UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT

For the transition period from                      to                     

The Sports Club Company, Inc.

(Exact name of registrant as specified in its charter)

Delaware		95-4479735
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
11100 Santa Monica Blvd., Suite 300
Los Angeles, California		90025
(Address of registrant’s principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code: (310) 479-5200
Securities registered pursuant to Section 12(b) of the Act:		Name of each exchange on which
Title of each class		registered
Common Stock $.01 par value		American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:		None

     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 o No þ

     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. o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No þ

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No o

     As of June 30, 2004, the aggregate market value of the Common Stock, par value $.01 per share, (the only class of common equity of the registrant outstanding) held by non-affiliates was $7,184,586.

 

 

PART I

ITEM 1. BUSINESS

General

     We were incorporated in Delaware 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 our Clubs in Los Angeles and Orange County.

     According to the International Health, Racquet & Sportsclub Association (“IHRSA”), the industry’s leading trade organization, it is estimated that 39.4 million Americans were members of more than 20,000 sports and fitness clubs in 2003. Revenues generated by the United States sports and fitness club industry increased at a compound annual rate of 7.7% from $7.8 billion in 1995 to $14.1 billion in 2003. 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

Sale of Assets and Debt Restructuring

     In December 2004, we committed to a plan and came to an understanding to sell six of our nine sports and fitness complexes to an affiliate of Millennium Partners for $65.0 million. Millennium Partners (collectively with its affiliates “Millennium”) is our largest stockholder and is our landlord at four of these Clubs. The Clubs to be sold include our three facilities located in New York City, and single Clubs in Boston, Massachusetts, Washington D.C. and San Francisco, California. In addition, our management agreement for the Club in Miami, Florida will be assigned to Millennium. Based on the following (i) we have $100 million of terms loans which are due in March 2006, (ii) Millennium is the landlord at four of the Clubs which are part of this transaction and they are the owner of the Club in Miami and therefore have an interest in these Clubs and (iii) Millennium has representation of the Board of Directors and have access to the financial information relating to these Clubs, management concluded that, as of December 31, 2004, the sale was probable and is expected to occur prior to December 31, 2005. On February 8, 2005, we entered into a formal letter of intent with Millennium. Following the sale, we will continue to own and operate our three Southern California Clubs. The letter of intent is nonbinding is subject to the execution of definitive agreements and the satisfaction of a number of other conditions. We have formed a Special Committee of our Board of Directors to approve the transaction. The proposal to sell assets will be evaluated by the Special Committee and its independent financial advisor, Barnett & Partners LLC. Since signing of the letter of intent, we have actively negotiated the terms of the definitive asset purchase agreement and have reached an understanding on substantially all the terms of the agreement with Millennium. We expect to execute the definitive asset purchase agreement in October 2005.

     As part of the proposed transaction, we intend to arrange for new financing secured by our real property in West Los Angeles and use a portion of the proceeds from the asset sale and new financing to retire our outstanding $100.0 million of Senior Secured Notes due in March 2006.

     We previously announced a potential “going private” transaction in connection with the foregoing sale of assets and debt restructuring. We do not presently contemplate that such a transaction will be consummated in connection with the sale of assets and debt restructuring. However, following consummation of the foregoing transactions we intend to continue to consider transactions to retire some of our outstanding Common or Preferred Stock.

     We are actively negotiating the foregoing transactions and while we expect to successfully conclude them we have not entered into binding agreements for any of them and can give no assurances that any or all the proposed transactions will be completed.

Issuance of Preferred Stock

     On September 14, 2004, we completed a $2.0 million private placement of a newly created series of Preferred Stock. We received $2.0 million in cash and issued 20,000 shares of $.01 per value Series E Preferred Stock at a price of $100 per share. Proceeds from the sale were primarily used to make our September 15, 2004 interest payment on our Senior Secured Notes. At any time after May 31, 2006, provided we are legally able to do so, (i) we may redeem all or part of the Series E Preferred Stock for cash at the redemption price of $100 per share, together with all accrued but unpaid dividends or (ii) the holders of at least 50% of the Series E Preferred Stock may demand that we redeem all the shares of the Series E Preferred Stock by paying the redemption price in cash to each holder of the Series E Preferred Stock.

     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.

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:

	•		large, fully equipped gyms with state-of-the-art fitness equipment, including weight training, cardio- vascular equipment, flexibility centers and functional performance areas,
	•		basketball, volleyball, racquetball, squash, tennis and paddle tennis courts,
	•		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,
	•		group cycling studios,
	•		rock climbing walls,
	•		boxing studios,
	•		swimming pools, sundecks, golf practice nets and running tracks,
	•		destination city spa offering massage, facials and full body treatments,
	•		men’s and women’s locker rooms featuring wood lockers,
	•		steam rooms, saunas and Jacuzzis,

	•		restaurants, sports bars, private dining/conference rooms and media centers,
	•		valet parking, pro shops, hair salons and childcare services,
	•		sports medicine and physical therapy facilities,
	•		personal trainers to develop and supervise members’ exercise routines,
	•		registered dietitians for nutritional consultations,
	•		FitLab assessment centers,
	•		PTS Private Trainer System nutritional programs and products,
	•		interactive children’s classes, as well as supervised age-specific junior recreation rooms and junior programs such as gymnastics, martial arts and dance,
	•		instruction in racquet sports, golf, swimming, boxing, martial arts and rock climbing,
	•		full-time activities directors responsible for social and media events for members, including organizing trips, lectures and charity events,
	•		sports instructors who present sports tournaments, leagues and classes, and
	•		wellness protocols such as exercise regimens designed for specific groups of members.

     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”) 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 22^nd 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 2003. 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 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. SportsMed also operated facilities within the Spectrum Club — Valencia, the Spectrum Club - Thousand Oaks and in a stand-alone facility in Calabasas, California. In October 2004, we sold these three locations to another physical therapy operator.

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 of New York City. 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 in prime, metropolitan locations that, like the project containing 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 each and offer services typically found at other Sports Club/LA sites.

     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. Four of these Clubs are now operating at a positive cash flow level while two Clubs are still building the membership base necessary to achieve this level. We believe that our revenues from these two Clubs will increase as membership levels mature. However, because of the significant occupancy costs at the Clubs, they may not achieve positive cash flows.

Future New Club Developments

     The completion of The Sports Club/LA at six 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 financing to develop additional new sites. Therefore, our primary focus is now on selling existing assets to reduce our outstanding debt and improving the operating performance of our existing Clubs. We are pursuing The Sports Club/LA developments at new sites that are financially structured to 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 provided all funds necessary to construct and equip 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.

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 facilities and services provided and 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 emphasizes personalized service and instruction and the creation of an “urban country club” atmosphere in which members can relax and socialize. Our marketing efforts at established Sports Club/LA locations 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.

     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. We believe that corporations are favorably disposed to The Sports Club/LA 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 of 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 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; 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.

     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 and the type of membership. The Sports Clubs’ market rate for initiation fees range from $400 to $2,900 and monthly membership dues range from $115 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 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 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 obtained full protection under Federal trademark laws for our SportsMed subsidiary name, Splash, the name of our spas, and For Kids Only, our childcare and children’s fitness program, as each such name is used in conjunction with its stylized design. We believe our trademarks and other proprietary rights are significant elements in our marketing and branding strategies and we aggressively protect all such rights.

