UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

THE SPORTS CLUB COMPANY, INC.

     A review of the Condensed Consolidated Financial Statements herein was not completed by the Company’s independent registered public accounting firm prior to the deadline for filing this Form 10-Q, as required by Rule 10-01(d) of Regulation S-X promulgated under the Securities Exchange Act of 1934.

     Indicate by check mark whether the company (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the preceding 12 months (or for such shorter period that the company was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes                      No            X          

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes                      No            X          

     Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

		Shares
		Outstanding at
Class		September 30, 2005
Common Stock, par value $.01 per share			19,315,262

 

 

THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 2004 and June 30, 2005
(in thousands, except per share amounts)
(unaudited)

		December 31,				June 30,
		2004				2005
ASSETS
Current assets:
Cash and cash equivalents		$	7,559			$	8,894
Accounts receivable, net of allowance for doubtful accounts of $396 and $399 at December 31, 2004 and June 30, 2005, respectively			2,030				1,692
Inventories			662				651
Prepaid expenses			993				758
Assets held for sale			143,408				142,593
Total current assets			154,652				154,588
Property and equipment, net			63,622				61,785
Goodwill			7,315				7,315
Restricted cash			3,403				3,438
Other assets			2,550				1,805
		$	231,542			$	228,931
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Current installments of notes payable and equipment financing loans		$	65,444			$	100,389
Accounts payable			2,040				1,577
Accrued liabilities			9,481				9,449
Deferred revenues			6,013				6,964
Liabilities related to assets held for sale			85,169				85,091
Total current liabilities			168,147				203,470
Notes payable and equipment financing loans, less current installments			54,286				19,103
Deferred lease obligations			2,354				2,599
Deferred revenues			617				—
Minority interest			600				600
Total liabilities			226,004				225,772
Commitments and contingencies
Redeemable Convertible Preferred Stock, Series B, $.01 par value, 10,500 shares authorized, issued and outstanding (liquidation preference of $13,148 and $13,622 at December 31, 2004 and June 30, 2005, respectively)			12,796				13,313
Redeemable Preferred Stock, Series E, $.01 par value, 20,000 shares authorized, issued and outstanding			2,000				2,000
Stockholders’ equity (deficit):
Preferred Stock, $.01 par value, 899,500 shares authorized; no shares issued or outstanding			—				—
Convertible Preferred Stock, Series C, $.01 par value, 5,000 shares authorized, issued and outstanding (liquidation preference of $6,040 and $6,263 at December 31, 2004 and June 30, 2005, respectively)			6,040				6,263
Convertible Preferred Stock, Series D, $.01 par value, 65,000 shares authorized, issued and outstanding (liquidation preference of $6,971 and $7,262 at December 31, 2004 and June 30, 2005, respectively)			6,543				6,834
Common Stock, $.01 par value, 40,000,000 shares authorized; 21,074,717 shares issued			211				211
Additional paid-in capital			98,392				97,362
Accumulated deficit			(106,974	)			(109,670	)
Treasury Stock, at cost, 2,097,079 and 1,924,401 shares at December 31, 2004 and June 30, 2005, respectively			(13,470	)			(13,154	)
Total Stockholders’ equity (deficit)			(9,258	)			(12,154	)
		$	231,542			$	228,931

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months and Six Months Ended June 30, 2004 and 2005
(in thousands, except per share amounts)
(unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2004				2005				2004				2005
		(Restated)								(Restated)
Revenues:
Membership revenues		$	7,291			$	8,091			$	14,378			$	15,928
Products and services			3,625				3,979				7,216				7,793
Total revenue			101,916				12,070				21,594				23,721
Operating expenses:
Club operating costs			4,315				4,343				8,619				8,774
Cost of products and services			3,224				3,387				6,213				6,605
Selling and marketing			350				247				787				665
General and administrative			2,146				1,995				4,131				4,043
Pre-opening expenses			—				—				46				—
Depreciation and amortization			1,073				1,279				2,155				2,503
Non-recurring items			—				—				1,104				—
Total operating expenses			11,108				11,251				23,055				22,590
Income (loss) from operations			(192	)			819				(1,461	)			1,131
Other income (expense):
Interest, net			(1,639	)			(1,629	)			(3,278	)			(3,261	)
Minority interests			(37	)			(37	)			(75	)			(74	)
Loss from continuing operations before income taxes and income (loss) on discontinued operations			(1,868	)			(847	)			(4,814	)			(2,204	)
Provision (benefit) for income taxes			—				—				—				—
Loss from continuing operations before income (loss) on discontinued operations			(1,868	)			(847	)			(4,814	)			(2,204	)
Income (loss) from discontinued operations			(2,840	)			394				(6,208	)			(491	)
Net loss			(4,708	)			(453	)			(11,022	)			(2,695	)
Dividends on Preferred Stock			495				495				876				988
Net income (loss) attributable to common stockholders		$	(5,203	)		$	(948	)		$	(11,898	)		$	(3,683	)
Net income (loss) per share — basic and diluted:
Discontinued operations		$	(0.15	)		$	0.02			$	(0.33	)		$	(0.02	)
Continuing operations			(0.13	)			(0.07	)			(0.31	)			(0.17	)
Net income (loss) per share		$	(0.28	)		$	(0.05	)		$	(0.64	)		$	(0.19	)
Weighted average number of common shares outstanding:
Basic and diluted			18,697				19,150				18,631				19,141

