719 125,333 137,360
--------- --------- --------- --------- ---------
Income (loss) from operations.............. 8,067 (10,616) (22,554) (4,480) (3,989)
Other income (expense):
Interest........................................ (5,991) (6,478) (13,001) (13,420) (13,750)
Minority interests.............................. (150) (150) (150) (150) (150)
Equity interest in net income of unconsolidated
subsidiary.................................... 931 -- -- -- --
Non-recurring items............................. 768 (3,242) 397 127 --
--------- --------- --------- --------- ---------
Total other income (expense)............... (4,442) (9,870) (12,754) (13,443) (13,900)
--------- --------- --------- --------- ---------
Income (loss) before income taxes and
cumulative effect of change in accounting
principle................................ 3,625 (20,486) (35,308) (17,923) (17,889)
Provision (benefit) for income taxes.............. 2,021 (7,982) 5,370 (310) 495
--------- --------- --------- --------- ---------
Income (loss) before cumulative effect of
change in accounting principle........... 1,604 (12,504) (40,678) (17,613) (18,374)
Cumulative effect of change in accounting principle,
net of income tax benefit of $600 in 1999 and $0
in 2002......................................... 899 -- -- 5,134 --
--------- --------- ---------- --------- ----------
Net income (loss).......................... 705 (12,504) (40,678) (22,747) (18,374)
Dividends on Preferred Stock...................... -- -- -- 888 1,400
--------- --------- ---------- ---------- ----------
Net income (loss) attributable to common
shareholders............................. $ 705 $ (12,504) $ (40,678) $ (23,635) $ (19,774)
========= ========== ========== ========== ==========
Net income (loss) per share:
Basic and diluted............................... $ 0.04 $ (0.70) $ (2.27) $ (1.31) $ (1.08)
========= ========= ========== ========== ==========
Weighted average number of common shares outstanding:
Basic........................................... 18,114 17,773 17,939 18,080 18,316
========= ========= ========= ========= =========
Diluted......................................... 18,290 17,773 17,939 18,080 18,316
========= ========= ========= ========= =========
At December 31,
-------------------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
(Restated)
(Dollars in thousands)
Balance Sheet Data:
Cash and cash equivalents.......................... $ 36,107 $ 11,059 $ 1,482 $ 3,185 $ 1,932
Restricted cash.................................... 41,389 6,996 -- 227 4,432
Property and equipment, net........................ 118,959 169,907 170,799 156,630 155,173
Total assets....................................... 225,088 223,773 197,114 181,252 183,959
Deferred membership revenue (Short and Long-Term).. 13,025 16,214 19,026 18,231 19,161
Long-term debt including current installments...... 103,887 110,331 115,491 104,040 121,830
Redeemable Preferred Stock......................... -- -- -- 5,140 5,590
Stockholders' equity............................... 94,806 82,793 42,469 24,145 5,454
12
ITEM 7. 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
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 utilized to develop five additional new Clubs in New
York City, Washington D.C., Boston and San Francisco. We have since opened The
Sports Club/LA in Beverly Hills and in Miami.
Most of our Clubs range in size from 90,000 to 140,000 square feet. Due to
the size of these facilities and the additional amenities included in our Clubs,
we spend significant amounts to construct a new facility. We compare the results
of our Clubs based upon how long the Clubs have been open at the most recent
measurement period. We categorize Clubs as either mature or recently opened.
Mature Clubs are those Clubs at which we believe the membership levels have
reached a stable level and based upon the amount of new membership sales and
attrition, or the size of the Club, we do not believe a significant additional
growth in the membership level will occur. Clubs are considered to be recently
opened while the membership level is increasing. Three of the Clubs that we own
are considered to be mature while the other six are considered to be recently
opened. Five of these Clubs were opened between 2000 and 2001 while The Sports
Club/LA - Beverly Hills was opened in October 2003. Newly developed Clubs tend
to achieve significant increases in revenues until a mature membership level is
reached. Recently opened Clubs that have not yet achieved mature membership
levels have operated at a loss or only a slight profit as a result of fixed
expenses that, together with variable operating expenses, approximate or exceed
membership fees and other revenues. Since 2000, we have invested significant
amounts of cash in the construction and operation of these new Clubs. Our
operating performances and our liquidity have been negatively impacted due to
the start up nature of these Clubs and the initial construction cost.
We measure performance using key operating statistics such as initiation
fees, monthly dues and ancillary revenues per member. We closely focus on new
membership sales and the level of membership attrition at each Club. We also
closely evaluate our expenses with an emphasis on controlling payroll costs. We
use Club operating income, before depreciation expenses and rent expense as a
means to evaluate the overall performance of an individual Club.
We have two primary sources of revenues. First, our largest source of
revenue is from membership dues and initiation fees. We recognize revenue from
dues in the month it is earned. Initiation fees are deferred and recognized as
revenue on a straight-line basis over a period of three years, which represents
the average life of a membership based upon historical data. 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 36.5% 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
13
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% is well
below the normal in the industry.
Our direct expenses include costs to operate our Clubs. These consist
primarily of payroll and employee benefits, rent and other occupancy related
costs, supplies, repairs, costs of products sold and various other operating
costs. A significant amount of these costs are fixed in nature.
General and administrative expenses include costs related to our
centralized support functions such as accounting, information technology,
development and our executive management. Costs associated with being a publicly
owned Company are also included in this category. Selling expenses include our
advertising, marketing department and promotional costs associated with the
generation of new memberships.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of the assets
and liabilities and disclosures of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. We base these estimates and assumptions upon
historical experience and existing known circumstances. Actual results could
differ from those estimates. Specifically, we must make estimates in the
following areas:
Revenue Recognition. We receive initiation fees and monthly membership dues
from our members. Substantially all of our members join on a month-to-month
basis and can therefore cancel their membership at any time. Initiation fees and
related direct expenses, primarily sales commissions, are deferred and
recognized, on a straight line basis, over a period of three years, which
represents the average life of a membership based upon historical data. Dues
that are received in advance are recognized on a pro-rated 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.
Effective July 1, 2003, we adopted EITF 00-21, Revenue Arrangements with
Multiple Deliverables. As a result of the adoption of EITF 00-21, the fair value
of any free products or services bundled with new memberships is now recorded as
revenue when the product is delivered or the service is performed. Prior to the
adoption of EITF 00-21, we considered all payments as initiation fees and no
revenue was recorded for the free products or services bundled with new
memberships. The impact upon implementation of EITF 00-21 was to increase our
2003 revenues by $862,000.
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.
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
14
determined by estimating the fair value of the assets and recording a loss if
the carrying value is greater than the fair value. There was no impairment of
long-lived assets at December 31, 2003.
Valuation of goodwill. Prior to January 1, 2002, we amortized goodwill,
which represents the excess of the purchase price over the net assets acquired
in business acquisitions, over 40 years. 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 initially completed the transitional
impairment test, in 2002, which did not result in the impairment of goodwill. In
early 2004, we determined that the methodology used to determine if goodwill was
impaired was incorrect and that a reevaluation was required. We reperformed the
transitional impairment test and determined that goodwill was impaired as of
January 1, 2002 by $5,134,000. The 2002 consolidated financial statements have
been restated to reflect this adjustment. We are also required to evaluate
goodwill on an annual basis. We performed the analysis, as of December 31, 2002
and 2003, and determined that our remaining goodwill was not impaired.
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 strategies among the
various tax jurisdictions in which we operate and any significant changes in the
tax laws.
Results of Operations
Fiscal 2003 compared to Fiscal 2002
Total revenue increased $12.5 million or 10.4% to $133.4 million for the
year ended December 31, 2003 from $120.9 million for the year ended December 31,
2002. Of the $12.5 million increase, $6.0 million was from membership dues and
initiation fees, $4.1 million was from ancillary revenues, and $2.4 million was
related to the recovery of operating costs at The Sports Club/LA - Miami, a Club
that we manage.
Revenue increased by $8.1 million at the five Sports Club/LA Clubs opened
in 2000 and 2001, primarily as a result of a 9.7% increase in membership at
these five Sports Club/LA Clubs from December 31, 2002 through December 31, 2003
and to annual rate increases for monthly dues and other ancillary services.
Revenue increased by $2.4 million due to cost reimbursements we received from
the owners of The Sports Club/LA - Miami, a Club we manage, which opened in
November 2003. Revenue increased by $1.3 million due to the opening of The
Sports Club/LA - Beverly Hills on October 7, 2003 and by $810,000, at our three
mature Clubs, primarily due to a $327,000 increase in food and beverage revenues
and a $444,000 increase in dues revenues. Revenue increased by $348,000 at our
SportsMed subsidiary primarily due to increased patient visits and by $88,000
due to management fees received from The Sports Club/LA - Miami. Revenue
decreased by $547,000 as a result of the sale of The Sports Club/Las Vegas on
January 31, 2002.
Our direct expenses increased by $6.9 million (6.8%) to $107.9 million for
the year ended December 31, 2003, versus $101.0 million for the same period in
2002. Direct expenses increased by $4.0 million at our five most recently opened
Sports Club/LA Clubs primarily due to increases in variable direct expenses
associated with the 9.7% membership increase and resulting revenue growth that
occurred at these five Sports Club/LA Clubs between December 31, 2002 and
December 31, 2003 and to increases in workers' compensation, group medical and
property/liability insurance rates. Direct expenses increased by $1.4 million as
a result of the opening of The Sports Club/LA - Beverly Hills on October 7,
2003. Direct expenses increased by $2.0 million at our three mature Clubs
primarily due to increased payroll, utility and property tax costs and to
increases in workers' compensation, group medical and property/liability
insurance rates. Direct expenses decreased by $505,000 due to the sale of The
Sports Club/Las Vegas on January 31, 2002. Direct expenses as a percent of
revenue for the year ended December 31, 2003,
15
decreased to 80.9% from 83.6% for the same period in 2002. As membership levels
and therefore revenues increase at the five Sports Club/LA Clubs opened in 2000
and 2001 and at The Sports Club/LA - Beverly Hills opened in October of 2003,
the direct expense percentage should continue to decrease. There is no
assurance, however, that such membership or revenue growth will occur.
Reimbursed costs were $2.4 million for the year ended December 31, 2003.
These costs relate to The Sports Club/LA - Miami, which is a non-owned Club that
we manage for its owner. We receive a management fee for managing the Club and
are reimbursed for all costs we incur pursuant to the management agreement. As
required by generally accepted accounting principles, reimbursed costs are
recorded as both revenue and expense in our consolidated financial statements.
The reimbursed costs of $2.4 million in the year ended December 31, 2003
represents both pre-opening expenses and normal operating expenses after the
Club opened in November 2003.
Our general and administrative expenses were $7.8 million for the year
ended December 31, 2003, versus $7.4 million for the same period in 2002, an
increase of $426,000 or 5.7%. The increase in our general and administrative
expenses was primarily the result of increased workers' compensation insurance
rates, increased group medical and property/liability insurance costs, plus a
small increase in payroll costs. General and administrative expenses decreased
as a percentage of revenue to 5.9% for the year ended December 31, 2003, from
6.1% for the same period in 2002. We believe that general and administrative
expenses should continue to decrease as a percentage of future revenues as we
expand and achieve economies of scale. There is no assurance, however, that said
expansion or economies of scale will be achieved.
Our selling expenses remained flat at $4.9 million for the years ended
December 31, 2003 and December 31, 2002. We continue to concentrate our
advertising and promotion efforts at the five Sports Club/LA Clubs opened in
2000 and 2001 and at The Sports Club/LA - Beverly Hills, which opened on October
7, 2003. Selling expenses decreased as a percentage of revenue to 3.7% for the
year ended December 31, 2003, from 4.1% for the same period in 2002.
Our depreciation and amortization expenses increased by $143,000 (1.2%) to
$12.1 million for the year ended December 31, 2003, versus $11.9 million for the
same period in 2002. Depreciation and amortization expenses increased by
$132,000 as a result of the opening of The Sports Club/LA - Beverly Hills on
October 6, 2003 and by $43,000 due to capital additions made at the Clubs during
2002 and 2003. Depreciation and amortization expenses decreased by $32,000 as a
result of the sale of The Sports Club/Las Vegas on January 31, 2002.
Pre-opening expenses were $2.3 million for the year ended December 31,
2003, versus $130,000 for the same period in 2002. Pre-opening expenses for the
year ended December 31, 2003, consisted of expenses related to The Sports
Club/LA - Beverly Hills, which opened on October 7, 2003. The pre-opening
expenses for the year ended December 31, 2002, consisted of expenses related to
a possible Club site on Long Island in New York. We have since decided not to
develop the Long Island site.
Our net interest expense increased by $330,000 (2.5%) to $13.7 million for
the year ended December 31, 2003, versus $13.4 million for the same period in
2002. Interest expense decreased by $182,000 due to a reduction of equipment
financing loans. Net interest expense increased by $944,000 primarily as a
result of interest incurred on our new five-year mortgage loan secured by The
Sport Club/LA - Orange County. We used a portion of the proceeds of the loan to
construct The Sports Club/LA - Beverly Hills and therefore, capitalized $432,000
of that interest during the construction period.
We recorded two non-recurring gains, totaling $127,000, during the year
ended December 31, 2002. We recorded a non-recurring gain of $30,000, related to
the sale of The Sports Club/Las Vegas on January 31, 2002 and a non-recurring
gain of $97,000, related to the sale of real estate in Houston, Texas on August
30, 2002.
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
16
review of our goodwill as of January 1, 2002 and to review goodwill annually for
impairment thereafter. We initially completed the transitional impairment test,
in 2002, which did not result in the impairment of goodwill. In early 2004, we
determined that the methodology used to determine if goodwill was impaired was
incorrect and that a reevaluation was required. We reperformed the transitional
impairment test and determined that goodwill was impaired as of January 1, 2002
by $5,134,000. The 2002 consolidated financial statements have been restated to
reflect this adjustment.
The tax provision of $485,000 recorded for the year ended December 31,
2003, is comprised of New York City and New York State income taxes incurred on
pre-tax earnings at Reebok Sports Club/NY. We did not record any federal or
state deferred tax benefit related to our consolidated pre-tax loss incurred for
the year ended December 31, 2003. After the tax provision of $485,000 and
dividends on preferred stock of $1.4 million, our consolidated net loss
attributable to common shareholders for the year ended December 31, 2003, was
$19.8 million or $1.08 per basic and diluted share. The tax benefit of $310,000
recorded for the year ended December 31, 2002, was the result of a $900,000
federal income tax refund we recorded due to tax law changes that allowed us to
carry-back our 2001 loss to prior tax years and New York City and New York State
income taxes of $590,000 incurred on pre-tax earnings at Reebok Sports Club/NY.
We did not record any federal or state deferred tax benefit related to our
consolidated pre-tax loss incurred for the year ended December 31, 2002. After
the tax benefit of $310,000 and dividends on preferred stock of $888,000, our
consolidated net loss attributable to common shareholders for the year ended
December 31, 2002, was $23.6 million or $1.31 per basic and diluted share.
Fiscal 2002 compared to Fiscal 2001
Total revenue increased $20.7 million or 20.7%, to $120.9 million for the
year ended December 31, 2002 from $100.2 million for the year ended December 31,
2001. Of the $20.7 million increase, $11.1 million was from membership dues and
initiation fees and $9.6 million was from ancillary revenues.
Revenue increased by $21.1 million, due to the opening of The Sports
Club/LA - Boston in September of 2001 and The Sports Club/LA - San Francisco in
October of 2001 and revenue increased by $6.2 million as a result of membership
growth at the three Sports Club/LA Clubs opened in 2000. Revenue decreased by
$5.4 million as a result of the sale of The Sports Club/Las Vegas on January 31,
2002, and by $2.2 million due to the transfer of our retail operations to
outside third party vendors. Revenue increased by $1.0 million at our other
Sports Clubs and our SportsMed subsidiary primarily due to an increase in
private training and monthly dues revenues at the Sports Clubs, partially offset
by a decrease in SportsMed revenues primarily due to the closing of The
SportsMed Agoura Hills location.
Our direct expenses increased by $13.4 million to $101.0 million for the
year ended December 31, 2002, versus $87.6 million in 2001. Direct expenses
increased by $20.8 million, due to the opening of The Sports Club/LA - Boston in
September of 2001 and The Sports Club/LA - San Francisco in October of 2001 and
by $1.8 million as a result of an increase in expenses associated with the
membership growth at the three Sports Club/LA Clubs opened in 2000. Direct
expenses decreased by $5.4 million due to the sale of The Sports Club/Las Vegas
on January 31, 2002, by $2.5 million due to the transfer of our retail
operations to outside third party vendors and by $1.3 million at our other
Sports Clubs and our SportsMed subsidiary primarily as a result of cost cutting
measures we implemented at these Clubs and the closing of The SportsMed Agoura
Hills location. Direct expenses as a percent of revenue for the year ended
December 31, 2002, decreased to 83.6% from 87.4% in 2001.
Our general and administrative expenses were $7.4 million for the year
ended December 31, 2002, versus $8.5 million in 2001, a decrease of $1.1 million
or 12.4%. Our general and administrative expenses decreased by $1.0 million due
to lower legal fees resulting from the settlement or dismissal of certain legal
matters in which we were involved. General and administrative expenses decreased
by $519,000 as a result of expense cutting measures that have reduced our
payroll and payroll related expenses. General and administrative expenses
increased by $419,000 primarily as a result of higher corporate office rent,
increased insurance premiums and a reduction in corporate costs capitalized on
certain development and information systems projects. General and administrative
expenses decreased as a percentage of revenue to 6.1% for the year ended
December 31, 2002, from 8.5% in 2001.
17
Our selling expenses were $4.9 million for the year ended December 31,
2002, versus $3.9 million in 2001, an increase of $1.0 million or 26.5%. The
increase in selling expenses was the result of expanded advertising and
promotion efforts at the five Sports Club/LA Clubs opened in 2000 and 2001 with
the majority of this increase attributable to our two most recently opened
Clubs. We also placed special emphasis on membership growth at The Sports
Club/LA - Rockefeller Center. Selling expenses for the year ended December 31,
2002 at these five most recently opened Clubs increased by $1.2 million as
compared to 2001. Selling expenses decreased by $432,000 as a result of the sale
of The Sports Club/Las Vegas on January 31, 2002 and selling expenses declined
by $63,000 at our other Sports Club/LA Clubs and our SportsMed subsidiary.
Selling expenses as a percentage of revenue for the year ended December 31,
2002, were 4.1% versus 3.9% in 2001.
Our depreciation and amortization expenses stayed flat at $11.9 million for
the years ended December 31, 2002 and 2001. Depreciation and amortization
expenses increased by $610,000 as a result of the opening of The Sports Club/LA
- Boston in September 2001 and The Sports Club/LA - San Francisco in October of
2001 and by $709,000 at our corporate headquarters, primarily due to the start
of amortization of our recently installed membership accounting software.
Depreciation and amortization expenses decreased by $344,000 as a result of the
sale of The Sports Club/Las Vegas on January 31, 2002 and by $455,000 at our
other Sports Club/LA Clubs primarily due to assets becoming fully depreciated.
Depreciation and amortization expense also decreased by $494,000 due to the
adoption of Statement of Financial Accounting Standards No. 142, effective
January 1, 2002, that requires goodwill and other indefinite lived intangibles
no longer be amortized.
Pre-opening expenses were $130,000 for the year ended December 31, 2002,
versus $5.9 million in 2001. Pre-opening expenses for the year ended December
31, 2002, consisted of legal fees incurred related to a possible club site on
Long Island in New York. We have since terminated our interest in this site.
Pre-opening expenses by Club for the year ended December 31, 2001, were $2.6
million at The Sports Club/LA - Boston, $2.9 million at The Sports Club/LA - San
Francisco and $405,000 at the possible club site on Long Island in New York.
We incurred impairment charges during the year ended December 31, 2001, of
$5.0 million. These impairment charges consisted of a $3.2 million impairment
charge related to the write down of fixed assets at The Sports Club/Las Vegas
and a $1.8 million impairment charge related to the write down of goodwill at
our SportsMed subsidiary.
