UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment 1)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended March 31, 2004
Commission File # 1-13290
THE SPORTS CLUB COMPANY, INC.
A Delaware corporation - I.R.S. No. 95-4479735
11100 Santa Monica Blvd., Suite 300, Los Angeles, CA 90025
(310) 479-5200
Indicate by check mark whether the company (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, during the preceding 12 months (or for such shorter period that the
company was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--------- -----------
Indicate the number of shares outstanding of each of the issuer's
classes of Common Stock, as of the latest practicable date.
Shares
Outanding at
Class June 21, 2004
------------------------------------- -----------------------------------
Common Stock, 18,783,744
par value $.01 per share
EXPLANATORY NOTE
This Amendment No. 1 on Form 10-Q/A (this "Amendment") to the Quarterly Report
of The Sports Club Company, Inc. on Form 10-Q for the fiscal quarter ended March
31, 2004, filed with the Securities and Exchange Commission (the "SEC") on June
21, 2004 (the "Original Filing") is being filed solely for the purpose of
responding to comments of the staff of the SEC received by us in connection with
our filing of a Form 8-K on July 12, 2004 and the periodic reports of the
Company referenced in that Form 8-K filing.
Item 4. Controls and Procedures has been amended to incorporate additional
disclosures requested by the SEC regarding certain reportable conditions in our
accounting controls and procedures identified by our independent auditor.
In connection with the filing of this Amendment and pursuant to the rules of the
SEC, we are including with this Amendment a currently dated signature page and
certain currently dated certifications as Exhibits 31.1, 31.2, 32.1 and 32.2.
None of these revisions change our previously reported net revenues, income from
operations, net income, income per share or cash flows for the periods included,
nor result in a restatement to our financial position or results of operations.
Except as described above, no other changes have been made to the Original
Filing, however, for the convenience of the reader we have restated the Original
Filing in its entirety, as amended pursuant to the description above, in this
Amendment.
This Amendment continues to speak as of the date of the Original Filing, and we
have not updated the disclosures contained therein to reflect any events that
occurred at a date subsequent to the filing of the Original Filing. Accordingly,
this Amendment should be read in conjunction with our subsequent filings with
the SEC.
1
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 2003 and March 31, 2004
(in thousands, except per share amounts)
(unaudited)
December 31, March 31,
ASSETS 2003 2004
---- ----
Current assets:
Cash and cash equivalents.............................................................. $ 1,932 $ 3,074
Accounts receivable, net of allowance for doubtful accounts of $517 and $464
at December 31, 2003 and March 31, 2004, respectively................................ 3,923 3,401
Inventories............................................................................ 994 1,028
Prepaid expenses....................................................................... 1,789 860
----------- -----------
Total current assets................................................................. 8,638 8,363
Property and equipment, net.............................................................. 155,173 153,480
Goodwill................................................................................. 7,660 7,660
Restricted cash.......................................................................... 4,432 4,381
Other assets............................................................................. 8,056 7,551
----------- -----------
$ 183,959 $ 181,435
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of notes payable and equipment financing loans.................... $ 2,099 $ 1,580
Accounts payable....................................................................... 2,464 2,647
Accrued liabilities.................................................................... 13,713 10,568
Deferred revenues...................................................................... 18,292 18,635
----------- -----------
Total current liabilities............................................................ 36,568 33,430
Notes payable and equipment financing loans,
less current installments.............................................................. 119,731 119,606
Accrued lease obligations................................................................ 8,976 9,183
Deferred revenues........................................................................ 869 796
Minority interest........................................................................ 600 600
----------- -----------
Total liabilities...................................................................... 166,744 163,615
Commitments and contingencies
Redeemable preferred stock, Series B, $.01 par value, 10,500 shares authorized;
10,500 shares issued and outstanding (liquidation preference of $12,198 and $12,435 at
December 31, 2003 and March 31, 2004, respectively).................................... 11,761 12,020
Stockholders' equity:
Preferred stock, $.01 par value, 919,500 shares authorized no shares issued or outstanding -- --
Preferred stock, Series C, $.01 par value, 5,000 shares authorized, issued and
outstanding (liquidation preference of $5,590 and $5,702 at December 31, 2003 and March
31, 2004, respectively).............................................................. 5,590 5,702
Preferred stock, Series D, $.01 par value, 65,000 shares authorized, issued and
outstanding (liquidation preference of $6,532 at March 31, 2004)..................... -- 6,139
Common stock, $.01 par value, 40,000,000 shares authorized; 21,074,717 shares issued... 211 211
Additional paid-in capital............................................................. 100,348 99,946
Accumulated deficit.................................................................... (86,217) (92,132)
Treasury stock, at cost, 2,650,003 and 2,451,511 shares at December 31, 2003
and March 31, 2004, respectively .................................................... (14,478) (14,066)
------------ ------------
Stockholders' equity............................................................... 5,454 5,800
------------ -----------
$ 183,959 $ 181,435
============ ===========
See accompanying notes to condensed consolidated financial statements.