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.

Employees

     At August 31, 2005, we had 2,592 employees, most of who are employed on a part-time basis in Club operating activities such as aerobics, private training and food and beverage services. At August 31, 2005, we employed 1,039 full-time employees, 960 of whom were involved in The Sports Club/LA operations such as sales, management, private training, food and beverage or support staff, 23 of whom work for our SportsMed subsidiary and 56 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/.

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. Our owned real property is pledged to secure our $100 million of outstanding Senior Secured Notes due in March 2006 and our $19.5 million mortgage note.

     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

     We remain obligated under lease agreements for six 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, terrorism and business interruption insurance. 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

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, 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 Ended December 31, 2004:
First Quarter			2.35				1.80
Second Quarter			1.72				1.45
Third Quarter			1.75				1.26
Fourth Quarter			1.84				1.62
Year Ending December 31, 2005:
First Quarter			1.95				1.39
Second Quarter			1.95				1.46
Third Quarter (through September 15th)			1.69				1.37

     As of September 15, 2005, we had 65 stockholders of record and approximately 270 non-objecting beneficial owners. The closing price of our Common Stock as reported by the American Stock Exchange (“AMEX”) on September 15, 2005 was $1.45.

     On September 13, 2004, AMEX notified us that we had not met certain of the AMEX continued listing standards as set forth in Sections 1003(a)(i), 1003(a)(ii) and 1003(a)(iv) of the AMEX Company Guide. We were afforded an opportunity to respond and on October 21, 2004, submitted a plan to comply with the AMEX listing standards. On November 29, 2004, AMEX approved our plan and granted us an extension of time to regain compliance with the continued listing standards. 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, or March 13, 2006, could result in our Common Stock being delisted from the AMEX.

     On April 20, 2005, AMEX notified us that we had not met certain of the AMEX continued listing standards, specifically sections 134 and 1101, due to our failure to timely file our annual report on Form 10-K for the fiscal year ended December 31, 2004. Our failure to timely file our quarterly report on Form 10-Q for the quarter ended March 31, 2005 has triggered an additional deficiency under Sections 1003(d), 134 and 1101.

     On June 13, 2005, due to our continued inability to file our financial reports, AMEX notified us of its determination to prohibit the continued listing of our Common Stock on AMEX and to initiate delisting proceedings. We requested a hearing before the Listing Qualifications Panel of the AMEX Committee on Securities (the “Panel”) to appeal the AMEX determination and on August 8, 2005, we appeared before the Panel to present our case. Based on the written and oral presentations made at the hearing, the Panel has deferred its decision on the delisting of our Common Stock to September 30, 2005. We expect to file the required financial reports on or before September 30, 2005 and to make further written submissions to the Panel in advance of the determination date. Until the Panel’s final determination and the expiration of any exception granted, our Common Stock will continue to be traded on 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.

Equity Compensation Plan Information

     The following information summarizes our equity compensation plans as of December 31, 2004.

		Number of Securities
		to be Issued Upon				Weighted Average
		Exercise of				Exercise Price of				Number of Securities
		Outstanding Options,				Outstanding Options,				Remaining Available
Plan Category		Warrants and Rights				Warrants and Rights				for Future Issuance
Equity compensation plans approved by security holders:
The Sports Club Company, Inc. 2001 Stock Incentive Plan			350,839				3.1087				2,149,161
The Sports Club Company, Inc. 1994 Stock Incentive Plan (as amended and restated June 3, 1998)			837,494				5.5054				—
The Sports Club Company, Inc. Amended and Restated 1994 Stock Compensation Plan (1)			—				—				—
Equity compensation plans not approved by security holders:
No such plans			—				—				—
Total			1,188,333				4.7978				2,149,161

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

     The following table presents our summary financial and operating data for the fiscal years ended December 31, 2000 through 2004 and has been derived from our consolidated financial statements. Such consolidated financial statements and summary financial and operating data have been reclassified 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,
		2000				2001				2002				2003				2004
		(Dollars in thousands, except per share data)
Statement of Operations Data:
Revenues:
Membership revenues		$	26,127			$	27,155			$	23,694			$	25,141			$	29,433
Products and services			13,462				13,164				11,350				11,904				14,239
Total revenues			39,589				40,319				35,044				37,045				43,672
Operating expenses:
Club operating costs			14,750				15,703				11,033				12,567				17,647
Cost of products and services			10,583				11,061				8,816				9,517				12,398
Selling and marketing			1,364				1,376				936				1,043				1,492
General and administrative			7,112				8,116				7,114				7,517				8,148
Pre-opening expenses			125				405				130				2,258				46
Impairment charge			—				5,044				—				—				—
Depreciation and amortization			2,963				3,571				3,532				3,706				4,369
Other			—				—				—				—				1,104
Total operating expenses			36,897				45,276				31,561				36,608				45,204
Income (loss) from operations			2,692				(4,957	)			3,483				437				(1,532	)
Other income (expense):
Interest, net			(1,924	)			(4,616	)			(4,909	)			(5,440	)			(6,580	)
Minority interests			(150	)			(150	)			(150	)			(150	)			(149	)
Other			(3,242	)			—				97				—				—
Loss from continuing operations before income taxes and loss on discontinued operations			(2,624	)			(9,723	)			(1,479	)			(5,153	)			(8,261	)
Provision (benefit) for income taxes			(2,231	)			14,299				(900	)			—				—
Loss from continuing operations			(393	)			(24,022	)			(579	)			(5,153	)			(8,261	)
Loss on discontinued operations			(12,111	)			(16,656	)			(22,168	)			(13,221	)			(12,496	)
Net loss			(12,504	)			(40,678	)			(22,747	)			(18,374	)			(20,757	)
Dividends on Preferred Stock			—				—				888				1,400				1,871
Net loss attributable to common stockholders		$	(12,504	)		$	(40,678	)		$	(23,635	)		$	(19,774	)		$	(22,628	)
Net loss per share attributable to common stockholders (basic and diluted):
Discontinued operations		$	(0.68	)		$	(0.93	)		$	(1.23	)		$	(0.72	)		$	(0.67	)
Continuing operations			(0.02	)			(1.34	)			(0.08	)			(0.36	)			(0.54	)
Net income (loss) per share		$	(0.70	)		$	(2.27	)		$	(1.31	)		$	(1.08	)		$	(1.21	)
Weighted average number of common shares outstanding:
Basic and diluted			17,773				17,939				18,080				18,316				18,733

		At December 31,
		2000				2001				2002				2003				2004
Membership Data:
Continuing Operations:
Beginning Membership			19,546				20,111				20,528				15,522				17,916
New Sales			5,877				6,471				4,015				6,426				5,466
Attrition			5,312				6,054				3,918				4,032				4,266
Sold Clubs			—				—				5,103				—				—
Ending Membership			20,111				20,528				15,522				17,916				19,116
Discontinued Operations:
Beginning Membership			9,754				18,463				27,971				33,355				35,461
New Sales			11,354				15,307				13,097				12,089				12,117
Attrition			2,645				5,799				7,713				9,983				10,338
Ending Membership			18,463				27,971				33,355				35,461				37,240

