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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2004
Commission File # 1-13290
THE SPORTS CLUB COMPANY, INC.
A Delaware corporation - I.R.S. No. 95-4479735
11100 Santa Monica Blvd., Suite 300, Los Angeles, CA 90025
(310) 479-5200
Indicate by check mark whether the company (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, during the preceding 12 months (or for such shorter period that the
company was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--------- ----------
Indicate 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 November 19, 2004
---------------------------------- -----------------------------------
Common Stock, 18,977,638
par value $.01 per share
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 2003 and September 30, 2004
(in thousands, except per share amounts, unaudited)
December 31, September 30,
ASSETS 2003 2004
(audited) (unaudited)
---- ----
Current assets:
Cash and cash equivalents.............................................................. $ 1,932 $ 2,385
Accounts receivable, net of allowance for doubtful accounts of $517 and $382
at December 31, 2003 and September 30, 2004, respectively............................ 3,923 3,372
Inventories............................................................................ 994 1,088
Refundable deposits.................................................................... - 2,730
Prepaid expenses....................................................................... 1,789 673
----------- ----------
Total current assets................................................................. 8,638 10,248
Property and equipment, net.............................................................. 155,173 149,481
Restricted cash.......................................................................... 4,432 3,391
Other assets............................................................................. 8,056 3,058
Goodwill................................................................................. 7,660 7,315
----------- -----------
$ 183,959 $ 173,493
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current installments of notes payable and equipment financing loans.................... $ 2,099 $ 779
Accounts payable....................................................................... 2,464 3,173
Accrued liabilities.................................................................... 13,713 10,053
Deferred revenues...................................................................... 18,292 18,081
----------- -----------
Total current liabilities............................................................ 36,568 32,086
Notes payable and equipment financing loans,
less current installments.............................................................. 119,731 119,382
Accrued lease obligations................................................................ 8,976 9,593
Deferred revenues........................................................................ 869 601
Preferred stock, Series E, $.01 par value, 20,000 shares authorized, issued and
outstanding (liquidation preference of $2,010 at September 30, 2004)................... - 2,010
Minority interest........................................................................ 600 1,204
----------- -----------
Total liabilities.................................................................... 166,744 164,876
Commitments and contingencies
Redeemable preferred stock, Series B, $.01 par value, 10,500 shares authorized;
10,500 shares issued and outstanding (liquidation preference of $12,198 and $12,910 at
December 31, 2003 and September 30, 2004, respectively)................................ 11,761 12,537
Stockholders' equity (deficit):
Preferred stock, $.01 par value, 984,500 and 899,500 shares authorized at December 31,
2003 and September 30, 2004, respectively; no shares issued or outstanding........... -- --
Preferred stock, Series C, $.01 par value, 5,000 shares authorized, issued and
outstanding (liquidation preference of $5,590 and $5,927 at December 31, 2003 and
September 30, 2004, respectively).................................................... 5,590 5,927
Preferred stock, Series D, $.01 par value, 65,000 shares authorized, issued and
outstanding (liquidation preference of $6,824 at September 30, 2004)................. -- 6,396
Common stock, $.01 par value, 40,000,000 shares authorized; 21,074,717 shares issued... 211 211
Additional paid-in capital............................................................. 100,348 98,901
Accumulated deficit.................................................................... (86,217) (101,587)
Treasury stock, at cost, 2,650,003 and 2,290,973 shares at December 31, 2003
and September 30, 2004, respectively ................................................ (14,478) (13,768)
------------ ------------
Stockholders' equity (deficit)..................................................... 5,454 (3,920)
----------- ------------
$ 183,959 $ 173,493
=========== ===========
See accompanying notes to condensed consolidated financial statements.
1
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three And Nine Months Ended September 30, 2003 and 2004
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2004 2003 2004
---- ---- ---- ----
(Restated) (Restated)
Revenues:
Membership revenues.............................. $ 31,728 $ 35,122 $ 96,311 $ 107,529
Reimbursed costs................................. 327 1,267 1,032 3,770
----------- ---------- --------- ---------
Total revenue.................................. 32,055 36,389 97,343 111,299
Operating expenses:
Direct........................................... 26,491 29,504 79,198 89,376
General and administrative....................... 1,949 1,898 5,919 6,150
Selling.......................................... 1,066 1,238 3,666 4,037
Reimbursed costs................................. 327 1,267 1,032 3,770
Depreciation and amortization.................... 2,992 3,200 8,920 9,539
Pre-opening expenses............................. 902 -- 1,677 46
Non-recurring items.............................. -- -- -- 1,104
Loss on assets held for sale..................... -- 527 -- 527
----------- ---------- --------- ----------
Total operating expenses....................... 33,727 37,634 100,412 114,549
----------- ---------- --------- ----------
Loss from operations......................... (1,672) (1,245) (3,069) (3,250)
Other income (expense):
Interest, net.................................... (3,502) (3,656) (10,037) (11,017)
Minority interests............................... (37) (200) (113) (716)
------------ ---------- ----------- -----------
Loss before income taxes .................... (5,211) (5,101) (13,219) (14,983)
Provision for income taxes......................... 56 48 415 387
----------- --------- ----------- ----------
Net loss..................................... (5,267) (5,149) (13,634) (15,370)
Dividends on Preferred Stock....................... 351 508 1,049 1,384
------------ --------- ----------- ----------
Net loss attributable to common stockholders. $ (5,618) $ (5,657) $ (14,683) $ (16,754)
============ ========== =========== ============
Net loss per share:
Basic and diluted................................ $ (0.31) $ (0.30) $ (0.80) $ (0.90)
============ ========== =========== ============
Weighted average shares outstanding:
Basic and diluted................................ 18,370 18,784 18,286 18,682
============ =========== ========== ============
See accompanying notes to condensed consolidated financial statements.
2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2003 and 2004
(in thousands)
(unaudited)
Nine Months Ended
September 30,
2003 2004
---- ----
Cash flows from operating activities:
Net loss..................................................................... $ (13,634) $ (15,370)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization........................................... 8,920 9,539
Related party costs settled with common stock........................... 617 711
Loss on assets held for sale............................................ - 527
Minority interests expense.............................................. 113 716
Distributions to minority interests..................................... (113) (112)
(Increase) decrease in:
Accounts receivable, net............................................. 517 501
Inventories.......................................................... (13) (94)
Other assets......................................................... (191) 3,303
Increase (decrease) in:
Accounts payable..................................................... 521 709
Accrued liabilities.................................................. (2,721) (3,660)
Deferred revenues.................................................... (4) (479)
Accrued lease obligations............................................ 379 617
------------ ------------
Net cash used in operating activities............................. (5,609) (3,092)
Cash flows from investing activities:
Capital expenditures.................................................... (8,536) (3,899)
Decrease (increase) in restricted cash.................................. (4,200) 1,041
------------- ------
Net cash used in investing activities............................. (12,736) (2,858)
Cash flows from financing activities:
Proceeds from issuance of Preferred Stock, net of issuance costs........ -- 8,072
Proceeds from notes payable and equipment financing loans............... 30,741 --
Repayments of notes payable and equipment financing loans............... (13,074) (1,669)
------------- -------------
Net cash provided by financing activities......................... 17,667 6,403
------------ ------------
Net increase in cash and cash equivalents......................... (678) 453
Cash and cash equivalents at beginning of period................................ 3,185 1,932
------------ ------------
Cash and cash equivalents at end of period...................................... $ 2,507 $ 2,385
============ ============
Supplemental disclosure of cash flow information:
Cash paid for interest.................................................. $ 12,075 $ 12,547
============ ============
Cash paid for income taxes.............................................. $ 386 $ 702
============ ============
Supplemental disclosure of non-cash financing activity:
Issuance of common stock to settle accrued related party
loan guarantee fees................................................... $ 617 $ 711
============ ============
See accompanying notes to condensed consolidated financial statements.
3
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003 (audited) and September 30, 2004 (unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements included herein
have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). The condensed consolidated financial
statements should be read in conjunction with the Company's December 31, 2003,
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K/A (SEC File Number 1-13290). Certain information and
footnote disclosures which are normally included in financial statements
prepared in accordance with United States generally accepted accounting
principles have been condensed or omitted pursuant to SEC rules and regulations
for interim financial statements. The Company believes that the disclosures made
are adequate to make the information presented not misleading. The information
reflects all adjustments that, in the opinion of management, are necessary for a
fair presentation of the financial position and results of operations for the
interim periods set forth herein. All such adjustments are of a normal and
recurring nature. The results for the three-month and nine-month periods ended
September 30, 2004, are not necessarily indicative of the results for the fiscal
year ending December 31, 2004.