2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2003 and 2004
(in thousands, except per share amounts)
(unaudited)
Three Months Ended
March 31,
2003 2004
---- ----
Revenues:
Membership revenues.............................. $ 32,403 $ 35,921
Reimbursed costs................................. 258 1,257
----------- ---------
Total revenue.................................. 32,661 37,178
Operating expenses:
Direct........................................... 26,349 30,042
Reimbursed costs................................. 258 1,257
General and administrative....................... 1,973 2,046
Selling.......................................... 1,367 1,531
Depreciation and amortization.................... 2,960 3,172
Pre-opening expenses............................. 139 46
Non-recurring items.............................. -- 1,104
----------- ---------
Total operating expenses....................... 33,046 39,198
----------- ---------
Loss from operations......................... (385) (2,020)
Other income (expense):
Interest, net.................................... (3,280) (3,688)
Minority interests............................... (38) (38)
------------ ---------
Loss before income taxes ..................... (3,703) (5,746)
Provision for income taxes.......................... 192 168
----------- ---------
Net loss..................................... (3,895) (5,914)
Dividends on Preferred Stock....................... 348 381
------------ ---------
Net loss attributable to common stockholders. $ (4,243) $ (6,295)
============ ==========
Net loss per share:
Basic and diluted................................. $ (0.23) $ (0.34)
============ ===========
Weighted average shares outstanding:
Basic and diluted................................. 18,160 18,565
============= ==========
See accompanying notes to condensed consolidated financial statements.
3
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2003 and 2004
(in thousands)
(unaudited)
Three Months Ended
March 31,
2003 2004
---- ----
Cash flows from operating activities:
Net loss..................................................................... $ (3,895) $ (5,914)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization........................................... 2,960 3,172
Related party costs settled with common stock........................... 233 412
(Increase) decrease in:
Accounts receivable, net............................................. 573 522
Inventories.......................................................... (79) (34)
Other current assets................................................. 244 929
Other assets, net.................................................... (621) 505
Increase (decrease) in:
Accounts payable..................................................... (368) 183
Accrued liabilities.................................................. (3,298) (3,145)
Deferred revenues.................................................... (955) 270
Accrued lease obligations............................................ 923 207
------------ ------------
Net cash used in operating activities............................. (4,283) (2,893)
Cash flows from investing activities:
Capital expenditures.................................................... (1,227) (1,479)
Decrease in restricted cash............................................ -- 51
------------ ------------
Net cash used in investing activities............................. (1,227) (1,428)
Cash flows from financing activities:
Proceeds from issuance of Series D Preferred Stock, net of issuance costs -- 6,107
Proceeds from notes payable and equipment financing loans............... 3,650 --
Repayments of notes payable and equipment financing loans............... (522) (644)
------------ ------------
Net cash provided by financing activities......................... 3,128 5,463
------------ ------------
Net increase (decrease) in cash and cash equivalents.............. (2,382) 1,142
Cash and cash equivalents at beginning of period................................ 3,185 1,932
------------ ------------
Cash and cash equivalents at end of period...................................... $ 803 $ 3,074
============ ============
Supplemental disclosure of cash flow information:
Cash paid for interest.................................................. $ 5,780 $ 6,092
============ ============
Cash paid for income taxes.............................................. $ 11 $ 465
============ ============
See accompanying notes to condensed consolidated financial statements.
4
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 and March 31, 2004
1. Basis of Presentation
The unaudited condensed consolidated financial statements included
herein have been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission ("SEC"). The condensed consolidated
financial statements should be read in conjunction with the Company's December
31, 2003, consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K and Form 10-K/A (SEC File Number 1-13290).
Certain information and footnote disclosures which are normally included in
financial statements prepared in accordance with United States generally
accepted accounting principles have been condensed or omitted pursuant to SEC
rules and regulations for interim financial statements. The Company believes
that the disclosures made are adequate to make the information presented not
misleading. The information reflects all adjustments that, in the opinion of
management, are necessary for a fair presentation of the financial position and
results of operations for the interim periods set forth herein. All such
adjustments are of a normal and recurring nature. The results for the
three-month period ended March 31, 2004, are not necessarily indicative of the
results for the fiscal year ending December 31, 2004.
2. 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
5
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.
3. Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. On March 31, 2004,
cash and cash equivalents were $3,074,000.
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 restricted
cash. At March 31, 2004, the Company had $4.4 million of restricted cash.
4. Notes Payable and Equipment Financing Loans
Notes payable and equipment financing loans are summarized as follows:
December 31, March 31,
2003 2004
---- ----
(in thousands)
Senior secured notes (a)............$ 100,000 $ 100,000
Mortgage note (b)................... 19,855 19,781
Equipment financing loans (c)....... 1,975 1,405
-------------- --------------
121,830 121,186
Less current installments........... 2,099 1,580
-------------- --------------
$ 119,731 $ 119,606
============== ==============
---------
(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 March 31,
2004, 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:
6
Period Percentage
------ ----------
Prior to March 15, 2005................. 102.844%
Thereafter.............................. 100.000%
(b) 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 promissory
loan 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 the Company's Chairman and it's Chief
Executive Officer. The note requires The Sports Club/LA - Orange County
to maintain a minimum operating income, as defined, or the Company will
be required to establish a payment reserve account of up to $607,000.