We incurred net interest expense of $13.4 million for the year ended
December 31, 2002, versus $13.0 million in 2001, an increase of $419,000. Net
interest expense increased by $496,000 due to our discontinuance of capitalizing
interest costs on Sports Clubs under development after the last Sports Club/LA
was opened in October 2001. Net interest expense increased by $323,000, due to a
reduction in interest income earned on invested cash balances. There was a
$162,000 decrease in net interest expense due to reductions of equipment
financing loans and a $238,000 decrease resulting from interest incurred in 2001
related to a sales tax audit at one of our Clubs.
We recorded a non-recurring gain of $97,000, related to the sale of
undeveloped land in Houston, Texas and a $30,000 non-recurring gain, related to
the sale of The Sports Club/Las Vegas during the year ended December 31, 2002.
The Houston, Texas site was sold on August 30, 2002 and The Sports Club/Las
Vegas was sold on January 31, 2002. We recorded a non-recurring gain of $397,000
during the year ended December 31, 2001. The non-recurring gain in 2001 was the
result of the reversal of accrued interest expense related to the settlement of
litigation. As part of the settlement we were no longer required to pay the
accrued interest due on the note in question.
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 and to review goodwill annually for impairment thereafter. We
initially completed the transitional impairment test, in 2002, which did not
result in the impairment of goodwill. In early 2004, we determined that the
methodology used to determine if goodwill was impaired was incorrect and that a
reevaluation was required. We reperformed the transitional impairment test and
determined that goodwill was impaired as of January 1, 2002 by $5,134,000. The
2002 consolidated financial statements have been restated to reflect this
adjustment.
18
The tax benefit recorded for the year ended December 31, 2002, is comprised
of a $900,000 federal income tax refund we received as a result of tax law
changes that allowed us to carry-back our 2001 loss to prior tax years,
partially offset by New York State and City income taxes incurred at Reebok
Sports Club/NY. We did not record any deferred tax benefit related to our loss
incurred for the year ended December 31, 2002. After the tax benefit and the
Preferred Stock dividends of $888,000, our loss attributable to common
shareholders for the year ended December 31, 2002, was $23.6 million or $1.31
per basic and diluted share. The income tax provision of $5.4 million for 2001
is related to the establishment of a valuation allowance against our deferred
tax assets that were recorded prior to January 1, 2001 and an accrual for any
current state income taxes due. We did not record any deferred tax benefit
related to our loss incurred in 2001. After the 2001 income tax provision of
$5.4 million, our net loss attributable to common shareholders was $40.7 million
or $2.27 per basic and diluted share. We did not record any deferred tax assets
related to the losses incurred in 2002 and 2001 based on our analysis of current
and projected operating results and our determination that it is more likely
than not that future taxable income will be insufficient to utilize any deferred
tax assets.
Non-GAAP Financial Measures
We use the term "EBITDA" in this discussion. EBITDA consists of net income
plus interest expense, net, provision for income taxes and depreciation and
amortization. This term, as we define it, may not be comparable to a similarly
titled measure used by other companies and is not a measure of performance
presented in accordance with GAAP. We use EBITDA and EBITDA margin as measures
of operating performance. EBITDA should not be considered as a substitute for
net income, cash flows provided by operating activities, or other income or cash
flow data prepared in accordance with GAAP. We believe EBITDA is useful to an
investor in evaluation our operating performance and liquidity because:
o it is a widely accepted financial indicator of a company's ability to
service its debt;
o it is widely used to measure a company's operating performance without
regard to items such as depreciation and amortization, which can vary
depending upon accounting methods and the book value of assets, and to
present a meaningful measure of corporate performance exclusive of our
capital structure and the method by which assets were acquired; and
o it helps investors to more meaningfully evaluate and compare the
results of our operations from period to period by removing from our
operating results the impact of our capital structure, primarily
interest expense from our outstanding debt, and asset base, primarily
depreciation and amortization of our properties.
Our management uses EBITDA:
o as a measurement of operating performance because it assists us in
comparing our performance on a consistent basis, as it removes from
our operating results the impact of our capital structure, which
includes interest expense from our outstanding debt, and our asset
base, which includes depreciation and amortization of our properties;
o in presentations to the members of our board of directors to enable
our board to have the same consistent measurement basis of operating
performance used by management; and
o as the basis for incentive bonuses paid to selected members of senior
and Club level management.
19
Below is a reconciliation of EBITDA to net income:
Year Ending
December 31, 2003
-----------------
EBITDA............................................. $ 7,913
Depreciation and amortization.................. (12,052)
Interest, net.................................. (13,750)
Provision for income taxes..................... (485)
-------------------
Net loss........................................... $ (18,374)
===================
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 the past several years have been 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 were required to issue $6.5 million of a newly created class of Series
D Convertible Preferred Stock. We are not certain that amounts we will generate
from operations through September 15, 2004 will be sufficient for us to make the
Senior Secured Note interest payment due on September 15, 2004. If cash flows
from operations are insufficient to make the September 15, 2004 or future
interest payments, we would be required to sell assets, offer additional equity
securities or increase our cash flow from operations to meet our cash flow
needs. There can be no assurance that we will be able to sell assets, raise
capital by offering additional equity securities or increase our cash flow from
operations.
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
Our cash balance on December 31, 2003 was $1.9 million. During 2003, our
earnings before interest, taxes, depreciation and amortization ("EBITDA") were
$7.9 million. We believe we will continue to generate positive EBITDA and that
such amount will increase as our new Clubs continue to mature.
We have various deposits that secure our performance under several
contracts. We expect to receive back $800,000 of such deposits in the second
quarter of 2004, $1.0 million in the third quarter of 2004 and the remaining
$1.7 million in the fourth quarter of 2004.
20
Investing Activities
Investing activities consist of new Club development and expenditures to
maintain and update our existing Clubs. Capital expenditures related to new
Clubs were $16.1 million in 2001, $6.7 million in 2002 and $10.6 million in
2003. 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 existing Clubs were
$5.3 million in 2001, $2.6 million in 2002 and $2.2 million in 2003. We estimate
that expenditures of between 2% and 4% of revenues, depending on the age of the
Club, will be necessary to maintain the quality of the Clubs to our
satisfaction. We also expect to spend approximately $600,000 during the next
year to upgrade our management information systems and enhance our disaster
recovery capabilities.
On April 22, 2002, we signed a lease to develop The Sports Club/LA -
Beverly Hills. The new Sports Club/LA, of approximately 40,000 square feet, is
located at 9601 Wilshire Boulevard in the heart of the Beverly Hill's retail and
commercial district. We view the Beverly Hills market as an excellent location
for The Sports Club/LA brand and this Club may serve as a prototype for smaller
size Clubs to be built in locations near existing Sports Club/LA sites. At
December 31, 2003, approximately $1.1 million of construction costs are accrued
and remain to be paid on this Club. The Club opened in October 2003.
We entered into a management service agreement with Terremark Brickell II
Ltd., an affiliate of Millennium to manage The Sports Club/LA - Miami.
Millennium provided all the capital to develop this facility and Millennium
retained a 100% ownership in the Club. We earn a management fee based upon the
Club's revenues and can also earn a profit participation based upon the Club's
net operating income. We were not required to invest any of our capital into
this development. The Club opened in November 2003.
We currently have no other plans for new Club developments that would
require our own capital.
During 2002, we generated $9.3 million of cash proceeds from the sale of
real estate in Houston, Texas and from the sale of The Sports Club/Las Vegas.
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. To the extent we sell assets, the proceeds from those sales would be
subject to the excess proceeds provision of the Indenture. We are currently not
required to make such an offer as a result of the sale of any of our assets. 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.
21
The Indenture allows us to incur up to $10.0 million of equipment financing
obligations. At December 31, 2003, we had $2.0 million of equipment financing
obligations outstanding and would be allowed to finance an additional $8.0
million with our equipment serving as collateral. We make monthly principal and
interest payments on this debt. These monthly payments are currently $205,000
and they will continue until December 2004, when a significant portion of the
debt will be repaid.
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.
Contractual Obligations
The following schedule lists known contractual obligations (amounts in
thousands):
Payments Due By Period
----------------------
Less More
Than 1 Than 5
Contractual Obligations Total Year 1-3 Years 3-5 Years Years
----------------------- ----- ---- --------- --------- -----
Senior Secured Notes (1)........ $ 100,000 $ -- $ 100,000 $ -- $ --
Mortgage note (2)............... 19,855 305 677 18,873 --
Equipment financing loans (3)... 1,975 1,794 139 42 --
Operating leases (4)............ 356,584 24,404 48,032 48,323 235,825
Minority interest (5)........... 900 150 750 -- --
Redeemable Preferred Stock (6).. 10,500 -- -- -- 10,500
---------- ----------- ----------- ----------- ----------
Total $ 489,814 $ 26,653 $ 149,598 $ 67,238 $ 246,325
========== =========== =========== =========== ==========
-------------
(1) On April 1, 1999, we issued in a private placement $100.0 million of 11
3/8% Senior Secured Notes due in March 2006 with interest due semi-annually.
(2) 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 bears
interest at a fixed interest rate of 7.25%; requires monthly principal and
interest payments of $144,561; and requires a final principal payment of $18.3
million on July 1, 2008.
(3) 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 3.5% and 13.3%.
(4) We lease certain facilities pursuant to various operating lease
agreements. Club facility leases are generally long-term and noncancelable
triple-net leases (requiring us to pay all real estate taxes, insurance and
maintenance expenses), and have an average remaining term of 43.17 years,
including renewal options which are included in the lease term, with the
earliest Sports Club lease expiration date of January 31, 2013. We are also
obligated under lease agreements for seven of our former Spectrum Club
locations. We have subleased each of these properties to the buyer of these
Clubs under sublease agreements which provide that all operating costs of these
facilities be assumed by the new owners. Amounts due for Spectrum Club leases
are excluded from this table.
(5) We own a 50.1% interest in the partnership that owns The Sports Club/LA
- Los Angeles, and D. Michael Talla, our Chairman, beneficially owns the
remaining 49.9%. We have the option to redeem Mr. Talla's preferred partnership
interest for $600,000, which expires on January 31, 2006. We have included the
annual preferred distribution of $149,700 to Mr. Talla in the above table for
the next two years and the redemption amount is included in 2006 (Year 3).
(6) On March 18, 2002, the Company issued 10,500 shares of Series B
Preferred Stock. The stock is redeemable by the stockholders on March 18, 2009.
22
Impact of Inflation
We do not believe inflation has had a material impact on our results of
operations for any of the years in the three-year period ended December 31,
2003. We cannot provide assurance that future inflation will not have an adverse
impact on our operating results and financial condition.
Seasonality of Business
Seasonal trends have a limited impact on our operations. We typically
experience a slight increase in membership sales in the first quarter.
Additionally, we normally experience a slight decrease in our ancillary revenues
during the summer months at our east coast Clubs due to lower membership
attendance.
Forward Looking Statements
From time to time we make "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements include the words "may,"
"will," "estimate," "continue," "believe," "expect" or "anticipate" and other
similar words. The forward-looking statements generally appear in the material
set forth under the heading "Management's Discussion and Analysis of Financial
Condition and Results of Operations" but may be found in other locations as
well. Forward-looking statements may also be found in our other reports filed
with the Securities and Exchange Commission and in our press releases and other
public disclosures. These forward-looking statements generally relate to our
plans and objectives for future operations and are based upon management's
reasonable estimates of future results or trends. Although we believe that our
plans and objectives reflected in or suggested by such forward-looking
statements are reasonable, such plans or objectives may not be achieved. 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,
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 new sports and fitness 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.
23
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are 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
December 31, 2003, we had Senior Secured Notes totaling $100.0 million due in
March 2006 bearing an interest rate of 11.375%. Annual interest of $11.4 million
is payable semi-annually in March and September. At December 31, 2003, the fair
value of the Senior Secured Notes is approximately $93.0 million. We also have a
$20.0 million loan with a fixed 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.
24
ITEM 8. FINANCIAL STATEMENTS
Index to Consolidated Financial Statements
PAGE
----
Report of Independent Registered Public Accounting Firm................ F-1
Consolidated Balance Sheets as of December 31, 2002 and 2003........... F-2
Consolidated Statements of Operations for each of the Years in the
Three-Year Period ended December 31, 2003.............................. F-3
Consolidated Statements of Stockholders' Equity for each of the
Years in the Three-Year Period ended December 31, 2003................. F-4
Consolidated Statements of Cash Flows for each of the Years in the
Three-Year Period ended December 31, 2003.............................. F-5
Notes to Consolidated Financial Statements............................. F-6
Consolidated Financial Statement Schedule
Valuation and Qualifying Accounts......................................F-31
All other schedules are omitted because they are not applicable or the
required information is shown in our consolidated financial statements or notes
thereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our Management, with the participation of our Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) as of the end of the fiscal period covered by this Annual Report
on Form 10-K. Based upon such evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that, as of the end of such period, except as
noted below, the Company's disclosure controls and procedures are effective in
recording, processing, summarizing and reporting information required to be
disclosed by us in the reports we file or submit under the Exchange Act within
the time periods specified in the SEC's rules and forms.
In performing its audit of our Consolidated Financial Statements for the
year ended December 31, 2003, our independent auditor, KPMG LLP ("KPMG") noted a
matter involving our internal controls that it considered to be a reportable
condition. A reportable condition, which may or may not be determined to be a
material weaknesses, involves matters relating to significant deficiencies in
the design or operation of internal controls that, in KPMG's judgment, could
adversely affect our ability to record, process, summarize and report financial
data consistent with the assertions of management on the financial statement.
The reportable condition, which was considered to be a material weakness, noted
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. Specifically, KPMG stated that during their
quarterly review for the quarter ended March 31, 2003, they noted the Company
had not properly accounted for private training revenues. In addition, during
their 2003 audit, KPMG noted we were not properly accounting for our management
arrangement for The Sports Club/LA - Miami, that we had not properly implemented
Statement of Financial Accounting Standard No. 142, relating to goodwill and not
properly accounted for the accretion of dividends on Series C Preferred Stock.
KPMG indicated that we enhance our financial and accounting personnel staffing
levels to ensure that we
25
have appropriate resources to implement new accounting standards and apply
existing accounting standards to new transactions.
(b) Changes in internal controls.
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d - 15(f) under the
Exchange Act) during the fiscal quarter ended December 31, 2003 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting. As noted, however, certain weaknesses in our
internal controls have been identified by KPMG.
26
F-31
Report of Independent Registered
Public Accounting Firm
The Board of Directors and Stockholders
The Sports Club Company, Inc.:
We have audited the accompanying consolidated financial statements of The
Sports Club Company, Inc. and subsidiaries as listed in the accompanying index.
In connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedule as listed in the accompanying
index. These consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with the Standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The Sports
Club Company, Inc. and subsidiaries as of December 31, 2002 and 2003, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3 to the
financial statements, the Company has suffered recurring net losses, has a
working capital deficiency and has negative cash flows from operating activities
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 3. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
As discussed in Note 2 to the consolidated financial statements, the
Company restated its 2002 consolidated financial statements.
As discussed in Note 4 to the consolidated financial statements the Company
adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, effective January 1, 2002.
/s/ KPMG LLP
Los Angeles, California
May 24, 2004
F-1
THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2003
(in thousands, except per share amounts)
ASSETS
2002 2003
---- ----
(Restated)
Current assets:
Cash and cash equivalents.......................................................... $ 3,185 $ 1,932
Accounts receivable, net of allowance for doubtful accounts of $534 and $517 at
December 31, 2002 and 2003, respectively......................................... 3,951 3,923
Inventories........................................................................ 1,169 994
Prepaid expenses................................................................... 1,148 1,789
--------- ---------
Total current assets.......................................................... 9,453 8,638
Property and equipment, net............................................................ 156,630 155,173
Goodwill............................................................................... 7,660 7,660
Restricted cash........................................................................ 227 4,432
Other assets........................................................................... 7,282 8,056
--------- ---------
$181,252 $ 183,959
======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of notes payable and equipment financing loans................ $ 2,158 $ 2,099
Accounts payable................................................................... 2,545 2,464
Accrued liabilities................................................................ 12,657 13,713
Deferred revenues.................................................................. 17,034 18,292
--------- ---------
Total current liabilities..................................................... 34,394 36,568
Notes payable and equipment financing loans, less current installments................. 101,882 119,731
Accrued lease obligations.............................................................. 8,307 8,976
Deferred revenues...................................................................... 1,197 869
Minority interest...................................................................... 600 600
--------- ---------
Total liabilities............................................................. 146,380 166,744
Commitments and contingencies
Redeemable Preferred Stock, Series B, $.01 par value, 10,500 shares authorized;
10,500 shares issued and outstanding at December 31, 2002 and December 31,
2003 (liquidation preference of $11,248 and $12,198 at December 31, 2002
and 2003, resepctively).......................................................... 10,727 11,761
Stockholders' equity:
Preferred Stock, $.01 par value, 984,500 shares authorized; no shares issued or
outstanding...................................................................... -- --
Preferred Stock, Series C, $.01 par value, 5,000 shares authorized; 5,000
shares issued and outstanding (liquidation preference of $5,140 and $5,590 at
December 31, 2002 and 2003, respectively)........................................ 5,140 5,590
Common Stock, $.01 par value, 40,000,000 shares authorized;
21,068,717 and 21,074,717 shares issued at
December 31, 2002 and 2003, respectively....................................... 211 211
Additional paid-in capital......................................................... 101,821 100,348
Accumulated deficit................................................................ (67,843) (86,217)
Treasury Stock, at cost, 2,964,764 and 2,650,003 shares at
December 31, 2002 and 2003, respectively......................................... (15,184) (14,478)
---------- ----------
Stockholders' equity.......................................................... 24,145 5,454
--------- ---------
$ 181,252 $ 183,959
========= =========
See accompanying notes to consolidated
financial statements.
F-2
THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Three-Year Period ended December 31, 2003
(in thousands, except per share amounts)
2001 2002 2003
---- ---- ----
(Restated)
Revenues:
Membership revenues................................................. $ 100,165 $ 120,853 $ 130,988
Reimbursed costs.................................................... -- -- 2,383
----------- ------------ ------------
Total revenue.................................................. 100,165 120,853 133,371
Operating expenses:
Direct.............................................................. 87,560 100,973 107,925
Reimbursed costs.................................................... -- -- 2,383
General and administrative.......................................... 8,468 7,414 7,840
Selling............................................................. 3,880 4,907 4,902
Depreciation and amortization....................................... 11,883 11,909 12,052
Pre-opening expenses................................................ 5,884 130 2,258
Impairment charges.................................................. 5,044 -- --
----------- ------------ ------------
Total operating expenses....................................... 122,719 125,333 137,360
----------- ------------ ------------
Loss from operations....................................... (22,554) (4,480) (3,989)
Other income (expense):
Interest, net....................................................... (13,001) (13,420) (13,750)
Minority interests.................................................. (150) (150) (150)
Non-recurring items................................................. 397 127 --
----------- ------------ ------------
Loss before income taxes and cumulative effect of change in
accounting principle......................................... (35,308) (17,923) (17,889)
Provision (benefit) for income taxes.................................... 5,370 (310) 485
----------- ------------- ------------
Loss before cumulative effect of change in accounting
principle.................................................... (40,678) (17,613) (18,374)
Cumulative effect of change in accounting principle..................... -- 5,134 --
----------- ------------ ------------
Net loss..................................................... (40,678) (22,747) (18,374)
Dividends on Preferred Stock............................................ -- 888 1,400
----------- ------------ ------------
Net loss attributable to common stockholders................. $ (40,678) $ (23,635) $ (19,774)
============ ============= =============
Loss per share before cumulative effect of change in accounting
principle - basic and diluted....................................... $ (2.27) $ (1.02) $ (1.08)
Per share effect of cumulative effect of change in accounting
principle - basic and diluted....................................... -- (0.29) --
----------- ------------- ------------
Net loss per share - basic and diluted.................................. $ (2.27) $ (1.31) $ (1.08)
============ ============= =============
Weighted average number of common shares outstanding:
Basic and diluted................................................... 17,939 18,080 18,316
=========== ============ ============
See accompanying notes to consolidated
financial statements.