		At December 31,
		2000				2001				2002				2003				2004
		(Dollars in thousands)
Balance Sheet Data:
Cash and cash equivalents		$	11,059			$	1,482			$	3,185			$	1,932			$	7,559
Restricted cash			6,996				—				227				4,432				3,403
Property and equipment, net			70,440				67,860				57,788				65,530				63,622
Assets held for sale			135,823				175,246				164,278				154,659				143,408
Total assets			250,598				261,043				243,261				245,498				231,542
Deferred membership revenue (Short and Long-Term)			4,577				4,797				4,233				5,499				6,630
Long-term debt including current installments			110,331				115,491				104,040				121,830				119,730
Liabilities related to assets held for sale (Current and Non-Current)			41,614				85,383				86,907				85,347				85,169
Redeemable Preferred Stock (Series B and Series E)			—				—				10,727				11,761				14,796
Stockholders’ equity (deficit)			82,793				42,469				24,145				5,454				(9,258	)

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 primarily utilized to develop five new Clubs in New York City, Washington D.C., Boston and San Francisco. We have since opened The Sports Club/LA in Beverly Hills and in Miami.

     Most of our Clubs range in size from 90,000 to 140,000 square feet. Due to the size of these facilities and the additional amenities included in our Clubs, we spend significant amounts to construct a new facility. We compare the results of our Clubs based upon how long the Clubs have been open at the most recent measurement period. We categorize Clubs as either mature or recently opened. Mature Clubs are those Clubs at which we believe the membership levels have reached a stable level and based upon the amount of new membership sales and attrition, or the size of the Club, we do not believe a significant additional growth in the membership level will occur. Clubs are considered to be recently opened while the membership level is increasing. Three of the Clubs that we own are considered to be mature while the other six are considered to be recently opened. Five of these Clubs were opened between 2000 and 2001 while The Sports Club/LA – Beverly Hills was opened in October 2003. Newly developed Clubs tend to achieve significant increases in revenues until a mature membership level is reached. Recently opened Clubs that have not yet achieved mature membership levels have operated at a loss or only a slight profit as a result of fixed expenses that, together with variable operating expenses, approximate or exceed membership fees and other revenues. Since 2000, we have invested significant amounts of cash in the construction and operation of these new Clubs. Our operating performances and our liquidity have been negatively impacted due to the start up nature of these Clubs and the initial construction cost.

     In February 2005, we entered into a letter of intent to sell six of our nine sports and fitness complexes for $65.0 million. The Clubs to be sold include our three New York facilities and single Clubs in Boston, Washington D.C. and San Francisco. In addition, the management agreement for the Club in Miami will be terminated. Following the sale, we will continue to own and operate our three Southern California Clubs. The operating results from the six Clubs to be sold and the fees and costs associated with the Miami management agreement have been classified as Discontinued Operations in the accompanying financial statements and in the other parts of this Form 10-K.

     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 for all Clubs. Secondly, we generate ancillary revenue from our membership within each Club. The largest of these revenues comes from individual private training. We also generate revenues from our spas, restaurants, childcare, sports programs and guest fees. Our total ancillary revenues represent 37.9% of total Club revenue and we believe that percentage is among the highest in the industry. We believe that membership levels are the primary indicator of a Clubs ability to generate revenue. Therefore, we are consistently generating programs to market the Clubs to potential new members as well as striving to reduce our membership attrition rates. We believe our current attrition rate of 27% is well below the norm in the industry.

     Our direct expenses include costs to operate our Clubs. These consist primarily of payroll and employee benefits, rent and other occupancy related costs, supplies, repairs, costs of products sold and various other operating costs. A significant amount of these costs are fixed in nature.

     General and administrative expenses include costs related to our centralized support functions such as accounting, information technology, development and our executive management. Costs associated with being a publicly owned company are also included in this category. Selling expenses include our advertising, marketing department and promotional costs associated with the generation of new memberships.

Critical Accounting Policies and Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of the assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base these estimates and assumptions upon historical experience and existing known circumstances. Actual results could differ from those estimates. Specifically, we must make estimates in the following areas:

     Revenue Recognition. We receive initiation fees and monthly membership dues from our members. Substantially all of our members join on a month-to-month basis and can therefore cancel their membership at any time. The transaction in which we receive initiation fees may include free private training sessions. Under Emerging Issues Task Force 00-21, “Revenue Arrangement with Multiple Elements,” we determined that the initiation fees and private training sessions did not represent separate units of accounting. Accordingly, initiation fees and related direct expenses, primarily sales commissions, are deferred and recognized, on a straight line basis, over a period of three years, which represents the average life of a membership based upon historical data for all Clubs. Dues that are received in advance are recognized on a pro-rata basis over the periods in which services are to be provided. In addition, payments of last months’ dues are deferred. Revenues for services including private training, spa treatments and physical therapy sessions are recorded when such services are performed. Amounts received in advance are recorded as deferred revenues. Revenues from our SportsMed subsidiary are recognized based upon the estimated amount to be collected.

     Allowance for doubtful accounts. We provide a reserve against our receivables for estimated losses that may result from our members’ inability to pay. We determine the amount of the reserve by analyzing known uncollectible accounts, economic conditions and historical losses and our members’ creditworthiness. The likelihood of a material loss from this area is minimal due to our limited exposure to credit risk.

     Lease Accounting. We record rent expense on our facilities under operating leases. The aggregate rental obligation is expensed on a straight line basis over the lease term, commencing with the date when we take possession of the property. If the lease imposes a significant economic penalty not to renew an option period, we use the initial period plus the option period as the lease term. Rent incurred before the facility is ready for use is capitalized as leasehold improvements.

     Impairment of long-lived assets. The carrying value of our long-lived assets is reviewed annually and whenever events or changes in circumstances indicate that such carrying values may not be recoverable. We consider a history of consistent and significant operating losses to be our primary indicator of potential impairment. Assets are grouped and evaluated for impairment at the lowest level for

which there are identifiable cash flows, which is generally at an individual Club or a group of Clubs located in the same geographical area. The determination of whether an impairment has occurred is based on an estimate of undiscounted future cash flows directly related to that Club or group of Clubs compared to the carrying value of the assets. If an impairment has occurred, the amount of impairment recognized is determined by estimating the fair value of the assets and recording a loss if the carrying value is greater than the fair value. There was no impairment of long-lived assets at December 31, 2003 or 2004.

     Valuation of goodwill. We recorded goodwill in connection with our acquisitions of The Sports Club/LA in Los Angeles and Orange County, Reebok Sports Club/NY and SportsMed. In January 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets, and as a result have ceased to amortize goodwill. Instead, we were required to perform a transitional impairment review of our goodwill as of January 1, 2002. We performed the transitional impairment test and determined that goodwill was impaired as of January 1, 2002 by $5,134,000. We are also required to evaluate goodwill on an annual basis or when certain events require us to reevaluate our goodwill. We performed the analysis, as of December 31, 2002, 2003 and 2004, 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.