As of March 31, 2004, 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.
(c) The equipment financing loans are secured by furniture, fixtures
and equipment. The amounts are generally repayable in monthly payments
over four or five years with effective interest rates between 3.5% and
13.3%.
5. Non-recurring Item
The non-recurring charge of $1.1 million during the three months
ended March 31, 2004 represents various costs, primarily legal fees and
investment banking fees, related to an equity raising transaction that was
initiated in April 2003 and cancelled in February 2004.
6. Income Tax Provision
The income tax provision recorded for the three months ended March 31,
2004 and three months ended March 31, 2003, was the result of an accrual for
state and city income taxes related to pre-tax profits at Reebok Sports Club/NY.
7. Net Loss per Share
Basic loss per share represents the net loss less Preferred Stock
dividends divided by the weighted-average number of shares of Common Stock
outstanding for the period. Diluted loss per share excludes the dilutive effect
of potential common shares. For the three months ended March 31, 2004, there
were 2,982,683 anti-dilutive potential common shares. For the three months ended
March 31, 2003, there were 2,438,782 anti-dilutive potential common shares.
8. 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
7
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 Convertible Preferred Stock (See Note 9), an
amount equal to $1,000 for each share of Series B Preferred then outstanding.
The initial carrying value of the Series B Preferred was recorded at
its "fair value" (sale price less costs to issue) on the date of issuance. The
carrying value of the Series B Preferred will be periodically adjusted so that
the carrying value equals the redemption value on the redemption date. The
carrying value of the Series B Preferred will also be periodically adjusted for
any accrued and unpaid dividends. At December 31, 2003 and March 31, 2004, the
Series B Preferred carrying value consisted of the following ($ in thousands):
December 31, March 31,
2003 2004
---- ----
Initial fair value, sale price of $10,500
less costs to issue of $592................$ 9,908 $ 9,908
Redemption value accretion...................... 155 177
Accrued and unpaid dividends accretion.......... 1,698 1,935
------------ -----------
Total carrying value........................$ 11,761 $ 12,020
============ ===========
9. 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, less some minor issuance costs, 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 dividends. 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
8
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 $1,000 for each
share of Series C Convertible Preferred then outstanding, plus earned and unpaid
dividends.
The carrying value of the Series C Convertible Preferred is
periodically adjusted for any accrued and unpaid dividends. The Series C
Convertible Preferred dividends are accrued because they must be paid
concurrently with any redemption of the Series B Preferred. At December 31, 2003
and March 31, 2004, the Series C Convertible Preferred carrying value consisted
of the following (in thousands):
December 31, March 31,
2003 2004
---- ----
Initial fair value...........................$ 5,000 $ 5,000
Accrued and unpaid dividend accretion........ 590 702
------------ ------------
Total carrying value at March 31, 2004.......$ 5,590 $ 5,702
============ ============
10. Series D Preferred Stock
On March 12, 2004, the Company completed a $6.5 million private
placement of a newly created series of Convertible Preferred Stock. The Company
received $6.1 million in cash, after issuance costs of $393,000, and issued
65,000 shares of $.01 par value Series D Convertible Preferred Stock ("Series D
Convertible Preferred"), at a price of $100 per share. The Series D Convertible
Preferred was purchased by three of the Company's 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.
Accordingly, the Company has recorded such Series D Convertible Preferred
dividends. 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 offering of Common Stock of at least $50.0 million
or if the closing price of the Common Stock for a period of thirty consecutive
trading days exceeds $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
9
plus any earned and unpaid dividends. In the event of liquidation, the Series D
Convertible Preferred holders are entitled to receive, prior and in preference
to any distribution to common shareholders and holders of the Series B Preferred
and Series C Convertible Preferred, an amount equal to $100 for each share of
Series D Convertible Preferred then outstanding, plus any earned and unpaid
dividends. The holders of the Series D Convertible Preferred are afforded
protective rights that among other things restrict the Company's ability to
incur debt or lease obligations, make investments or acquisitions, sell a Club
leased from Millennium, issue any new class of equity securities, repurchase or
redeem any equity securities, hire or fire the Chief Executive Officer, enter
into any new line of business or change the primary line of business and issue
options under the Company's stock option plans. In addition, Millennium is
entitled to designate two directors (at least one of whom must be independent)
and the other two holders are each entitled to designate one director, to serve
on the Company's Board of Directors.