2. Restatement
Revenues and operating expenses for the three months and nine months ended
September 30, 2003, have been restated to record the impact of reimbursed costs,
which previously had not been shown on the consolidated statement of operations.
Reimbursed costs relate to The Sports Club/LA - Miami, which is a non-Company
owned Club that the Company manages for its owner. The Company receives a
management fee for managing the Club and is reimbursed for costs that are
advanced on the owner's behalf. Reimbursed costs are recorded as both revenue
and expense in the consolidated financial statements. The effect of reimbursed
costs on the Company's loss from operations, net loss, loss attributable to
common stockholders and net loss per share (basic and diluted) is zero, since
reimbursed costs are reported both as revenue and as operating expenses in the
consolidated financial statements in equal amounts. Reimbursed costs represent
both pre-opening expenses and normal operating expenses of the Club.
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:
4
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
2003 2004 2003 2004
---- ---- ---- ----
(in thousand, except per share data)
Net loss attributable to common
stockholders, as reported.................... $ (5,618) $ (5,657) $ (14,683) $ (16,754)
Stock-based employee compensation expense
Included in reported net loss................ -- -- -- --
Stock-based employee compensation expense
determined under fair value based method
for all awards............................... (164) -- (491) (93)
---------- ---------- ----------- ------------
Adjusted net loss attributable to
Common stockholders.......................... $ (5,782) $ (5,657) $ (15,174) $ (16,847)
========== =========== =========== ============
Net loss per share as reported basic and
Diluted...................................... $ (0.31) $ (0.30) $ (0.80) $ (0.90)
========== =========== =========== ============
Adjusted net loss per share basic and diluted $ (0.31) $ (0.30) $ (0.83) $ (0.90)
========== =========== =========== ============
4. Liquidity/Going Concern
The Company has experienced net losses of $22.7 million and $18.4 million
during the years ended December 31, 2002 and 2003, respectively. The Company has
also experienced net cash flows used in operating activities of $4.4 million and
$3.5 million during the years ended December 31, 2002 and 2003, respectively.
Additionally, the Company is expected to incur a significant loss and net cash
flows used in operating activities during the year ending December 31, 2004. The
Company has had to raise funds through the offering of equity securities in
order to make interest payments due on its Senior Secured Notes. The above
historical and estimated future results of operations and cash flows raise doubt
about the Company's ability to continue as a going concern.
The Company's continued existence is primarily dependent upon its ability
to increase membership levels at its six most recently opened Clubs. Five Clubs
were opened during 2000 and 2001 and The Sports Club/LA-Beverly Hills was opened
in October 2003. Recently opened Clubs that have not yet achieved mature
membership levels have operated at a loss or only a slight profit as a result of
fixed expenses that, together with variable operating expenses, approximate or
exceed current revenues. Increasing membership levels at these six most recently
opened Clubs is the key to producing operating profits and positive cash flows
from operating activities. The Company is constantly generating programs to
market the Clubs to potential new members as well as striving to reduce its
membership attrition rates. The Company has also pursued aggressive cost cutting
programs that have reduced general and administrative expenses (including
employment costs) from $8.5 million during the year ended December 31, 2001 to
$7.8 million during the year ended December 31, 2003. Direct and selling
expenses have also dropped as a percentage of revenues during the last three
years.
5
If the Company is unable to increase membership levels or reduce costs to
the point where cash flows from operating activities are sufficient to make the
March 15, 2005, or future interest payments, the Company will be required to
sell assets or issue additional equity or debt securities.
Management has engaged an independent investment banker to assist the
Company in selling certain assets or Clubs in order to generate cash for working
capital purposes and to retire a portion of the Senior Secured Notes. While
management is optimistic that such sales will be completed, no assurance can be
given that such transactions will be consummated.
Additional funds will be required to provide working capital and to service
interest payments on our Senior Secured Notes. In addition, Management will not
consider future acquisitions or the development or management of new Clubs
unless such transactions are structured in a way that would not require
significant expenditures of the Company's capital; would be done in partnership
with other development partners or other third parties; would be expected to
generate cash flow; or would further enhance The Sports Club/LA brand name in
the market place.
There can be no assurance that the Company will be able to sell assets or
additional equity or debt securities to generate the funds with which to make
such payments, or that any such sales would be on terms and conditions
reasonable to the Company. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
5. Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. On September 30,
2004, cash and cash equivalents were $2.4 million.
The Company considers cash, cash equivalents and other short-term
investments that are required to be held as deposits to satisfy certain
governmental regulatory or Club security deposits as restricted cash. At
September 30, 2004, the Company had $3.4 million of restricted cash.
6. Notes Payable and Equipment Financing Loans
Notes payable and equipment financing loans are summarized as follows:
December 31, September 30,
2003 2004
---- ----
(in thousands)
Senior secured notes (a).................$ 100,000 $ 100,000
Mortgage note (b)........................ 19,855 19,628
Equipment financing loans (c)............ 1,975 533
-------------- ------------
121,830 120,161
Less current installments................ 2,099 779
-------------- ------------
$ 119,731 $ 119,382
============== ============
6
---------
(a) On April 1, 1999, the Company issued in a private placement $100.0
million of 11 3/8% Senior Secured Notes due in March 2006 (the "Senior
Notes") with interest due semi-annually. In May 1999, the Senior Notes
were exchanged for registered Series B Senior Secured Notes (the
"Senior Secured Notes"). The Senior Secured Notes are secured by
substantially all of the Company's assets, other than certain excluded
assets. In connection with the issuance of the Senior Secured Notes,
the Company entered into an indenture dated as of April 1, 1999 (the
"Indenture") that includes certain covenants, which as of September
30, 2004, restrict the Company's ability, subject to certain
exceptions, to: (i) incur additional indebtedness; (ii) pay dividends
or other distributions, or repurchase capital stock or other equity
interests or subordinated indebtedness; and (iii) make certain
investments. The Indenture also limits the Company's ability to: (i)
enter into transactions with affiliates, (ii) create liens on or sell
certain assets, and (iii) enter into mergers and consolidations. The
Senior Secured Notes are subject to redemption at the option of the
Company, in whole or in part, at the redemption prices (expressed as
percentages of principal amount) set forth below, plus accrued and
unpaid interest thereon:
Period Percentage
------ ----------
Prior to March 15, 2005................ 102.844%
Thereafter............................. 100.000%
(b) On June 12, 2003, the Company obtained mortgage financing in the
form of a secured five-year promissory loan in the amount of $20.0
million. The loan is evidenced by a promissory note that bears
interest at a fixed interest rate of 7.25%; requires monthly principal
and interest payments of $144,561; is secured by the common stock and
all the assets of Irvine Sports Club, Inc., the Company's wholly owned
subsidiary that owns The Sports Club/LA - Orange County; and is
guaranteed by the Company's Chairman and it's Chief Executive Officer.
The note requires The Sports Club/LA - Orange County to maintain a
minimum operating income, as defined, or the Company will be required
to establish a payment reserve account of up to $607,000. As of
September 30, 2004, the Company has maintained the minimum operating
income. The note may be prepaid at any time without penalty or premium
and requires a final principal payment of $18.3 million on July 1,
2008.
(c) The equipment financing loans are secured by furniture, fixtures
and equipment. The amounts are generally repayable in monthly payments
over four or five years with effective interest rates between 3.5% and
13.3%.
7. Non-recurring Items
The non-recurring charge of $1.1 million during the nine months ended
September 30, 2004 represents various costs, primarily legal fees and investment
banking fees, related to an equity raising transaction that was initiated in
April 2003 but abandoned in February 2004.
8. Loss On Assets Held For Sale
On October 18, 2004, the Company sold three SportsMed physical therapy
facilities, not located within The Sports Club/LA locations, for a total of
$600,000. These three SportsMed facilities were located in Calabasas, Valencia
and Thousand Oaks, California. The Company continues to own and operate two
SportsMed facilities that are located within The
7
Sports Club/LA Clubs in Los Angeles and Orange County, California. The September
30, 2004 statement of operations includes a provision of $527,000 for the
estimated loss on assets held for sale, in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets.
9. Income Tax Provision
The income tax provision recorded for the three-month and nine-month
periods ended September 30, 2004 and 2003, are accruals for state and city
income taxes related to pre-tax profits at Reebok Sports Club/NY.