     Interest expense. In accordance with Emerging Issues Task Force (“EITF”) Issue No. 87-24, “Allocation of Interest to Discontinued Operations,” interest was allocated to discontinued operations based on the interest on debt that will be required to be repaid as a result of disposal transactions. On February 8, 2005, we entered into a formal letter of intent to sell six of our nine sports and fitness Clubs (see Footnote No. 5 to our consolidated financial statements appearing elsewhere in this 10-K). The proceeds of $65.0 million from the proposed sale are required to be used to repay a portion of our $100.0 million of Senior Secured Notes (see Footnote No. 7 to our consolidated financial statements appearing elsewhere in this 10-K). Accordingly we have allocated to discontinued operations 65.0% of the interest associated with the Senior Secured Notes. For the years ended December 31, 2002, 2003 and 2004, the amount of interest allocated to discontinued operations was $8,046,000 for each year.

Results of Operations

     Several reclassifications have been made to the consolidated statement of operations for the years ended December 31, 2003 and 2002 as discussed in Note 2 to the consolidated financial statements. The following discussion that compares our results of operations for various periods is after consideration of such reclassifications.

Fiscal 2004 compared to Fiscal 2003

     Our total revenue from continuing operations for the year ended December 31, 2004, was $43.7 million, compared to $37.0 million for the same period in 2003, an increase of $6.7 million or 17.9%. Revenue increased by $6.5 million as a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Revenues at The Sports Club/LA-Los Angeles, The Sports Club/LA-Orange County and our remaining SportsMed facilities, were up approximately $200,000 from the prior year.

     Our club operating costs and cost of products and services increased by $8.0 million (36.2%) to $30.1 million for the year ended December 31, 2004, versus $22.1 million for the same period in 2003. Club operating costs and cost of products and services increased by $6.7 million as a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Club operating costs and cost of products and services increased by $1.3 million at The Sports Club/LA-Los Angeles, The Sports Club/LA-Orange County and our remaining SportsMed facilities primarily due to increased payroll and payroll related costs at our two Sports Club/LA Clubs and to an increase in our reserve for bad debts of $200,000 related to our remaining SportsMed facilities.

     Our selling and marketing expenses were $1.5 million for the year ended December 31, 2004, versus $1.0 million for the same period in 2003, an increase of $449,000 or 43.0%. The entire increase in selling and marketing expenses was a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003.

     General and administrative expenses were $8.1 million for the year ended December 31, 2004, versus $7.5 million for the same period in 2003, an increase of $631,000. Payroll and payroll-related expenses for the year ended December 31, 2004 increased by $570,000, primarily due to normal compensation and headcount increases. Accounting and legal fees decreased by approximately $400,000, primarily due to the reimbursement of certain legal costs incurred and expensed in prior years related to litigation at one of our Clubs. Outside service fees and travel expenses increased by $533,000, primarily due to costs incurred as a result of the retention of an investment bank to assist us in evaluating alternatives to restructure our debt and due to costs incurred for an advisor regarding certain potential real estate related transactions. There were other minor increases and decreases in other general and administrative expenses accounting for a net decrease of $72,000.

     Pre-opening expenses of $46,000 and $2.3 million for the years ended December 31, 2004 and 2003, respectively, consisted of expenses related to The Sports Club/LA-Beverly Hills, which opened on October 7, 2003.

     Our depreciation and amortization expenses were $4.4 million for the year ended December 31, 2004, versus $3.7 million for the same period in 2003, an increase of $663,000 or 17.9%. Depreciation and amortization expenses increased by $561,000 as a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003 and by $102,000 primarily due to capital additions made at The Sports Club/LA-Los Angeles and The Sports Club/LA-Orange County during 2003 and 2004.

     We recorded a charge of $1.1 million during the year ended December 31, 2004. This charge is comprised of various costs, primarily legal fees and investment banking fees, related to a proposed equity transaction that was initiated in April 2003 and abandoned in February 2004.

     In the years ended December 31, 2004 and 2003 we allocated $8.0 million of interest expense to discontinued operations. Our net remaining interest expense increased by $1.1 million (21.0%) to $6.6 million for the year ended December 31, 2004, versus $5.5 million for the same period in 2003. Net interest expense increased by $708,000 as a result of interest incurred on a new $20.0 million five-year mortgage loan, which funded on June 12, 2003. Net interest expense increased by $432,000 due to the termination of the capitalization of interest on our construction costs for The Sports Club/LA-Beverly Hills in 2003 when the Club was ready for use.

     We did not record any federal or state deferred tax benefit related to our consolidated loss from continuing operations for the years ended December 31, 2004 and 2003.

     Our loss from discontinued operations was $12.5 million for the year ended December 31, 2004, versus $13.2 million for the same period in 2003, a decrease of $725,000 or 5.5%. Our net loss decreased primarily as a result of a 5.8% increase in membership at our Clubs held for sale during the year ended December 31, 2004 and to annual rate increases for monthly dues and other ancillary services. In 2004, we also sold three SportsMed facilities that we classified as discontinued operations. We recorded a loss on the disposal of these three SportsMed facilities of $527,000 during September 2004.

     After the loss from discontinued operations and dividends on preferred stock of $1.9 million in 2004 and $1.4 million in 2003, our consolidated net loss attributable to common stockholders was $22.6 million, or $1.21 per basic and diluted share for the year ended December 31, 2004, versus a loss of $19.8 million, or $1.08 per basic and diluted share for the year ended December 31, 2003.

Fiscal 2003 compared to Fiscal 2002

     Our total revenue for the year ended December 31, 2003, was $37.0 million, compared to $35.0 million for the same period in 2002, an increase of $2.0 million or 5.7%. Revenue increased by $1.3 million as a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Revenue increased by a net $1.2 million at The Sports Club/LA-Los Angeles and The Sports Club/LA-Orange County primarily due to annual rate increases for dues and other ancillary services. Revenue increased by approximately $100,000 at our remaining SportsMed facilities primarily due to increased patient visits. Revenue decreased by $547,000 as a result of the sale of The Sports Club/LA-Las Vegas on January 31, 2002.

     Our club operating costs and cost of products and services increased by $2.2 million (11.1%) to $22.1 million for the year ended December 31, 2003, versus $19.9 million for the same period in 2002. Club operating costs and cost of products and services increased by $1.4 million as a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Club operating costs and cost of products and services increased by another $1.3 million at The Sports Club/LA-Los Angeles, The Sports Club/LA-Orange County and our remaining SportsMed facilities, primarily due to increased payroll and payroll related costs, utility rate increases and to increases in workers compensation, group medical and property/liability insurance rates. Our Club operating costs and cost of products and services decreased by $505,000 as a result of the sale of The Sports Club/LA-Las Vegas on January 31, 2002.

     Our selling and marketing expenses were $1.0 million for the year ended December 31, 2003, versus $936,000 for the same period in 2002, an increase of $107,000 or 11.4%. $99,000 of the increase in selling and marketing expenses was a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Selling and marketing expenses increased by approximately $42,000 at The Sports Club/LA-Los Angeles and The Sports Club/LA-Orange County, primarily due to increased direct mail costs. Our selling and marketing expenses decreased by $34,000 as a result of the sale of The Sports Club/LA-Las Vegas on January 31, 2002.