The carrying value of the Series D Convertible Preferred is
periodically adjusted for any accrued and unpaid dividends. The Series D
Convertible Preferred dividends are accrued because they must be paid prior to
any redemption of the Series B Preferred. At March 31, 2004, the Series D
Convertible Preferred carrying value consisted of the following (in thousands):
Initial fair value......................... $ 6,500
Issuance costs (393)
Accrued and unpaid dividend accretion...... 32
-----------------
Total carrying value at March 31, 2004..... $ 6,139
=================
11. Litigation
The Company is involved in various claims and lawsuits incidental to
its business, including claims arising from accidents. However, in the opinion
of management, the Company is adequately insured against such claims and
lawsuits involving personal injuries, and any ultimate liability arising out of
any such proceedings, whether insured or not, will not have a material adverse
effect on the Company's consolidated financial condition, cash flows or results
of operations.
12. Accounting for Stock-Based Compensation
The Company has elected to account for stock options granted to
employees and directors under the provisions of APB Opinion No. 25, using the
intrinsic value method. Entities electing to continue using the accounting
prescribed by APB Opinion No. 25 must make pro forma disclosures of net income
and income per share, as if the fair value based method of accounting defined in
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 income (loss) attributable to common stockholders and
income (loss) per share would have been reduced to the pro-forma amounts
indicated below:
10
Three Months Ended March 31,
----------------------------
2003 2004
---- ----
(in thousand, except per share data)
Net loss attributable to common
stockholders, as reported................................... $ (4,243) $ (6,295)
Stock-based employee compensation expense
included in reported net loss............................... -- --
Stock-based employee compensation expense
determined under fair value based method
for all awards.............................................. (164) (93)
----------------- -----------------
Adjusted net loss attributable to
common stockholders......................................... $ (4,407) $ (6,388)
================= =================
Net loss per share as reported, basic and
diluted..................................................... $ (0.23) $ (0.34)
================= =================
Adjusted net loss per share, basic and diluted................ $ (0.24) $ (0.34)
================= =================
13. New Accounting Pronouncements
Consolidation of Variable Interest Entities
In December 2002, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, an interpretation of ARB 51 ("FIN
46"). The primary objectives of FIN 46 are to provide guidance on the
identification of entities for which control is achieved through means other
than through voting right (variable interest entities, or "VIE") and how to
determine when and which business enterprise should consolidate the VIE (the
primary beneficiary). In December 2003, the FASB modified and issued a revised
Interpretation ("FIN 46R"). FIN 46R clarifies the interpretation's scope and
also extends 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
adoption of FIN 46 did not have a material impact on the accompanying
consolidated financial statements.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of our historical results of operations and
our liquidity and capital resources should be read in conjunction with the
condensed consolidated financial statements and related notes appearing
elsewhere herein. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosures. On an on-going
basis, we evaluate our estimates and judgments that are based on historical
experience and other assumptions that we believe to be reasonable under the
circumstances. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements.
Overview
We are the operator of ten sports and fitness Clubs located in major
metropolitan markets across the United States, including one Club operated under
a management agreement. Our Clubs are spacious, modern facilities that typically
include spas, restaurants, fitness centers, swimming pools and basketball
courts. Our Clubs, which are usually named The Sports Club/LA are recognized as
among the finest sports and fitness facilities in the United States. In 1999, we
decided to focus our efforts on the national development of The Sports Club/LA
brand. At that time, we sold all of our smaller sized Clubs. We also issued
$100.0 million of Senior Secured Notes due in March 2006. The proceeds from
these transactions were 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 evaluate 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 for 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.
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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 38.8% of total Club revenue and we believe that
percentage is among the highest in the industry. We believe that membership
levels are the primary indicator of a Clubs ability to generate revenue.
Therefore, we are consistently generating programs to market the Clubs to
potential new members as well as striving to reduce our membership attrition
rates. We believe our current attrition rate of 24.2% 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
13
payments as initiation fees and no revenue was recorded for the free products or
services bundled with new memberships.
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 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 March 31,
2004.
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 reperformed the transitional impairment test
and determined that goodwill was impaired as of January 1, 2002 by, $5,134,000.
This amount was expensed in our 2002 financial statements. We are required to
evaluate goodwill for impairment on at least 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
Comparison of Three Months Ended March 31, 2004 to Three Months Ended March 31,
2003.
Our revenues for the three months ended March 31, 2004, were $37.2
million, compared to $32.7 million for the same period in 2003, an increase of
$4.5 million or 13.8%. Revenue increased by $1.7 million as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Revenue
increased by another $1.7 million at the five new Clubs opened in 2001 and 2002
primarily as a result of an 8.2% increase in membership at these Clubs and to
annual rate increases for monthly dues and other ancillary services. Revenue
increased by $1.0 million as a result of increased cost reimbursements due us
from our
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management of The Sports Club/LA-Miami, a non-owned Club in Florida. Revenue
increased by $94,000 at our SportsMed subsidiary primarily due to increased
patient visits and revenue increased by $81,000 due to increased management fees
earned from our management of The Sports Club/LA-Miami. Revenue decreased by
$54,000 at our three mature Clubs primarily due to a 2.9% decrease in membership
which was partially offset by annual rate increases for monthly dues and other
ancillary services.