F-3
THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three-Year Period ended December 31, 2003
(in thousands)
Preferred Stock Additional
Series C Common Stock Paid-in Accumulated Treasury Stock
Shares Amount Shares Amount Capital Deficit Shares Amount
------ ------ ------ ------ ------- ------- ------ ------
Balance, December 31, 2000...................... -- $ -- 21,053 $ 211 $ 102,743 $ (4,419) 3,156 $(15,742)
Net loss...................................... -- -- -- -- -- (40,678) -- --
Reissuance of Treasury Stock
for employee stock plans.................... -- -- -- -- -- 1 (65) 181
Reissuance of Treasury Stock
for loan guarantee fee...................... -- -- -- -- -- -- (46) 151
Exercise of employee stock options............ -- -- 2 -- 5 -- -- --
Issuance of Common Stock to outside directors. -- -- 6 -- 16 -- -- --
------ ------- ------- ------- --------- --------- -------- --------
Balance, December 31, 2001...................... -- -- 21,061 211 102,764 (45,096) 3,045 (15,410)
Net loss, as restated......................... -- -- -- -- -- (22,747) -- --
Issuance of series C Preferred Stock.......... 5 5,000 -- -- -- -- -- --
Issuance of Common Stock to outside directors. -- -- 8 -- 15 -- -- --
Reissuance of Treasury Stock for employee
stock plans................................. -- -- -- -- -- -- (80) 226
Accretion of dividends on Series B Preferred
Stock....................................... -- -- -- -- (748) -- -- --
Accretion of issuance costs on Series B
Preferred Stock............................. -- -- -- -- (70) -- -- --
Accretion of dividends on Series C Preferred
Stock, as restated.......................... -- 140 -- -- (140) -- -- --
------- ------- ------- ------- --------- ---------- -------- ---------
Balance, December 31, 2002, as restated......... 5 5,140 21,069 211 101,821 (67,843) 2,965 (15,184)
Net loss...................................... -- -- -- -- -- (18,374) -- --
Issuance of Common Stock to outside directors -- -- 6 -- 12 -- -- --
Reissuance of Treasury Stock for loan
guarantee fee............................... -- -- -- -- -- -- (213) 472
Reissuance of Treasury Stock for employee
stock plans................................. -- -- -- -- -- -- (102) 234
Accretion of dividends on Series B Preferred
Stock....................................... -- -- -- -- (950) -- -- --
Accretion of dividends on Series C Preferred
Stock....................................... -- 450 -- -- (450) -- -- --
Accretion of issuance costs on Series B
Preferred Stock............................. -- -- -- -- (85) -- -- --
------- ------- ------- ------- ---------- --------- -------- ---------
Balance, December 31, 2003...................... 5 $ 5,590 21,075 $ 211 $ 100,348 $ (86,217) 2,650 $(14,478)
======= ======= ======= ======= ========= ========== ======== =========
See accompanying notes to consolidated
financial statements.
F-4
THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three-year Period ended December 31, 2003
(in thousands)
2001 2002 2003
---- ---- ----
(Restated)
Cash flows from operating activities:
Net loss............................................................. $(40,678) $(22,747) $ (18,374)
Adjustments to reconcile net loss to cash used in operating
activities:
Loss (gain) on disposition of real estate....................... 282 (127) --
Impairment charges.............................................. 5,044 -- --
Depreciation and amortization................................... 11,883 11,909 12,052
Related party costs settled with common stock................... 349 241 718
Cumulative effect of change in accounting principle............. -- 5,134 --
Deferred taxes.................................................. 4,524 -- --
(Increase) decrease in:
Accounts receivable, net.................................... (1,215) 725 28
Inventories................................................. 1,629 (50) 175
Other current assets........................................ 2,547 (439) (642)
Other assets, net........................................... 1,164 (2,283) (15)
Increase (decrease) in:
Accounts payable............................................ 1,102 (233) (81)
Accrued liabilities......................................... 1,834 679 1,056
Deferred revenues........................................... 2,812 (439) 930
Accrued lease obligations................................... 2,758 3,242 669
-------- -------- ---------
Net cash used in operating activities.................... (5,965) (4,388) (3,484)
Cash flows from investing activities:
Capital expenditures................................................. (16,122) (6,653) (10,595)
Distributions from unconsolidated subsidiary......................... 32 -- --
(Increase) decrease in restricted cash............................... 6,996 -- (4,205)
Proceeds from sale of The Sports Club/Las Vegas - net of costs....... -- 6,154 --
Proceeds from sale of Houston real estate - net of costs............. -- 3,133 --
-------- -------- ---------
Net cash provided by (used in) investing activities......... (9,094) 2,634 (14,800)
Cash flows from financing activities:
Proceeds from issuance of Preferred Stock - net of costs............. -- 14,908 --
Exercise of employee stock options................................... 5 -- --
Proceeds from notes payable and equipment financing loans............ 24,588 21,725 30,741
Repayments of notes payable and equipment financing loans............ (19,111) (33,176) (13,710)
--------- --------- ----------
Net cash provided by financing activities................... 5,482 3,457 17,031
-------- -------- ---------
Net increase (decrease) in cash and cash equivalents....... (9,577) 1,703 (1,253)
Cash and cash equivalents at beginning of year........................... 11,059 1,482 3,185
-------- -------- ---------
Cash and cash equivalents at end of year................................. $ 1,482 $ 3,185 $ 1,932
======== ======== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest............................... $ 12,118 $ 11,902 $ 12,500
======== ======== =========
Cash paid during the year for income taxes........................... $ 533 $ 242 $ 386
======== ======== =========
See accompanying notes to consolidated
financial statements.
F-5
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2002 and 2003
1. Organization
The Sports Club Company, Inc. (the "Company") operates sports and fitness
Clubs ("Clubs"), primarily under the "The Sports Club/LA" name. The Sports
Club/LA sites are developed as "urban country clubs" offering a full range of
services including numerous fitness and recreation options, diverse facilities
and other amenities. The Sports Club/LA is marketed to affluent, health
conscious individuals who desire a premier Club.
2. Restatement
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 requires that goodwill and certain intangibles
no longer be amortized, but instead be reviewed for impairment on at least an
annual basis. The Company adopted SFAS No. 142 effective January 1, 2002. The
Company initially completed the transitional impairment test, in 2002, which did
not result in the impairment of goodwill. During the first quarter of 2004, the
Company determined that the methodology used to determine if goodwill was
impaired was incorrect and that a reevaluation was required. The Company has
reperformed the transitional impairment test and determined that goodwill was
impaired as of January 1, 2002, by $5,134,000. The 2002 consolidated financial
statements have been restated to reflect this adjustment.
The Company has restated the December 31, 2002 balance sheet to reclassify
$1,197,000 of deferred revenues to a long-term liability and to accrete/record
$140,000 of Series C Preferred Stock dividends from paid in capital to Series C
Preferred Stock.
A restated consolidated balance sheet at December 31, 2002, a restated
consolidated statement of operations and a restated consolidated statement of
cash flows for the year ended December 31, 2002, reflecting the above
adjustments, is presented below. The amounts are in thousands, except per share
amounts:
F-6
At December 31, 2002
-------------------------------------
As Restatement As
Reported Adjustments Restated
-------- ----------- --------
ASSETS
Current assets:
Cash and cash equivalents............................... $ 3,185 $ -- $ 3,185
Accounts receivable, net of allowance for doubtful
accounts.............................................. 3,951 -- 3,951
Inventories............................................. 1,169 -- 1,169
Other current assets.................................... 1,148 -- 1,148
--------- --------- ---------
Total current assets.................................. 9,453 -- 9,453
Property and equipment, net................................. 156,630 -- 156,630
Goodwill.................................................... 12,794 (5,134) 7,660
Restricted cash............................................. 227 -- 227
Other assets................................................ 7,282 -- 7,282
--------- --------- ---------
$ 186,386 $ (5,134) $ 181,252
========= ========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current lnstallments of notes payable and equipment
financing loans....................................... $ 2,158 $ -- $ 2,158
Accounts payable........................................ 2,545 -- 2,545
Accrued liabilities..................................... 12,657 -- 12,657
Deferred revenues....................................... 18,231 (1,197) 17,034
--------- ---------- ---------
Total current liabilities............................. 35,591 (1,197) 34,394
Notes payable and equipment financing loans, less
current installments..................................... 101,882 -- 101,882
Accrued lease obligations................................... 8,307 -- 8,307
Deferred revenues........................................... -- 1,197 1,197
Minority interest........................................... 600 -- 600
--------- --------- ---------
Total liabilities....................................... 146,380 -- 146,380
Commitments and contingencies
Redeemable Preferred Stock.................................. 10,727 -- 10,727
Shareholders' equity:
Preferred Stock, Series C............................... 5,000 140 5,140
Common Stock............................................ 211 -- 211
Additional paid-in capital.............................. 101,961 (140) 101,821
Accumulated deficit..................................... (62,709) (5,134) (67,843)
Treasury Stock, at cost................................. (15,184) -- (15,184)
--------- --------- ---------
Stockholders' equity.................................. 29,279 (5,134) 24,145
--------- ---------- ---------
$ 186,386 $ (5,134) $ 181,252
========= ========== =========
F-7
Year Ended December 31, 2002
-------------------------------------
As Restatement As
Reported Adjustments Restated
-------- ----------- --------
Membership revenues......................................... $ 120,853 $ -- $ 120,853
Operating expenses:
Direct.................................................. 100,973 -- 100,973
General and administrative.............................. 7,414 -- 7,414
Selling................................................. 4,907 -- 4,907
Depreciation and amortization........................... 11,909 -- 11,909
Pre-opening expenses.................................... 130 -- 130
--------- --------- ---------
Total operating expenses.............................. 125,333 -- 125,333
--------- --------- ---------
Loss from operations................................ (4,480) -- (4,480)
Other income (expense):
Interest, net........................................... (13,420) -- (13,420)
Minority interests...................................... (150) -- (150)
Non-recurring items..................................... 127 -- 127
--------- --------- ---------
Loss before income taxes and cumulative effect of
change in accounting principle...................... (17,923) -- (17,923)
Provision (benefit) for income taxes........................ (310) -- (310)
---------- --------- ----------
Loss before cumulative effect of change in
accounting principle.................................. (17,613) -- (17,613)
Cumulative effect of change in accounting principle......... -- 5,134 5,134
--------- --------- ---------
Net loss................................................ (17,613) (5,134) (22,747)
Dividends on Preferred Stock................................ 888 -- 888
--------- --------- ---------
Net loss attributable to common stockholders............ $ (18,501) $ (5,134) $ (23,635)
========== ========== ==========
Net loss per share:
Basic and diluted....................................... $ (1.02) $ (0.29) $ (1.31)
========== ========= ==========
Weighted average number of common shares outstanding:
Basic and diluted....................................... 18,080 -- 18,080
========= ========== ==========
F-8
Year Ended December 31, 2002
-------------------------------------
As Restatement As
Reported Adjustments Restated
-------- ----------- --------
Cash flows from operating activities:
Net loss................................................ $ (17,613) $ (5,134) $ (22,747)
Adjustments to reconcile net loss to cash used in
operating activities:
Gain on disposition of real estate................... (127) -- (127)
Impairment charges................................... -- -- --
Depreciation and amortization........................ 11,909 -- 11,909
Related party costs settled with common stock........ 241 -- 241
Cumulative effect of change in accounting principle.. -- 5,134 5,134
(Increase) decrease in:
Accounts receivable, net.......................... 725 -- 725
Inventories....................................... (50) -- (50)
Other current assets.............................. (439) -- (439)
Other assets, net................................. (2,283) -- (2,283)
Increase (decrease) in:
Accounts payable.................................. (233) -- (233)
Accrued liabilities............................... 679 -- 679
Deferred revenues................................. (439) -- (439)
Accrued lease obligations......................... 3,242 -- 3,242
--------- --------- ---------
Net cash used in operating activities.......... (4,388) -- (4,388)
Cash flows from investing activities:
Capital expenditures.................................... (6,653) -- (6,653)
Proceeds from sale of The Sports Club/Las Vegas-net of
costs................................................. 6,154 -- 6,154
Proceeds from sale of Houston real estate-net of costs.. 3,133 -- 3,133
--------- --------- ---------
Net cash provided by investing activities 2,634 -- 2,634
Cash flows from financing activities:
Proceeds from issuance of Preferred Stock-net of costs 14,908 -- 14,908
Proceeds from notes payable and equipment financing loans 21,725 -- 21,725
Repayments of notes payable and equipment financing loans (33,176) -- (33,176)
---------- --------- ----------
Net cash provided by financing activities..... 3,457 -- 3,457
--------- --------- ---------
Net increase in cash and cash equivalents...... 1,703 -- 1,703
Cash and cash equivalents at beginning of year.............. 1,482 -- 1,482
--------- --------- ---------
Cash and cash equivalents at end of year.................... $ 3,185 $ -- $ 3,185
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest.................. $ 11,902 -- $ 11,902
Cash paid during the year for income taxes.............. $ 242 -- $ 242
F-9
3. Liquidity/Going Concern
The Company has experienced recurring net losses of $40.7 million, $22.7
million and $18.4 million during the years ended December 31, 2001, 2002 and
2003, respectively. The Company has also experienced net cash flows used in
operating activities of $6.0 million, $4.4 million and $3.5 million during the
years ended December 31, 2001, 2002 and 2003, respectively. Additionally, the
Company may suffer a significant loss and net cash flows used in operating
activities during the year ending December 31, 2004. 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 raise doubt about the
Company's ability to continue as a going concern.
The Company's continued existence is primarily dependent upon its ability
to increase membership levels at its six most recently opened Clubs. Five Clubs
were opened during 2000 and 2001 and The Sports Club/LA-Beverly Hills was opened
in October 2003. Recently opened Clubs that have not yet achieved mature
membership levels have operated at a loss or only a slight profit as a result of
fixed expenses that, together with variable operating expenses, approximate or
exceed current membership fees and other ancillary revenues. Increasing
membership levels at these six most recently opened Clubs is the key to
producing operating profits and positive cash flows from operating activities.
The Company is constantly generating programs to market the Clubs to potential
new members as well as striving to reduce its membership attrition rates. The
Company has also pursued aggressive cost cutting programs that have reduced
general and administrative expenses (including employment costs) from $8.5
million during the year ended December 31, 2001 to $7.8 million during the year
ended December 31, 2003. Direct and selling expenses have also dropped as a
percentage of revenues during the last three years.
If the Company is unable to increase membership levels or reduce costs to
the point where cash flows from operating activities are sufficient to make the
September 15, 2004 or future interest payments, the Company would be required to
sell assets or 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.
4. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its majority owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation. The Company has
a 50.1% interest in the partnership that owns The Sports Club/LA - Los Angeles,
and the Company's Chairman beneficially owns the remaining 49.9%. The Company
includes The Sports Club/LA - Los Angeles in its consolidated financial
statements. The partnership agreement provides that, on an annual basis, the
partners will share in the first $300,000 of the Club's net cash flow and
profits in proportion to their percentage interests. The next $35.0 million of
annual net cash flow will be distributed to the Company. All distributions of
net cash flow thereafter, if any, will be made to the partners in proportion to
their percentage interests. The Company has the option to redeem the preferred
partnership interest in the partnership held by the Company's Chairman. The
option expires as of January 31, 2006. The preferred partnership interest is
carried at its redemption amount, which is $600,000 at December 31, 2003 and
2002 and has been classified as minority interest on the accompanying
consolidated balance sheets.
Revenue Recognition
The Company receives initiation fees and monthly membership dues from its
members. Substantially all of the Company's members join on a month-to-month
basis and can therefore cancel their membership at any time. Initiation fees and
related direct expenses, primarily sales commissions, are deferred and
recognized, on a straight-line basis, over an estimated membership period of
three years.
F-10
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
month 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 of performing these services are recorded
as deferred revenues. Revenues from the Company's SportsMed subsidiary are
recognized as services are performed based upon the estimated amount to be
collected by the Company. Management fees, including reimbursed costs, are
recognized as the management services are provided.
Effective July 1, 2003, the Company adopted Emerging Issues Task Forces
("EITF") 00-21, Revenue Arrangements with Multiple Deliverables. As a result of
the adoption of EITF 00-21, the fair value of any free products or services
bundled with new memberships is now recorded as revenue when the product is
delivered or the service is performed. Prior to the adoption of EITF 00-21, the
Company considered all payments as initiation fees and no revenue was recognized
specifically for the free products or services bundled with new memberships. The
impact upon implementation of EITF 00-21 was to increase the Company's 2003
revenues by $862,000.
Membership fees and other ancillary revenues are often prepaid and
amortized to revenue as the membership fees and other ancillary revenues are
earned. The following is a rollforward of deferred revenues for the years ended
December 31, 2001, 2002 and 2003:
Years Ended December 31,
------------------------
2001 2002 2003
---- ---- ----
(in thousands)
Deferred revenues - beginning of year......... $ 16,214 $ 19,026 $ 18,231
Plus cash received from members............... 13,404 12,555 14,848
Less revenue recognized as earnings........... (10,592) (13,350) (13,918)
-------------- -------------- -------------
Deferred revenues - end of year............... $ 19,026 $ 18,231 $ 19,161
============= ============= ============
Reimbursed Costs
The Company accounts for reimbursed costs in accordance with Emerging Issue
Task Force ("EITF") 99-19, Reporting Revenue Gross as a Principal versus Net as
an Agent. EITF 99-19 requires that revenue be reported gross with separate
display of cost of sales to arrive at gross profit or on a net basis, when the
Company acts as a primary obligor in the transaction, has discretion in
selecting the service provider and has credit risk as the Company receives
reimbursements after the goods or services have been purchased. Reimbursed costs
relate to The Sports Club/LA - Miami, which is a non-owned Club that the Company
manages for its owner. The Company receives a management fee for managing the
Club and is reimbursed for all costs that are advanced on the owner's behalf.
Reimbursed costs are recorded as both revenue and expense in the consolidated
financial statements. Reimbursed costs represent both pre-opening expenses and
normal operating expenses of the Club during 2003.
Allowance for Doubtful Accounts.
The Company provides a reserve against its receivables for estimated losses
that may result from its members' inability to pay. The Company determines the
amount of the reserve by analyzing known uncollectible accounts, economic
conditions and historical losses and its members' creditworthiness. The
likelihood of a material loss from this area is minimal due to the Company's
limited exposure to credit risk.
Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. At December 31, 2002
and 2003, cash and cash equivalents were $3.2 million and $1.9 million,
respectively.
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 operating lease security deposits as
F-11
restricted cash. At December 31, 2002 and 2003, the Company had $227,000 and
$4.4 million, respectively, of restricted cash.
Inventories
Inventories are stated at the lower of average cost or market. Inventories
consist of retail merchandise sold at spas, nutritional products, food and
beverage products, uniforms and supplies.
Advertising Costs
Amounts incurred for advertising costs with third parties are expensed as
incurred. Advertising expense totaled approximately $1.2 million, $1.5 million
and $1.4 million for the years ended December 31, 2001, 2002 and 2003,
respectively.
Loan Costs
Loan costs and the debt discount on the Senior Notes are amortized over the
terms of the related loans using the straight line method which approximates the
effective interest method.
Start-up Costs
All costs related to the development of new sports and fitness clubs,
except for real estate related costs are expensed as incurred. Real estate
related costs, which include construction costs and rent payments prior to
opening, are capitalized.
Long-Lived Assets
Property and equipment are recorded at cost.
Depreciation is computed primarily using the straight-line method over the
estimated useful lives of the assets, ranging from five to seven years for
equipment and forty years for buildings. Leasehold improvements are amortized
using the straight-line method over the shorter of the lease term (including
option periods in which the Company will incur a penalty for non-renewal) or the
estimated useful lives of the improvements.
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. The Company
adopted SFAS No. 144 on January 1, 2002. The Company evaluates its long-lived
assets on a club-by-club basis with the exception of its three New York Clubs,
which are evaluated on a combined basis due to the inter-related nature of the
operations of the New York Clubs.