     General and administrative expenses were $7.5 million for the year ended December 31, 2003, versus $7.1 million for the same period in 2002, an increase of $403,000 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.

     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 depreciation and amortization expenses were $3.7 million for the year ended December 31, 2003, versus $3.5 million for the same period in 2002, an increase of $174,000 or 4.9%. Depreciation and amortization expenses increased by $150,000 as a result of the opening of The Sports Club/LA-Beverly Hills on October 7, 2003 and by $56,000 primarily due to capital additions made at The Sports Club/LA-Los Angeles and The Sports Club/LA-Orange County during 2002 and 2003. Depreciation and amortization expenses decreased by $32,000 as a result of the sale of The Sports Club/LA-Las Vegas on January 31, 2002.

     In the years ended December 31, 2003 and 2002, we allocated $8.0 million of interest expense to discontinued operations. Our remaining net interest expense increased by $531,000 (10.8%) to $5.4 million for the year ended December 31, 2003, versus $4.9 million for the same period in 2002. Net interest expense increased by $944,000 primarily as a result of interest incurred on a new $20.0 million five-year mortgage loan, which funded on June 12, 2003. Net interest expense decreased by $432,000 due to the capitalization of interest costs during our construction of The Sports Club/LA-Beverly Hills, which opened on October 7, 2003. Other miscellaneous interest expense increased by $19,000.

     We recorded a gain of $97,000, related to the sale of real estate in Houston, Texas on August 30, 2002. We had originally planned to develop a Club on this site.

     We did not record any federal or state deferred tax benefit related to our consolidated pre-tax losses incurred for the year ended December 31, 2003 and 2002. The tax benefit of $900,000 recorded for the year ended December 31, 2002, was the result of a federal income tax refund we recorded due to tax law changes that allowed us to carry-back our 2001 loss to prior tax years.

     Our loss from discontinued operations was $13.2 million for the year ended December 31, 2003, versus $22.2 million for the same period in 2002, a decrease of $9.0 million or 40.5%. $3.9 million of the decrease in our net loss from discontinued operations was primarily a result of a 9.7% increase in membership at our discontinued Clubs during the year ended December 31, 2003 and to annual rate increases for monthly dues and other ancillary services. $5.1 million of the decrease in our net loss from discontinued operations was the result the write off of impaired goodwill in January 2002 when we adopted SFAS No. 142, Goodwill and Other Intangible Assets and determined that goodwill was impaired by $5,134,000 and recorded a charge to reflect this impairment.

     After the loss from discontinued operations and dividends on preferred stock of $1.4 million in 2003 and $888,000 in 2002, our consolidated net loss attributable to common stockholders was $19.8 million, or $1.08 per basic and diluted share for the year ended December 31, 2003, versus a loss of $23.6 million, or $1.31 per basic and diluted share for the year ended December 31, 2002.

     Liquidity and Capital Resources

Liquidity

     Historically, we have satisfied our liquidity needs through various debt arrangements, sales of Common or Preferred Stock and cash from operations. Our primary liquidity needs during the past several years have been for the development of new Clubs and the interest cost associated with our $100.0 million Senior Secured Notes.

     In order to make our March 15, 2004 interest payment on the Senior Secured Notes, we issued $6.5 million of a newly created class of Series D Convertible Preferred Stock. In order to make our September 15, 2004 interest payment, we issued $2.0 million of a newly created class of Series E Preferred Stock.

     During the nine months ended September 30, 2005, we generated cash flows from operations and received $2,500,000 of deposits back as cash. These amounts allowed us to make our March 15, 2005 and September 15, 2005, interest payments without raising any additional capital.

     On March 15, 2006, our entire $100.0 million principal amount of the Senior Secured Notes are due along with $5.6 million of interest. We do not have the cash to make these payments and therefore we have decided to sell six of our Clubs for $65.0 million. We believe we will be able to mortgage our property in West Los Angeles, California and that the proceeds from the asset sale and financing will be sufficient for us to retire the entire $100.0 million of Senior Secured Notes prior to their maturity date. However, there can be no assurance that we will able to consummate any of these transactions. If we are unable to sell these assets or finance the West Los Angeles property, we would be required to raise additional capital by issuing equity if the bondholders are not willing to extend the due date of the Senior Secured Notes. If those events would not occur, we would probably default on the principal payment of the Senior Secured Notes and the holders of the Senior Secured Notes could elect to foreclose on our assets.

     If we complete the sale of the six Clubs and therefore continue to own and operate three Clubs, we will implement a plan to significantly reduce our general and administrative expenses. If we consummate the sale of the six Clubs, refinance our West Los Angeles Club as described above and reduce our general and administrative expenses, we believe that we will be able to operate the remaining three clubs without the infusion of additional funds, although there can be no assurance that we would be able to do so.

     Following the sale of the six Clubs, additional funds will be required to undertake any future acquisitions or the development of additional new Clubs. We would consider entering into joint ventures, partnership agreements or management agreements (subject to the restrictions and limitations on such transactions in the Indenture) for the purpose of developing new Clubs, but only if such arrangements would generate additional cash flow or further enhance The Sports Club/LA brand name in the market place.

Operating Activities

     At December 31, 2004, our cash balance was $7.6 million. During 2004, we generated cash flows from operating activities, both continuing and discontinued, of $1.7 million. We believe we will continue to generate positive cash flows in the future. We had various deposits to secure our performance under several contracts, the largest of which is a required security deposit at The Sports Club/LA-Rock Center. In the first seven months of 2005, we received back $2.5 million of such deposits.

Investing Activities

     Investing activities consist of new Club development and expenditures to maintain and update our existing Clubs. Our Clubs are upscale and capital improvements are regularly needed to retain the upscale nature and presentation of the Clubs. A deterioration of the quality of the Clubs can lead to reduction in membership levels and lower revenues. Capital expenditures to maintain and update our Clubs, including costs to construct The Sports Club/LA — Beverly Hills that opened in October 2003, were $10.6 million in 2003 and $3.6 million in 2004. We estimate that expenditures of between 2% and 4% of revenues, depending on the age of the Club, will be necessary to maintain the quality of the Clubs to our satisfaction. We also expect to spend approximately $600,000 during the next year to upgrade our management information systems and enhance our disaster recovery capabilities.

     We currently have no plans for new Club developments that would require our own capital.

     In October 2004, we received $600,000 of cash proceeds from the sale of three of our SportsMed facilities.

     In February 2005, we entered into a letter of intent to sell six of our nine Clubs for $65.0 million. Proceeds from this transaction would be used to retire long-term debt. The letter of intent is nonbinding on the Company and Millennium and is subject to the execution of a definitive agreement and the satisfaction of a number of conditions. Accordingly, we can give no assurances that the proposed sale will be completed.