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2004 and 2005
(in thousands)
(unaudited)

		Six Months Ended
		June 30,
		2004				2005
		(Restated)
Cash flows provided from (used in) operating activities:
Net income (loss)		$	(11,022	)		$	(2,695	)
Adjustments to reconcile net income (loss) to cash used in operating activities:
(Income) loss from discontinued operations			6,208				491
Depreciation and amortization			2,155				2,503
Related party costs settled with common stock			711				316
Minority interests expense			75				74
Distributions to minority interests			(75	)			(74	)
(Increase) decrease in:
Accounts receivable, net			(73	)			338
Inventories			(19	)			11
Other current assets			888				235
Other assets, net			1,179				745
Increase (decrease) in:
Accounts payable			(79	)			(463	)
Accrued liabilities			(1,575	)			(32	)
Deferred revenues			431				334
Deferred lease obligations			266				245
Net cash provided from (used in) operating activities			(930	)			2,028
Cash flows (used in) investing activities:
Capital expenditures			(1,688	)			(666	)
(Increase) decrease in restricted cash			51				(35	)
Net cash (used in) investing activities			(1,637	)			(701	)
Cash flows provided from (used in) financing activities:
Proceeds from issuance of Preferred Stock — net of costs			6,072				—
Repayments of notes payable and equipment financing loans			(1,227	)			(238	)
Net cash provided from (used in) financing activities			4,845				(238	)
Cash flows provided from (used in) discontinued operations:
Capital expenditures			(668	)			(391	)
Net cash from operating activities			181				637
Net cash provided from (used in) discontinued operations			(487	)			246
Net increase (decrease) in cash and cash equivalents			1,791				1,335
Cash and cash equivalents at beginning of period			1,932				7,559
Cash and cash equivalents at end of period		$	3,723			$	8,894
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	6,475			$	6,405
Cash paid during the period for income taxes		$	590			$	303

See accompanying notes to consolidated financial statements.

THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and June 30, 2005

1. Basis of Presentation

     A review of the Condensed Consolidated Financial Statements herein was not completed by the Company’s independent registered public accounting firm prior to the deadline for filing this Form 10-Q, as required by Rule 10-01(d) of Regulation S-X promulgated under the Securities Exchange Act of 1934.

     The unaudited, condensed consolidated financial statements, included herein, have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2004, consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K (SEC File Number 1-13290). Certain information and footnote disclosures, which are normally included in financial statements prepared in accordance with United States generally accepted accounting principles, have been condensed or omitted pursuant to SEC rules and regulations for interim financial statements. The Company believes that the disclosures made are adequate to make the information presented not misleading. The information reflects all adjustments that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods set forth herein. All such adjustments are of a normal and recurring nature. The results for the three-month and six-month periods ended June 30, 2005, are not necessarily indicative of the results for the fiscal year ending December 31, 2005.

     In accordance with Emerging Issues Task Force Issue No. 87-24, “Allocation of Interest to Discontinued Operations,” interest was allocated to discontinued operations based on the interest on debt that will be required to be repaid as a result of the disposal transactions. On February 8, 2005, the Company entered into a formal letter of intent to sell six of its nine sports and fitness Clubs (see Note. 5). The proceeds of $65.0 million from the proposed sale are required to be used to repay a portion of the $100.0 million of Senior Secured Notes. Accordingly the Company has allocated to discontinued operations 65.0% of the interest associated with the Senior Secured Notes. For the three-month and six-month periods ended June 30, 2004 and 2005, the amount of interest allocated to discontinued operations was $2,011,000 and $4,023,000, respectively.

2. Reclassification

     Statement of Financial Accounting Standards (“SFAS”) No. 13, Accounting for Leases, governs the Company’s accounting for lease transactions. During the first quarter of 2005, the Company determined that it was not properly accounting for leasehold improvements that were funded by landlord allowances. SFAS No. 13 requires that such improvements be recognized as assets and amortized over the term of the lease and that the landlord allowance incentive should be recorded as deferred rent and recognized, also over the term of the lease, as a reduction of rent expense. Previously the Company netted the deferred rent against the leasehold improvements. The 2004 consolidated financial statements have been adjusted to reflect this reclassification.

     The Company has reclassified its June 30, 2004 balance sheet to record $67.4 million of landlord allowance incentives as additional leasehold improvements, record an additional $7.9 million of accumulated amortization related to those leasehold improvement additions and record deferred lease obligations of $59.5 million. At June 30, 2004, $59.0 million of the additional net leasehold improvements and additional deferred lease obligations relate to assets and liabilities now held for sale and, accordingly, are reported in those captions on the reclassified June 30, 2004 balance sheet.