Our direct expenses increased by $3.7 million (14.0%) to $30.0 million
for the three months ended March 31, 2004, versus $26.3 million for the same
period in 2003. Direct expenses increased by $1.9 million as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Direct expenses
increased by $1.3 million at the five Clubs opened in 2000 and 2001 primarily as
a result of an increase in variable direct expenses associated with the 10.0%
revenue growth that occurred at these five Clubs between March 31, 2003 and
March 31, 2004. Direct expenses increased by $474,000 at our three mature Clubs
and our SportsMed subsidiary primarily due to increased payroll costs. Direct
expenses as a percent of revenue for the three months ended March 31, 2004,
increased to 80.8% from 80.7% for the same period in 2003. As membership levels
and therefore revenues increase at the five Sports Club/LA Clubs opened in 2000
and 2001, the direct expense percentage should decrease. There is no assurance,
however, that such membership or revenue growth will occur.
Reimbursed costs were $1.3 million for the three months ended March 31,
2004, versus $258,000 for the same period in 2003, an increase of $999,000.
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 advance on the owner's behalf. Management fees
and reimbursed costs are recorded as revenue and the reimbursed costs are also
recorded as expenses in our consolidated financial statements. The effect of
reimbursed costs on our loss from operations is therefore zero, since reimbursed
costs are both reported as revenue and as operating costs in our consolidated
financial statements. The reimbursed costs of $258,000, for the three months
ended March 31, 2003, represent pre-opening expenses incurred by us on the
owner's behalf. The reimbursed costs of $1.3 million, for the three months ended
March 31, 2004, represent operating costs of the Club, which opened in November
2003. The increase for the period of $999,000 is due to the Club becoming fully
operational.
Our general and administrative expenses remained flat at $2.0 million
for both the three months ended March 31, 2004 and the three months ended March
31, 2003. Payroll expense for the three months ended March 31, 2004 increased by
$55,000, primarily due to compensation increases, but were offset by minor
changes in various other general and administrative expense categories. General
and administrative expenses decreased as a percentage of revenue to 5.5% for the
three months ended March 31, 2004, from 6.0% for the same period in 2003. 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 were $1.5 million for the three months ended March
31, 2004, versus $1.4 million for the same period in 2003, an increase of
$164,000 or 12.0%. Selling expenses increased by $177,000 as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003 and decreased by
$13,000 at our other Clubs. Selling expenses as a percentage of revenue
decreased to 4.1% for the three months ended March 31, 2004, from 4.2% for the
same period in 2003.
15
Our depreciation and amortization expenses were $3.2 million for the
three months ended March 31, 2004, versus $3.0 million for the same period in
2003, an increase of $212,000 or 7.2%. Depreciation and amortization expenses
increased by $165,000 as a result of the opening of The Sports Club/LA-Beverly
Hills on October 7, 2003 and by $47,000 primarily due to capital additions made
at our other Clubs during 2003 and 2004.
Pre-opening expenses of $46,000 and $139,000 for the three months ended
March 31, 2004 and three months ended March 31, 2003, respectively, consisted of
expenses related to The Sports Club/LA-Beverly Hills, which opened on October 7,
2003.
We recorded a non-recurring charge of $1.1 million during the three
months ended March 31, 2004. This charge is comprised of various costs,
primarily legal fees and investment banking fees, related to a "Going
Private/Equity Investment" transaction that was initiated in April 2003 and
cancelled in February 2004.
Our net interest expense increased by $408,000 (12.4%) to $3.7 million
for the three months ended March 31, 2004, versus $3.3 million for the same
period in 2003. Net interest expense increased by $401,000 as a result of
interest incurred on a new $20.0 million five-year mortgage loan, which closed
on June 12, 2003. A portion of the proceeds from this new mortgage loan were
used to payoff, and then cancel, a $10.0 million credit line with our bank.
Net interest expense increased by $67,000 primarily due to loan guarantee fees
incurred on the new $20.0 million mortgage loan and decreased by $60,000
primarily due to a reduction of equipment financing loans and increased interest
earned on invested cash balances.
The tax provisions recorded for the three months ended March 31, 2004
and 2003 are 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 losses incurred
for the three months ended March 31, 2004 and 2003. After the tax provisions and
dividends on preferred stock of $381,000 in 2004 and $348,000 in 2003, our
consolidated net loss attributable to common shareholders, was $6.3 million or
$0.34 per basic and diluted share for the three months ended March 31, 2004
versus a loss of $4.2 million or $0.23 per basic and diluted share for the three
months ended March 31, 2003.
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
16
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.