The Company reviews its long-lived assets and certain identifiable
intangible assets for impairment on an annual basis or whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net undiscounted
operating cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
Goodwill
In July 2001, the FASB issued SFAS No. 141, Business Combinations, and No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the
purchase method be used for all business combinations initiated after June 30,
2001. SFAS No. 142 requires that goodwill and certain intangibles no
F-12
longer be amortized, but instead be reviewed for impairment on at least an
annual basis. Through December 31, 2001, goodwill was being amortized on a
straight-line basis over forty years. In December 2001, the Company recorded an
impairment loss of $1.8 million related to goodwill at its SportsMed subsidiary.
The amortization of goodwill and certain intangibles ceased upon the adoption of
SFAS No. 142, which is effective for fiscal years starting after December 15,
2001. The Company adopted SFAS No. 141 and SFAS No. 142 effective January 1,
2002. The Company has goodwill recorded which will no longer be amortized
subsequent to the adoption of SFAS No. 142. The Company initially completed the
transitional impairment test, in 2002, which did not result in the impairment of
goodwill. In early 2004, the Company determined that the methodology used to
determine if goodwill was impaired was incorrect and that a reevaluation was
required. The Company has reperformed the transitional impairment test and
determined that goodwill was impaired as of January 1, 2002 by $5,134,000. The
2002 consolidated financial statements have been restated to reflect this
adjustment. In addition, the Company was not required to reclassify any portion
of goodwill as a result of the adoption of SFAS No. 142.
The adoption of SFAS No. 142 had the following effect on the Company's
reported net income (loss) attributable to common shareholders and net income
(loss) per share for the years ended December 31, 2001, 2002 and 2003 (in
thousands, except per share amounts):
Years Ended
December 31,
------------
2001 2002 2003
---- ---- ----
(Restated)
Reported loss attributable to
common stockholders.......................... $ (40,678) $ (23,635) $ (19,774)
Add back: Goodwill amortization, net of tax...... 494 -- --
---------- ---------- ----------
Adjusted loss attributable to
common stockholders.......................... $ (40,184) $ (23,635) $ (19,774)
=========== =========== ===========
Reported basic and diluted
loss per share............................... $ (2.27) $ (1.31) $ (1.08)
=========== =========== ===========
Adjusted basic and diluted
loss per share............................... $ (2.24) $ (1.31) $ (1.08)
=========== =========== ===========
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes. Under this method, deferred income taxes are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis and net operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to be applied to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred taxes of a change in tax rates
is recognized in income in the period that includes the enactment date.
In the fourth quarter of 2001, the Company determined, based on year to
date operating results and projections for the next three years, that it was
more likely than not that future taxable income will be insufficient to utilize
its deferred tax assets. As a result of this determination, the Company ceased
recording any further deferred tax benefit related to its taxable losses
incurred in 2001, 2002 and 2003, and in the fourth quarter of 2001, the Company
recorded a valuation allowance of $19,627,000 to offset its net deferred tax
asset recorded through that date (See Note 12 - Income Taxes). The Company will
continue to evaluate its projected future taxable operating income and
reconsider its current determination when appropriate.
Earnings per Share
The Company presents basic and diluted earnings per share. Basic earnings
reflects the actual weighted average shares of Common Stock outstanding during
the period. Diluted earnings per share
F-13
includes the effects of all dilutive options, warrants and other securities and
utilizes the treasury stock method or if converted method as appropriate.
The securities whose conversion would result in an incremental number of
shares that would be included in determining the weighted average shares
outstanding for diluted earnings per share if their effect was not antidilutive
are as follows:
o December 31, 2003 - 1,754,609 stock options, 10,500 shares of Series B
mandatorily redeemable convertible Preferred Stock and 5,000 shares of
Series C convertible Preferred Stock.
o December 31, 2002 - 1,785,333 stock options, 10,500 shares of Series B
mandatorily redeemable convertible Preferred Stock and, 5,000 shares
of Series C convertible Preferred Stock.
o December 31, 2001 - 1,850,275 stock options.
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 (loss) and
income (loss) per share, as if the fair value based method of accounting defined
in SFAS No. 123 had been applied. In accordance with APB Opinion No. 25, no
compensation cost has been recognized as the fair value of the Company's stock
was equal to the exercise price of the options at the date of grant. Had
compensation cost for the Company's plan been determined consistent with SFAS
No. 123, the Company's net loss attributable to common shareholders and loss per
share would have been increased to the pro-forma amounts indicated below:
Year ended December 31,
-----------------------
2001 2002 2003
---- ---- ----
(Restated)
(in thousands, except per share data)
Net loss attributable to common
stockholders, as reported.................. $ (40,678) $ (23,635) $ (19,774)
Stock-based employee compensation expense
included in reported net loss............... -- -- --
Stock-based employee compensation expense
determined under fair value based method for
all awards.................................. (1,540) (1,239) (583)
------------ ------------ ------------
Adjusted net loss attributable to common
stockholders................................ $ (42,218) $ (24,874) $ (20,357)
============ ============ ============
Net loss per share as reported basic and
diluted..................................... $ (2.27) $ (1.31) $ (1.08)
============ ============ ============
Adjusted net loss per share basic and diluted... $ (2.35) $ (1.38) $ (1.11)
============ ============ ============
The fair value of all option grants for the Company's plans are estimated
on the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for all option grants in 2001:
dividend yield of 0%; expected volatility of 119%; risk-free interest rate of
4.48% and expected economic life of 6.0 years. There were no options granted in
2002 and 2003.
F-14
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make certain estimates and assumptions. These affect the reporting
of assets and liabilities, the disclosure of any contingent assets and
liabilities and the reported amounts of revenues and expenses during the
reporting periods. Those estimates include the estimated undiscounted cash flows
used to determine any potential impairment of long-lived assets and a change in
such undiscounted cash flows may change the Company's conclusion as to their
impairment. Actual results could differ from these estimates.
Fair Value of Financial Instruments
The carrying amounts related to cash equivalents, short-term investments,
accounts receivable, other current assets and accounts payable approximate fair
value due to the relatively short maturity of such instruments. The fair value
of long-term debt is estimated by discounting the future cash flows of each
instrument at rates currently available to the Company for similar debt
instruments of comparable maturities or by obtaining the then current fair value
from the publicly traded bond market. The fair value of long-term debt at
December 31, 2003 was estimated to be $112.7 million.
Redeemable Preferred Stock
Mandatorily redeemable convertible Preferred Stock (Series B) is stated at
redemption value, less the unamortized discount. The discount is accreted into
the carrying value of the mandatorily redeemable convertible Preferred Stock
through the date at which the Preferred Stock is redeemable at the option of the
holder with a charge to accumulated deficit using the effective-interest method.
Due to the inherent uncertainties regarding the ability and ultimate timing of
either the redemption or conversion of these preferred shares and the accretion
method used, it is not practicable for management to determine their fair value.
Segment Reporting
Management has determined that the Company has one reporting segment.
Impact of Recent Accounting Pronouncements
In June 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. Statement No. 146 nullified
Emerging Issues Task Force ("EITF") issue 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). Under EITF issue 94-3, a
liability for an exit cost was recognized at the date of an entity's commitment
to an exit plan. Under Statement No. 146, the liabilities associated with an
exit or disposal activity will be measured at fair value and recognized when the
liability is incurred and meets the definition of a liability in the FASB's
conceptual framework. This Statement is effective prospectively for exit or
disposal activities initiated after December 31, 2002. The adoption of Statement
No. 146 did not have any impact on the Company's consolidated financial
statements.
On December 31, 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure ("SFAS 148"), which amends
SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). SFAS 148
amends the disclosure requirements in SFAS 123 for stock-based compensation for
annual periods ending after December 15, 2002 and for interim periods beginning
after December 15, 2002. The disclosure requirements apply to all companies,
including those that continue to recognize stock-based compensation under APB
Opinion No. 25, Accounting for Stock Issued to Employees. Effective for
financial statements for fiscal years ending after December 15, 2002, SFAS 148
also provides three alternative transition methods for companies that choose to
adopt the fair value measurement provisions of SFAS 123. Management has chosen
not to adopt the fair value measurement provisions of SFAS 123.
F-15
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45"), which addresses the disclosure
to be made by a guarantor in its interim and annual financial statements about
its obligations under guarantees. The disclosure requirements are effective for
interim and annual financial statements ending after December 15, 2002. The
Company does not have any guarantees that require disclosure under FIN 45.
In November 2002, the EITF issued EITF 00-21, Revenue Arrangements with
Multiple Deliverables ("EITF 00-21"). EITF 00-21 addresses certain aspects of
the accounting by a vendor for arrangements under which it will perform multiple
revenue-generating activities. Specifically, EITF 00-21 addresses how to
determine whether an arrangement involving multiple deliverables contains more
than one unit of accounting. In applying EITF 00-21, separate contracts with the
same entity or related parties that are entered into at or near the same time
are presumed to have been negotiated as a package and should, therefore, be
evaluated as a single arrangement in considering whether there are one or more
units of accounting. That presumption may be overcome if there is sufficient
evidence to the contrary. EITF 00-21 also addresses how consideration should be
measured and allocated to the separate units of accounting in the arrangement.
The guidance in EITF 00-21 is effective for revenue arrangements entered into in
fiscal periods beginning after June 15, 2003. Alternatively, companies may elect
to report the change in accounting as a cumulative-effect adjustment. Effective
July 1, 2003, the Company adopted EITF 00-21, Revenue Arrangements with Multiple
Deliverables on a prospective basis. As a result of the adoption of EITF 00-21,
the fair value of any free products or services bundled with new memberships is
now separated and recognized as revenue when the product is delivered or the
service is performed. Prior to the adoption of EITF 00-21, the Company
considered all payments as initiation fees and no revenue was recognized
separately for the free products or services bundled with new memberships. The
impact upon implementation of EITF 00-21 was to increase the Company's 2003
revenues by $862,000.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"), which addressed the consolidation by
business enterprises of variable interest entities, which have one or both of
the following characteristics: (i) the equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
financial support from other parties, or (ii) the equity investors lack one or
more of the following essential characteristics of a controlling financial
interest: (a) the direct or indirect ability to make decisions about the
entity's activities through voting or similar rights, (b) the obligation to
absorb the expected losses of the entity if they occur, or (c) the right to
receive the expected residual returns of the entity if they occur. FIN 46
applies immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. It applies in the first fiscal year or interim period
beginning after December 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
In December 2003, the interpretation was revised by the FASB when it issued FIN
46R, which clarified its scope and also extended the requirement to apply its
provisions to investments created prior to January 31, 2003 until the end of the
Company's first quarter in 2004. The implementation extension does not apply to
special purpose entities. The Company does not expect FIN 46 or FIN 46R to have
an impact on the consolidated financial statements.
On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amends
and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133. This Statement is effective for contracts entered into or
modified after June 30, 2003, and hedging relationships designated after June
30, 2003. The Company has no derivative instruments and is not involved in any
hedging activities and therefore the adoption of SFAS 149 did not have any
impact on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150"),
which addresses how an issuer classifies and measures in its statement of
financial position certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument as a liability if it embodies an
F-16
obligation for the issuer such as a mandatorily redeemable financial instrument.
SFAS 150 is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise shall be effective for the first interim period
beginning after June 15, 2003. The application of SFAS 150 did not have any
effect on the Company's consolidated financial statements and it did not change
the presentation of any liability or equity items in its consolidated balance
sheets.
5. Dispositions
Disposition of Real Estate
In June 1998, the Company acquired undeveloped land in Houston, Texas with
the intention of developing a Club on the site. In 2000, the Company decided not
to develop this site and to dispose of the property. An impairment loss of
$749,000 was recorded in December 2000 to reduce the carrying value of the asset
to its estimated fair value less costs to sell. The Houston site was sold on
August 30, 2002 and a non-recurring gain of $97,000 was recorded (See Note 13).
Disposition of Club
In January 2002, the Company sold The Sports Club/Las Vegas to another club
operator. An impairment loss of $3,243,000 was recorded in December 2001 to
reduce the carrying value of The Sports Club/LasVegas to its fair value less
costs to sell. A gain of $30,000, related to the sale of The Sports Club/Las
Vegas was recorded in January 2002. The gain was based upon the actual proceeds
received from the sale of this Club.
F-17
6. Property and Equipment
Property and equipment is carried at cost, less accumulated depreciation
and amortization, which is summarized as follows:
At December 31,
---------------
2002 2003
---- ----
(in thousands)
Land....................................................... $ 10,621 $ 10,621
Building and leasehold improvements........................ 146,814 153,690
Furniture, fixtures and equipment.......................... 40,314 44,018
----------- -----------
197,749 208,329
Less accumulated depreciation and amortization............. 41,119 53,156
----------- -----------
Net property and equipment................................. $ 156,630 $ 155,173
=========== ===========
Equipment, which secures equipment financing loans, was $8,151,000 and
$8,251,000 at December 31, 2002 and 2003, respectively.
7. Notes Payable and Equipment Financing Loans
Notes payable and equipment financing loans are summarized as follows:
At December 31,
---------------
2002 2003
---- ----
(in thousands)
Senior secured notes (a)................................... $ 100,000 $ 100,000
Equipment financing loans (b).............................. 4,040 1,975
Mortgage note (c).......................................... -- 19,855
----------- ------------
104,040 121,830
Less current installments.................................. 2,158 2,099
----------- ------------
$ 101,882 $ 119,731
=========== ============
(a) On April 1, 1999, the Company issued in a private placement $100.0 million
of 11 3/8% Senior Secured Notes due in March 2006 (the "Senior Notes") with
interest due semi-annually. In May 1999, the Senior Notes were exchanged for
registered Series B Senior Secured Notes (the "Senior Secured Notes"). The
Senior Secured Notes are secured by substantially all of the Company's assets,
other than certain excluded assets. In connection with the issuance of the
Senior Secured Notes, the Company entered into an indenture dated as of April 1,
1999 (the "Indenture") that includes certain covenants, which as of December 31,
2003, 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
Notes are subject to redemption at the option of the Company, in whole or in
part, at the redemption prices (expressed as percentages of principal amount)
set forth below, plus accrued and unpaid interest thereon:
Period Percentage
------ ----------
Prior to March 15, 2004.............. 105.688%
Prior to March 15, 2005.............. 102.844%
Thereafter........................... 100.000%
F-18
If the Company undergoes a "change in control", as defined in the
Indenture, it must give holders of the Senior Secured Notes the opportunity to
sell their Senior Secured Notes to the Company at 101% of their face amount,
plus interest. At December 31, 2003, the Company was in compliance with the
terms of the Indenture, except as noted below. At December 31, 2003, the
estimated fair value of the Senior Secured Notes was $93.0 million.
On May 25, 2004, the Company received a letter from the Trustee of the
Indenture Agreement notifying the Company that an "event of default" under the
Indenture would arise if the Company failed to file its financial reports with
the Securities and Exchange Commission ("SEC") within thirty (30) days after the
Company's receipt of such notice. The Company has filed its report with the SEC
within the thirty (30) day period thereby curing and nullifying the Trustee's
notice.
(b) 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 3.5% and 13.3%.
(c) Prior to June 12, 2003, the Company had a $10.0 million credit facility from
a commercial bank. On June 12, 2003, the Company obtained alternative financing
in the form of a secured five-year mortgage in the amount of $20.0 million.
Amounts outstanding under the previous bank credit facility were repaid with a
portion of the proceeds of the new loan. 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., the Company's wholly owned
subsidiary that owns The Sports Club/LA - Orange County; and is guaranteed by
two of the Company's major shareholders. 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
December 31, 2003, the Company has maintained the minimum operating income. The
note may be prepaid at any time without penalty and requires a final principal
payment of $18.3 million on July 1, 2008.
Future minimum annual principal payments at December 31, 2003, are as
follows (in thousands):
2004............................................. $ 2,099
2005............................................. 444
2006............................................. 100,372
2007............................................. 400
2008............................................. 18,515
-----------
$ 121,830
-----------
-----------
8. Commitments and Contingencies
Lease Commitments
The Company leases certain facilities pursuant to various operating lease
agreements. Club facility leases are generally long-term and noncancelable
triple-net leases (requiring the Company to pay all real estate taxes, insurance
and maintenance expenses). The Company is also obligated under lease agreements
for seven of its former Spectrum Club locations. The Company has subleased each
of these properties to the buyer of these Clubs under sublease agreements which
provide that all operating costs of these facilities be assumed by the new
owners. Future minimum noncancelable operating lease payments as of December 31,
2003 are as follows (in thousands):
F-19
Net
Sublease Rental
Commitments Rentals Commitments
----------- ------- -----------
Year ending December 31:
2004................................. $ 30,116 $ 5,712 $ 24,404
2005................................. 29,892 5,917 23,975
2006................................. 29,974 5,917 24,057
2007................................. 30,004 5,990 24,014
2008................................. 29,726 5,417 24,309
Thereafter........................... 266,139 30,314 235,825
----------- ---------- -----------
Total minimum lease payments.... $ 415,851 $ 59,267 $ 356,584
=========== ========== ===========
Rent expense for facilities, including minimum lease payments recorded on a
straight-line basis over the lease term, aggregated $18,685,000, $23,301,000 and
$23,743,000 for the years ended December 31, 2001, 2002 and 2003, respectively.
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 will not have an material adverse effect on the Company's financial
condition, cash flow or results of operations.
Employment Agreements
At December 31, 2003, the Company did not have any employment agreements
with any employees.
9. Series B Redeemable Preferred Stock
On March 18, 2002, the Company completed a $10.5 million private placement
of a newly created series of its 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
(resulting in the issuance of 3,636,867 shares of Common Stock if 100% of the
Series B Preferred is converted at that price). 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 the Series B Preferred is redeemed before March 18, 2005,
the holders will receive warrants to purchase shares of Common Stock at a price
of $3.00 per share, exercisable before March 18, 2007. 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 Preferred Stock, an amount equal to $1,000 for each
share of Series B Preferred then outstanding.
The initial carrying value of the Series B Preferred was recorded at its
"fair value" (sale price less costs to issue) on the date of issuance. The
carrying value
F-20
of the Series B Preferred will be 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. The Series B Preferred carrying value consisted of the
following (in thousands):
Initial fair value, sale price of $10,500
less costs to issue of $592.......................... $ 9,908
Redemption value accretion................................ 71
Accrued and unpaid dividends accretion.................... 748
-------------
Total carrying value at December 31, 2002............. 10,727
Redemption value accretion................................. 84
Accrued and unpaid dividends accretion..................... 950
-------------
Total carrying value at December 31, 2003............. $ 11,761
=============
F-21
10. Series C 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 are earned 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 Stock. In addition, upon conversion any earned and unpaid dividends
would become payable. Accordingly, the Company has recorded such Series C
divdidends. 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 (resulting
in the issuance of 1,731,842 shares of Common Stock if 100% of the Series C
Convertible Preferred is converted at that price). 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 Stock
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 the Series C
Convertible Preferred is redeemed before September 6, 2005, the holders will
receive warrants to purchase shares of Common Stock at a price of $3.00 per
share, exercisable before September 6, 2007. 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. The Series C Convertible
Preferred dividends are accrued because they must be paid concurrently with any
redemption of the Series B Preferred. At December 31, 2003, the Series C
Convertible Preferred carrying value consisted of the following (in thousands):
Initial fair value............................. $ 5,000
Accrued and unpaid dividend accretion.......... 590
------------
Total carrying value at December 31, 2003...... $ 5,590
============
11. Loss per Share
Basic and diluted loss per share computations for the years 2001, 2002 and
2003 are as follows:
Years ended December 31,
------------------------
2001 2002 2003
---- ---- ----
(Restated)
(in thousands, except per share data)
Net loss attributabel to common shareholders used for
basic and diluted loss per share...................... $ (40,678) $ (23,635) $ (19,774)
=========== =========== ===========
Weighted average shares outstanding:
Basic and diluted.................................... 17,939 18,080 18,316
=========== =========== ===========
Loss per share:
Basic and diluted.................................... $ (2.27) $ (1.31) $ (1.08)
=========== =========== ===========
F-22
12. Income Taxes
The provision for income taxes consists of the following:
Years ended December 31,
------------------------
2001 2002 2003
---- ---- ----
(in thousands)
Current:
Federal......................................... $ 89 $ (930) $ --
State........................................... 757 620 485
----------- ----------- -----------
846 (310) 485
Deferred:
Federal......................................... 3,486 -- --
State........................................... 1,038 -- --
----------- ----------- -----------
4,524 -- --
----------- ----------- -----------
Income tax provision (benefit)........................ $ 5,370 $ (310) $ 485
=========== ============ ===========
Income tax expense (benefit) as computed differs from the statutory rate as
applied to pre-tax net income (loss) as follows:
Years ended December 31,
------------------------
2001 2002 2003
---- ---- ----
(in thousands)
Computed "expected" tax expense (benefit)............. $ (12,005) $ (7,839) $ (6,070)
Increase (decrease) in tax resulting from:
State taxes - net of federal benefit.............. (2,091) (1,102) (1,009)
Meals and entertainment........................... 63 75 79
Change in valuation allowance..................... 19,627 9,048 6,592
Other............................................. (224) (492) 893
------------ ------------ ----------
Income tax provision (benefit)........................ $ 5,370 $ (310) $ 485
=========== ============ ==========
The effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities are presented as follows:
At December 31,
---------------
2002 2003
---- ----
(in thousands)
Deferred tax assets:
Deferred revenues.................................... $ 1,368 $ 1,232
Operating loss carry forwards........................ 24,198 31,723
Accrued vacation..................................... 257 294
Bad debt............................................. 193 186
Depreciation and amortization........................ 507 263
State taxes.......................................... 315 165
Other................................................ 1,837 1,404
--------------- ----------------
Gross deferred tax assets.......................... 28,675 35,267
Valuation allowance....................................... (28,675) (35,267)
---------------- -----------------
Net deferred tax asset.................................... $ -- $ --
=============== ================
The Company has determined, based on historical operating results and
projections for the next three years that it is more likely than not that future
taxable income will be insufficient to utilize its deferred tax assets. As a
result of this determination, the Company ceased recording any deferred tax
benefit related to its taxable losses and recorded valuation allowances of
$19,627,000, $9,048,000 and $6,592,000 in 2001, 2002 and 2003, respectively to
offset the Company's net deferred tax assets.