10. Net Loss per Share
Basic and diluted loss per share represents the net loss less Preferred
Stock dividends divided by the weighted-average number of shares of Common Stock
outstanding for the period. Diluted loss per share excludes the dilutive effect
of potential common shares. For the three-months and nine-months ended September
30, 2004, there were 4,035,250 and 3,536,184 anti-dilutive potential common
shares, respectively. For the three-months and nine-months ended September 30,
2003, there were 1,694,768 and 1,886,998 anti-dilutive potential common shares,
respectively.
11. 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 (resulting in the issuance of 3,636,867 shares of Common Stock if
100% of the Series B Preferred is converted at that price). The conversion price
will be adjusted downward in the event the Company issues additional shares of
Common Stock at a price below $2.8871 per share, subject to certain exceptions;
and any such downward adjustment is subject to the prior approval of the
American Stock Exchange. In the event the Series B Preferred is redeemed before
March 18, 2005, the holders will receive warrants to purchase shares of Common
Stock at a price of $3.00 per share, exercisable before March 18, 2007. In the
event of liquidation, the Series B Preferred holders are entitled to receive,
prior and in preference to any distribution to common shareholders and pari
passu with holders of the Series C Convertible Preferred Stock (See Note 9), an
amount equal to $1,000 for each share of Series B Preferred then outstanding.
The initial carrying value of the Series B Preferred was recorded at its
"fair value" (sale price less costs to issue) on the date of issuance. The
carrying value of the Series B Preferred is periodically adjusted so that the
carrying value equals the redemption value on the redemption date. The carrying
value of the Series B Preferred will also be periodically adjusted for any
accrued and unpaid dividends. Since the Series B Preferred has conditional
8
redemption features, this transaction has been accounted for in accordance with
Regulation S-X, Article 5-02, and presented on the consolidated balance sheet
outside permanent equity and liabilities. At December 31, 2003 and September 30,
2004, the Series B Preferred carrying value consisted of the following ($ in
thousands):
December 31, September 30,
2003 2004
---- ----
Initial fair value, sale price of $10,500
less costs to issue of $592............... $ 9,908 $ 9,908
Redemption value accretion.................... 155 219
Accrued and unpaid dividends accretion........ 1,698 2,410
---------- ----------
Total carrying value...................... $ 11,761 $ 12,537
========== ==========
12. 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 are earned at an annual rate of $90.00 per share.
Dividends are payable when and as declared by the Board of Directors. Such
dividends are cumulative, but do not accrue interest and at the Company's
option, may be paid in cash or additional shares of Series C Convertible
Preferred. Dividends are paid pari passu with dividends on the Series B
Preferred. 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
(resulting in the issuance of 1,731,842 shares of Common Stock if 100% of the
Series C Convertible Preferred is converted at that price). Upon conversion, any
earned and unpaid dividends would become payable in cash or additional shares of
Series C Convertible Preferred, at the Company's option. The conversion price
will be adjusted downward in the event the Company issues additional shares of
Common Stock at a price below $2.8871 per share, subject to certain exceptions;
and any such downward adjustment is subject to the prior approval of the
American Stock Exchange. At the option of the Company, the Series C Convertible
Preferred may be redeemed in whole or in part by paying in cash the sum of
$1,000 per share plus any earned and unpaid dividends. In the event the Series C
Convertible Preferred is redeemed before September 6, 2005, the holders will
receive warrants to purchase shares of Common Stock at a price of $3.00 per
share, exercisable before September 6, 2007. In the event of liquidation, the
Series C Convertible Preferred holders are entitled to receive, prior and in
preference to any distribution to common shareholders, and pari passu with
holders of the Series B Preferred, an amount equal to $1,000 for each share of
Series C Convertible Preferred then outstanding, plus earned and unpaid
dividends.
The carrying value of the Series C Convertible Preferred is periodically
adjusted for any accrued and unpaid dividends. At December 31, 2003 and
September 30, 2004, the Series C Convertible Preferred carrying value consisted
of the following (in thousands):
December 31, September 30,
2003 2004
---- ----
Initial fair value............................$ 5,000 $ 5,000
Accrued and unpaid dividend accretion......... 590 927
----------- -----------
Total carrying value..........................$ 5,590 $ 5,927
=========== ===========
9
13. 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 are
earned at an annual rate of $9.00 per share and shall be paid prior and in
preference to any dividends earned on the Series B Preferred, Series C
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 (resulting in the issuance of 3,250,000 shares of
Common Stock if 100% of the Series D Convertible Preferred is converted). Each
share of Series D Convertible Preferred shall automatically be converted into
shares of Common Stock upon the consummation of a qualified 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 (30) consecutive trading days exceeds $4.00 per
share until March 15, 2005, or $6.00 per share thereafter, and at least 150,000
shares of Common Stock have been traded during such applicable thirty (30) 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 the Series D Convertible Preferred
conversion price then in effect. Commencing on the sixth anniversary of the
issuance of the Series D Convertible Preferred, the Company at its option may
redeem the Series D Convertible Preferred in whole or in part by paying in cash
the sum of $100 per share plus any earned and unpaid dividends. In the event of
liquidation, the Series D Convertible Preferred holders are entitled to receive,
prior and in preference to any distribution to common shareholders and holders
of the Series B Preferred and Series C Convertible Preferred, an amount equal to
$100 for each share of Series D Convertible Preferred then outstanding, plus any
earned and unpaid dividends. The holders of the Series D Convertible Preferred
are afforded protective rights that among other things restrict the Company's
ability to incur debt or lease obligations, make investments or acquisitions,
sell a Club leased from Millennium, issue any new class of equity securities,
repurchase or redeem any equity securities, hire or fire the Chief Executive
Officer, enter into any new line of business or change the primary line of
business or issue options under the Company's stock option plans. At September
30, 2004, the Company is in compliance with all the protective rights
requirements. In addition, one of the holders 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 September 30, 2004, the Series
D Convertible Preferred carrying value consisted of the following (in
thousands):
Initial fair value........................... $ 6,500
Issuance costs............................... (428)
Accrued and unpaid dividend accretion........ 324
-----------------
Total carrying value......................... $ 6,396
=================
10
14. Series E Redeemable Preferred Stock
On September 14, 2004, the Company completed a $2.0 million private
placement of a newly created series of 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.
Dividends are earned 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 Stock. The Series E Preferred Stock 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 Stock for cash at the redemption price of $100.00 per share,
together with all accrued but unpaid dividends or (ii) the holders of at least
50% of the Series E Preferred Stock may demand that the Company redeem all the
shares of the Series E Preferred Stock by paying the redemption price in cash to
each holder of the Series E Preferred Stock. The Series E Preferred has been
classified as a liability on the Company's consolidated balance sheet in
accordance with SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity.
The carrying value of the Series E Preferred is periodically adjusted for
any accrued and unpaid dividends. At September 30, 2004, the Series E
Convertible Preferred carrying value consisted of the following (in thousands):
Initial fair value....................................$ 2,000
Accrued and unpaid dividends.......................... 10
-----------
Total carrying value......................... $ 2,010
===========
15. 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.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of our historical results of operations and our
liquidity and capital resources should be read in conjunction with the condensed
consolidated financial statements and related notes appearing elsewhere herein.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures. On an on-going basis, we evaluate our
estimates and judgments that are based on historical experience and other
assumptions that we believe to be reasonable under the circumstances. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements.
Overview
We are the operator of ten (10) sports and fitness Clubs located in major
metropolitan markets across the United States, including one Club operated under
a management agreement. Our Clubs are spacious, modern facilities that typically
include spas, restaurants, fitness centers, swimming pools and basketball
courts. Our Clubs, which are usually named The Sports Club/LA, are recognized as
among the finest sports and fitness facilities in the United States. In 1999, we
decided to focus our efforts on the national development of The Sports Club/LA
brand. At that time, we sold all of our smaller sized Clubs. We also issued
$100.0 million of Senior Secured Notes due in March 2006. The proceeds from
these transactions were utilized to develop five additional new Clubs in New
York City, Washington D.C., Boston and San Francisco. We have since opened The
Sports Club/LA in Beverly Hills and are operating The Sports Club/LA-Miami under
a management agreement.
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 provided, we have
historically expended significant amounts to construct a new facility. We
evaluate the results of our Clubs based upon how long the Clubs have been open
at the most recent measurement period. We categorize Clubs as either "mature" or
"recently opened". Mature Clubs are those Clubs where we believe the membership
levels have reached a stable level and, based upon the amount of new membership
sales and attrition, the size of the Club, we do not believe a significant
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; of these six Clubs, five 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 historically have initially operated at a loss or only a
slight profit as a result of fixed expenses that, together with variable
operating expenses, approximate or exceed membership fees and other revenues.