Financing Activities

     On April 1, 1999, we issued in a private placement $100.0 million of 11 3/8% Senior Secured Notes due in March 2006, with interest due semi-annually. The Senior Secured Notes were issued pursuant to the terms of an indenture agreement dated April 1, 1999 (the “Indenture”). The Senior Secured Notes are secured by substantially all of our assets, other than certain excluded assets. The Indenture includes certain covenants that restrict our ability to: (i) incur additional indebtedness; (ii) pay dividends or other distributions, or repurchase capital stock or other equity interests or subordinated indebtedness; and (iii) make certain investments. The Indenture also limits our ability to: (i) enter into transactions with affiliates; (ii) create liens on or sell certain assets; and (iii) enter into mergers and consolidations. The Indenture requires us to make an offer to retire the Senior Secured Notes if the net proceeds of any asset sale are not reinvested in assets related to our business, unless the remaining net proceeds are less than $10.0 million. The Indenture requires us to make semi-annual interest payments of $5.7 million on March 15^th and September 15^th of each year.

     On June 12, 2003, we obtained financing in the form of a secured five-year promissory loan in the amount of $20.0 million. The new loan is evidenced by a promissory note that bears interest at a fixed interest rate of 7.25%; requires monthly principal and interest payments of $144,561; is secured by the

common stock and all the assets of Irvine Sports Club, Inc., our wholly owned subsidiary that owns The Sports Club/LA — Orange County; and is guaranteed by two of our major stockholders. The note may be prepaid at any time without penalty and requires a final payment of $18.3 million on July 1, 2008.

     In March 2004, three of our principal shareholders purchased $6.5 million of a newly created class of Series D Convertible Preferred Stock in a private placement offering. The proceeds were used to pay the March 15, 2004 interest payment on our Senior Secured Notes and to provide additional working capital. In September 2004, three of our principal shareholders purchased $2.0 million of a newly created class of Series E Preferred Stock in another private placement offering. The proceeds were used to pay the September 15, 2004 interest payment on our Senior Secured Notes.

Contractual Obligations

     The following schedule lists known contractual obligations (amounts in thousands) as of December 31, 2004:

		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			$	65,000			$	35,000			$	—			$	—
Interest on Senior Secured Notes (1)			17,063				11,375				5,688				—				—
Mortgage note (2)			19,550				326				727				18,497				—
Equipment financing loans (3)			180				118				44				18				—
Operating leases (4)			337,575				24,342				48,071				48,701				216,461
Minority interest (5)			750				150				600				—				—
Redeemable Preferred Stock (6)			14,796				—				2,000				12,796				—
Total		$	489,914			$	101,311			$	92,130			$	80,012			$	216,461

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, 2004. 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:

	•		the availability and adequacy of our cash flow and financing facilities for our requirements, including payment of the Senior Secured Notes,
	•		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,
	•		our ability to successfully develop new sports and fitness clubs,
	•		disputes or other problems arising with our development partners or landlords,
	•		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,
	•		competition,
	•		changes in personnel or compensation, and
	•		changes in statutes and regulations or legal proceedings and rulings.

     We will not update forward-looking statements even though our situation may change in the future.

ITEM 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, 2004, 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. We also have a $19.5 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 hypothetical change in interest rates of 1% would impact our interest expense by approximately $1.2 million per year.

     The fair value of our financial instruments as of December 31, 2004 is estimated as follows (in thousands):

Senior Secured Notes		$	94,000
First Mortgage Note			19,500
		$	113,500

ITEM 8. FINANCIAL STATEMENTS

Index to Consolidated Financial Statements

		PAGE
Report of Independent Registered Public Accounting Firm for 2004			F-1
Report of Independent Registered Public Accounting Firm for 2002 and 2003			F-2
Consolidated Balance Sheets as of December 31, 2003 and 2004			F-3
Consolidated Statements of Operations for each of the Years in the Three-Year Period ended December 31, 2004			F-4
Consolidated Statements of Stockholders’ Equity (Deficit) for each of the Years in the Three-Year Period ended December 31, 2004			F-5
Consolidated Statements of Cash Flows for each of the Years in the Three-Year Period ended December 31, 2004			F-6
Notes to Consolidated Financial Statements			F-7

Consolidated Financial Statement Schedule

Valuation and Qualifying Accounts			F-34

     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

     Following completion of KPMG LLP’s (“KPMG”) review of the Company’s unaudited condensed interim financial statements included in the Company’s Form 10-Q for the quarter ending June 30, 2004, KPMG was dismissed as the Company’s principal accountants and the firm of Stonefield Josephson was engaged to audit the Company’s consolidated financial statements for the year ending December 31, 2004. Reference is made to the Company’s reports on Form 8-K filed with the Securities and Exchange Commission on July 12, 2004 and August 23, 2004, respectively.

     We have agreed to indemnify and hold KPMG harmless against and from any and all legal costs and expenses incurred by KPMG in successful defense of any legal action or proceeding that arises as a result of KPMG’s consent to the incorporation by reference of its audit report on the Company’s past financial statements into our Registration Statements on Form S-8 and Form S-3.

ITEM 9A. CONTROLS AND PROCEDURES

     (a) Evaluation of disclosure controls and procedures.

     We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our internal control system is designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements. All internal control systems are designed based in part upon certain assumptions about the likelihood of future events, and, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation and may not prevent or detect all misstatements. Our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 10-K. This evaluation included a review of the steps management undertook in an effort to ensure that information required to be disclosed in its Exchange Act filings is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. In light of certain material weaknesses in our controls and procedures described below, the CEO and CFO concluded that, as of the end of such period, these deficiencies have caused our disclosure controls and procedures not to be effective to enable us to record, process, summarize, and report information required to be included in our SEC filings within the required time period, and to ensure that such information is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosure. As described below, we are taking steps to remediate the deficiencies in our control over the financial reporting process.

     In performing its audit of our Consolidated Financial Statements for the year ended December 31, 2003, KPMG LLP (“KPMG”) noted a matter involving our internal controls that it considered to be a “reportable condition,” as defined under standards established by the American Institute of Certified Public Accountants. In performing its audit of our Consolidated Financial Statements for the year ended December 31, 2004, Stonefield Josephson, Inc. (“Stonefield”) also noted a matter involving our internal controls that it considered to be a “reportable condition.” A “reportable condition,” which may or may not be deemed a material weakness, involves matters relating to significant deficiencies in the design or operation of internal controls that, in the auditor’s judgment, could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements.

     The reportable condition, that KPMG considered to be a material weakness, was that the Company does not have adequate internal controls over the application of new accounting principles or the application of existing accounting principles to new transactions. In this regard, KPMG noted that, during their review of our financial statements for the quarter ended March 31, 2003, the Company had not properly accounted for private training revenues. In addition, in connection with their audit of our financial statements for the year ended December 31, 2003, KPMG determined that we were not properly accounting for our management arrangement with The Sports Club/LA-Miami; that we had not properly followed Financial Accounting Standard No. 142 relating to goodwill; and that we had not properly accounted for the accretion of dividends on our Series C Convertible Preferred Stock. Finally, KPMG suggested that we needed to consider additional staffing in our accounting department, and take other action (such as attending training seminars on new accounting rules and pronouncements) to ensure that we have the expertise and resources to implement new accounting standards and apply existing accounting standards to new transactions. KPMG’s observations were summarized in its letter dated June 16, 2004, to the Audit Committee of the Board of Directors.

     The reportable condition, that Stonefield considered to be a material weakness, was that the Company was unable to process its financial information and present financial statements within a timely

fashion. Stonefield’s observation was summarized in its letter dated September 30, 2005 to the Audit Committee of the Board of Directors.