     The consolidated statements of operations for the three months and six months ended June 30, 2004, have also been reclassified to increase depreciation and amortization expense by $598,000 and $1,195,000, respectively, and to decrease rent expense by the same amount for each period. In the three months and six months ended June 30, 2004, $580,000 and $1,160,000, respectively, of the change in depreciation expense and rent expense relates to discontinued operations and therefore is reported in those captions. There has been no change to net income (loss) as a result of this reclassification.

     Certain reclassifications have also been made to the 2004 consolidated financial statements to reflect various assets and liabilities now held for sale and to report the results of operations associated with those assets as discontinued operations (See Note 5). The consolidated statements of operations have also been reformatted to breakout product and services revenues and expenses.

     The Company has also restated its June 30, 2004 operating statement to more properly account for initiation fees. During the six months ended June 30, 2004, the Company recognized a portion of its membership initiation fees as private training revenue since members were granted the opportunity to utilize private training at no charge. In the fourth quarter of 2004, the Company determined it was more appropriate to record this revenue as initiation fees and amortize it over the estimated membership life. Accordingly, the operating statements for the periods ended June 30, 2004 have been restated.

     A reclassified consolidated statement of operations for the three months and six months ended June 30, 2004, reflecting the above reclassifications is presented below. The amounts are in thousands, except per share amounts:

		Consolidated Statement of Operations
		Three Months Ended June 30, 2004
		As				Initiation								Discontinued								As
		Reported				Fees				SFAS No. 13				Operations				Reformat				Reclassified
Revenues:
Membership revenues		$	36,486			$	—			$	—			$	(16,067	)		$	(13,128	)		$	7,291
Reimbursed costs			1,246				—				—				(1,246	)			—				—
Products and services			—				(600	)			—				(8,828	)			13,053				3,625
Management fees			—				—				—				(75	)			75				—
Total revenue			37,732				(600	)			—				(26,216	)			—				10,916
Operating expenses:
Direct			29,830				—				—				—				(29,830	)			—
Reimbursed costs			1,246				—				—				(1,246	)			—				—
Club operating costs			—				(200	)			(598	)			(14,534	)			19,647				4,315
Cost of products and services			—				—				—				(6,959	)			10,183				3,224
Selling and marketing			1,267				—				—				(917	)			—				350
General and administrative			2,206				—				—				(60	)			—				2,146
Pre-opening expenses			—				—				—				—				—				—
Depreciation and amortization			3,168				—				598				(2,693	)			—				1,073
Total operating expenses			37,717				(200	)			—				(26,409	)			—				11,108
Income (loss) from operations			15				(400	)			—				193				—				(192	)
Other income (expense):
Interest, net			(3,672	)			—				—				2,033				—				(1,639	)
Minority interests			(479	)			—				—				442				—				(37	)
Non-recurring items			—				—				—				—				—				—
Income (loss) before income taxes and loss from discontinued operations			(4,136	)			(400	)			—				2,668				—				(1,868	)
Provision (benefit) for income taxes			172				—				—				(172	)			—				—
Income (loss) before loss from discontinued operations			(4,308	)			(400	)			—				2,840				—				(1,868	)
Loss from discontinued operations			—				—				—				(2,840	)			—				(2,840	)
Net loss			(4,308	)			(400	)			—				—				—				(4,708	)
Dividends on Preferred Stock			495				—				—				—				—				495
Net loss attributable to common stockholders		$	(4,803	)		$	(400	)		$	—			$	—			$	—			$	(5,203	)
Net loss per share – basic and diluted:
Discontinued operations		$	—																			$	(0.15	)
Continuing operations			(0.26	)																			(0.13	)
Net income (loss) per share		$	(0.26	)																		$	(0.28	)
Weighted average number of common shares outstanding:
Basic and diluted			18,697																				18,697