F-23
As of December 31, 2003, the Company had federal and state net operating
loss carryforwards of $70,094,000 and $84,147,000 respectively, beginning
expiration in 2020 and 2005, respectively.
13. Non-Recurring Items
The Company recorded the following as non-recurring items for 2001, 2002
and 2003:
Years Ended December 31,
------------------------
2001 2002 2003
---- ---- ----
(in thousands)
Gain on sale of Houston real estate (See Note 5)................ $ -- $ 97 $ --
Gain on sale of The Sports Club/Las Vegas (See Note 5).......... -- 30 --
Interest expense reversal on litigation settlement (a).......... 397 -- --
-------- ----------- ----------
$ 397 $ 127 $ --
======== =========== ==========
(a) The Company recorded a non-recurring gain of $397,000 during the year
ended December 31, 2001. The non-recurring gain in 2001 was the result of the
reversal of accrued interest expense related to the settlement of litigation. As
part of the settlement the Company was no longer required to pay the accrued
interest due on the note in question.
14. Stock Plans
Stock Incentive Plans
The Company's shareholders reserved 1,800,000 shares of Common Stock under
the Company's Amended and Restated 1994 Stock Incentive Plan, which authorized
the issuance of various stock incentives to directors, officers, employees and
consultants including options, stock appreciation rights and purchase rights. On
December 31, 2000, the 1994 Stock Incentive Plan expired and in May 2001, the
Company's shareholders adopted the 2001 Stock Incentive Plan (the "Plan"). The
2001 Stock Incentive Plan reserves 2.5 million shares of Common Stock, expires
in May 2011 and also authorizes stock appreciation rights and purchase rights.
Options allow for the purchase of Common Stock at prices determined by the
Company's Compensation Committee. Incentive stock options must be granted at a
price equal to or greater than the fair value of a share of Common Stock on the
date the option is granted. Non-statutory options must have an exercise price
equal to at least 85% of the fair value of the Company's Common Stock at the
date of grant. Options granted under the Plans may, at the election of the
Compensation Committee, become exercisable in installments. Except for the
number of options granted to the Company's former Co-Chief Executive Officer D.
Michael Talla, which expire on the fifth anniversary of the grant date, all
options expire on the tenth anniversary of the grant date.
F-24
A summary of the status of the Company's stock option plans as of December
31, 2001, 2002 and 2003 and changes during the years then ended are presented
below:
Weighted
Average Exercise
Shares Price
------ -----
Outstanding at January 1, 2001....................................... 1,533,832 $ 5.94
Granted.............................................................. 411,915 3.09
Canceled............................................................. (93,472) 2.23
Exercised............................................................ (2,000) 2.56
----------
Outstanding at December 31, 2001..................................... 1,850,275 5.37
==========
Options exercisable at December 31, 2001............................. 915,284 5.83
==========
Weighted-average per share fair value of options
granted during year ended December 31, 2001.......................... 3.09
Outstanding at January 1, 2002....................................... 1,850,275 5.37
Granted.............................................................. -- --
Canceled............................................................. (64,942) 5.20
Exercised............................................................ -- --
----------
Outstanding at December 31, 2002..................................... 1,785,333 5.38
==========
Options exercisable at December 31, 2002............................. 1,296,448 5.61
==========
Outstanding at January 1, 2003....................................... 1,785,333 5.38
Granted.............................................................. -- --
Canceled............................................................. (30,724) 8.13
Exercised............................................................ -- --
----------
Outstanding at December 31, 2003..................................... 1,754,609 5.33
==========
Options exercisable at December 31, 2003............................. 1,621,965 5.52
==========
The following table summarizes information about stock options outstanding
at December 31, 2003:
Weighted
Average
Remaining
Exercise Number Contractual Options
Prices Outstanding Life (Years) Exercisable
------ ----------- ------------ -----------
$2.5625 24,333 2.41 24,334
2.6875 70,000 2.11 70,000
2.7500 26,000 2.84 26,000
3.0100 282,932 7.39 188,621
3.3110 115,000 2.39 76,667
3.9375 210,000 5.10 210,000
4.2500 219,344 6.85 219,343
4.3750 60,000 3.22 60,000
5.2500 42,000 1.24 42,000
5.3750 32,000 3.50 32,000
8.0000 211,000 4.29 211,000
8.0000 450,000 6.11 450,000
8.3750 12,000 3.85 12,000
------------- -------------
1,754,609 1,621,965
============= =============
F-25
Stock appreciation rights ("SAR's") may be granted in combination with
options or on a stand-alone basis. SAR's permit the holder to receive shares of
stock, cash or a combination of shares and cash based upon by the difference
between the option price and the fair value of the Common Stock on the date of
exercise. Upon exercise of a SAR granted in combination with an option, the
related option is canceled. At December 31, 2003, no SAR's had been granted.
Rights to purchase shares of Common Stock to be offered for direct sale
under the Plan must be at a purchase price equal to not less than 85% of the
fair value of the shares on the day preceding the date of grant. Purchase rights
are generally exercisable for a period of thirty days following the date of
grant. At December 31, 2003, no purchase rights had been granted.
1994 Stock Compensation Plan
In July 1994, the Company instituted its 1994 Stock Compensation Plan (that
was amended by the Company's shareholders in July 1999) for the purpose of
compensating outside directors by issuing them shares of the Company's Common
Stock as part of their directors' fees. A total of 50,000 shares were reserved
for issuance pursuant to this plan and a total of 50,000 shares have been issued
to outside directors under the plan. During the years ended December 31, 2001,
2002 and 2003, the Company issued 6,000, 8,000 and 6,000 shares of Common Stock
as director compensation for aggregate consideration of $16,000, $15,000 and
$12,000, respectively.
15. Related Party Transactions
Millennium Partners LLC (collectively with its affiliate "Millennium") is a
significant shareholder of the Company and has jointly developed Clubs with the
Company. A representative of Millennium is on the Company's Board of Directors.
Millennium is a partner in the Reebok Sports Club/NY partnership as well as the
landlord of the building in which the Reebok Sports Club/NY is located. The
Reebok Sports Club/NY pays rent to Millennium in the amount of $2.0 million per
year and the partnership agreement provides for a first priority annual
distribution of $3.0 million to Millennium. The Company is entitled to certain
additional priority distributions and 60% of the remaining cash flow. Millennium
is entitled to 20% of such remaining cash flows.
The Company pays rent to Millennium for The Sports Club/LA - Washington
D.C., The Sports Club/LA - Boston and The Sports Club/LA - San Francisco and in
2001, 2002 and 2003 a total of $4.8 million, $9.5 million and $9.5 million,
respectively, was paid to Millennium for rent on these three Clubs. All such
payments are reflected as rent expense in the Company's consolidated statements
of operations. In addition, after the Company receives a management fee equal to
6% of all revenues, an amount equal to its capital investment in the Boston and
Washington D.C. Clubs and a 11% annual return on the capital investment and an
amount equal to its operating investment in the Club and a 10% annual return on
the operating investment, Millennium is entitled to receive a percentage of all
additional cash flows from each Club as additional rent. Millennium's percentage
of the excess cash flow, as defined, is 25% for the Washington and Boston Clubs
and 60% for the San Francisco Club. Millennium has not received any payments to
date under these provisions.
On November 24, 2003, the Company opened The Sports Club/LA - Miami as part
of the exclusive new Four Seasons Hotel and Tower in Miami, Florida. The Company
operates this 40,000 square foot Club pursuant to a management agreement with
Millennium, the developer of the project. The Company receives a fee of 6% of
gross revenues and a participation in the Club's net cash flow. For the year
ended December 31, 2003, management fees of $131,000 were earned by the Company.
The Company was also reimbursed $2,383,000 for costs it incurred related to the
operation of The Sports Club/LA - Miami.
The Company has a 50.1% interest in the partnership that owns The Sports
Club/LA - Los Angeles, and the Company's Chairman beneficially owns the
remaining 49.9%. The Company includes The Sports Club/LA - Los Angeles in its
consolidated financial statements. The partnership agreement provides that, on
an annual basis, the partners will share in the first $300,000 of the Club's net
cash flow in
F-26
proportion to their percentage interests. The next $35.0 million of annual net
cash flow will be distributed to the Company. All distributions of net cash flow
thereafter, if any, will be made to the partners in proportion to their
percentage interests. The Company has the option to redeem the preferred
partnership interest in the partnership held by the Company's Chairman. The
option expires as of January 31, 2006. The preferred partnership interest is
carried at its redemption amount, which is $600,000 at December 31, 2003 and
2002 and has been classified as minority interest on the accompanying
consolidated balance sheets.
As of May 4, 2001, the Company entered into a ten-year sublease for space
located within The Sports Club/LA - Upper East Side. The sublease provides for
two five-year renewal options and one seven-year renewal option; an initial
monthly rent of $125,000, and rental increases of 10% at the end of each
five-year period. The subtenant for this lease is Club at 60th Street, Inc., a
New York corporation owned by Mr. Talla.
In September 1999, the Company sold the property on which the Spectrum Club
- Thousand Oaks is located for a sales price of $12.0 million. The Company
entered into a sale and leaseback agreement for the property under a long-term
lease with an initial annual base rent of $1.3 million. The Thousand Oaks
property consists of the Spectrum Club - Thousand Oaks, a SportsMed facility,
unimproved office space, and a parking ramp. The Company is currently subleasing
the Spectrum Club space to another club operator. Mr. Licklider owns an
approximate 4.6% interest in the purchaser of the property, and trusts for the
benefit of Mr. Talla's minor children own an approximately 5.2% interest in the
purchaser of the property.
On March 18, 2002, the Company sold an aggregate of 10,500 shares of Series
B Convertible Preferred Stock to Kayne Anderson Capital Advisors and four
affiliates thereof for aggregate offering proceeds of $10.5 million. The shares
of Series B Preferred may, at the option of the holder, be converted into shares
of the Company's Common Stock at the current rate of $2.8871 per share; entitle
each holder to one vote for each share of Common Stock into which such Series B
Preferred could then be converted; and provide for the payment of dividends at
an annual rate of $90.00 per share. Dividends are cumulative, do not accrue
interest and, at the Company's discretion, may be paid in additional shares of
Series B Preferred. As part of the sale of the Series B Preferred to Kayne
Anderson, the Company agreed that for so long as Kayne Anderson beneficially
owns at least 12% of the Company's equity securities (on an "as-converted
basis") Kayne Anderson will have the right to designate one member to the
Company's Board of Directors. Mr. Charles A. Norris is currently serving on the
Board as the nominee of Kayne Anderson.
On September 6, 2002, the Company sold an aggregate of 5,000 shares of
Series C Convertible Preferred Stock to three of the Company's major
shareholders, D. Michael Talla, Rex Licklider and MDP Ventures II, LLC, an
affiliate of Millennium, for aggregate offering proceeds of $5.0 million. The
shares of Series C Preferred may, at the option of the holder, be converted into
shares of the Company's Common Stock at the current rate of $2.8871 per share;
entitle each holder to one vote for each share of Common Stock into which such
Series C Preferred could then be converted; and provide for the payment of
dividends at an annual rate of $90.00 per share. Dividends are cumulative, do
not accrue interest and, at the Company's discretion, may be paid in additional
shares of Series C Preferred.
In consideration of executing a guaranty in favor of Comerica-Bank -
California (the "Bank") in connection with the Bank's renewal of the Company's
credit facility (the "Credit Facility"), Messrs. Talla and Licklider and MDP
Ventures II, LLC, an affiliate of Millennium, entered into agreements with the
Company as of July 3, 2001, pursuant to which the Company was obligated to pay a
1% annual commitment fee to each of the guarantors. In addition to the committee
fee, the Company was obligated to pay to each guarantor a usage fee equal to 2%
per annum of such guarantor's pro rata portion of any amounts advanced to the
Company by the Bank. At the Company's discretion all earned commitment fees and
usage fees under the agreements were paid in restricted shares of Common Stock
with each guarantor receiving in the aggregate 86,392 shares. In June 2003, the
Company replaced the Credit Facility and, as of February 15, 2004, all payment
obligations due the guarantors have been met.
Upon termination of the Credit Facility, on June 12, 2003, the Company
entered into a new promissory note with another financial institution. The new
note is for $20.0 million (the "Loan") and is guaranteed by Messrs. Talla and
Licklider. Messrs. Talla and Licklider entered into agreements with the
F-27
Company as of December 1, 2003, pursuant to which the Company is obligated to
pay a quarterly fee to each guarantor equal to 3% per annum of their pro rata
portion of the average outstanding principal balance of the Loan. At the
Company's discretion, such fees may be paid in Common Stock, cash or a
combination thereof. The third quarter 2003 fee was paid in stock with each
guarantor receiving 28,509 shares. The Company has also elected to pay the
fourth quarter 2003 fee in stock and has determined that each guarantor will
receive 40,731 shares.
16. Concentration of Credit Risk
The Company markets its products principally to customers in Southern
California, New York City, Washington D.C., Boston and San Francisco. Management
performs regular evaluations concerning the ability of its customers to satisfy
their obligations and records a provision for doubtful accounts based upon these
evaluations. The Company's credit losses for the periods presented are
insignificant and have not exceeded managements' estimates (see Note 4 -
allowance for doubtful accounts).
17. Subsequent Events
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, net of costs, 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 Stock was purchased
by three of the Company's major shareholders consisting of Rex Licklider (the
Company's Chief Executive Officer), Millennium and Kayne Anderson Capital
Advisors. Dividends are earned 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 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 (resulting in the issuance of 3,250,000 shares of
Common Stock if 100% of the Series D Convertible Preferred is converted). Each
share of Series D Convertible Preferred shall automatically be converted into
shares of Common Stock upon the consummation of a qualified secondary stock
offering of at least $50.0 million or if the closing price of the Common Stock
for a period of thirty consecutive trading days exceeds $4.00 per share until
March 15, 2005, or $6.00 per share thereafter, 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 into Common
Stock) at a price per share less than the Series D Convertible Preferred
conversion price then in effect. 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.
F-28
18. Quarterly Summary of Information (Unaudited)
Revenues and operating expenses for the first, second, and third quarters
of 2003 have been restated to record the impact of reimbursed costs which
previously had not been shown on the consolidated statement of operations.
Reimbursed costs relate to The Sports Club/LA - Miami, which is a non-owned Club
that the Company manages for its owner. The Company receives a management fee
for managing the Club and is reimbursed for costs that are advanced on the
owner's behalf. Reimbursed costs are recorded as both revenue and expense in the
consolidated financial statements. The effect of reimbursed costs on the
Company's loss from operations, net loss, loss attributable to common
stockholders and net loss per share (basic and diluted) is zero, since
reimbursed costs are reported both as revenue and as operating expenses in the
consolidated financial statements in equal amounts. Reimbursed costs represent
both pre-opening expenses and normal operating expenses of the Club. Reimbursed
costs by quarter for the first, second, third and fourth quarters of 2003 were
$258,000, $448,000, $327,000 and $1,350,000, respectively.
2003
---------------------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
(in thousands, except per share amounts)
Revenue:
As reported............................... $ 32,403 $ 32,181 $ 31,727 $ 36,027
=========== ============ ============ ============
As restated............................... $ 32,661 $ 32,629 $ 32,054 $ 36,027
=========== ============ ============ ============
Operating expenses:
As reported............................... $ 32,788 $ 33,193 $ 33,399 $ 36,947
=========== ============ ============ ============
As restated............................... $ 33,046 $ 33,641 $ 33,726 $ 36,947
=========== ============ ============ ============
Net loss attributable to common stockholders:
As reported............................... $ (4,243) $ (4,822) $ (5,618) $ (5,091)
=========== ============ ============ ============
As restated............................... $ (4,243) $ (4,822) $ (5,618) $ (5,091)
=========== ============ ============ ============
Net loss per share basic and diluted:
As reported............................... $ (0.23) $ (0.26) $ (0.31) $ (0.28)
=========== ============ ============ ============
As restated............................... $ (0.23) $ (0.26) $ (0.31) $ (0.28)
=========== ============ ============ ============
The following unaudited condensed quarterly financial data for the four
quarters ended December 31, 2002 have been restated as described in Note 2:
2002
---------------------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
(in thousands, except per share amounts)
Revenues:
As reported............................. $ 29,968 $ 29,946 $ 30,195 $ 30,744
============ ============= ============= =============
As restated ............................ $ 29,968 $ 29,946 $ 30,195 $ 30,744
============ ============= ============= =============
Net loss attributable to common stockholders:
As reported............................. $ (4,312) $ (5,239) $ (3,882) $ (5,068)
============ ============= ============= =============
As restated............................. $ (9,446) $ (5,239) $ (3,882) $ (5,068)
============ ============= ============= =============
F-29
Net loss per share basic and diluted:
As reported............................ $ (0.24) $ (0.29) $ (0.21) $ (0.29)
============ ============= ============= =============
As restated............................ $ (0.52) $ (0.29) $ (0.21) $ (0.29)
============ ============= ============= =============
19. Employee Benefit Plan
The Company maintains a 401(k) defined contribution plan and is subject to
the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA").
The Plan provides for the Company to make a discretionary employer matching
contribution currently equal to 33% of the first 8% of each participating
employees' wages. The employer matching contribution can be made in cash or
Company stock, at the Company's discretion. Employer matching contributions
totaling $225,667, $233,995 and $256,066 were made for the Plan years ended
December 31, 2001, 2002 and 2003, respectively. The employer contribution vests
pro-rata over four years. In order to participate in the Plan, employees must
have been employed by the Company for at least one year and must have worked at
least 1,000 hours during that one year period. In order to receive an employer
matching contribution the participant must be employed by the Company at
December 31st and must have worked a minimum of 1,000 hours for each applicable
Plan year.
F-30
THE SPORTS CLUB COMPANY, INC.