Below is a reconciliation of EBITDA to net income ($'s in thousands):
Quarter Ending
March 31, 2004
--------------
EBITDA .......................................... $ 1,114
Depreciation and amortization.................... (3,172)
Interest, net.................................... (3,688)
Provision for income taxes....................... (168)
-----------------
Net loss .......................................... $ (5,914)
==================
Liquidity and Capital Resources
Liquidity
Historically, we have satisfied our liquidity needs through various
debt arrangements, sales of Common or Preferred Stock and cash flows 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 issued $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.
17
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 March 31, 2004 was $3.1 million. During 2004, our
earnings before interest, taxes, depreciation and amortization ("EBITDA") were
$1.1 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.
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 approximately $600,000 in the first quarter of 2004. 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 approximately
$900,000 in the first quarter of 2004. We estimate that expenditures of between
2% and 4% of revenues, depending on the age of the Club, will be necessary to
maintain the quality of the Clubs to our satisfaction. We also expect to spend
approximately $600,000 during the next year to upgrade our management
information systems and enhance our disaster recovery capabilities.
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 Hills 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 March
31, 2004, approximately $430,000 of construction costs are accrued and unpaid 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.
18
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 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 January 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.
The Indenture allows us to incur up to $10.0 million of equipment
financing obligations. At March 31, 2004, we had $1.4 million of equipment
financing obligations outstanding and would be allowed to finance an additional
$8.6 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.
Other than our normal operating activities and capital expenditures,
our total cash requirements for our existing operations through March 31, 2005
are estimated to be as follows (amounts in thousands):
Indenture interest........................... $ 11,375
Information system upgrades.................. 600
Payments on long-term debt................... 3,065
-------------
$ 15,040
-------------
-------------
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Impact of Inflation
We do not believe inflation has had a material impact on our
consolidated results of operations. We cannot provide assurance that future
inflation will not have an adverse impact on our consolidated operating results
and financial condition.
Seasonality of Business
Seasonal trends have a limited impact on our operations. We typically
experience a slight increase in membership sales in the first quarter.
Additionally, we normally experience a slight decrease in our ancillary revenues
during the summer months at our east coast Clubs due to lower membership
attendance
Forward Looking Statements
From time to time we make "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements include the words
"may," "will," "estimate," "continue," "believe," "expect" or "anticipate" and
other similar words. The forward-looking statements generally appear in the
material set forth under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations" but may be found in other
locations as well. Forward-looking statements may also be found in our other
reports filed with the Securities and Exchange Commission and in our press
releases and other public disclosures. These forward-looking statements
generally relate to our plans and objectives for future operations and are based
upon managements' reasonable estimates of future results or trends. Although we
believe that our plans and objectives reflected in or suggested by such
forward-looking statements are reasonable, such plans or objectives may not be
achieved. Actual results may differ from projected results due to unforeseen
developments, including developments relating to the following:
o the availability and adequacy of our cash flow and financing
facilities for our requirements, including payment of the Senior
Secured Notes and mortgage note,
o our ability to attract and retain members, which depends on
competition, market acceptance of new and existing sports and fitness
clubs and services, demand for sports and fitness club services
generally and competitive pricing trends in the sports and fitness
market,
o our ability to successfully develop 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.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are also exposed to risk from a change in interest rates to the
extent we are required to refinance existing fixed rate indebtedness at rates
higher than those prevailing at the time the existing indebtedness was incurred.
As of March 31, 2004, we had Senior Secured Notes totaling $100.0 million due in
March 2006. Annual interest of $11.4 million is payable semi-annually in March
and September. At March 31, 2004, the fair value of the Senior Secured Notes is
approximately $95.0 million. We also have a $19.8 million loan with a fixed
interest rate of 7.25% that matures and requires a final principal payment of
$18.3 million on July 1, 2008. A change in interest rates of 1% would impact our
interest expense by approximately $1.2 million per year.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our management, with the participation of our Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"), has evaluated the effectiveness of
our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act") as of the end of the quarterly period ended March 31, 2004. This
evaluation included a review of the steps management undertook in an effort to
ensure that information required to be disclosed in its Exchange Act filings is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission (the "SEC"), in
light of certain deficiencies in our controls and procedures identified by our
independent auditor, KPMG LLP ("KPMG"), as more particularly described below.
Based on such evaluation and input from KPMG, the CEO and CFO concluded that, as
of the end of such period, these deficiencies have caused our disclosure
controls and procedures not to be effective at a reasonable assurance level.
In performing its audit of our Consolidated Financial Statements for
the year ended December 31, 2003, KPMG noted a matter involving our internal
controls that it considered a "reportable condition", as defined under standards
established by the American Institute of Certified Public Accountants. A
"reportable condition", which may or may not be deemed a material weakness,
involves matters relating to significant deficiencies in the design or operation
of internal controls that, in KPMG's judgment, could adversely affect our
ability to record, process, summarize and report financial data consistent with
the assertions of management in the financial statements.