		Consolidated Statement of Operations
		Six Months Ended June 30, 2004
		As				Initiation								Discontinued								As
		Reported				Fees				SFAS No. 13				Operations				Reformat				Reclassified
Revenues:
Membership revenues		$	72,407			$	—			$	—			$	(31,927	)		$	(26,102	)		$	14,378
Products and services			—				(1,200	)			—				(17,541	)			25,957				7,216
Management fees			—				—				—				(145	)			145				—
Reimbursed costs			2,503				—				—				(2,503	)			—				—
Total revenue			74,910				(1,200	)			—				(52,116	)			—				21,594
Operating expenses:
Direct			59,872				—				—				—				(59,872	)			—
Club operating costs			—				(400	)			(1,195	)			(29,618	)			39,832				8,619
Cost of products and services			—				—				—				(13,827	)			20,040				6,213
Selling and marketing			2,798				—				—				(2,011	)			—				787
General and administrative			4,252				—				—				(121	)			—				4,131
Reimbursed costs			2,503				—				—				(2,503	)			—				—
Pre-opening expenses			46				—				—				—				—				46
Depreciation and amortization			6,340				—				1,195				(5,380	)			—				2,155
Non-recurring items			1,104				—				—				—				—				1,104
Total operating expenses			76,915				(400	)			—				(53,460	)			—				23,055
Income (loss) from operations			(2,005	)			(800	)			—				1,344				—				(1,461	)
Other income (expense):
Interest, net			(7,360	)			—				—				4,082				—				(3,278	)
Minority interests			(517	)			—				—				442				—				(75	)
Loss before income taxes and loss from discontinued operations			(9,882	)			(800	)			—				5,868				—				(4,814	)
Provision (benefit) for income taxes			340				—				—				(340	)			—				—
Loss before loss from discontinued operations			(10,222	)			(800	)			—				6,208				—				(4,814	)
Loss from discontinued operations			—				—				—				(6,208	)			—				(6,208	)
Net loss			(10,222	)			(800	)			—				—				—				(11,022	)
Dividends on Preferred Stock			876				—				—				—				—				876
Net loss attributable to common stockholders		$	(11,098	)		$	(800	)		$	—			$	—			$	—			$	(11,898	)
Net loss per share – basic and diluted:
Discontinued operations		$	—																			$	(0.33	)
Continuing operations			(0.60	)																			(0.31	)
Net income (loss) per share		$	(0.60	)																		$	(0.64	)
Weighted average number of common shares outstanding:
Basic and diluted			18,631																				18,631

3. Accounting for Stock-Based Compensation

     The Company has elected to account for stock options granted to employees and directors under the provisions of APB Opinion No. 25, using the intrinsic value method. Entities electing to continue using the accounting prescribed by APB Opinion No. 25 must make pro forma disclosures of net income and income per share, as if the fair value based method of accounting defined in Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), had been applied. In accordance with APB Opinion No. 25, no compensation cost for employees, officers and non-employee directors, has been recognized, as the fair value of the Company’s stock was equal to the exercise price of the options at the date of grant. Had compensation cost for the Company’s plan been determined consistent with SFAS No. 123, the Company’s net income (loss) attributable to common stockholders and income (loss) per share would have been reduced to the pro-forma amounts indicated below:

		Three Months Ended June 30,								Six Months Ended June 30,
		2004				2005				2004				2005
Net loss attributable to common stockholders, as reported		$	(5,203	)		$	(948	)		$	(11,898	)		$	(3,683	)
Stock-based employee compensation expense included in reported net loss			—				—				—				—
Stock-based employee compensation expense determined under fair value based method for all awards			—				—				(93	)			—
Pro forma net loss attributable to Common stockholders		$	(5,203	)		$	(948	)		$	(11,991	)		$	(3,683	)
Net loss per share as reported basic and diluted		$	(0.28	)		$	(0.05	)		$	(0.64	)		$	(0.19	)
Pro forma net loss per share basic and diluted		$	(0.28	)		$	(0.05	)		$	(0.64	)		$	(0.19	)

4. Liquidity/Going Concern

     The Company has experienced recurring net losses of $22.7 million, $18.4 million and $20.8 million during the years ended December 31, 2002, 2003 and 2004, respectively. The Company has also experienced net cash flows used in operating activities (both continuing and discontinuing operations) of $4.4 million and $3.5 million during the years ended December 31, 2002 and 2003, respectively. During 2004 the Company experienced net cash flows from operating activities of $1.7 million. Additionally, the Company may suffer a significant loss during the year ending December 31, 2005. On March 15, 2006, the Company is required to repay its $100.0 million Senior Secured Notes (See Note 7). In the past the Company has had to raise funds through the offering of equity securities in order to make the interest payments due on its Senior Secured Notes. The above historical and estimated future results of operations and cash flows in relation to the Company’s debt obligations raise doubt about the Company’s ability to continue as a going concern.

     The Company’s continued existence is dependent upon its ability to satisfy the interest and principal obligation of its Senior Secured Notes. The Company’s March 15, 2005 and September 15, 2005 interest payments were made using cash balances on hand. In order to satisfy the $105.6 million principal and interest payment due on March 15, 2006, the Company will be required to either issue new equity securities, refinance all or a portion of the Senior Secured Notes, or sell certain assets.

     In order to generate funds for the March 2006 payment, the Company entered into a letter of intent on February 8, 2005 to sell six of its nine sports and fitness Clubs for $65.0 million. The Company continues to negotiate this transaction and believes that it is probable that the transaction will be completed, however, no assurance can be given that the transaction will be completed. Proceeds from this transaction would be used to reduce the Senior Secured Notes. In addition, the Company is also seeking to refinance its West Los Angeles property to generate funds to retire the remainder of the Senior Secured Notes.

     In addition, the Company’s continued existence is dependent upon its ability to increase membership levels at its most recently opened Clubs. Six Clubs were opened between 2000 and 2003. Recently opened Clubs that have not yet achieved mature membership levels have operated at a loss or only a slight profit as a result of fixed expenses that, together with variable operating expenses, approximate or exceed current membership fees and other ancillary revenues. Increasing membership levels at these six most recently opened Clubs is the key to producing operating profits and positive cash flows from operating activities. The Company is constantly generating programs to market the Clubs to potential new members as well as striving to reduce its membership attrition rates.