VALUATION AND QUALIFYING ACCOUNTS
Three-year period ended December 31, 2003
Balance at
beginning of Balance at end
Description period Additions Deletions of period
------------------------------------------ -------------- -------------- ------------- ----------------
Year ended December 31, 2001:
Allowance for doubtful accounts $ 671,000 $ 782,000 $ 1,135,000 $ 318,000
=========== =========== =========== ===========
Year ended December 31, 2002:
Allowance for doubtful accounts $ 318,000 $ 798,000 $ 582,000 $ 534,000
=========== =========== =========== ===========
Year ended December 31, 2003:
Allowance for doubtful accounts $ 534,000 $ 684,000 $ 701,000 $ 517,000
=========== =========== =========== ===========
F-31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers and directors and their ages as of June 15, 2004 are
as follows:
Name Age Position
---- ---- ---------
D. Michael Talla.........57 Chairman of the Board
Rex A. Licklider.........61 Vice Chairman of the Board and
Chief Executive Officer
Philip J. Swain..........46 President and Chief Operating Officer
Nanette Pattee Francini..55 Executive Vice President
Timothy M. O'Brien.......52 Chief Financial Officer and Assistant Secretary
Mark S. Spino............49 Senior Vice President of Development
Andrew L. Turner.........57 Director
George J. Vasilakos......66 Director
Charles A. Norris........58 Director
Christopher M. Jeffries..54 Director
Charles J. Ferraro.......60 Director
The following information summarizes the business experience during at
least the past five years of each of our executive officers and directors.
D. Michael Talla began developing sports and fitness clubs in 1977 when he
co-founded our predecessor non-public company. He has served as Chairman of the
Board since the inception of our public company in 1994, and served until July
1999 as our Chief Executive Officer. From February 2000 until March 2004, Mr.
Talla held the position of Co-Chief Executive Officer with Mr. Licklider. Since
1978, Mr. Talla has owned Talla Development Company and West Hollywood
Development Company, both real estate holding companies with properties in
California and Nevada. He has served on the Board of Trustees for the Curtis
School in Brentwood, California; West L.A. Little League; For Kids Only
Foundation; American Youth Soccer Association and Los Angeles Youth Programs.
Rex A. Licklider has served as Vice Chairman of the Board since 1994 and as
Chief Executive Officer since March 2004, having served with Mr. Talla as
Co-Chief Executive Officer from February 2000. Previously, Mr. Licklider served
as a consultant to us for strategic and financial planning. He founded Com
Systems, Inc., a publicly traded long-distance telecommunications company, and
at various times between 1975 and April 1992 served as its Chairman, President
and Chief Executive Officer. Since January 1993, Mr. Licklider has been a member
of the Pentium Group, an entity investing, and often taking a management role,
in early stage and turn around/growth businesses. He is a director of The
Learning Network, Inc., and Deckers Outdoor Corporation. He also serves on the
Board of Directors of The Children's Bureau of Southern California, The
Achievable Foundation and For Kids Only Foundation.
Philip J. Swain was appointed President and Chief Operating Officer in
April 2003, having been our Senior Vice President of Operations since February
2000. Mr. Swain served as Vice President of Operations from 1994 until his
promotion in 2000.
Nanette Pattee Francini began developing sports and fitness clubs in 1977
when she co-founded our predecessor non-public company. She has served as our
Executive Vice President and has been responsible for overseeing all
Branding/Marketing as well as new concept development since the inception of our
public company in 1994. Ms. Francini served on the Board of Directors from 1994
until April 2004. She founded and is Chairman of the Board of Directors of For
Kids Only Foundation. In 2003, Ms. Francini received the Golden Star Award from
Big Brothers Big Sisters, and in 2004 she accepted the Visionary Award bestowed
by the City of Beverly Hills.
24
Timothy M. O'Brien has been our Chief Financial Officer since February 1995
and since June 1995 has also served as Assistant Secretary. Mr. O'Brien is a
Certified Public Accountant.
Mark S. Spino was appointed Senior Vice President of Development in
February 2000, having served as Vice President of Development since 1994.
Andrew L. Turner has been a director since 1994. Mr. Turner currently
serves as Chairman of the Board for EnduraCare Therapy Management, the nation's
largest privately held contract physical therapy company. He serves on the Board
of Directors for Watson Pharmaceuticals, Inc., a New York Stock Exchange traded
pharmaceutical manufacturing company. From 1989 until August 2000, Mr. Turner
served as Chairman and Chief Executive Officer of Sun Healthcare Group, Inc., a
New York Stock Exchange traded health care services provider. In October 1999,
Sun Healthcare Group, Inc. filed voluntary petitions with the U.S. Bankruptcy
Court to reorganize under Chapter 11 of the Federal Bankruptcy Code.
George J. Vasilakos has been a director since June 2002. Since January
1993, Mr. Vasilakos has been a member of the Pentium Group, an entity investing,
and often taking a management role, in early stage and turn around/growth
businesses. He was a principal and served as the Chief Executive Officer of
Golden Tel, the largest payphone provider in Nevada, which was sold in 1998.
Currently, Mr. Vasilakos serves as Chief Executive Officer for The Learning
Network, Inc., an e-learning company, and DiTronics, LLC, a provider of
Automated Teller Machine services. He has served as a member of the Board of
Directors and Executive Committee for the long distance industry trade
association, COMPTEL, and on the advisory committees for the masters programs in
telecommunications at Colorado University and Golden Gate University.
Charles A. Norris was elected to the Board of Directors in August 2002. Mr.
Norris currently serves as Chairman of the Board of Directors of Glacier Water
Services, Inc. Previously, Mr. Norris was President of McKesson Water Products
Company and a Senior Vice President of McKesson Corporation. He is past
President and served on the Board of Directors and Executive Committee of the
International Bottled Water Association. Mr. Norris is also a member of the
Board of Directors of the AEM/DC Sports, a mid sized auto after market company.
As part of the sale of the Series D Convertible Preferred Stock in March 2004,
we agreed that Kayne Anderson, one of the three principal purchasers of the
Series D would be entitled to designate one director to serve on our Board of
Directors. Mr. Norris is currently serving as Kayne Anderson's designee pursuant
to this agreement.
Christopher M. Jeffries became a member of the Board of Directors in April
2004. Mr. Jeffries has founded, owned and managed several real-estate
development companies. He founded Millennium Partners in 1990 to meet the
lifestyle demands of affluent urbanites by creating luxury mixed-use properties
in the New York marketplace. The Millennium portfolio now includes projects in
New York, Boston, Washington D.C., Miami and San Francisco. Mr. Jeffries
graduated from Columbia College in 1968 and the University of Michigan Law
School in 1972. As part of the sale of the Series D Convertible Preferred Stock
in March 2004, we agreed that Millennium has the right to designate two
directors (one of whom must be independent) to serve on our Board of Directors.
Mr. Jeffries is a principal of Millennium and is currently serving as one of
Millennium's two designees pursuant to this agreement.
Charles J. Ferraro became a member of the Board of Directors in April 2004.
Mr. Ferraro has been with the Four Seasons Hotels and Resorts since 1980 and
currently serves as its Senior Vice President of Operations with operating
responsibilities in Texas, California, Hawaii, Washington, Florida, the
Caribbean, Mexico, Central America and South America. Mr. Ferraro graduated from
Paul Smith's College of Hotel and Restaurant Management. As part of the sale of
the Series D Convertible Preferred Stock in March 2004, we agreed that
Millennium has the right to designate two directors (one of whom must be
independent) to serve on our Board of Directors. Mr. Ferraro meets the criteria
of "independent" as defined by the Securities and Exchange Commission and the
American Stock Exchange and is serving as Millennium's independent designee
pursuant to this agreement.
25
The rules of the American Stock Exchange generally require that a majority
of the directors of a listed company be independent directors, that nominations
for members of the Board of Directors must be selected or recommended either by
a nominating committee comprised solely of independent directors or by a
majority of independent directors on the Board, that the compensation of all
officers must be determined or recommended to the Board for determination either
by a compensation committee comprised of independent directors or by a majority
of the independent directors on the Board and that the Chief Executive Officer
may not be present during discussion of his compensation. However, a company in
which over 50% of the voting power is held by a "group" (a "Controlled Company")
is not required to comply with these general rules.
Rex A. Licklider ("Licklider"), Millennium and Kayne Anderson Capital
Advisors, L.P. and its affiliates ("Kayne") own Common Stock and various series
of voting Convertible Preferred Stock, which in the aggregate, constitute 63.7%
of the voting power of the Company. In connection with their purchase of the
Series D Convertible Preferred Stock on March 12, 2004, Licklider, Millennium
and Kayne entered into an Investors' Rights Agreement with us, which affords
each of them certain consent rights with respect to the operation of our
business. In addition, the Investors' Rights Agreement affords each of Licklider
and Kayne the right to designate one director and affords Millennium the right
to designate two directors, one of whom must be an independent director, in each
case so long as certain specified Common Stock ownership thresholds are
maintained. As a result of the provisions of the Investors' Rights Agreement,
Licklider, Millennium and Kayne are a group that holds over 50% of the voting
power of the Company within the meaning of the rules of the American Stock
Exchange.
We have determined that we are a Controlled Company and as such we are
entitled to take advantage of the exceptions set forth above. Therefore, it is
likely that nominations for members of our Board as well as officers'
compensation will be determined by the entire Board and not solely by our
independent directors.
Both the Securities and Exchange Commission and the American Stock Exchange
require that a public company maintain a permanent independent audit committee.
The designation of a company as a Controlled Company does not negate this
responsibility. The Board has appointed Messrs. Vasilakos, Turner and Norris to
the Audit Committee and has charged them with the responsibility of (i)
reviewing our annual audit and appointing our independent auditors, and (ii)
reviewing our internal controls and financial management practices and (iii)
implementing and maintaining procedures for the reporting and treatment of any
complaints or concerns regarding accounting matters or otherwise as specified
under the Sarbanes-Oxley Act of 2002.
The Board has created two other permanent committees: Compensation and
Nominating and Governance. The Compensation Committee, composed of Messrs
Turner, Vasilakos and Norris (Mr. Collins also served on this Committee until
his resignation in April 2004), recommends compensation for key-employees,
oversees the management bonus program and administers our stock incentive plans.
The Nominating and Governance Committee, composed of Messrs Norris, Vasilakos
and Turner, insures that the Board meets its fiduciary responsibilities to our
stockholders and that we are in full compliance with standard governance
policies and procedures.
Pending adoption by the stockholders at the next annual meeting, the Board
of Directors on April 8, 2004, approved an amendment to the our Restated
Certificate of Incorporation providing for the annual election of directors.
Previously the directors had been divided into three classes with the
stockholders electing approximately one-third of the members of the Board of
Directors at each annual meeting. If approved, the Amendment would call for the
annual election of each member of the Board of Directors, with each Director
being elected to serve a one-year term.
26
In August of 2002, the Board approved certain cash compensation to be paid
to non-employee directors. Because of the declared Controlled Company status, in
April 2004 the Board modified the plan so that only independent directors were
eligible for cash compensation. This action in effect results in Mr. Jeffries, a
principal of Millennium, not receiving any cash award. Our independent directors
(currently, Messrs. Ferraro, Norris, Turner and Vasilakos) will be paid the
following compensation: (i) an annual directorship retainer of $12,000, (ii) an
annual committee chair retainer of $4,000, (iii) $1,000 for each Board and
committee meeting attended and (iv) an annual option award of 2,000 shares under
our 2001 Incentive Stock Plan. All directors are entitled to reimbursement of
expenses for attending meetings.
Additionally, in December 2002, the Board created a special committee and
in recognition of the added responsibilities and demands of the work to be
performed by this committee, its members will receive additional compensation
of: (i) $1,000 for each meeting of the special committee attended in person,
(ii) $500 for each telephonic meeting, and (iii) $1,000 for each day committee
members devote a material portion of their business day to the affairs of the
committee.
Section 16(a) Beneficial Ownership Reporting Compliance
Under Section 16(a) of the Securities Exchange Act of 1934 our directors,
executive officers and any persons holding more than 10% of our Common Stock
(who we refer to as "Reporting Persons") are required to report their initial
ownership and any subsequent changes in that ownership to the Securities and
Exchange Commission. Such Reporting Persons are also required to furnish us with
copies of all Section 16(a) forms they file. Specific due dates for these
reports have been established and we are required to identify all Reporting
Persons who failed to timely file these reports.
To our knowledge, based solely on review of copies of such reports
furnished to us and written representations that no other reports were required,
during the fiscal year ended December 31, 2003, all the Reporting Persons
complied with applicable filing requirements, except:
D. Michael Talla, a director and executive officer, did not timely file a
Form 4 relating to a March 18, 2003 transaction.
Rex A. Licklider, a director and executive officer, did not timely file a
Form 4 relating to an April 8, 2003 transaction.
Philip J. Swain, an executive officer, did not timely file a Form 4
relating to an April 8, 2003 transaction.
Millennium did not timely file Forms 4 with respect to various transactions
that occurred in 2001 and 2002.
Each party subsequently filed the required report.
27
Code of Ethics
We have drafted a written code of ethics that applies to our principal
executive officers, principal financial officer, principal accounting officer
and other persons performing similar functions. This code of standards fulfills
the requirements recently imposed by the Securities and Exchange Commission and
covers such topics as conflict of interest, confidentiality, compliance with
legal requirements and other business ethics subjects. We have also drafted a
Code of Business Conduct for members of our Board of Directors. This code of
conduct seeks to guide our Board members in (i) recognizing and dealing with
ethical issues, (ii) fulfilling their fiduciary and oversight responsibilities
and (iii) establishing and maintaining mechanisms for reporting by our employees
of unethical conduct. Once approved, we intend to post these codes on our
website www.thesportsclubla.com in connection with our investor relations
materials. We further intend to promptly disclose on our website (i) the nature
of any amendment to these codes and (ii) the nature of any waiver, including an
implicit waiver, from a provision of our codes that is granted, the name of such
person who is granted the waiver and the date of the waiver. We presently rely
on the written policies in our Employee Handbook, as well as informal policies
and procedures, our directors' awareness of their fiduciary duties and our
employees' understanding of their responsibilities to the Company and our
shareholders to fulfill our duties as a public company. These policies may not
adequately protect us from all conflict of interest situations; therefore, it is
our intention in addition to the code of financial conduct and the code of
business conduct to also adopt: (i) corporate governance principles that will
establish oversight responsibilities for the conduct of our business and (ii) a
code of standards that will expand our current Employee Handbook and define how
all employees and directors will act in areas of professional conduct.
To demonstrate our commitment to operating fairly and ethically, we
currently require that each employee acknowledge receipt of our Employee
Handbook, which sets forth, among other things, our professional standards
requiring proper business conduct and confidentiality of proprietary
information. We are in the process of finalizing a contract with an independent
outside hotline provider to implement an anonymous avenue for the reporting of
employee concerns relating to our financial reporting.
ITEM 11. EXECUTIVE COMPENSATION
The table below shows, for the last three fiscal years, the amount of
compensation earned by the Co-Chief Executive Officers and the next four most
highly-compensated executive officers (the "Named Executive Officers"). The
current salaries of such executive officers are described below under
"Employment Agreements."
Long-Term
Compensation
Shares All Other
Annual Compensation Underlying Compensation
Name & Position Year Salary($) Bonus($) Options Awards ($)(a)
--------------- ---- ------------- -------------- ----------------- -----------
D. Michael Talla.......... 2003 200,000(b) -- -- 15,281
Chairman of the Board 2002 200,000(b) -- -- 17,814
2001 240,000(b) -- 115,000 17,979
Rex A. Licklider.......... 2003 200,000 -- -- 11,321
Chief Executive Officer and 2002 200,000 -- -- 14,184
Vice Chairman of the Board 2001 240,000 -- 115,000 14,613
Philip J. Swain........... 2003 160,000 -- -- 14,885
President and 2002 160,000 20,000 -- 17,385
Chief Operating Officer 2001 200,000 -- 21,733 16,923
Nanette Pattee Francini... 2003 160,000 -- -- 9,925
Executive Vice President 2002 160,000 20,000 -- 11,906
2001 200,000 -- 21,733 12,195
Mark S. Spino............. 2003 160,000 -- -- 14,291
Senior Vice President of 2002 160,000 20,000 -- 13,962
Development 2001 200,000 -- 21,733 17,913
Timothy M. O'Brien........ 2003 160,000 -- -- 12,102
28
Chief Financial Officer 2002 160,000 20,000 -- 15,953
and Assistant Secretary 2001 200,000 -- 21,733 17,913
----------
(a) Represents value of (i) amounts paid by us on behalf of the Named Executive
Officer and dependents for medical and life insurance and (ii) our Common
Stock contributed for the benefit of the Named Executive Officer under the
401K Profit Sharing Plan, based upon the December 31 closing market price
each year of our Common Stock, on the American Stock Exchange.
(b) Mr. Talla also receives, on an annual basis, 49.9% of the first $300,000 of
The Sports Club/LA - Los Angeles' net cash flow. This amount is not
included in Mr. Talla's compensation. See "Certain Relationships and
Related Transactions."
Option Grants, Exercises and Year-End Values
There were no option grants made to any Named Executive Officer during the
last fiscal year.
Unexercised Stock Options and Fiscal Year-End Option Values
None of the Named Executive Officers exercised stock options during the
last fiscal year. The following table provides information with respect to
unexercised stock options outstanding as of December 31, 2003.
Number of Shares Underlying Value of In-the-Money
Unexercised Options at Fiscal Unexercised Options at Fiscal
Year-End(a) Year-End(b)
----------------------------- -----------------------------
Exercisable Unexercisable Exercisable Unexercisable
Name (#) (#) ($) ($)
---- ------------ ------------- ------------ -------------
D. Michael Talla........ 326,667 38,333 -0- -0-
Rex A. Licklider........ 76,667 38,333 -0- -0-
Philip J. Swain......... 212,756 7,244 -0- -0-
Nanette Pattee Francini. 202,756 7,244 -0- -0-
Mark S. Spino........... 202,756 7,244 -0- -0-
Timothy M. O'Brien...... 232,756 7,244 -0- -0-
----------
(a) All options were granted pursuant to one of our two Stock Incentive Plans.
(b) The closing price of our Common Stock on the American Stock Exchange on
December 31, 2003 was $1.81. Since all options have been granted at prices
above $1.81, there are no options considered to be in-the-money.
Employment Agreements
The Company has no written employment agreements. Currently, our executive
officers receive the following salaries:
Rex A. Licklider Chief Executive Officer 200,000
Philip J. Swain President and Chief Operating Officer 180,000
Nanette Pattee Francini Executive Vice President 160,000
Mark S. Spino Senior Vice President 160,000
Timothy M. O'Brien Chief Financial Officer 160,000
On March 16, 2004, D. Michael Talla, founder and Chairman of the Board,
relinquished his position as Co-Chief Executive Officer. In light of this
change, the Compensation Committee is reviewing Mr. Talla's current salary
package and is expected to present their recommendations for future compensation
based solely on services rendered as Chairman at the next meeting of our Board
of Directors. Until our Board makes this determination, Mr. Talla will continue
to receive his current annual salary of $200,000.
29
Compensation of Directors
Our independent directors receive the following compensation:
o Annual retainer fee of $12,000,
o Annual retainer fee of $4,000 for each committee chair,
o $1,000 for eachBoard and committee meeting attended,
o Reimbursement of expenses for attending Board and committee meetings,
o Annual option award of 2,000 shares under our 2001 Incentive Stock
Plan (timing of such grant is at the discretion of the Board, and as
of June 15, 2004 no option awards have been granted).
Messrs. Turner, Vasilakos, Norris and Ferraro currently serve on the Board
as independent directors. Prior to April 2004, compensation for services on the
Board was given to non-employee directors. Therefore, Mr. Licklider received
amounts due non-employee directors until his appointment to Co-Chief Executive
Officer in February 2000; and until his resignation in June 2002, Mr. Dennison
T. Veru also received amounts due non-employee directors. From 2001 through his
resignation in 2004, Mr. Collins, because of his executive position with
Millennium, waived all cash compensation. All directors receive reimbursement of
reasonable out-of-pocket expenses incurred in connection with meetings of the
Board.
In December 2002, Messrs. Turner and Vasilakos were appointed to a special
committee, and in recognition of the added responsibilities and demands of the
work to be performed by them, Messrs. Turner and Vasilakos are to receive the
following additional compensation: $1,000 for each meeting of the special
committee attended in person, $500 for each telephonic meeting and $1,000 per
day on which they devote a material portion of their business day to the affairs
of the committee.