Since 2000, we have invested significant amounts of cash in the construction and
operation of these new Clubs. Our operating performances and our liquidity have
been negatively impacted due to the start up nature of these Clubs and the
initial construction cost.
We measure performance using key operating statistics such as initiation
fees, monthly dues and ancillary revenues per member. We closely focus on new
membership sales and the level of membership attrition at each Club. We also
closely evaluate our expenses with an emphasis on controlling payroll costs. We
use Club operating income, before depreciation
12
expenses and rent expense, as a means to evaluate the overall performance of an
individual Club.
We have two primary sources of revenues. Our largest source of revenue is
from membership dues and initiation fees. We recognize revenue from dues in the
month it is earned. Initiation fees are deferred and recognized as revenue on a
straight-line basis over a period of three years, which represents the average
life of a membership based upon historical data. Secondly, we generate ancillary
revenue from our membership within each Club. The largest of these ancillary
revenue sources is 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 Club's 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 26.4% 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 is 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 development of The Sports Club/LA brand and the generation of new
memberships.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of the assets
and liabilities and disclosures of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. We base these estimates and assumptions upon
historical experience and existing known circumstances. Actual results could
differ from those estimates. Specifically, we must make estimates in the
following areas:
Revenue Recognition. We receive initiation fees and monthly membership dues
from our members. Substantially all of our members join on a month-to-month
basis and can therefore cancel their membership at any time. Initiation fees and
related direct expenses, primarily sales commissions, are deferred and
recognized, on a straight line basis, over a period of three years, which
represents the average life of a membership based upon historical data. Dues
that are received in advance are recognized on a pro-rated basis over the
periods in which services are to be provided. In addition, payments of last
months' dues are deferred. Revenues for services including private training, spa
treatments and physical therapy sessions are recorded when such services are
performed. Amounts received in advance are recorded as deferred revenues.
Revenues from our SportsMed subsidiary are recognized when the services are
performed based upon the estimated amount to be collected.
13
Effective July 1, 2003, we adopted EITF 00-21, Revenue Arrangements with
Multiple Deliverables. As a result of the adoption of EITF 00-21, the fair value
of any products or services bundled with new membership sales, which can be
unbundled, is now recorded as revenue when the product is delivered or the
service is performed. Prior to the adoption of EITF 00-21, we considered all
payments as initiation fees and no revenue was recorded for the products or
services bundled with new memberships.
Allowance for doubtful accounts. We provide a reserve against our
receivables for estimated losses that may result from our members' inability to
pay. We determine the amount of the reserve by analyzing known uncollectible
accounts, economic conditions, historical losses and our members'
creditworthiness. The likelihood of a material collection loss is minimal
because we collect most revenues in advance.
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 September
30, 2004.
Valuation of goodwill. Prior to January 1, 2002, we amortized goodwill,
which represents the excess of the purchase price over the net assets acquired
in business acquisitions, over 40 years. We recorded goodwill in connection with
our acquisitions of The Sports Club/LA in Los Angeles and Orange County, Reebok
Sports Club/NY and SportsMed. We are required to evaluate goodwill for
impairment on at least an annual basis, or earlier, if a triggering event
requires us to do so. We performed the analysis, as of December 31, 2002 and
2003, respectively, and determined that our remaining goodwill was not impaired.
As of September 30, 2004, no triggering events have occurred that would require
us to evaluate goodwill during any interim periods.
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.
14
Results of Operations
Comparison of Three Months Ended September 30, 2004 to Three Months Ended
September 30, 2003.
Our revenues for the three months ended September 30, 2004, were $36.4
million, compared to $32.1 million for the same period in 2003, an increase of
$4.3 million or 13.5%. Revenue increased by $2.1 million as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Revenue
increased by another $1.4 million at the five Clubs opened in 2001 and 2002
primarily as a result of a 7.8% increase in membership at these Clubs and annual
rate increases for monthly dues and other ancillary services. Revenue increased
by $940,000 as a result of increased cost reimbursements due us primarily from
our management of The Sports Club/LA-Miami, a non-owned Club in Florida. Revenue
decreased by $112,000 at our SportsMed subsidiary primarily due to decreased
patient visits, revenue increased by $63,000 primarily due to increased
management fees earned from our management of The Sports Club/LA-Miami and
revenue decreased by $40,000 at our three mature Clubs.
Our direct expenses increased by $3.0 million (11.4%) to $29.5 million for
the three months ended September 30, 2004, versus $26.5 million for the same
period in 2003. Direct expenses increased by $2.1 million as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Direct expenses
increased by $503,000 at the five Clubs opened in 2000 and 2001 primarily as a
result of an increase in variable direct expenses associated with the 7.8%
revenue growth that occurred at these five Clubs between September 30, 2003 and
September 30, 2004. Direct expenses increased by $410,000 at our three mature
Clubs and our SportsMed subsidiary primarily due to increased payroll costs.
Direct expenses as a percent of revenue for the three months ended September 30,
2004, decreased to 81.1% from 82.6% for the same period in 2003. As membership
levels and therefore revenues increase at the six new Clubs, the direct expense
percentage should decrease. There is no assurance, however, that such membership
or revenue growth will occur.
General and administrative expenses were $1.9 million for the three months
ended September 30, 2004, versus $2.0 million for the same period in 2003, a
decrease of $51,000. Payroll and payroll related expenses for the three months
ended September 30, 2004, increased by $47,000, primarily due to normal
compensation increases. Accounting and legal fees decreased by approximately
$544,000, 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 $294,000, 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. As a
result of the resignation of our Co-Chief Executive Officer, D. Michael Talla,
we wrote-off the difference between the carrying value and cash value of his
key-man life insurance policy. This write-down of the carrying value of the
key-man life insurance policy resulted in an increase in general and
administrative expenses of $189,000. Other minor increases and decreases in
other general and administrative expenses accounting for a net decrease of
$37,000. General and administrative expenses decreased as a percentage of
revenue to 5.2% for the three months ended September 30, 2004, from 6.1% for the
same period in 2003. We believe that general and administrative expenses should
continue to decrease as a percentage of future revenues as we expand and achieve
economies of scale. There is no assurance, however, that said expansion or
economies of scale will be achieved.
15
Our selling expenses were $1.2 million for the three months ended September
30, 2004, versus $1.1 million for the same period in 2003, an increase of
$172,000 or 16.1%. Selling expenses increased by $128,000 as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003 and increased by
$44,000 at our other Clubs primarily due to the timing of our direct mail
campaigns. Selling expenses as a percentage of revenue increased to 3.4% for the
three months ended September 30, 2004, from 3.3% for the same period in 2003.
Reimbursed costs were $1.3 million for the three months ended September 30,
2004, versus $327,000 for the same period in 2003, an increase of $940,000.
These costs primarily relate to The Sports Club/LA-Miami, which is a non-owned
Club that we manage for its owner. We receive a management fee for managing the
Club and are reimbursed for all costs we advance on the owner's behalf.
Management fees and reimbursed costs are recorded as revenue and the reimbursed
costs are also recorded as expenses in our consolidated financial statements.
The effect of reimbursed costs on our loss from operations is therefore zero,
since reimbursed costs are both reported as revenue and as operating costs in
our consolidated financial statements. The reimbursed costs of $327,000 for the
three months ended September 30, 2003, represent pre-opening expenses incurred
by us on the owner's behalf. The reimbursed costs of $1.3 million, for the three
months ended September 30, 2004, represent operating costs of the Club, which
opened in November 2003. The increase of $940,000 compared to the same period in
2003 is due to the Club becoming fully operational.
Our depreciation and amortization expenses were $3.2 million for the three
months ended September 30, 2004, versus $3.0 million for the same period in
2003, an increase of $208,000 or 7.0%. Depreciation and amortization expenses
increased by $161,000 as a result of the opening of The Sports Club/LA-Beverly
Hills on October 7, 2003, and by $47,000 due principally to capital additions
made at our other Clubs during 2003 and 2004.
Pre-opening expenses of $902,000 for the three months ended September 30,
2003 consisted of expenses related to The Sports Club/LA-Beverly Hills, which
opened on October 7, 2003.
On October 18, 2004, we sold three SportsMed physical therapy facilities.
We continue to own and operate two SportsMed physical therapy facilities that
are located in The Sports Club/LA Clubs located in Los Angeles and Orange
County, California. We incurred a net loss on the sale, after costs of sale, of
approximately $527,000. The September 30, 2004 operating statement includes a
provision of $527,000 for the estimated loss on this sale.