     If the Company is unable to sell certain of its assets and/or refinance the West Los Angeles property it would be required to issue additional equity securities. There can be no assurance that the Company will be able to sell assets or raise capital by offering additional equity securities. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

5. Sale of Assets

     In December 2004, the Company committed to a plan and came to an understanding to sell six of its nine sports and fitness complexes to an affiliate of Millennium for $65.0 million. Millennium is the Company’s largest stockholder and is the landlord at four of these Clubs. The Clubs to be sold include three facilities located in New York City, and single Clubs in Boston, Massachusetts, Washington D.C. and San Francisco, California. In addition, the management agreement for the Club in Miami, Florida will be assigned to Millennium. Based on the following (i) the Company has $100 million of term loans which are due in March 2006, (ii) Millennium is the landlord at four of the Clubs which are part of this transaction and they are the owner of the Club in Miami and therefore have an interest in these Clubs and (iii) Millennium has representation of the Board of Directors and have access to the financial information relating to these Clubs, the Company concluded that, as of December 31, 2004, the sale was probable and is expected to occur prior to December 31, 2005. On February 8, 2005, the Company entered into a formal letter of intent with Millennium. Accordingly, the Company reported the assets of the Clubs as held for sale, the

liabilities as liabilities relating to assets held for sale and operations of the Clubs as discontinued operations in accordance with SFAS No. 144.

     In October 2004, the Company sold three SportsMed physical therapy facilities for $600,000. The Company continues to own and operate two SportsMed facilities that are located within The Sports Cub/LA Clubs in Los Angeles and Orange County. The Company recorded a provision of $527,000 for the loss on the sale of these SportsMed assets in the third quarter of 2004.

     The operating results of the six Clubs to be sold and SportsMed facilities have been classified as discontinued operations in the accompanying condensed consolidated statements of operations. Summarized financial data for these locations are as follows:

		Statements of Operations
		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2004				2005				2004				2005
						(in thousands)
Revenues:
Membership revenues		$	16,067			$	16,873			$	31,927			$	33,523
Products and services			8,828				9,073				17,541				17,495
Management fees			75				92				145				184
Reimbursed costs			1,246				1,457				2,503				2,907
Total revenue			26,216				27,495				52,116				54,109
Operating, expenses:
Club operating costs			14,534				15,143				29,618				30,165
Costs of products and services			6,959				6,962				13,827				13,570
Selling and marketing			917				692				2,011				1,565
General and administrative			60				130				121				188
Depreciation and amortization			2,693				151				5,380				1,149
Reimbursed costs			1,246				1,457				2,503				2,907
Total operating expenses			26,409				24,535				53,460				49,544
Income (loss) from operations			(193	)			2,960				(1,344	)			4,565
Other income (expense):
Interest, net			(2,033	)			(2,003	)			(4,082	)			(4,011	)
Minority interests			(442	)			(339	)			(442	)			(670	)
Income (loss) before income taxes			(2,668	)			618				(5,868	)			(116	)
Provision for income taxes			172				224				340				375
Income (loss) from discontinued operations		$	(2,840	)		$	394			$	(6,208	)		$	(491	)

     Assets and liabilities related to assets held for sale consist of the following at:

		December 31,				June 30,
		2004				2005
		(in thousands)
Assets held for sale:
Accounts receivable, net of allowance for doubtful accounts		$	1,320			$	1,176
Inventories			442				450
Prepaid expenses			433				512
Property and equipment, net			141,015				140,256
Other assets			198				199
Total assets held for sale		$	143,408			$	142,593
Liabilities related to assets held for sale:
Accrued liabilities		$	3,354			$	3,663
Deferred revenues			15,178				15,576
Accrued lease obligations			65,774				64,719
Minority interest			863				1,133
Total liabilities related to assets held for sale		$	85,169			$	85,091

6. Cash, Cash Equivalents and Restricted Cash

     The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. On June 30, 2005, cash and cash equivalents were $8.9 million.

     The Company considers cash, cash equivalents and other short-term investments that are required to be held as deposits to satisfy certain governmental regulatory or Club security deposits as restricted cash. At June 30, 2005, the Company had $3.4 million of restricted cash.

7. Notes Payable and Equipment Financing Loans

     Notes payable and equipment financing loans are summarized as follows:

		December 31,				June 30,
		2004				2005
		(in thousands)
Senior secured notes (a)		$	100,000			$	100,000
Mortgage note (b)			19,550				19,389
Equipment financing loans (c)			180				103
			119,730				119,492
Less current installments			65,444				100,389
		$	54,286			$	19,103

     The Company has classified $65.0 million of the Senior Secured Notes as a current liability as of December 31, 2004 because the Company expects to complete a transaction to sell six of its Clubs for $65.0 million (See Note 5) before December 31, 2005 and the Indenture requires that the proceeds from that transaction retire a portion of the outstanding Senior Secured Notes. If for any reason the Company were to be in default under any covenants or requirements of the Indenture, the remaining $35.0 million would need to be reclassified from long-term debt to current debt.