Following are the amounts paid to all directors for each of the last three
years:
Year Amount
---- ------
2001 $ 56,863
2002 68,502
2003 112,675
Under the Amended and Restated 1994 Stock Compensation Plan an aggregate of
50,000 shares of Common Stock was issued to non-employee directors through
December 31, 2003. There are no more shares available for issuance under this
current plan.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board (the "Committee") administers
executive compensation. Mr. Turner has been a member of the Committee since
September 13, 1994, and became its Chairman on February 27, 1995. Mr. Vasilakos
was appointed on August 2, 2002 following the resignation of Dennison Veru. Mr.
Norris was appointed to the Committee on February 25, 2003. Mr. Collins had been
a member of the Committee from 1998 until his resignation in April 2004. None of
these individuals has ever been an officer or employee.
30
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table shows the shares of our Common Stock beneficially owned
as of June 15, 2004 by our directors and Named Executive Officers. It also shows
other individuals or entities that beneficially owned more than 5% of our Common
Stock.
Shares Issuable
Shares Issuable upon
Shares Upon Exercise Shares Held Total and Percent of
Name and Address Owned Conversion of of Options Under Stock Ownership
of Beneficial Owner(a) Directly(b) Preferred Stock within 60 days(c) 401-K Plan(d) Number Percent
---------------------- --------- --------------- ----------------- ------ -------- --------
D. Michael Talla (e).................. 4,629,019 346,365 365,000 8,126 5,348,510 32.78
Nanette Pattee Francini (e)........... 256,107 -- 210,000 4,086 470,193 32.78
Mark S. Spino (e)..................... 227,969 -- 210,000 6,030 443,999 32.78
Philip J. Swain (e)................... 112,164 -- 220,000 6,002 338,166 32.78
Voting Trust (e)...................... 5,225,259 346,365 1,005,000 24,244 6,660,868 32.78
Timothy O'Brien....................... 3,000 -- 240,000 6,242 249,242 1.31
The Licklider Living Trust
Dated May 2, 1986 .................. 2,055,132 1,192,730 115,000 -- 3,362,862 16.74
Andrew L. Turner...................... 7,500 -- -- -- 176,683 21.53
Charles A. Norris(f).................. 3,500 173,183 -- -- 176,683 21.53
George J. Vasilakos................... 327,400 -- -- -- 327,400 1.74
Christopher M. Jeffries (g)........... 29,000 -- -- -- 29,000 42.28
Charles J. Ferraro.................... -- -- -- -- -- *
All Directors and Executive Officers
as a Group (11 persons)............. 7,650,791 1,712,278 1,360,000 30,486 10,753,555 49.20
Millennium (g)........................ 6,243,749 2,942,730 -- -- 9,186,479 42.28
Kayne Anderson Capital Advisors, L.P.(f) 797,128 4,136,833 -- -- 4,933,961 21.53
----------
* Less than 1%
(a) The address of all directors and executive officers is c/o The Sports Club
Company, Inc., at 11100 Santa Monica Blvd., Suite 300, Los Angeles,
California 90025.
(b) Includes shares for which the named person is considered the owner because:
1. the named person has sole voting and investment power,
2. the named person's spouse has voting and investment power, or
3. the shares are held by other members of the named person's immediate
family.
(c) Includes shares that can be acquired through stock option exercises through
August 14, 2004.
(d) Includes shares issued pursuant to our 401(k) Profit Sharing Plan's
discretionary match as of June 15, 2004.
(e) Named persons share voting power pursuant to a voting agreement that
requires each party to vote his or her shares in the manner determined by a
majority of all holders. The agreement is effective until October 20, 2004,
or until terminated by persons holding 66 2/3% of the shares of our Common
Stock subject to the agreement. Each of the parties to the voting agreement
effectively controls the voting of all shares held by the parties to the
agreement, and, under SEC rules, are deemed beneficial owners of the shares
subject to the agreement.
(f) Kayne Anderson Capital Advisors, L.P. and several of their affiliates are
owners of our Convertible Preferred Stock. Kayne Anderson is deemed to be
the beneficial owner of the shares. Mr. Norris is also deemed to
beneficially hold these shares because of his affiliation with Kayne
Anderson. Mr. Norris' ownership has therefore been reflected (1) next to
his name so that the table accurately reflects the share ownership of our
officers and directors and (2) in the totals for Kayne Anderson so that the
Kayne Anderson total accurately reflects their joint ownership as noted
below. The address of all such entities is 1800 Avenue of the Stars, Second
Floor, Los Angeles, California 90067.
31
The Preferred Stock carries voting rights and is convertible into shares of
Common Stock. The following table reflects the ownership of the Kayne
affiliates as to outstanding Common Stock currently owned and Common Stock
into which the preferred shares are convertible:
Outstanding
Common Series B Series D
Directly Convertible Convertible
Owner Held Preferred Preferred Total
----- ---- --------- --------- -----
Kayne Anderson Capital
Advisors, L.P.......... 793,628 3,073,990 -- 3,867,618
Ric Kayne................ -- 346,365 -- 346,365
Charles Norris........... 3,500 173,183 -- 176,683
Howard Zelikow........... -- 34,636 -- 34,636
David Shladovsky......... -- 8,659 -- 8,659
Arbco Associates, L.P.... -- -- 166,668 166,668
Kayne Anderson Non-
Traditional
Investments, L.P......... -- -- 166,666 166,666
Kayne Anderson Select
Investments A, L.P..... -- -- 166,666 166,666
--------- ----------- ---------- ----------
Total............... 797,128 3,636,833 500,000 4,933,961
========= =========== ========== ==========
(g) Millennium Entertainment Partners and several of their affiliates are
owners of our Common and our Preferred Stock. Millennium is deemed to be
the beneficial owner of the shares. Mr. Jeffries because of his position
with Millennium is also deemed to be a beneficial owner of these shares.
Mr. Jeffries' ownership has therefore been reflected (1) next to his name
so that the table accurately reflects the share ownership of our officers
and directors, and (2) in the totals for Millennium so that the Millennium
total accurately reflects their joint ownership as noted below. The address
of all such entities is c/o Millennium Partners Management LLC, 1995
Broadway, New York, New York, 10023.
The Preferred Stock carries voting rights and is convertible into shares of
Common Stock. The following table reflects the ownership of the Millennium
affiliates as to outstanding Common Stock currently owned and Common Stock
into which the preferred shares are convertible:
Outstanding
Common Series C Series D
Directly Convertible Convertible
Owner Held Preferred Preferred Total
----- ---- --------- --------- -----
Christopher M. Jeffries... 29,000 -- -- 29,000
Millennium Partners LLC... 2,253,863 -- -- 2,253,863
Millennium Development
Partners L.P............ 978,900 -- -- 978,900
MDP Ventures I LLC........ 72,100 -- -- 72,100
MDP Ventures II LLC....... 2,284,886 692,730 2,250,000 5,227,616
Millennium Entertainment
Partners L.P............ 625,000 -- -- 625,000
------------- ---------- ------------ -------------
6,243,749 692,730 2,250,000 9,186,479
============= ========== ============ =============
32
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
From time to time we have entered into transactions with our officers,
directors and stockholders. We believe that each of the following transactions
have been on terms no less favorable to us than could have been obtained from
unaffiliated third parties. All transactions between us and any of our directors
or officers are subject to the approval of the disinterested directors.
Millennium. Millennium is a partner in the Reebok-Sports Club/NY
partnership as well as the landlord of the building in which Reebok Sports
Club/NY is located. Reebok-Sports Club/NY partnership pays rent to Millennium in
the amount of $2.0 million per year, and the partnership agreement provides for
a first priority annual distribution of $3.0 million to Millennium. We are
entitled to certain additional priority distributions and 60% of the remaining
cash flow. Millennium's partnership interest entitles them to 20% of such
remaining cash flow.
In June 1997, we issued to Millennium 2,105,263 shares of our Common Stock
in exchange for $10.0 million. In December 1997, we sold 625,000 shares of
Common Stock to Millennium for $5.0 million. We also granted to Millennium
certain registration and preemptive rights regarding its shares.
We have entered into leases with Millennium relating to The Sports Club/LA
- San Francisco, The Sports Club/LA - Washington, D.C. and The Sports Club/LA -
Boston. On March 27, 2001, the leases were amended with Millennium's landlord
contribution increasing by $16.5 million in exchange for additional rent
payments. In addition, after we receive a management fee equal to 6% of all
revenues, an amount equal to our capital investment in the Boston and Washington
D.C. Clubs and an 11% annual return on the capital investment and an amount
equal to our operating investment in the Clubs and a 10% annual return on the
operating investment, Millennium is entitled to receive a percentage of all
additional cash flows from each Club as additional rent. Millennium's percentage
of the excess cash flow, as defined, previously was 20% for each of these Clubs.
Under the amended lease agreements, their percentage increases to 25% for the
Washington and Boston Clubs and 60% for the San Francisco Club. Millennium has
not received any payments to date under these provisions.
On November 24, 2003, we opened The Sports Club/LA - Miami as part of the
exclusive new Four Seasons Hotel and Tower in Miami, Florida. We operate this
40,000 square foot Club pursuant to a management agreement with Millennium, the
developer of the project. We will receive a fee of 6% of gross revenues and a
participation in the Club's net cash flow.
Mr. Talla. We have a 50.1% interest in the partnership that owns The Sports
Club/LA - Los Angeles and Mr. Talla beneficially owns the remaining 49.9%. The
partnership agreement provides that, on an annual basis, the partners will share
in the first $300,000 of the Club's net cash flow in proportion to their
percentage interests. The next $35.0 million of annual net cash flow will be
distributed to us. All distributions of net cash flow thereafter, if any, will
be made to the partners in proportion to their percentage interests. The Company
has the option to redeem the preferred partnership interest in the partnership
held by Mr. Talla. The option expires as of January 31, 2006. The preferred
partnership interest is carried at its redemption amount, which is $600,000 at
December 31, 2003.
As of May 4, 2001, we entered into a ten-year sublease for space located in
the building in which The Sports Club/LA - Upper East Side is located. The
sublease provides for two five-year renewal options and one seven-year renewal
option, an initial monthly rent of $125,000, and rental increases of 10% at the
end of each five-year period. The subtenant for this lease is Club at 60th
Street, Inc., a New York corporation owned by Mr. Talla.
33
Messrs. Talla and Licklider. In September 1999, we sold the property on
which the Spectrum Club - Thousand Oaks is located for a sales price of $12.0
million. We entered into a sale and leaseback agreement for the property under a
long-term lease with an initial annual base rent of $1.3 million. The Thousand
Oaks property consists of the Spectrum Club - Thousand Oaks, a SportsMed
facility, unimproved office space, and a parking ramp. We are currently
subleasing the Spectrum Club space to another club operator. Mr. Licklider owns
an approximate 4.6% interest in the purchaser of the property, and trusts for
the benefit of Mr. Talla's minor children own an approximately 5.2% interest in
the purchaser of the property.
Kayne Anderson. On March 18, 2002, we sold an aggregate of 10,500 shares of
Series B Convertible Preferred Stock to Kayne Anderson Capital Advisors and four
affiliates thereof for aggregate offering proceeds of $10.5 million. The shares
of Series B Preferred may, at the option of the holder, be converted into shares
of our Common Stock at a rate of $2.8871 per share; entitle each holder to one
vote for each share of Common Stock into which such Series B Preferred could
then be converted; and provide for the payment of dividends at an annual rate of
$90.00 per share. Dividends are cumulative, do not accrue interest and, at our
discretion, may be paid in additional shares of Series B Preferred.
Messrs. Talla and Licklider and Millennium. In consideration of executing a
guaranty in favor of Comerica-Bank - California (the "Bank") in connection with
the Bank's renewal of our $15.0 million credit facility (the "Credit Facility"),
Messrs. Talla and Licklider and MDP Ventures II, LLC, an affiliate of
Millennium, entered into agreements with us as of July 3, 2001, pursuant to
which we were obligated to pay an 1% percent annual commitment fee to each of
the guarantors. In addition to the commitment fee, we were obligated to pay to
each guarantor a usage fee equal to 2% per annum of such guarantor's pro rata
portion of any amounts advanced to us by the Bank. At our discretion all earned
commitment fees and usage fees under the agreements were paid in restricted
shares of Common Stock with each guarantor receiving in the aggregate 86,392
shares. In June 2003, we replaced the Credit Facility and, as of February 15,
2004, all payment obligations due the guarantors have been met.
Upon termination of the Credit Facility, on June 12, 2003, we entered into
a new promissory note with another financial institution. The new note is for
$20.0 million (the "Loan") and is guaranteed by Messrs. Talla and Licklider.
Messrs. Talla and Licklider entered into agreements with us as of December 1,
2003, pursuant to which we are obligated to pay a quarterly fee to each
guarantor equal to 3% per annum of their pro rata portion of the average
outstanding principal balance of the Loan. At our discretion, such fees may be
paid in Common Stock, cash or a combination thereof. The third quarter 2003 fee
was paid in stock with each guarantor receiving 28,509 shares. On May 20, 2004,
we paid the fourth quarter 2003 and the first quarter 2004 fees in Common Stock
and each guarantor received 80,269 shares. These obligations have been funded
out of Treasury Shares.
On September 6, 2002, we sold an aggregate of 5,000 shares of Series C
Convertible Preferred Stock to three of our major shareholders, D. Michael
Talla, Rex Licklider and MDP Ventures II, LLC, an affiliate of Millennium, for
aggregate offering proceeds of $5.0 million. The shares of Series C Preferred
may, at the option of the holder, be converted into shares of our Common Stock
at a rate of $2.8871 per share; entitle each holder to one vote for each share
of Common Stock into which such Series C Preferred could then be converted; and
provide for the payment of dividends at an annual rate of $90.00 per share.
Dividends are cumulative, do not accrue interest and, at our discretion, may be
paid in additional shares of Series C Preferred.
34
Mr. Licklider , Millennium and Kayne Anderson. On March 12, 2004, we sold
an aggregate of 65,000 shares of Series D Convertible Preferred Stock to these
three shareholders for aggregate proceeds of $6.5 million. The shares of Series
D Preferred may, at the option of the holders, be converted into shares of our
Common Stock at a rate of $2.00 per share; entitle each holder to one vote for
each share of Common Stock into which such Series D Preferred could then be
converted; and provide for the payment of dividends at an annual rate of $9.00
per share. Dividends are cumulative, do not accrue interest and, at our
discretion, may be paid in additional shares of Series D Preferred. Each share
of Series D Preferred shall automatically be converted into shares of Common
Stock upon the consummation of a qualified secondary stock offering of at least
$50.0 million or if the closing price of our Common Stock for a period of thirty
consecutive trading days exceeds $4.00 per share until March 15, 2005, or $6.00
per share thereafter, and at least 150,000 shares of Common Stock have been
traded during such applicable thirty day period. As part of the sale of the
Series D Preferred, we agreed that for so long as certain specified Common Stock
ownership is maintained, Mr. Licklider and Kayne Anderson each have the right to
designate one director and Millennium has the right to designate two directors,
one of whom must be independent. Pursuant to this agreement, Mr. Licklider is
currently serving as the designee of Mr. Licklider; Mr. Norris is currently
serving as the designee of Kayne Anderson and Messrs. Jeffries and Ferraro (an
independent board member) are currently serving as Millennium's designees.
35
PART IV
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
We were billed for the following services provided by KPMG LLC, our
principal independent accountants, during 2002 and 2003:
2002 2003
---- ----
Audit fees(1)........................... $ 129,500 $ 161,500
Audit related fees...................... 3,000 3,000
Tax fees................................ -- --
All other fees.......................... -- --
------------- -------------
Total................................... $ 132,500 $ 164,500
============= =============
(1) Audit fees include fees for (i) the audits of the Company's consolidated
financial statements, (ii) review of the unaudited condensed consolidated
interim financial statements included in quarterly reports and (iii) the
review of debt agreements and issuance of compliance letters.
The Audit Committee's policy is to pre-approve all audit and permissible
non-audit services provided by the independent accountants. These services may
include audit services, audit-related services, tax services, and other
services. Pre-approval is generally provided for up to one year and is detailed
as to the particular service or category of services. The Audit Committee may
also pre-approve particular services on a case-by-case basis. The Audit
Committee pre-approved 100% of the audit fees for the fiscal year ended December
31, 2003.
The Audit Committee determined that the provision of services discussed
above is compatible with maintaining the independence of KPMG LLC from the
Company.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements filed as part of this Report are listed in Item 8
of this Report.
(2) No other financial schedules have been included because they are not
applicable, not required or because required information is included
in the consolidated financial statements or notes thereto.
(3) The following exhibits are filed as part of this Report.
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
3.1 Restated Certificate of Incorporation S-1 33-79552 10/13/94
of the Registrant.
3.2 Bylaws of the Registrant. S-1 33-79552 10/13/94
3.3 Amendment to Bylaws dated February 1, 10-K/A 1-13290 10/14/97
1995.
3.4 Certificate of Designation of Series 8-K 1-13290 03/26/02
B Convertible Preferred Stock of the
Registrant.
36
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
3.5 Corrected Certificate of Designation 8-K 1-13290 09/09/02
of Series B Convertible Preferred
Stock of the Registrant.
3.6 Certificate of Designation of Series 8-K 1-13290 09/09/02
C Convertible Preferred Stock of the
Registrant.
3.7 Amendment No. 2 to Bylaws dated July 10-K 1-13290 03/31/03
21, 1999.
3.8 Certificate of Designation of Series 8-K 1-13290 03/18/04
D Convertible Preferred Stock of the
Registrant
4.1 Specimen Common Stock Certificate. S-1 33-79552 10/13/94
4.2 Rights Agreement by and between the 8-K 1-13290 10/06/98
Registrant and American Stock Transfer
& Trust dated as of October 6, 1998.
4.3 First Amendment to Rights Agreement 8-K 1-13290 03/15/99
by and between the Registrant and American
Stock Transfer & Trust entered into as of
February 18, 1999.
4.4 Indenture by and among Registrant, 8-K 1-13290 04/14/99
U.S. Bank Trust National Association
and the Subsidiary Guarantors
referred to therein, dated as of
April 1, 1999.
4.5 Registration Rights Agreement by and 8-K 1-13290 04/14/99
among the Registrant, Jeffries &
Company, Inc. and CIBC Oppenheimer
Corp., dated as of April 1, 1999.
4.6 Purchase Agreement by and among the 8-K 1-13290 04/14/99
Registrant, Jeffries & Company, Inc.
and CIBC Oppenheimer Corp., dated
March 29, 1999.
4.7 Second Amendment to Rights Agreement 10-K 1-13290 03/28/00
by and between the Registrant and American
Stock Transfer & Trust entered into as of
July 2, 1999.
37
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
4.8 Third Amendment to Rights Agreement 10-K 1-13290 03/30/01
by and between the Registrant and American
Stock Transfer & Trust made and entered into
as of April 27, 2000.
4.9 Fourth Amendment to Rights Agreement 8-K 1-13290 07/17/01
by and between the Registrant and American
Stock Transfer & Trust entered into as of
June 27, 2001.
4.10 Fifth Amendment to Rights Agreement 8-K 1-13290 09/9/02
by and between the Registrant and American
Stock Transfer & Trust entered into as of
September 6, 2002.
4.11 Sixth Amendment to Rights Agreement 10-K 1-13290 03/31/03
by and between the Registrant and American
Stock Transfer & Trust entered into as of
March 5, 2003.
4.12 Seventh Amendment to Rights Agreement 8-K 1-13290 04/17/03
by and between the Registrant and American
Stock Transfer & Trust entered into as of
April 14, 2003.
4.13 Eighth Amendment to Rights Agreement 8-K 1-13290 06/02/03
by and between the Registrant and American
Stock Transfer & Trust entered into as of
May 30, 2003.
4.14 Ninth Amendment to Rights Agreement 8-K 1-13290 07/31/03
by and between the Registrant and American
Stock Transfer & Trust entered into as of
July 30, 2003.
4.15 Tenth Amendment to Rights Agreement 8-K 1-13290 10/03/03
by and between the Registrant and American
Stock Transfer & Trust entered into as of
September 30, 2003.
38
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
4.16 Eleventh Amendment to Rights 8-K 1-13290 12/03/03
Agreement by and between the Registrant
and American Stock Transfer & Trust entered
into as of November 25, 2003.