Our net interest expense increased by $154,000 (4.4%) to $3.7 million for
the three months ended September 30, 2004, versus $3.5 million for the same
period in 2003. Net interest expense increased by $195,000 due to the
termination of the capitalization of interest on our construction costs for The
Sports Club/LA-Beverly Hills, which opened on October 7, 2003. Net interest
expense decreased by $41,000 primarily due to a reduction of equipment financing
loans.
Our minority interests increased by $163,000 to $200,000 for the three
months ended September 30, 2004, versus $37,000 for the same period in 2003.
Minority interests increased by $163,000, as a result of the accrual of a
minority interest at our Reebok Sports Club/NY. Prior to 2004, we had no
obligation to share the profits of this partnership with our other partners.
16
The tax provisions recorded for the three months ended September 30, 2004
and 2003 are comprised of New York City and New York State income taxes incurred
on pre-tax earnings at Reebok Sports Club/NY. We did not record any federal or
state deferred tax benefit related to our consolidated pre-tax losses incurred
for the three months ended September 30, 2004 and 2003.
After the tax provisions and dividends on preferred stock of $508,000 in
2004 and $351,000 in 2003, our consolidated net loss attributable to common
shareholders was $5.7 million, or $0.30 per basic and diluted share for the
three months ended September 30, 2004, versus a loss of $5.6 million, or $0.31
per basic and diluted share for the three months ended September 30, 2003.
Comparison of Nine Months Ended September 30, 2004 to Nine Months Ended
September 30, 2003.
Our revenues for the nine months ended September 30, 2004, were $111.3
million, compared to $97.3 million for the same period in 2003, an increase of
$14.0 million or 14.3%. Revenue increased by $5.8 million as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Revenue
increased by another $5.3 million at the five Clubs opened in 2001 and 2002
primarily as a result of an 7.8% increase in membership at these Clubs and
annual rate increases for monthly dues and other ancillary services. Revenue
increased by $2.8 million primarily as a result of increased cost reimbursements
due us from our management of The Sports Club/LA-Miami, a non-owned Club in
Florida. Revenue decreased by $53,000 at our SportsMed subsidiary primarily due
to decreased patient visits and revenue increased by $213,000 due to increased
management fees earned primarily from our management of The Sports
Club/LA-Miami. Revenue decreased by $103,000 at our three mature Clubs.
Our direct expenses increased by $10.2 million (12.9%) to $89.4 million for
the nine months ended September 30, 2004, versus $79.2 million for the same
period in 2003. Direct expenses increased by $6.1 million as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003. Direct expenses
increased by $2.7 million at the five Clubs opened in 2000 and 2001 primarily as
a result of an increase in variable direct expenses associated with the 7.8%
revenue growth that occurred at these five Clubs between September 30, 2003 and
September 30, 2004. Direct expenses increased by $1.4 million at our three
mature Clubs and our SportsMed subsidiary primarily due to increased payroll
costs. Direct expenses as a percent of revenue for the nine months ended
September 30, 2004, decreased to 80.3% from 81.4% for the same period in 2003.
As membership levels and therefore revenues increase at the six new Clubs, the
direct expense percentage should decrease. There is no assurance, however, that
such membership or revenue growth will occur.
General and administrative expenses were $6.1 million for the nine months
ended September 30, 2004, versus $5.9 million for the same period in 2003, an
increase of $231,000. Payroll and payroll-related expenses for the nine months
ended September 30, 2004 increased by $158,000, primarily due to normal
compensation increases. As a result of the resignation of our Co-Chief Executive
Officer, D. Michael Talla, we wrote-off the difference between the carrying
value and cash value of his key-man life insurance policy. This write-down of
the carrying value of the key-man life insurance policy resulted in an increase
in general and administrative expenses of $189,000. Accounting and legal fees
decreased by approximately $455,000, 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
$392,000, 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
17
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 $53,000. General
and administrative expenses decreased as a percentage of revenue to 5.5% for the
nine months ended September 30, 2004, from 6.1% for the same period in 2003. We
believe that general and administrative expenses should continue to decrease as
a percentage of future revenues as we expand and achieve economies of scale.
There is no assurance, however, that said expansion or economies of scale will
be achieved.
Our selling expenses were $4.0 million for the nine months ended September
30, 2004, versus $3.7 million for the same period in 2003, an increase of
$371,000 or 10.1%. Selling expenses increased by $444,000 as a result of the
opening of The Sports Club/LA-Beverly Hills on October 7, 2003 and decreased by
$73,000 at our other Clubs primarily due to the timing of our media advertising.
Selling expenses as a percentage of revenue decreased to 3.6% for the nine
months ended September 30, 2004, from 3.8% for the same period in 2003.
Reimbursed costs were $3.8 million for the nine months ended September 30,
2004, versus $1.0 million for the same period in 2003, an increase of $2.8
million. These costs relate to The Sports Club/LA-Miami, which is a non-owned
Club that we manage for its owner. We receive a management fee for managing the
Club and are reimbursed for all costs we advance on the owner's behalf.
Management fees and reimbursed costs are recorded as revenue and the reimbursed
costs are also recorded as expenses in our consolidated financial statements.
The effect of reimbursed costs on our loss from operations is therefore zero,
since reimbursed costs are both reported as revenue and as operating costs in
our consolidated financial statements. The reimbursed costs of $1.0 million, for
the nine months ended September 30, 2003, represent pre-opening expenses
incurred by us on the owner's behalf. The reimbursed costs of $3.8 million, for
the nine months ended September 30, 2004, represent operating costs of the Club,
which opened on October 7, 2003. The increase of $2.8 million compared to the
same period in 2003 is due to the Club becoming fully operational.
Our depreciation and amortization expenses were $9.5 million for the nine
months ended September 30, 2004, versus $8.9 million for the same period in
2003, an increase of $619,000 or 6.9%. Depreciation and amortization expenses
increased by $477,000 as a result of the opening of The Sports Club/LA-Beverly
Hills on October 7, 2003 and by $142,000 primarily due to capital additions made
at our other Clubs during 2003 and 2004.
Pre-opening expenses of $46,000 and $1.7 million for the nine months ended
September 30, 2004 and nine months ended September 30, 2003, respectively,
consisted of expenses related to The Sports Club/LA-Beverly Hills, which opened
on October 7, 2003.
We recorded a non-recurring charge of $1.1 million during the nine months
ended September 30, 2004. This charge is comprised of various costs, primarily
legal fees and investment banking fees, related to a proposed restructuring
transaction that was initiated in April 2003 and abandoned in February 2004.
On October 18, 2004, we sold three SportsMed physical therapy facilities.
We continue to own and operate two SportsMed physical therapy facilities that
are located in The Sports Club/LA Clubs located in Los Angeles and Orange
County, California. We incurred a net loss on the sale, after costs of sale, of
approximately $527,000. The September 30, 2004 operating statement includes a
provision of $527,000 for the estimated loss on this sale.
Our net interest expense increased by $980,000 (9.8%) to $11.0 million for
the nine months ended September 30, 2004, versus $10.0 million for the same
period in 2003. Net
18
interest expense increased by $832,000 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 $344,000 due to the termination of the
capitalization of interest on our construction costs for The Sports
Club/LA-Beverly Hills, which opened on October 7, 2003. Net interest expensed
decreased by $196,000 due principally to a reduction of equipment financing
loans, and the payoff of the former credit line with our bank.
Our minority interests increased by $603,000 to $716,000 for the nine
months ended September 30, 2004, versus $113,00 for the same period in 2003.
Minority interests increased by $603,000, as a result of the accrual of a
minority interest at our Reebok Sports Club/NY. Prior to 2004, we had no
obligation to share the profits of this partnership with our other parties.
The tax provisions recorded for the nine months ended September 30, 2004
and 2003 are comprised of New York City and New York State income taxes incurred
on pre-tax earnings at Reebok Sports Club/NY. We did not record any federal or
state deferred tax benefit related to our consolidated pre-tax losses incurred
for the nine months ended September 30, 2004 and 2003.
After the tax provisions and dividends on preferred stock of $1.4 million
in 2004 and $1.0 million in 2003, our consolidated net loss attributable to
common shareholders was $16.8 million, or $0.90 per basic and diluted share for
the nine months ended September 30, 2004, versus a loss of $14.7 million, or
$0.80 per basic and diluted share for the nine months ended September 30, 2003.