     If the Company undergoes a “change in control”, as defined in the Indenture, it must give holders of the Senior Secured Notes the opportunity to sell their Senior Secured Notes to the Company at 101% of their face amount, plus interest. At December 31, 2004, the estimated fair value of the Senior Secured Notes was $94.0 million.

     The Company did not file its 2004 annual report on Form 10-K or its March 31, 2005 and June 30, 2005 quarterly reports on Form 10-Q with the Securities and Exchange Commission on a timely basis and therefore violated one of the provisions of the Indenture Agreement. The trustee for the bondholders granted a waiver of this provision to the Company and extended the allowable filing date to September 30, 2005 in exchange for a $250,000 consent fee.

8. Non-recurring Items

     The non-recurring charge of $1.1 million during the six months ended June 30, 2004 represents various costs, primarily legal fees and investment banking fees, related to an equity raising transaction that was initiated in April 2003 but abandoned in February 2004.

9. Income Tax Provision

     The income tax provision recorded for the three-month and six-month periods ended June 30, 2004 and 2005, are accruals for state and city income taxes related to pre-tax profits at Reebok Sports Club/NY.

10. Consolidated Statements of Operations

     Total revenue and total operating expenses consist of the following:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2004				2005				2004				2005
		(in thousands)
Revenues:
Membership revenues:
Monthly dues		$	6,708			$	7,452			$	13,205			$	14,639
Initiation fees			449				510				878				1,020
Other			134				129				295				269
Total membership revenues			7,291				8,091				14,378				15,928
Products and Services:
Private training			1,841				2,058				3,648				3,983
Food and beverage			876				921				1,703				1,834
Spa services			315				504				689				996
Physical therapy			438				318				882				632
Other			155				178				294				348
Total products and services			3,625				3,979				7,216				7,793
Total revenue		$	10,916			$	12,070			$	21,594			$	23,721

Operating expenses:
Club operating costs:
Payroll and benefits		$	2,110			$	2,132			$	4,221			$	4,314
Rent			481				476				950				940
Other operating costs			1,724				1,735				3,448				3,520
Total Club operating costs			4,315				4,343				8,619				8,774
Costs of products and services:
Private training			1,573				1,743				3,087				3,433
Food & beverage			1,045				986				1,907				1,832
Spa services			325				429				685				871
Physical therapy			260				207				499				424
Other			21				22				35				45
Total cost of products and services			3,224				3,387				6,213				6,605
Sales and marketing			350				247				787				665
General and administrative			2,146				1,995				4,131				4,043
Pre-opening			—				—				46				—
Depreciation and amortization			1,073				1,279				2,155				2,503
Non-recurring items			—				—				1,104				—
Total operating expenses		$	11,108			$	11,251			$	23,055			$	22,590

11. Net Loss per Share

     Basic and diluted loss per share represents the net loss less Preferred Stock dividends divided by the weighted-average number of shares of Common Stock outstanding for the period. Diluted loss per share excludes the dilutive effect of potential common shares. For the three-months and six-months ended June 30, 2004, there were 3,610,479 and 3,301,518 anti-dilutive potential common shares, respectively. For the three-months and six-months ended June 30, 2005, there were 3,058,039 and 3,754,825 anti-dilutive potential common shares, respectively.

12. Series B Redeemable Convertible Preferred Stock

     On March 18, 2002, the Company completed a $10.5 million private placement of a newly created series of its redeemable convertible Preferred Stock. The Company received $9.9 million in cash, after issuance costs, and issued 10,500 shares of Series B Preferred Stock, $.01 par value (“Series B Preferred”), at a price of $1,000 per share. The Company has the option to redeem any outstanding shares of Series B Preferred at any time and the holders may require the redemption of any outstanding shares of Series B Preferred on or after March 18, 2009 at a price of $1,000 per share plus accrued but unpaid dividends. Dividends accrue at the annual rate of $90.00 per share. Such dividends are cumulative but do not accrue interest and at the Company’s option, may be paid in cash or in additional shares of Series B Preferred. The Series B Preferred may, at the option of the holder, be converted into shares of Common Stock at the rate of $2.8871 per share, as adjusted for the issuance of Series D Preferred Stock in March 2004. At June 30, 2005, the Series B Preferred, including accrued dividends of $3,122,000, was convertible into 4,718,229 shares of Common Stock. The conversion price will be adjusted downward in the event the Company issues additional shares of Common Stock at a price below $2.8871 per share, subject to certain exceptions; and any such downward adjustment is subject to the prior approval of the American Stock Exchange. In the event of liquidation, the Series B Preferred holders are entitled to receive, prior and in preference to any distribution to common shareholders and pari passu with holders of the Series C Convertible Preferred Stock, an amount equal to $1,000 for each share of Series B Preferred then outstanding.