     In connection with the completion of the 2003 audit, the Company’s accounting personnel worked with, and considered the recommendations of, KPMG in accounting for private training revenues, goodwill, management fees and dividend accrual on our Series C Convertible Preferred Stock. They conducted detailed validation work on these accounts to substantiate the accuracy of the financial information and related disclosures contained in this Form 10-K. The accounting personnel reviewed the requirements of Financial Accounting Standards No. 142 to understand the methodology underlying the accounting treatment of goodwill and continue to monitor any new developments or changes in accounting treatment or policies for these assets to ensure that they are accurately disclosed in our financial statements.

     In December 2004, the Company received a comment letter relating to the Company’s Form 10-K/A for the year ended December 31, 2003 and Form 10-Q for the quarter ended September 30, 2004 from the staff of the SEC. One of the issues dealt with accounting for initiation fees under the provision of Emerging Issues Task Force (“EITF”) No. 00-21. The eventual resolution of this issue contributed to the untimely filing of the Company’s financial statements for the year ended December 31, 2004 and quarterly periods ended March 31, 2005 and June 30, 2005.

     The Audit Committee has authorized and directed management to devise and implement actions to address these deficiencies and to enhance the reliability and effectiveness of the Company’s internal controls over financial reporting and to provide reasonable assurance that our disclosure controls and procedures allow for the accurate presentation and timely filing of our financial statements. The Company’s accounting personnel have reviewed their reporting and certification obligations under the Exchange Act and the Sarbanes Oxley Act of 2002, and have consulted with the Company’s outside counsel with respect to those obligations. We are now performing regular analyses of revenues attributable to private training and management fees. In addition, our accounting personnel have determined that if there should occur any changes in existing accounting rules or policies, or if accounting principles are adopted, which apply to the Company’s financial accounts (particularly with respect to the manner in which private training revenues, management fees, goodwill and dividend accrual is accounted for), such matters will be brought to the attention of our independent auditor and, if necessary, outside counsel to ensure that all required disclosures are accurate and complete and are made in a timely fashion. We have assigned a high priority to both the short-term and long-term strengthening of these controls and have identified certain additional measures, which we believe will address the conditions identified by our auditors as a material weakness, including the following:

     • engaging an accounting or financial consulting firm (other than the Company’s independent auditor) to consult with the Company on accounting issues, including the interpretation of new accounting rules and releases promulgated by the SEC, the Financial Accounting Standards Board and other organizations, and the application of accounting principles to new transactions in which the Company engages;

     • creating and maintaining a written “log” in which new FASB, EITF, SOP and other accounting rules and pronouncements are recorded. The log will include a description of the new rule or pronouncement; whether or not it amends or modifies an existing rule or pronouncement; its applicability to the Company or any transactions in which the Company has engaged, or proposes to engage; and the appropriate accounting ramifications of the new rule or pronouncement. Management intends to submit this log to the Audit Committee and its independent auditors on a quarterly basis, as part of their respective financial statement review;

     • subscribing to selected professional publications that discuss new accounting rules and regulations applicable to reporting companies, and sending our senior accounting personnel to seminars and other presentations which focus on new accounting and financial disclosure rules and pronouncements; and

     • establishing an internal audit procedure to ensure that transactional recording, transactional review and adherence to applicable accounting policies and principles are observed.

     Management believes that the foregoing measures will address the conditions identified as material weaknesses by KPMG and Stonefield. We will continue to monitor and evaluate the effectiveness of our disclosure controls and procedures and our internal controls over financial reporting on an ongoing basis, and are committed to taking further action and implementing additional enhancements or improvements, as necessary. We believe that these measures are reasonably likely to have a material impact on both our internal controls over financial reporting and disclosure controls and procedures in future periods.

     (b) Changes in internal controls.

     During the reporting period, the following changes occurred in the Company’s internal controls over financial reporting (as those terms are defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting:

	•		the Company has worked with an accounting firm (other than Company’s independent auditor) to consult with on accounting issues;
	•		the Company has reviewed new accounting pronouncements to determine the applicability to the Company;
	•		the Company has subscribed to professional publications that discuss new accounting rules and regulations;
	•		several members of Company’s accounting management attended financial related seminars.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
The Sports Club Company, Inc.
Los Angeles, California

We have audited the accompanying consolidated balance sheet of The Sports Club Company, Inc. and subsidiaries as of December 31, 2004 and the related statements of operations, stockholders’ equity (deficit) and cash flows for the year then ended. Our audit also included the financial statement schedule listed at the index in Item 8 as of and for the year ended December 31, 2004. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Sports Club Company, Inc. and Subsidiaries as of December 31, 2004 and the results of its operations and its cash flows for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the consolidated 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 consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. As discussed in Note 3, the Company has suffered recurring net losses, has a working capital deficiency of $12,295,000 and an accumulated deficit of $106,974,000 as of December 31, 2004, and has its senior debt of $100,000,000 maturing by March 2006. The foregoing matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3. These consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

/s/ Stonefield Josephson, Inc.
CERTIFIED PUBLIC ACCOUNTANTS
Santa Monica, California
August 26, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
The Sports Club Company, Inc.:

We have audited the accompanying consolidated balance sheet of The Sports Club Company, Inc. and subsidiaries as of December 31, 2003, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the two-year period ended December 31, 2003. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule for each of the years in the two-year period ended December 31, 2003. 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, 2003, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. 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 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, except as to
Notes 2 and 5, which are as of
September 27, 2005

THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2004
(in thousands, except per share amounts)

		2003				2004
ASSETS
Current assets:
Cash and cash equivalents		$	1,932			$	7,559
Accounts receivable, net of allowance for doubtful accounts of $382 and $396 at December 31, 2003 and 2004, respectively			2,103				2,030
Inventories			544				662
Prepaid expenses			1,345				993
Assets held for sale			3,688				143,408
Total current assets			9,612				154,652
Property and equipment, net			65,530				63,622
Goodwill			7,315				7,315
Restricted cash			4,432				3,403
Other assets			7,638				2,550
Assets held for sale			150,971				—
		$	245,498			$	231,542
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Current installments of notes payable and equipment financing loans		$	2,099			$	65,444
Accounts payable			2,464				2,040
Accrued liabilities			10,705				9,481
Deferred revenues			4,737				6,013
Liabilities related to assets held for sale			17,473				85,169
Total current liabilities			37,478				168,147
Notes payable and equipment financing loans, less current installments			119,731				54,286
Deferred lease obligations			1,838				2,354
Deferred revenues			762				617
Minority interest			600				600
Liabilities related to assets held for sale			67,874				—
Total liabilities			228,283				226,004
Commitments and contingencies:
Redeemable Convertible Preferred Stock, Series B, $.01 par value, 10,500 shares authorized, issued and outstanding at December 31, 2003 and 2004 (liquidation preference of $12,198 and $13,148 at December 31, 2003 and 2004, respectively)			11,761				12,796
Redeemable Preferred Stock, Series E, $.01 par value, 20,000 shares authorized, issued and outstanding at December 31, 2004			—				2,000
Stockholders’ equity (deficit):
Preferred Stock, $.01 par value, 984,500 and 899,500 shares authorized at December 31, 2003 and 2004, respectively; no shares issued or outstanding			—				—
Convertible Preferred Stock, Series C, $.01 par value, 5,000 shares authorized, issued and outstanding at December 31, 2003 and 2004 (liquidation preference of $5,590 and $6,040 at December 31, 2003 and 2004, respectively)			5,590				6,040
Convertible Preferred Stock, Series D, $.01 par value, 65,000 shares authorized; issued and outstanding at December 31, 2004 (liquidation preference of $6,971 at December 31, 2004)			—				6,543
Common Stock, $.01 par value, 40,000,000 shares authorized; 21,074,717 shares issued and outstanding at December 31, 2003 and 2004			211				211
Additional paid-in capital			100,348				98,392
Accumulated deficit			(86,217	)			(106,974	)
Treasury Stock, at cost, 2,650,003 and 2,097,079 shares at December 31, 2003 and 2004, respectively			(14,478	)			(13,470	)
Total Stockholders’ equity (deficit)			5,454				(9,258	)
		$	245,498			$	231,542