Non-GAAP Financial Measures
We use the term "EBITDA" in this discussion. EBITDA consists of net income
(loss) plus interest, net, provision for income taxes and depreciation and
amortization. This term, as we define it, may not be comparable to a
similarly-titled measure used by other companies and is not a measure of
performance presented in accordance with GAAP. We use EBITDA and EBITDA margin
as measures of operating performance. EBITDA should not be considered as a
substitute for net income (loss), cash flows provided by operating activities,
or other income or cash flow data prepared in accordance with GAAP. We believe
EBITDA is useful to an investor in evaluating our operating performance and
liquidity because:
o it is a widely accepted financial indicator of a company's ability to
service its debt;
o it is widely used to measure a company's operating performance without
regard to items such as depreciation and amortization, which can vary
depending upon accounting methods and the book value of assets, and to
present a meaningful measure of corporate performance exclusive of our
capital structure and the method by which assets were acquired; and
o it helps investors to more meaningfully evaluate and compare the
results of our operations from period to period by removing from our
operating results the impact of our capital structure, primarily
interest expense from our outstanding debt, and asset base, primarily
depreciation and amortization of our properties.
19
Our management uses EBITDA:
o as a measurement of operating performance because it assists us in
comparing our performance on a consistent basis, as it removes from
our operating results the impact of our capital structure, which
includes interest expense from our outstanding debt, and our asset
base, which includes depreciation and amortization of our properties;
o in presentations to the members of our board of directors to enable
our board to have the same consistent measurement basis of operating
performance used by management; and
o as the basis for incentive bonuses paid to selected members of senior
and Club level management.
Below is a reconciliation of EBITDA to net income ($'s in thousands):
Nine Months Ended
September 30, 2004
------------------
EBITDA ...................................... $ 5,573
Depreciation and amortization................ (9,539)
Interest, net................................ (11,017)
Provision for income taxes................... (387)
--------------------
Net loss ...................................... $ (15,370)
=====================
Liquidity and Capital Resources
Liquidity
Historically, we have satisfied our liquidity needs through various debt
arrangements, sales of Common or Preferred Stock and cash flows from operations.
Our primary liquidity needs the past several years have been the development of
new Clubs and the interest cost associated with our $100.0 million Senior
Secured Notes.
In order to make our March 15, 2004 and September 15, 2004 semi-annual
interest payments on the Senior Secured Notes, we issued $6.5 million of a
newly-created class of Series D Convertible Preferred Stock and $2.0 million of
a newly-created class of Series E Preferred Stock, respectively. We are not
certain that amounts we will generate from operations through March 15, 2005
will be sufficient for us to make the Senior Secured Note interest payment due
on March 15, 2005. If cash flows from operations are insufficient to make the
March 15, 2005 or future interest payments, we will be required to dispose of
assets or sell additional equity or debt securities to generate cash to make
such payments. There can be no assurance that we will be able to sell assets or
issue additional equity or debt securities, or that any such sales or issuances
will be on reasonable terms. If we were unable to complete such sales or
issuances prior to the date such interest payments are due, our ability to
continue to operate our business would be materially adversely affected.
20
We have engaged an independent investment banker to assist us in selling
certain assets or Clubs in order to generate cash for working capital purposes
and to retire a portion of the Senior Secured Notes. While we are optimistic
that such sales will be completed, no assurance can be given that such
transactions will be consummated.
Additional funds will be required to provide working capital and to service
interest payments on our Senior Secured Notes. In addition, we will not consider
future acquisitions or the development or management of new Clubs unless such
transactions are structured in a way that would not require significant
expenditures of our capital; would be done in partnership with other development
partners or other third parties; would be expected to generate cash flow; or
would further enhance The Sports Club/LA brand name in the market place.
Operating Activities
Our cash balance on September 30, 2004 was $2.4 million. During the first
nine months of 2004, our earnings before interest, taxes, depreciation and
amortization ("EBITDA") were $5.6 million. We believe we will continue to
generate positive EBITDA and that such amount will increase as our new Clubs
continue to mature.
We have various deposits that secure our performance under several
contracts. We expect to receive back $2.2 million of such deposits in the fourth
quarter of 2004 and $500,000 in the first quarter of 2005.
Investing Activities
Investing activities consist of new Club development and expenditures to
maintain and update our existing Clubs. Capital expenditures related to new
Clubs were approximately $1.4 million in the first nine months of 2004. Our
Clubs are upscale and capital improvements are regularly needed to retain the
upscale nature and presentation of the Clubs. A deterioration of the quality of
the Clubs can lead to reduction in membership levels and lower revenues. Capital
expenditures to maintain and update our existing Clubs were approximately $2.5
million in the first nine months of 2004. We estimate that expenditures of
between 2% and 4% of revenues, depending on the age of the Club, will be
necessary to maintain the quality of the Clubs to our satisfaction. We have
budgeted approximately $527,000 during the next year to upgrade our management
information systems and enhance our disaster recovery capabilities.
On April 22, 2002, we signed a lease to develop The Sports Club/LA -
Beverly Hills. The new Sports Club/LA, of approximately 40,000 square feet, is
located at 9601 Wilshire Boulevard in the heart of the Beverly Hills retail and
commercial district. We view the Beverly Hills market as an excellent location
for The Sports Club/LA brand and this Club may serve as a prototype for smaller
size Clubs to be built in locations near existing The Sports Club/LA sites. At
September 30, 2004, all construction costs for this Club have been accrued and
paid. The Club opened in October 2003.
We entered into a management service agreement with Terremark Brickell II
Ltd., an affiliate of Millennium (one of our principal shareholders) to manage
The Sports Club/LA - Miami. Millennium provided all the capital to develop this
facility and retained a 100% ownership in the Club. We earn a management fee
based upon the Club's revenues and can also earn a profit participation based
upon the Club's net operating income. We were not required to invest any of our
capital into this development. The Club opened in November 2003.
21
We currently have no other plans for new Club developments that would
require the expenditure of our own capital. As noted above, our involvement in
any new Club development or acquisition will depend upon the structure of the
arrangement; the absence of any material expenditure of capital by us; a
reasonable expectation of positive cash flow; and the enhancement of The Sports
Club/LA brand name in the market place.
Financing Activities
On April 1, 1999, we issued in a private placement $100.0 million of 11
3/8% Senior Secured Notes (the "Senior Secured Notes") due in March 2006, with
interest due semi-annually. The Senior Secured Notes were issued pursuant to the
terms of an indenture agreement dated April 1, 1999 (the "Indenture"). The
Senior Secured Notes are secured by substantially all of our assets, other than
certain excluded assets. The Indenture includes certain covenants that restrict
our ability to: (i) incur additional indebtedness; (ii) pay dividends or other
distributions, or repurchase capital stock or other equity interests or
subordinated indebtedness; and (iii) make certain investments. The Indenture
also limits our ability to: (i) enter into transactions with affiliates; (ii)
create liens on or sell certain assets; and (iii) enter into mergers and
consolidations. The Indenture requires us to make an offer to retire Senior
Secured Notes if the net proceeds of any asset sale are not reinvested in assets
related to our business, unless the remaining net proceeds are less than $10.0
million. To the extent we sell assets, the proceeds from those sales would be
subject to the excess proceeds provision of the Indenture. We are currently not
required to make such an offer as a result of the sale of any of our assets. The
Indenture requires us to make semi-annual interest payments of $5.7 million on
March 15th and September 15th of each year.
On January 12, 2003, we obtained financing in the form of a secured
five-year promissory loan in the amount of $20.0 million. The new loan is
evidenced by a promissory note that bears interest at a fixed interest rate of
7.25%; requires monthly principal and interest payments of $144,561; is secured
by the common stock and all the assets of Irvine Sports Club, Inc., our wholly
owned subsidiary that owns The Sports Club/LA - Orange County; and is guaranteed
by two of our major stockholders. The note may be prepaid at any time without
penalty or premium and requires a final principal payment of $18.3 million on
July 1, 2008.
The Indenture allows us to incur up to $10.0 million of equipment financing
obligations. At September 30, 2004, we had $533,000 of equipment financing
obligations outstanding and would be allowed to finance an additional $9.5
million with new equipment purchased serving as collateral. We make monthly
principal and interest payments on this debt. These monthly payments are
currently $124,000 and they will continue until December 2004, when a
significant portion of the debt will be repaid.
In March 2004, three of our principal shareholders purchased $6.5 million
of a newly created class of Series D Convertible Preferred Stock in a private
placement. 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, we issued a newly created class of Series E Preferred Stock in a private
placement in the amount of $2.0 million. The proceeds were used to pay a portion
of the September 15, 2004 interest payment on our Senior Secured Notes.
22
Other than our normal operating activities and capital expenditures, our
total cash requirements for our existing operations through September 30, 2005,
are estimated to be as follows (amounts in thousands):
Indenture interest........................... $ 11,375
Information system upgrades.................. 527
Payments on long-term debt................... 2,222
-------------
$ 14,124
=============
Impact of Inflation
We do not believe inflation has had a material impact on our consolidated
results of operations. We cannot provide assurance that future inflation will
not have an adverse impact on our consolidated operating results and financial
condition.