     The initial carrying value of the Series B Preferred was recorded at its sale price less costs to issue on the date of issuance. The carrying value of the Series B Preferred is periodically adjusted so that the carrying value equals the redemption value on the redemption date. The carrying value of the Series B Preferred will also be periodically adjusted for any accrued and unpaid dividends. At December 31, 2004 and June 30, 2005, the Series B Preferred carrying value consisted of the following ($ in thousands):

		December 31,				June 30,
		2004				2005
Initial fair value, sale price of $10,500 less costs to issue of $592		$	9,908			$	9,908
Redemption value accretion			240				283
Accrued and unpaid dividends accretion			2,648				3,122
Total carrying value		$	12,796			$	13,313

13. Series C Convertible Preferred Stock

     On September 6, 2002, the Company completed a $5.0 million private placement of a newly created series of convertible Preferred Stock. The Company received $5.0 million in cash and issued 5,000 shares of Series C Convertible Preferred Stock, $.01 par value (“Series C Convertible Preferred”), at a price of $1,000 per share. Dividends accrue at an annual rate of $90.00 per share. Dividends are payable when and as declared by the Board of Directors. Such dividends are cumulative, but do not accrue interest and at the Company’s option, may be paid in cash or additional shares of Series C Convertible Preferred. Dividends are paid pari passu with dividends on the Series B Preferred. In addition, upon conversion any earned and unpaid dividends would become payable. The Series C Convertible Preferred may, at the option of the holder, be converted into shares of Common Stock at the rate of $2.8871 per share, as adjusted for the issuance of Series D Preferred Stock in March 2004. At June 30, 2005, the Series C Preferred, including accrued dividends of $1,263,000, was convertible into 2,169,305 shares of Common Stock. Upon conversion, any earned and unpaid dividends would become payable in cash or additional shares of Series C Convertible Preferred, at the Company’s option. The conversion price will be adjusted downward in the event the Company issues additional shares of Common Stock at a price below $2.8871 per share, subject to certain exceptions; and any such downward adjustment is subject to the prior approval of the American Stock Exchange. At the option of the Company, the Series C Convertible Preferred may be redeemed in whole or in part by paying in cash the sum of $1,000 per share plus any earned and unpaid dividends. In the event of liquidation, the Series C Convertible Preferred holders are entitled to receive, prior and in preference to any distribution to common shareholders, and pari passu with holders of the Series B Preferred, an amount equal to $1,000 for each share of Series C Convertible Preferred then outstanding, plus earned and unpaid dividends.

     The carrying value of the Series C Convertible Preferred is periodically adjusted for any accrued and unpaid dividends. At December 31, 2004 and June 30, 2005, the Series C Convertible Preferred carrying value consisted of the following (in thousands):

		December 31,				June 30,
		2004				2005
Initial fair value		$	5,000			$	5,000
Accrued and unpaid dividend accretion			1,040				1,263
Total carrying value		$	6,040			$	6,263

14. Series D Convertible Preferred Stock

     On March 12, 2004, the Company completed a $6.5 million private placement of a newly created series of Convertible Preferred Stock. The Company received $6.1 million in cash, after issuance costs of $393,000, and issued 65,000 shares of $.01 par value Series D Convertible Preferred Stock (“Series D Convertible Preferred”), at a price of $100 per share. The Series D Convertible Preferred was purchased by three of the Company’s principal shareholders. Dividends accrue at an annual rate of $9.00 per share and shall be paid prior and in preference to any dividends earned on the Series B Preferred, Series C Convertible Preferred, Common Stock or any other class of equity security that is junior to the Series D Convertible Preferred. Dividends are payable when and as declared by the Board of Directors. Such dividends are cumulative, but do not accrue interest and at the Company’s option, may be paid in cash or additional shares of Series D Convertible Preferred. The Series D Convertible Preferred may, at the option of the holder, be converted into shares of Common Stock at the rate of $2.00 per share. At June 30, 2005, the Series D Preferred, including accrued dividends of $762,000, was convertible into 3,631,000 shares of Common Stock. Each share of Series D Convertible Preferred shall automatically be converted into shares of Common Stock upon the consummation of a qualified public offering of Common Stock of at least $50.0 million or if the closing price of the Common Stock for a period of thirty consecutive trading days exceeds $6.00 per share and at least 150,000 shares of Common Stock have been traded during such applicable thirty day period. Upon conversion, any earned and unpaid dividends would become payable. The conversion price will be adjusted equitably in the event of any combination, recapitalization, merger, reclassification or similar transaction or issuance of Common Stock (or any instrument convertible into or exercisable for Common Stock) at a price per share less than $2.00. Commencing on the sixth anniversary of the issuance of the Series D Convertible Preferred, the Company at its option may redeem the Series D Convertible Preferred in whole or in part by paying in cash the sum of $100 per share plus any earned and unpaid dividends. In the event of liquidation, the Series D Convertible Preferred holders are entitled to receive, prior and in preference to any distribution to common shareholders and holders of the Series B Preferred and Series C Convertible Preferred, an amount equal to $100 for each share of Series D Convertible Preferred then outstanding, plus any earned and unpaid dividends. The holders of the Series D Convertible Preferred are afforded protective rights that among other things restrict the Company’s ability to incur debt or lease obligations, make investments or acquisitions, sell a Club leased from Millennium, issue any new class of equity securities, repurchase or redeem any equity securities, hire or fire the Chief Executive Officer, enter into any new line of business or change the primary line of business and issue options under the Company’s stock option plans. In addition, Millennium is entitled to designate two directors (at least one of whom must be independent) and the other two holders are each entitled to designate one director, to serve on the Company’s Board of Directors.