The reportable condition, which KPMG considered to be a material
weakness, was that we do not have adequate internal controls over the
application of new accounting principles or the application of existing
accounting principles to new transactions. In this regard, KPMG noted that,
during their review of our financial statements for the quarter ended March 31,
2003, we had not properly accounted for private training revenues. In addition,
in connection with their audit of our financial statements for the year ended
December 31, 2003, KPMG determined that we were not properly accounting for our
management arrangement with The Sports Club/LA-Miami; that we had not properly
followed Financial Accounting Standard No. 142 relating to goodwill; and that we
had not properly accounted for the accretion of dividends on our Series C
Convertible Preferred Stock. Finally, KPMG suggested that we needed to consider
additional staffing in our accounting department, and take other action (such as
encouraging attendance at training seminars on new accounting rules and
pronouncements) to ensure that we have the expertise and resources to implement
new
21
accounting standards and apply existing accounting standards to new
transactions. KPMG's observations were summarized in its letter dated June 16,
2004, to the Audit Committee of the Board of Directors.
In connection with the completion of the 2003 audit, our accounting
personnel worked with, and considered the recommendations of, KPMG in accounting
for private training revenues, goodwill, management fees and dividend accrual on
our Series C Convertible Preferred Stock. They conducted detailed validation
work on these accounts to substantiate the accuracy of the financial information
and related disclosures contained in this Form 10-Q. The accounting personnel
reviewed the requirements of Financial Accounting Standards 142 to understand
the methodology underlying the accounting treatment of goodwill and continue to
monitor any new developments or changes in accounting treatment or policies for
these assets to ensure that they are accurately disclosed in our financial
statements.
As a result of KPMG's observations, the Audit Committee has
authorized and directed management to devise and implement actions to address
these deficiencies and to enhance the reliability and effectiveness of our
internal controls over financial reporting and to provide reasonable assurance
that our disclosure controls and procedures allow for the accurate presentation
and timely filing of our financial statements. Our accounting personnel have
reviewed their reporting and certification obligations under the Exchange Act
and the Sarbanes Oxley Act of 2002, and have consulted with our outside counsel
with respect to those obligations. We are now performing regular analyses of
revenues attributable to private training and management fees. In addition, our
accounting personnel have determined that if there should occur any changes in
existing accounting rules or policies, or if accounting principles are adopted,
which apply to our financial accounts (particularly with respect to the manner
in which private training revenues, management fees, goodwill and dividend
accrual is accounted for), such matters will be brought to the attention of our
independent auditor and, if necessary, outside counsel to ensure that all
required disclosures are accurate and complete and are made in a timely fashion.
We have assigned a high priority to both the short-term and long-term
strengthening of these controls and have identified certain additional measures
which we believe will address the conditions identified by KPMG as a material
weakness, including the following:
o engaging an independent accounting or financial consulting firm
(other than the our independent auditor) to consult with us on accounting
issues, including the interpretation of new accounting rules and releases
promulgated by the SEC, the Financial Accounting Standards Board and other
organizations, and the application of accounting principles to new transactions
in which we engage;
o creating and maintaining a written "log" in which new FASB, EITF,
SOP and other accounting rules and pronouncements are recorded. The log will
include a description of the new rule or pronouncement; whether or not it amends
or modifies an existing rule or pronouncement; its applicability to us or any
transactions in which we have engaged, or propose to engage; and the appropriate
accounting ramifications of the new rule or pronouncement. Management intends to
submit this log to the Audit Committee and its independent auditors on a
quarterly basis, as part of their respective financial statement review;
o subscribing to selected professional publications that discuss new
accounting rules and regulations applicable to reporting companies, and
encouraging our accounting personnel to attend seminars and other presentations
which focus on new accounting and financial disclosure rules and pronouncements;
and
22
o establishing an internal audit procedure to ensure that
transactional recording, transactional review and adherence to applicable
accounting policies and principles are observed.
Management believes that the foregoing measures will address the
conditions identified as a material weakness by KPMG. We will continue to
monitor and evaluate the effectiveness of our disclosure controls and procedures
and our internal controls over financial reporting on an ongoing basis, and are
committed to taking further action and implementing additional enhancements or
improvements, as necessary. We believe that these measures are reasonably likely
to have a material impact on our internal controls over reporting in future
periods.
(b) Changes in internal controls.
Except as described above, there have been no changes in our internal
controls over financial reporting (as those terms are defined in Rules 13a-15(f)
under the Exchange Act) that have materially affected, or are reasonably likely
to materially affect, its internal controls over financial reporting.
23
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
We are involved in various claims and lawsuits incidental to our
business, including claims arising from accidents. However, in the opinion of
management, we are adequately insured against such claims and lawsuits involving
personal injuries, and any ultimate liability, whether insured or not, arising
out of any such proceedings will not have a material adverse effect on our
consolidated financial condition, cash flows or results of operations.
Item 2. Changes in Securities
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
offering of Common Stock of at least $50.0 million or if the closing price of
the Common Stock for a period of thirty consecutive trading days exceeds $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 Convertible C 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.