Seasonality of Business
Seasonal trends have a limited impact on our operations. We typically
experience a slight increase in membership sales in the first quarter.
Additionally, we normally experience a slight decrease in our ancillary revenues
during the summer months at our east coast Clubs due to lower membership
attendance.
Forward Looking Statements
From time to time we make "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements include the words "may,"
"will," "estimate," "continue," "believe," "expect" or "anticipate" and other
similar words. The forward-looking statements generally appear in the material
set forth under the heading "Management's Discussion and Analysis of Financial
Condition and Results of Operations" but may be found in other locations as
well. Forward-looking statements may also be found in our other reports filed
with the Securities and Exchange Commission and in our press releases and other
public disclosures. These forward-looking statements generally relate to our
plans and objectives for future operations and are based upon management's
reasonable estimates of future results or trends. Although we believe that our
plans and objectives reflected in or suggested by such forward-looking
statements are reasonable, such plans or objectives may not be achieved. Actual
results may differ from projected results due to unforeseen developments,
including developments relating to the following:
o the availability and adequacy of our cash flow and financing
facilities for our requirements, including payment of the Senior
Secured Notes and mortgage note,
o our ability to attract and retain members, which depends on
competition, market acceptance of new and existing sports and fitness
clubs and services, demand for sports and fitness club services
generally and competitive pricing trends in the sports and fitness
market,
o our ability to successfully develop Clubs,
o disputes or other problems arising with our development partners or
landlords,
o changes in economic, competitive, demographic and other conditions in
the geographic areas in which we operate, including business
interruptions resulting from earthquakes or other causes,
23
o competition,
o changes in personnel or compensation, and
o changes in statutes and regulations or legal proceedings and rulings.
We will not update forward-looking statements even though our situation may
change in the future.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are also exposed to risk from a change in interest rates to the extent
we are required to refinance existing fixed rate indebtedness at rates higher
than those prevailing at the time the existing indebtedness was incurred. As of
September 30, 2004, we had Senior Secured Notes totaling $100.0 million due in
March 2006. Annual interest of $11.4 million is payable semi-annually in March
and September. At September 30, 2004, the fair value of the Senior Secured Notes
was approximately $94.0 million. We also have a $19.6 million loan with a fixed
interest rate of 7.25% that matures and requires a final principal payment of
$18.3 million on July 1, 2008. A change in interest rates of 1% would impact our
interest expense by approximately $1.2 million per year.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our management, with the participation of our Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"), has evaluated the effectiveness of
our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act") as of the end of the quarterly period ended September 30, 2004. This
evaluation included a review of the steps management undertook in an effort to
ensure that information required to be disclosed in its Exchange Act filings is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission (the "SEC"). In
light of certain deficiencies in our controls and procedures identified by our
former independent auditor, KPMG LLP ("KPMG"), as more particularly described
below, the CEO and CFO have concluded that, as of the end of such period, these
deficiencies have caused our disclosure controls and procedures not to be
effective at a reasonable assurance level.
In performing its audit of our Consolidated Financial Statements for the
year ended December 31, 2003, KPMG noted a matter involving our internal
controls that it considered a "reportable condition", as defined under standards
established by the American Institute of Certified Public Accountants. A
"reportable condition", which may or may not be deemed a material weakness,
involves matters relating to significant deficiencies in the design or operation
of internal controls that, in KPMG's judgment, could adversely affect our
ability to record, process, summarize and report financial data consistent with
the assertions of management in the financial statements.
The reportable condition, which KPMG considered to be a material weakness,
was that we do not have adequate internal controls over the application of new
accounting principles or the application of existing accounting principles to
new transactions. In this regard, KPMG noted that, during their review of our
financial statements for the quarter ended March 31, 2003, we had not properly
accounted for private training revenues. In addition, in connection with their
audit of our financial statements for the year ended December 31, 2003, KPMG
determined that we were not properly accounting for our management arrangement
with The Sports Club/LA-Miami; that we had not properly followed Financial
Accounting Standard No. 142 relating to goodwill; and that we had not properly
accounted for the accretion of dividends on our Series C Convertible Preferred
Stock. Finally, KPMG suggested that we needed to consider additional staffing in
our accounting department, and take other action (such as encouraging attendance
at training seminars on new accounting rules and pronouncements) to ensure that
we have the expertise and resources to implement new
25
accounting standards and apply existing accounting standards to new
transactions. KPMG's observations were summarized in its letter dated June 16,
2004, to the Audit Committee of the Board of Directors.
In connection with the completion of the 2003 audit, our accounting
personnel worked with, and considered the recommendations of, KPMG in accounting
for private training revenues, goodwill, management fees and dividend accrual on
our Series C Convertible Preferred Stock. They conducted detailed validation
work on these accounts to substantiate the accuracy of the financial information
and related disclosures contained in this Form 10-Q. The accounting personnel
reviewed the requirements of Financial Accounting Standards 142 to understand
the methodology underlying the accounting treatment of goodwill and continue to
monitor any new developments or changes in accounting treatment or policies for
these assets to ensure that they are accurately disclosed in our financial
statements.
As a result of KPMG's observations, the Audit Committee has authorized and
directed management to devise and implement actions to address these
deficiencies and to enhance the reliability and effectiveness of our internal
controls over financial reporting and to provide reasonable assurance that our
disclosure controls and procedures allow for the accurate presentation and
timely filing of our financial statements. Our accounting personnel have
reviewed their reporting and certification obligations under the Exchange Act
and the Sarbanes Oxley Act of 2002, and have consulted with our outside counsel
with respect to those obligations. We are now performing regular analyses of
revenues attributable to private training and management fees. In addition, our
accounting personnel have determined that if there should occur any changes in
existing accounting rules or policies, or if accounting principles are adopted,
which apply to our financial accounts (particularly with respect to the manner
in which private training revenues, management fees, goodwill and dividend
accrual is accounted for), such matters will be brought to the attention of our
independent auditor and, if necessary, outside counsel to ensure that all
required disclosures are accurate and complete and are made in a timely fashion.
We have assigned a high priority to both the short-term and long-term
strengthening of these controls and have identified certain additional measures
that we believe will address the conditions identified by KPMG as a material
weakness, including the following:
o engaging an independent accounting or financial consulting firm (other
than the our independent auditor) to consult with us on accounting issues,
including the interpretation of new accounting rules and releases promulgated by
the SEC, the Financial Accounting Standards Board and other organizations, and
the application of accounting principles to new transactions in which we engage;
o creating and maintaining a written "log" in which new FASB, EITF, SOP and
other accounting rules and pronouncements are recorded. The log will include a
description of the new rule or pronouncement; whether or not it amends or
modifies an existing rule or pronouncement; its applicability to us or any
transactions in which we have engaged, or propose to engage; and the appropriate
accounting ramifications of the new rule or pronouncement. Management intends to
submit this log to the Audit Committee and its independent auditors on a
quarterly basis, as part of their respective financial statement review;
o subscribing to selected professional publications that discuss new
accounting rules and regulations applicable to reporting companies, and
encouraging our accounting personnel to attend seminars and other presentations
which focus on new accounting and financial disclosure rules and pronouncements;
and
26
o establishing an internal audit procedure to ensure that transactional
recording, transactional review and adherence to applicable accounting policies
and principles are observed.
Management believes that the foregoing measures will address the conditions
identified as a material weakness by KPMG. We will continue to monitor and
evaluate the effectiveness of our disclosure controls and procedures and our
internal controls over financial reporting on an ongoing basis, and are
committed to taking further action and implementing additional enhancements or
improvements, as necessary. We believe that these measures are reasonably likely
to have a material impact on our internal controls over reporting in future
periods.
(b) Changes in internal controls.
Except as described above, there have been no changes in our internal
controls over financial reporting (as those terms are defined in Rules 13a-15(f)
under the Exchange Act) that have materially affected, or are reasonably likely
to materially affect, its internal controls over financial reporting.
27
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
We are involved in various claims and lawsuits incidental to our business,
including claims arising from accidents. However, in the opinion of management,
we are adequately insured against such claims and lawsuits involving personal
injuries, and any ultimate liability, whether insured or not, arising out of any
such proceedings will not have a material adverse effect on our consolidated
financial condition, cash flows or results of operations.
Item 2. Changes in Securities
On September 14, 2004, the Company completed a $2.0 million private
placement of a newly created series of 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.