     The carrying value of the Series D Convertible Preferred is periodically adjusted for any accrued and unpaid dividends. At December 31, 2004 and June 30, 2005, the Series D Convertible Preferred carrying value consisted of the following (in thousands):

		December 31,				June 30,
		2004				2005
Initial fair value		$	6,500			$	6,500
Issuance costs			(428	)			(428	)
Accrued and unpaid dividend accretion			471				762
Total carrying value		$	6,543			$	6,834

15. Series E Redeemable Preferred Stock

     On September 14, 2004, the Company completed a $2.0 million private placement of a newly created series of Redeemable Preferred Stock. The Company received $2.0 million in cash and issued 20,000 shares of $.01 par value Series E Preferred Stock (“Series E Preferred”) at a price of $100 per share. The Series E Preferred was purchased by three of the Company’s principal shareholders consisting of Kayne Anderson Capital Advisors, Rex Licklider and D. Michael Talla. Dividends accrue at an annual rate of $11.375 per share. Dividends are cumulative, do not accrue interest and, at the Company’s option, may be paid in additional shares of Series E Preferred. The Series E Preferred is not convertible into shares of the Company’s Common Stock and, except as required by law, does not entitle the holder(s) to vote on matters brought before the Company’s stockholders. At any time after May 31, 2006, provided the Company is legally able to do so, (i) the Company may, redeem all or part of the Series E Preferred for cash at the redemption price of $100.00 per share, together with all accrued but unpaid dividends or (ii) the holders of at least 50% of the Series E Preferred may demand that the Company redeem all the shares of the Series E Preferred by paying the redemption price in cash to each holder of the Series E Preferred. Dividends are accrued on the Series E Preferred with any unpaid dividends included in accrued liabilities on the accompanying condensed consolidated balance sheet.

16. Litigation

     The Company is involved in various claims and lawsuits incidental to its business, including claims arising from accidents. However, in the opinion of management, the Company is adequately insured against such claims and lawsuits involving personal injuries, and any ultimate liability arising out of any such proceedings, whether insured or not, will not have a material adverse effect on the Company’s consolidated financial condition, cash flows or results of operations.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion of our historical results of operations and our liquidity and capital resources should be read in conjunction with the condensed consolidated financial statements and related notes appearing elsewhere herein. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an on-going basis, we evaluate our estimates and judgments that are based on historical experience and other assumptions that we believe to be reasonable under the circumstances. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements.

Overview

     We are the operator of ten sports and fitness Clubs located in major metropolitan markets across the United States, including one Club operated under a management agreement. Our Clubs are spacious, modern facilities that typically include spas, restaurants, fitness centers, swimming pools and basketball courts. Our Clubs, which are usually named The Sports Club/LA, are recognized as among the finest sports and fitness facilities in the United States. In 1999, we decided to focus our efforts on the national development of The Sports Club/LA brand. At that time, we sold all of our smaller sized Clubs. We also issued $100.0 million of Senior Secured Notes due in March 2006. The proceeds from these transactions were primarily utilized to develop five additional new Clubs in New York City, Washington D.C., Boston and San Francisco. We have since opened The Sports Club/LA in Beverly Hills and in Miami.

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

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

agreement have been classified as Discontinued Operations in the accompanying financial statements and in other parts of this Form 10-Q.

     We measure performance using key operating statistics such as initiation fees, monthly dues and ancillary revenues per member. We closely focus on new membership sales and the level of membership attrition at each Club. We also closely evaluate our expenses with an emphasis on controlling payroll costs. We use Club operating income, before depreciation expenses and rent expense as a means to evaluate the overall performance of an individual Club.

     We have two primary sources of revenues. First, our largest source of revenue is from membership dues and initiation fees. We recognize revenue from dues in the month it is earned. Initiation fees are deferred and recognized as revenue on a straight-line basis over 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 37.6% of total Club revenue and we believe that percentage is among the highest in the industry. We believe that membership levels are the primary indicator of a Clubs ability to generate revenue. Therefore, we are consistently generating programs to market the Clubs to potential new members as well as striving to reduce our membership attrition rates. We believe our current attrition rate of 24.05% is well below the normal in the industry.

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

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

Critical Accounting Policies and Estimates

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