4.17 Twelfth Amendment to Rights Agreement 8-K 1-13290 03/04/04
by and between the Registrant and American
Stock Transfer & Trust entered into as of
March 3, 2004.
4.18 Thirteenth Amendment to Rights 8-K 1-13290 03/18/04
Agreement by and between the Registrant
and American Stock Transfer & Trust entered
into as of March 10, 2004.
9.1 Voting Agreement among D. Michael S-1 33-79552 10/13/94
Talla, Nanette Pattee Francini, Mark
S. Spino, Peter Feinstein, Philip J.
Swain and FP II.
10.1 1994 Stock Incentive Plan. # S-1 33-79552 10/13/94
10.2 Form of Stock Option Agreement. # S-1 33-79552 10/13/94
10.3 Form of Stock Purchase Agreement. # S-1 33-79552 10/13/94
10.4 1994 Stock Compensation Plan. # S-1 33-79552 10/13/94
10.5 Form of Indemnification Agreement S-1 33-79552 10/13/94
between the Registrant and its
directors and certain officers.
10.6 Indemnification Agreement between the S-1 33-79552 10/13/94
Registrant and D. Michael Talla.
10.7 Indemnification Agreement between S-1 33-79552 10/13/94
Registrant and Rex A. Licklider.
10.8 Lease of premises for Reebok Sports S-1 33-79552 10/13/94
Club/NY located at 160 Columbus
Avenue, New York 10023 dated June 3,
1992.
10.9 Management Agreement effective as of S-1 33-79552 10/13/94
June 3, 1992, between R-SC/NY, Ltd.
and Pontius Realty, Inc.
39
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.10 License Agreement between Reebok S-1 33-79552 10/13/94
Fitness Centers, Inc. and R-SC/NY,
Ltd. dated June 3, 1992.
10.11 Letter Agreement regarding R-SC/NY S-1 33-79552 10/13/94
dated June 3, 1992.
10.12 Memorandum of Agreement between S-1 33-79552 10/13/94
Reebok Fitness Centers, Inc. and the
Company dated as of June 3, 1992.
10.13 Seventh Amendment and Restated S-1 33-79552 10/13/94
Agreement of Limited Partnership of
L.A./Irvine Sports Club, Ltd., a
California Limited Partnership, dated
as of October 12, 1994.
10.14 First Amendment to Seventh Amended S-1 33-79552 10/13/94
and Restated Agreement of Limited
Partnership of L.A./Irvine Sports
Club, Ltd., a California Limited
Partnership, dated as of October 12,
1994.
10.15 Form of Option Agreement by and S-1 33-79552 10/13/94
between D. Michael Talla, an
individual, TTO Partners, a
California Limited Partnership, and
Sports Club, Ltd., a California
Corporation, relating to L.A./Irvine
Sports Club, Ltd., a California
Limited Partnership.
10.16 Amended and Restated Agreement of S-1 33-79552 10/13/94
Limited Partnership of TTO Partners,
a California Limited Partnership,
dated June 30, 1992, as amended
January 1, 1993, January 4, 1993 and
February 12, 1994 and as assigned
January 1, 1993.
10.17 First Amended and Restated Agreement S-1 33-79552 10/13/94
of Limited Partnership of
Reebok-Sports Club/NY, Ltd. Dated as
of October 12, 1994.
10.18 Letter Agreement by and between S-1 33-79552 10/13/94
Reebok Fitness Centers, Inc. and the
Company dated October 12, 1994.
40
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.19 Amendment to First Amended and S-1 33-79552 10/13/94
Restated Agreement of Limited
Partnership of Reebok-Sports Club/NY,
Ltd. dated as of October 12, 1994.
10.20 Letter Agreement by and between S-1 33-79552 10/13/94
Reebok Fitness Centers, Inc. and the
Company, which became effective on
October 29, 1994.
10.21 License Agreement by and between S-1 33-79552 10/13/94
Reebok Fitness Centers, Inc. and the
Company, which became effective on
October 20, 1994.
10.22 Agreement by and among Reebok-Sports 10-K/A 1-13290 10/14/97
Club/NY Ltd., Talla New York, Inc.,
RFC, Inc., LMP Health Club Co.,
Millennium Entertainment Partners,
L.P. and Registrant dated as of
December 30, 1996.
10.23 Letter Agreement between Millennium 10-K/A 1-13290 10/14/97
Entertainment Partners, L.P. and the
Registrant dated as of March 13, 1997.
10.24 First Amendment to Option Agreement 10-K 1-13290 02/26/98
between D. Michael Talla and TTO
Partners dated May 27, 1997.
10.25 Amendment of Lease between Lincoln 10-K 1-13290 02/26/98
Metrocenter Partners, L.P. and
Reebok-Sports Club/NY Ltd. as of
January 31, 1998.
10.26 Lease Agreement between RCPI Trust 10-K 1-13290 03/25/99
and the Registrant as of February 27,
1998.
10.27 Amended and Restated Net Operating 10-K 1-13290 03/25/99
Lease among Hirschfeld Realty Club
Corporation and 328 E. 61 Corp., and
Vertical Fitness and Racquet Club,
Ltd., dated March 26, 1985.
41
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.28 Lease Modification Agreement by and 10-K 1-13290 03/25/99
among Hirschfeld Realty Corporation
and 328 E. 61 Corp., and Vertical
Fitness and Racquet Club, Ltd., dated
July 1, 1990.
10.29 Assignment and Assumption of Lease by 10-K 1-13290 03/25/99
and between Vertical Fitness and
Racquet Club, Ltd., and Bally
Entertainment Corporation dated
January 8, 1996.
10.30 Assignment of Lease executed by 10-K 1-13290 03/25/99
Hilton Hotels Corporation, as successor
to tenant, and agreed to and accepted by
the Registrant, dated April 15, 1998.
10.31 Second Amendment to Amended and 10-K 1-13290 03/25/99
Restated Net Operating Lease by and
among Hirschfeld Realty Club
Corporation and 328 E. 61 Corp., and
the Registrant dated April 15, 1998.
10.32 Note Payable issued by the Registrant 10-K 1-13290 03/25/99
to Hilton Hotels Corporation dated
April 15, 1998.
10.33 Amended and Restated 1994 Stock 10-K 1-13290 03/25/99
Incentive Plan as of June 2, 1998. #
10.34 Letter Agreement between the 10-K 1-13290 03/25/99
Registrant and Millennium Partners
LLC dated as of October 27, 1998.
10.35 First Amendment to Lease between RCPI 10-K 1-13290 03/25/99
Trust and the Registrant dated
October 30,1998.
10.36 Second Amendment to Lease between 10-K 1-13290 03/25/99
RCPI Trust and the Registrant dated
March 4, 1999.
10.37 Lease between CB-1 Entertainment 10-K 1-13290 03/25/99
Partners LP and S.F. Sports Club,
Inc. dated June 1, 1997.
10.38 Lease between 2200 M Street LLC and 10-K 1-13290 03/25/99
Washington D.C. Sports Club, Inc.
dated March 1999.
42
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.39 Fourth Amended and Restated Loan 8-K 1-13290 04/14/99
Agreement by and among the Registrant,
certain of its subsidiaries and Comerica
Bank-California, dated April 1, 1999.
10.40 Intercreditor Agreement by and among 8-K 1-13290 04/14/99
the Registrant, certain of its
subsidiaries, Comerica
Bank-California and U.S. Bank Trust
National Association, dated April 1, 1999.
10.41 Amended and Restated 1994 Stock 10-K 1-13290 03/28/00
Compensation Plan. #
10.42 Lease Agreement as of September 24, 10-K 1-13290 03/28/00
1999 between The Spectrum Club
Company, Inc. and West Hollywood
Property Limited Partnership and 2400
Willow Lane Associates Limited
Partnership.
10.43 Lease Agreement as of November 5, 10-K 1-13290 03/28/00
1999 by and between New Commonwealth
Center Limited Partnership and
Washington D.C. Sports Club, Inc.
10.44 Letter Agreement dated March 11, 1999 10-K 1-13290 03/28/00
amending the October 27, 1998 Letter
Agreement between the Registrant and
Millennium Partners, LLC.
10.45 Amendment adopted November 4, 1999 to 10-K 1-13290 03/28/00
the Registrant's 1994 Stock Incentive
Plan. #
10.46 Certificate representing Series B 10-K 1-13290 03/28/00
Senior Secured Notes.
10.47 First Amendment to Fourth Amended and 10-K 1-13290 03/28/00
Restated Loan Agreement among the
Registrant and certain of its
subsidiaries and Comerica Bank -
California as of December 3, 1999.
10.48 Form of The Sports Club Membership 10-K 1-13290 03/28/00
Agreements.
43
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.49 Second Amendment to Fourth Amended 10-K 1-13290 03/30/01
and Restated Loan Agreement among the
Registrant and certain of its subsidiaries
and Comerica Bank-California as of August 10,
2000.
10.50 Reaffirmation of Intercreditor and 10-K 1-13290 03/30/01
Subordination Agreement dated as of
August 10, 2000 among the Registrant
and certain of its subsidiaries and
U.S. Bank Trust, National Association.
10.51 First Supplemental Agreement of Lease 10-K 1-13290 03/30/01
made as of the 27th day of March,
2001 between CB-1 Entertainment
Partners, LP and S.F. Sports Club,
Inc.
10.52 First Supplemental Agreement of Lease 10-K 1-13290 03/30/01
made as of the 27th day of March 2001
between New Commonwealth Center
Limited Partnership and Washington
D.C. Sports Club, Inc.
10.53 First Supplemental Agreement of Lease 10-K 1-13290 03/30/01
made as of the 27th day of March 2001
between 2200 M Street LLC and
Washington D.C. Sports Club, Inc.
10.54 Third Amendment to Fourth Amended and 8-K 1-13290 07/17/01
Restated Loan Agreement entered into
as of June 1, 2001 by and among
Registrant and various of its
subsidiaries and Comerica Bank -
California.
10.55 Indemnification and Contribution 8-K 1-13290 07/17/01
Agreement entered into as of July 3,
2001 by and among the Registrant.,
Rex A. Licklider, D. Michael Talla
and MDP Ventures II LLC.
10.56 The Sports Club Company, Inc. 2001 10-K 1-13290 03/29/02
Stock Incentive Plan. #
44
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.57 Preferred Stock Purchase Agreement 8-K 1-13290 03/26/02
made as of March 18, 2002 by and among
Registrant and the holders of the Series B
Convertible Preferred Stock.
10.58 Investor Rights Agreement made as of 8-K 1-13290 03/26/02
the 18th day of March 2002 by and
between the Registrant and the
holders of the Series B Convertible
Preferred Stock.
10.59 Asset Purchase Agreement dated as of 10-K 1-13290 03/29/02
January 25, 2002, by and between SCC
Nevada, Inc. and LSI-Nevada, LLC.
10.60 Standard Form Lease between the 10-K 1-13290 03/29/02
Registrant and Club at 60th St., Inc.
for space located at 333 East 60th
Street, New York, dated May 4, 2001.
10.61 First Amendment to Lease by and among 10-K 1-13290 03/29/02
Registrant and Club at 60th St., Inc.
dated as of March 1, 2002.
10.62 Waiver of Covenant Compliance Letter 10-K 1-13290 03/29/02
Agreement between the Registrant and
Comerica Bank - California dated
March 14, 2002.
10.63 Fourth Amendment to Fourth Amended 8-K 1-13290 06/04/02
and Restated Loan Agreement and First
Amendment to Amended and Restated
Revolving Loan between the Registrant
and certain of its Subsidiaries and
Comerica Bank - California dated May
31, 2002.
10.64 Fifth Amendment to Fourth Amended and 8-K 1-13290 09/04/02
Restated Loan Agreement between the
Registrant and certain of its
Subsidiaries and Comerica Bank - California
dated August 30, 2002.
45
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.65 Reaffirmation of Intercreditor and 8-K 1-13290 09/04/02
Subordination Agreement dated as of
August 30, 2002 among the Registrant
and certain of its Subsidiaries and
U.S. Bank Trust, National Association.
10.66 Investors' Rights Agreement made as 8-K 1-13290 09/09/02
of September 6, 2002 by and between
the Registrant and the holders of the
Series C Convertible Preferred Stock.
10.67 Preferred Stock Purchase Agreement 8-K 1-13290 09/09/02
made as of September 6, 2002 by and
among the Registrant and the holders
of the Series C Convertible Preferred
Stock.
10.68 Sixth Amendment to Fourth Amended and 8-K 1-13290 11/12/02
Restated Loan Agreement by and among
the Registrant and certain of its
Subsidiaries, Comerica Bank -
California and KASCY, L.P. dated
October 31, 2002.
10.69 Consent and Reaffirmation of 8-K 1-13290 11/12/02
Intercreditor and Subordination
Agreement dated as of October 31,
2002 among the Registrant and certain
of its Subsidiaries, Comerica Bank -
California and U.S. Bank Trust,
National Association.
10.70 Fitness Club and Spa Management and X
Pre-Opening Service Agreement between
Terramark Brickell II, Ltd. and the
Registrant effective as of January 1,
2003.
10.71 First Supplement to Fitness Club and X
Spa Management and Pre-Opening
Services Agreement effective as of
January 1, 2003.
10.72 Waiver of Covenant Compliance Letter 10-K 1-13290 03/31/03
from Comerica Bank - California dated
March 26, 2003.
10.73 Promissory Note dated June 12, 2003 8-K 1-13290 06/18/03
in favor of Orange County's Credit
Union in the amount of $20,000,000.
46
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.74 Deed of Trust, Assignment of Rents, 8-K 1-13290 06/18/03
Security Agreement and Fixture Filing
dated as of June 12, 2003, made by
Irvine Sports Club, Inc. for the
benefit of Orange County's Credit
Union.
10.75 Reserve and Security Agreement made 8-K 1-13290 06/18/03
as of June 12, 2003 by Irvine Sports
Club, Inc. in favor of Orange
County's Credit Union.
10.76 Pledge and Security Agreement made as 8-K 1-13290 06/18/03
of June 12, 2003 by the Registrant
and Irvine Sports Club, Inc. in favor
of Orange County's Credit Union.
10.77 Indemnity and Guaranty Agreement X
entered into as of December 1, 2003
among the Registrant, Irvine Sports
Club, Inc., Rex A. Licklider and D.
Michael Talla.
10.78 Supplemental Indenture dated as of 8-K 1-13290 04/04/03
March 28, 2003 between the
Registrant, the Subsidiary Guarantors
and U.S. Bank Trust National
Association.
10.79 Supplemental Indenture dated as of X
February 4, 2004 between the
Registrant, the Subsidiary Guarantors
and U.S. Bank National Association.
10.80 Third Supplemental Indenture made as 8-K 1-13290 03/18/04
of March 9, 2004 between the
Registrant, the Subsidiary Guarantors
and U.S. Bank National Association.
10.81 Investors' Rights Agreement made as 8-K 1-13290 03/18/04
of March 10, 2004, by and among the
Registrant and the holders of the
Series D Convertible Preferred Stock.
10.82 Preferred Stock Purchase Agreement 8-K 1-13290 03/18/04
made as of March 10, 2004 by and among
the Registrant and the holders of the
Series D Convertible Preferred Stock.
47
Exhibit Incorporated by Reference Filed
----------------------------------------------
Number Exhibit Description Form File No. Filing Date Herewith
----------- --------------------------------------- ------------- ----------- -------------- ----------
10.83 Consent Letter dated March 10, 2004 8-K 1-13290 03/18/04
by holders of the Series B
Convertible Preferred Stock.
10.84 Consent Letter dated March 10, 2004 8-K 1-13290 03/18/04
by holders of the Series C
Convertible Preferred Stock.
21.1 Subsidiaries of the Registrant. X
23.1 Consent of Independent Registered X
Public Accounting Firm.
31.1 Certification of Rex A. Licklider X
Pursuant to Section 302 of the
Sarbanes - Oxley Act of 2002.
31.2 Certification of Timothy O'Brien X
Pursuant to Section 302 of the
Sarbanes - Oxley Act of 2002.
32.1 Certification of Rex A. Licklider X
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 X
Pursuant to 18 U.S.C. Section 1350,
as adopted Pursuant to Section 906 of
the Sarbanes - Oxley Act of 2002.
------------------
# Compensation agreement or plan.
48
(b) Reports on Form 8-K
The following reports on Form 8-K were filed from October 1, 2003 through
December 31, 2003:
o On October 3, 2003, we filed a report on Form 8-K announcing that on
September 29, 2003, the Special Committee of our Board of Directors
approved an amendment to our Rights Agreement adopted on September 29,
1998. The Amendment provides that until November 30, 2003, the Rights
Plan will not be triggered as a result of any non-binding "going
private" negotiations or understandings between and among the
principal shareholders, so long as such negotiations or understandings
relate to a transaction that has been, or is intended to be, proposed
to our special committee.
o On October 9, 2003, we filed a report on Form 8-K stating that on
October 8, 2003, we issued a press release announcing the opening of
The Sports Club/LA - Beverly Hills. The new Club opened on October 7,
2003 and is located in Beverly Hills, California. The Club, a
two-story 40,000 square foot luxury sports and fitness complex offers
a state-of-the art environment including a Bar and Lounge and spa
services.
o On October 14, 2003, we filed a report on Form 8-K stating that on
October 13, 2003, we issued a press release announcing that we had
mutually agreed with Palisade Concentrated Equity Partnership, L.P.
("Palisade") to set aside the previously announced offer of "going
private." We also stated that we expected to receive an amended letter
of intent setting forth the revised terms and conditions under which
Palisade would propose to make an $18.5 million equity investment in
us, subject to an additional investment by certain of our existing
stockholders, the proceeds of which would be retained by us to fund
operations.
o On November 3, 2003, we filed a report on Form 8-K stating that on
November 3, 2003, we issued a press release announcing operating
results for the third quarter and nine months ending September 30,
2003.
o On December 3, 2003, we filed a report on Form 8-K announcing that on
November 25, 2003, the Special Committee of our Board of Directors
approved an amendment to our Rights Agreement adopted on September 29,
1998. The Amendment provides that until February 29, 2004, the Rights
Plan will not be triggered as a result of any non-binding "going
private" negotiations or understandings between and among the
principal shareholders, so long as such negotiations or understandings
relate to a transactions that has been, or is intended to be, proposed
to our Special Committee.
49
(c) Exhibits
Index to Exhibits of Form 10-K
Exhibit
Number Exhibit
------ -------
10.70 Fitness Club and Spa Management and Pre-Opening Service
Agreement between Terramark Brickell II, Ltd. and the
Registrant effective as of January 1, 2003.
10.71 First Supplement to Fitness Club and Spa Management and
Pre-Opening Services Agreement effective as of January 1, 2003.
10.77 Indemnity and Guaranty Agreement entered into as of December 1,
2003 among the Registrant, Irvine Sports Club, Inc., Rex A.
Licklider and D. Michael Talla.
10.79 Supplemental Indenture dated as of February 4, 2004 between the
Registrant, the Subsidiary Guarantors and U.S. Bank National
Association.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Registered Public Accounting Firm.
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.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, on the 21st
day of June 2004.
THE SPORTS CLUB COMPANY, INC.
/s/ Rex A. Licklider
-----------------------------
Rex A. Licklider
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K has been signed below by the following persons on behalf of
the Registrant, in the capacities and on the date indicated.
Signature Title Date
------------------------------------------------------------------------------
/s/ Rex A. Licklider Vice Chairman of the Board June 21, 2004
---------------------------------
Rex A. Licklider and Chief Executive Officer
/s/ Timothy O'Brien Chief Financial Officer June 21, 2004
---------------------------------
Timothy M. O'Brien (Principal Financial and
Accounting Officer)
/s/ D. Michael Talla Chairman of the Board June 21, 2004
---------------------------------
D. Michael Talla
Director June 21, 2004
---------------------------------
Charles Ferraro
/s/ Christopher M. Jeffries Director June 21, 2004
---------------------------------
Christopher M. Jeffries
/s/ Charles Norris Director June 21, 2004
---------------------------------
Charles Norris
/s/ Andrew L. Turner Director June 21, 2004
---------------------------------
Andrew L. Turner
/s/ George Vasilakos Director June 21, 2004
---------------------------------
George Vasilakos
51