Dividends are earned 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 Stock. The Series E Preferred Stock 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 Stock for cash at the redemption price of $100.00 per share,
together with all accrued but unpaid dividends or (ii) the holders of at least
50% of the Series E Preferred Stock may demand that the Company redeem all the
shares of the Series E Preferred Stock by paying the redemption price in cash to
each holder of the Series E Preferred Stock.
The carrying value of the Series E Preferred is periodically adjusted for
any accrued and unpaid dividends. At September 30, 2004, the Series E
Convertible Preferred carrying value consisted of the following (in thousands):
Initial fair value....................................$ 2,000
Accrued and unpaid dividends.......................... 10
-----------
Total carrying value......................... $ 2,010
===========
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
31.1 Certification of Rex A. Licklider pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
28
31.2 Certification of Timothy O'Brien pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Rex A. Licklider pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Timothy O'Brien pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
b) The following reports on Form 8-K have been filed between July 1, 2004
and September 30, 2004:
July 12, 2004. We filed a report on Form 8-K announcing that on July 6,
2004, we notified KPMG LLP ("KPMG") that we would not be renewing our engagement
of KPMG as our principal accountants for the audit of our consolidated financial
statements for the year ending December 31, 2004. Our Audit Committee of the
Board of Directors approved the termination of KPMG as our principal
accountants.
We did not have any disagreements with KPMG on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedures, which disagreements, if not resolved to KPMG's satisfaction, would
have caused it to make a reference to the subject matter of the disagreements in
connection with its reports.
In performing its audit of our consolidated financial statements for the
year ended December 31, 2003, KPMG noted a matter involving our internal
controls that it considered to be a reportable condition. A reportable
condition, which may or may not be determined to be a material weaknesses,
involves matters relating to significant deficiencies in the design or operation
of internal controls that, in KPMG's judgment, could adversely affect our
ability to record, process, summarize and report financial data consistent with
the assertions of management on the financial statement. The reportable
condition, which was considered to be a material weakness, noted that we did not
have adequate internal controls over the application of new accounting
principles or the application of existing accounting principles to new
transactions. Specifically, KPMG stated that during their quarterly review for
the quarter ended March 31, 2003, they noted we had not properly accounted for
private training revenues. In addition, during their 2003 audit, KPMG noted we
were not properly accounting for our management arrangement for The Sports
Club/LA - Miami, that we had not properly implemented Statement of Financial
Accounting Standard No. 142, relating to goodwill and had not properly accounted
for the accretion of dividends on Series C Preferred Stock. KPMG indicated that
we should enhance our financial and accounting personnel staffing levels or take
other actions (i.e. attend training seminars on new accounting pronouncements)
to ensure that we have appropriate resources to implement new accounting
standards and apply existing accounting standards to new transactions.
August 16, 2004. We filed a report on Form 8-K announcing that on August
13, 2004, we issued a press release announcing the second quarter 2004 operating
results. A copy of the press release was furnished to the United States
Securities and Exchange Commission with this current report on Form 8-K as an
exhibit.
August 23, 2004. We filed a report on Form 8-K announcing that (i) on July
6, 2004, we notified KPMG LLP ("KPMG") that we would not be renewing our
engagement of
29
KPMG as our principal accountants for the audit of our consolidated financial
statements for the year ending December 31, 2004, (ii) KPMG's dismissal will be
effective upon KPMG's completion of its review of our unaudited condensed
consolidated interim financial statements included in our Form 10-Q for the
quarter ended June 30, 2004, and (iii) the Audit Committee of our Board of
Directors approved the termination of KPMG as our principal accountants.
We filed our Form 10-Q for the period ended June 30, 2004 on August 16,
2004 and accordingly KPMG was dismissed effective August 16, 2004.
September 17, 2004. We filed a report on Form 8-K announcing that on
September 14, 2004, we completed a $2,000,000 private placement of a newly
created series of preferred stock. D. Michael Talla, Rex A. Licklider, and
affiliates of Kayne Anderson Capital Advisors, three of our existing
stockholders, purchased the entire offering. Additionally, Rex A. Licklider
serves as our Chief Executive Officer and each of the purchasers is a member of,
or is represented by a member on, our Board of Directors.
The proceeds of the offering were used to assist us in making the September
15, 2004 interest payment on our Senior Secured Notes.
We also announced that on September 13, 2004, the American Stock Exchange
(the "Exchange") informed us that we are not in compliance with certain of the
Exchange's continued listing standards as set forth in the Exchange's Company
Guide. Specifically, the Exchange noted that our stockholders' equity is less
than $2 million, and we have reported net losses in two of our most recent
fiscal years, in violation of Section 1003(a)(i); our stockholders' equity is
less than $4 million, and we have sustained losses in three of our four most
recent fiscal years, in violation of Section 1003(a)(ii); and we have sustained
losses which are so substantial in relation to our overall operations or our
existing financial resources, or our financial condition has become so impaired,
that it appears questionable, in the opinion of the Exchange, whether we will be
able to continue operations or meet our obligations as they mature, in violation
of Section 1003(a)(iv). In order to maintain the listing of our Common Stock,
$0.01 par value (the "Common Stock"), on the Exchange, we must submit a plan by
October 14, 2004, advising the Exchange of action we have taken, or will take,
that would bring us into compliance with the applicable listing standards. If
the Exchange accepts the plan, we may be able to continue listing during the
plan period of up to 18 months, during which time we will be subject to periodic
review to determine whether we are making progress consistent with the plan. If
the Exchange does not accept our plan, or, even if accepted, we are not in
compliance with the continued listing standards at the end of the 18-month
period or we do not make progress consistent with the plan during such period,
the Exchange may initiate delisting proceedings with respect to the Common
Stock.
We submitted the plan to the Exchange an our Common Stock continues to
trade on the Exchange.
September 29, 2004. We filed a report on Form 8-K announcing that effective
September 27, 2004, Stonefield Josephson, Inc. has agreed to act as our
independent registered public accounting firm to audit our financial statements
for the year ended December 31, 2004. We did not consult the new accountant
prior to its engagement regarding the application of
30
accounting principles to a specific completed or proposed transaction, or the
type of audit opinion that might be rendered on our financial statements.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SPORTS CLUB COMPANY, INC.
Date: November 19, 2004 by /s/ Rex A. Licklider
-----------------------------------
Rex A. Licklider
Chief Executive Officer
(Principal Executive Officer)
Date: November 19, 2004 by /s/ Timothy M. O'Brien
-----------------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and
Accounting Officer)
32
EXHIBIT 31.1
CERTIFICATIONS
I, Rex A. Licklider, Chief Executive Officer of The Sports Club Company, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Sports Club
Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information
relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those
entities, particularly during the period in which this
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures (as of the end of the period covered
by this report based on such evaluation); and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's second fiscal quarter in the case of this
quarterly report) that has materially affected, or is
reasonably likely to materially affect, the registrant's
internal control over financial reporting; and;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls over financial reporting.
Dated, November 19, 2004
/s/ Rex A. Licklider
- --------------------------------------
Rex A. Licklider
Chief Executive Officer
33
EXHIBIT 31.2
CERTIFICATIONS
I, Timothy O'Brien, Chief Financial Officer of The Sports Club Company, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Sports Club
Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information
relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those
entities, particularly during the period in which this
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures (as of the end of the period covered
by this report based on such evaluation); and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the
registrant's second fiscal quarter in the case of this
quarterly report) that has materially affected, or is
reasonably likely to materially affect, the registrant's
internal control over financial reporting; and;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls over financial reporting.
Dated, November 19, 2004
/s/ Timothy O'Brien
- --------------------------------------
Timothy O'Brien
Chief Financial Officer
34
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of The Sports Club Company, Inc. (the
"Company") on Form 10-Q for the period ending September 30, 2004 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Rex A.
Licklider, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. (Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act
of 2002, that to my knowledge:
(i) The Report fully complies with the requirements of
section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(ii) The information contained in the Report fairly
represents, in all material respects, the financial condition and result of
operations of the Company.
/s/ Rex A. Licklider
--------------------------------
The Sports Club Company, Inc.
Chief Executive Officer
November 19, 2004
35
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of The Sports Club Company, Inc. (the
"Company") on Form 10-Q for the period ending September 30, 2004 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Timothy
O'Brien, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
(Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of
2002, that to my knowledge:
(i) The Report fully complies with the requirements of
section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(ii) The information contained in the Report fairly
represents, in all material respects, the financial condition and result of
operations of the Company.
/s/ Timothy O'Brien
---------------------------------
The Sports Club Company, Inc.
Chief Financial Officer
November 19, 2004
36