24
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
31.1 Certification of Rex A. Licklider pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Timothy O'Brien pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Rex A. Licklider pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Timothy O'Brien pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
b) The following reports on Form 8-K have been filed since January 1,
2004:
February 19, 2004. We filed a report on Form 8-K announcing that three
of our principal shareholders had agreed to purchase $6.5 million of a newly
created class of Series D Convertible Preferred Stock in a private placement
offering. The proceeds will be used to provide working capital and to pay the
March 15, 2004 interest payment on our Senior Secured Notes. In a related
development, we stated that we had mutually agreed with Palisade Concentrated
Equity Partnership, L.P. to terminate any further discussions relating to an
equity investment by Palisade in us.
March 4, 2004. We filed a report on Form 8-K stating that on February
28, 2004, the Special Committee of the Board of Directors approved an amendment
to our Rights Agreement adopted on September 29, 1998. The Amendment provides
that until March 31, 2004, the Rights Plan will not be triggered as a result of
any arrangement or understandings between and among the Investor Stockholders
(as defined in the Amendment as "certain of Millennium Partners, L.P., Rex A.
Licklider and Kayne Anderson Capital Advisors, and their respective Affiliates")
resulting from (i) discussions or negotiations regarding a private purchase of
newly issued shares of Series D Convertible Preferred Stock or any modification
of such transaction, so long as such negotiations or understandings relate to a
transaction that has been, or is intended to be, proposed to the Special
Committee, or (b) the execution of the Series D Preferred Stock Purchase
Agreement, so long as the purchase agreement and all related documents and
instruments contemplated thereby, and the issuance of the Series D
25
Preferred are approved in advance of the consummation of the purchase by both
the Special Committee and our Board of Directors.
March 18, 2004. We filed a report on Form 8-K stating that D. Michael
Talla, founder and chairman of the Board had relinquished his position as
Co-Chief Executive Officer.
We also announced that we completed a $6.5 million private placement of
a newly created Series D Preferred Stock. The entire offering was purchased by
Rex A. Licklider, affiliates of Kayne Anderson Capital Advisors, and affiliates
of Millennium. The proceeds of the offering were used to make our March 15, 2004
interest payment on our Senior Secured Notes.
We also announced that the Special Committee of our Board of Directors
approved an amendment to our Rights Agreement adopted on September 29, 1998. The
amendment provides that the Rights Agreement will not be triggered as a result
of the acquisition of any shares of Common Stock issued to any Series D
Preferred Stockholder upon conversion of any Series D Preferred Stock.
We also announced that we amended our Indenture entered into on April
1, 1999. The amendment stated that consummation of the Series D Preferred Stock
sale did not constitute a change of control under the Indenture and the terms of
the Indenture that prescribe the respective rights and obligations of the
Company and the noteholders upon the occurance of a change in control were
waived.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SPORTS CLUB COMPANY, INC.
Date: August 18, 2004 by /s/ Rex A. Licklider
---------------------------------
Rex A. Licklider
Chief Executive Officer
(Principal Executive Officer)
Date: August 18, 2004 by /s/ Timothy M. O'Brien
---------------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and
Accounting Officer)
27
EXHIBIT 31.1
CERTIFICATIONS
I, Rex A. Licklider, Chief Executive Officer of The Sports Club Company, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The Sports
Club Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures (as of the end of the period covered by this
report based on such evaluation); and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's first
fiscal quarter in the case of this quarterly report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal controls over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls over financial reporting.
Dated, August 18, 2004
/s/ Rex A. Licklider
--------------------------------------
Rex A. Licklider
Chief Executive Officer
28
EXHIBIT 31.2
CERTIFICATIONS
I, Timothy O'Brien, Chief Financial Officer of The Sports Club Company, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of The Sports
Club Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures (as of the end of the period covered by this
report based on such evaluation); and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's first
fiscal quarter in the case of this quarterly report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal controls over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls over financial reporting.
Dated, August 18, 2004
/s/ Timothy O'Brien
--------------------------------------
Timothy O'Brien
Chief Financial Officer
29
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of The Sports Club Company, Inc. (the
"Company") on Form 10-Q/A for the period ending March 31, 2004 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Rex A.
Licklider, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. (Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act
of 2002, that to my knowledge:
(i) The Report fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(ii) The information contained in the Report
fairly represents, in all material respects, the financial condition and result
of operations of the Company.
/s/ Rex A. Licklider
--------------------------------------
The Sports Club Company, Inc.
Chief Executive Officer
August 18, 2004
30
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of The Sports Club Company, Inc. (the
"Company") on Form 10-Q/A for the period ending March 31, 2004 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Timothy
O'Brien, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
(Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of
2002, that to my knowledge:
(i) The Report fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(ii) The information contained in the Report
fairly represents, in all material respects, the financial condition and result
of operations of the Company.
/s/ Timothy O'Brien
--------------------------------------
The Sports Club Company, Inc.
Chief Financial Officer
August 18, 2004
31