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Three-Year Period ended December 31, 2004
(in thousands, except per share amounts)

		2002				2003				2004
Revenues:
Membership revenues		$	23,694			$	25,141			$	29,433
Products and services			11,350				11,904				14,239
Total revenue			35,044				37,045				43,672
Operating expenses:
Club operating costs			11,033				12,567				17,647
Cost of products and services			8,816				9,517				12,398
Selling and marketing			936				1,043				1,492
General and administrative			7,114				7,517				8,148
Pre-opening expenses			130				2,258				46
Depreciation and amortization			3,532				3,706				4,369
Other			—				—				1,104
Total operating expenses			31,561				36,608				45,204
Income (loss) from operations			3,483				437				(1,532	)
Other income (expense):
Interest, net			(4,909	)			(5,440	)			(6,580	)
Minority interests			(150	)			(150	)			(149	)
Other			97				—				—
Loss from continuing operations before income tax benefit			(1,479	)			(5,153	)			(8,261	)
Income tax benefit			(900	)			—				—
Loss from continuing operations			(579	)			(5,153	)			(8,261	)
Discontinued operations:
Loss from operations of discontinued operations			(17,034	)			(13,221	)			(11,969	)
Cumulative effect of change in accounting principle			(5,134	)			—				—
Loss on disposal			—				—				(527	)
Loss from discontinued operations			(22,168	)			(13,221	)			(12,496	)
Net loss			(22,747	)			(18,374	)			(20,757	)
Dividends on Preferred Stock			888				1,400				1,871
Net loss attributable to common stockholders		$	(23,635	)		$	(19,774	)		$	(22,628	)
Net loss per share — basic and diluted:
Continuing operations		$	(0.08	)		$	(0.36	)		$	(0.54	)
Discontinued operations			(1.23	)			(0.72	)			(0.67	)
Net loss per share		$	(1.31	)		$	(1.08	)		$	(1.21	)
Weighted average number of common shares outstanding:
Basic and diluted			18,080				18,316				18,733

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
Three-Year Period ended December 31, 2004
(in thousands)

		Preferred Stock								Preferred Stock																Additional
		Series C								Series D								Common Stock								Paid-in				Accumulated				Treasury Stock
		Shares				Amount				Shares				Amount				Shares				Amount				Capital				Deficit				Shares				Amount
Balance, December 31, 2001			—				—				—				—				21,061			$	211			$	102,764			$	(45,096	)			3,045			$	(15,410	)
Net loss			—				—				—				—				—				—				—				(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			—				140				—				—				—				—				(140	)			—				—				—
Balance, December 31, 2002			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	)
Net loss			—				—												—				—				—				(20,757	)			—				—
Issuance of Series D Preferred Stock			—				—				65				6,072				—				—				—				—				—				—
Reissuance of Treasury Stock for loan guarantee fee			—				—				—				—				—				—				—				—				(411	)			752
Reissuance of Treasury Stock for employee stock plans			—				—				—				—				—				—				—				—				(142	)			256
Accretion of dividends on Series B Preferred Stock			—				—				—				—				—				—				(950	)			—				—				—
Accretion of dividends on Series C Preferred Stock			—				450				—				—				—				—				(450	)			—				—				—
Accretion of dividends on Series D Preferred    Stock			—				—				—				471				—				—				(471	)			—				—				—
Accretion of issuance costs on Series B Preferred Stock			—				—				—				—				—				—				(85	)			—				—				—
Balance, December 31, 2004			5			$	6,040				65			$	6,543				21,075			$	211			$	98,392			$	(106,974	)			2,097			$	(13,470	)

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
Three-year Period ended December 31, 2004
(in thousands)

		2002				2003				2004
Cash flows from operating activities:
Net loss		$	(22,747	)		$	(18,374	)		$	(20,757	)
Adjustments to reconcile net loss to cash used in operating activities:
Loss from discontinued operations			22,168				13,221				12,496
Loss (gain) on disposition of real estate			(127	)			—				—
Depreciation and amortization			3,532				3,706				4,369
Related party costs settled with common stock			241				718				1,008
Minority interests expense			150				150				150
Distributions to minority interests			(150	)			(150	)			(150	)
(Increase) decrease in:
Accounts receivable, net			529				17				73
Inventories			(10	)			163				(118	)
Other current assets			(151	)			(655	)			352
Other assets, net			(2,232	)			72				5,088
Increase (decrease) in:
Accounts payable			(233	)			(81	)			(424	)
Accrued liabilities			(67	)			468				(1,224	)
Deferred revenues			(238	)			1,266				1,131
Accrued lease obligations			—				135				516
Net cash provided by operating activities			665				656				2,510
Cash flows from (used in) investing activities:
Capital expenditures			(2,030	)			(9,573	)			(2,461	)
Proceeds from sale of real estate – net of costs			3,133				—				—
Proceeds from sale of The Sports Club/Las Vegas – net of costs			6,154				—				—
(Increase) decrease in restricted cash			—				(4,205	)			1,029
Net cash provided by (used in) investing activities			7,257				(13,778	)			(1,432	)
Cash flows from financing activities:
Proceeds from issuance of Preferred Stock — net of costs			14,908				—				8,072
Proceeds from notes payable and equipment financing loans			21,725				30,741				—
Repayments of notes payable and equipment financing loans			(33,176	)			(13,710	)			(2,100	)
Net cash provided by financing activities			3,457				17,031				5,972
Cash (used in) discontinued operations:
Proceeds from sale of SportsMed facilities			—				—				600
Capital expenditures			(4,607	)			(1,024	)			(1,179	)
Net cash used in operating activities			(5,069	)			(4,138	)			(844	)
Net cash used in discontinued operations			(9,676	)			(5,162	)			(1,423	)
Net increase (decrease) in cash and cash equivalents			1,703				(1,253	)			5,627
Cash and cash equivalents at beginning of year			1,482				3,185				1,932
Cash and cash equivalents at end of year		$	3,185			$	1,932			$	7,559
Supplemental disclosure of cash flow information:
Cash paid during the year for interest		$	11,902			$	12,500			$	12,912
Cash paid during the year for income taxes		$	242			$	386			$	792

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2003 and 2004

1. Organization