UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED MARCH 31, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTON 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO
____________.
Commission File Number: 1-13290
------------------------------------------
The Sports Club Company, Inc.
(Exact name of registrant as specified in its charter)
Delaware 95-4479735
(State or other jurisdiction (I.R.S. Employer
of incorporation of organization) Identification No.)
11151 Missouri Avenue
Los Angeles, California 90025
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 310-479-5200
11100 Santa Monica Blvd.; Suite 300; Los Angeles, CA 90025
(Former name, former address and former fiscal year,
if changed since last report.)
---------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934,
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerate filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Shares of common stock outstanding at July 31, 2006: 19,405,718
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, 2005 and March 31, 2006
(in thousands, except per share amounts)
ASSETS
December 31, March 31,
2005 2006
---- ----
(Unaudited)
Current assets:
Cash and cash equivalents.......................................................... $ 10,287 $ 11,643
Marketable securities.............................................................. -- 3,822
Restricted cash.................................................................... -- 1,834
Accounts receivable, net of allowance for doubtful accounts of $464 and $484 at
December 31, 2005 and March 31, 2006, respectively............................... 1,883 2,112
Receivable from stockholder/related party.......................................... -- 1,465
Inventories........................................................................ 435 470
Prepaid expenses................................................................... 1,353 752
Assets held for sale............................................................... 127,849 --
--------- ---------
Total current assets.......................................................... 141,807 22,098
Property and equipment, net........................................................... 60,743 61,966
Goodwill............................................................................... 7,315 7,315
Marketable securities.................................................................. -- 11,150
Restricted cash........................................................................ 1,379 1,231
Other assets........................................................................... 1,318 2,192
--------- ---------
$ 212,562 $ 105,952
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current installments of notes payable and equipment financing loans................ $ 100,373 $ 1,330
Accounts payable................................................................... 2,454 1,845
Accrued liabilities................................................................ 10,975 9,292
Deferred revenues.................................................................. 8,846 8,913
Liabilities related to assets held for sale........................................ 78,370 --
--------- ---------
Total current liabilities..................................................... 201,018 21,380
Notes payable and equipment financing loans, less current installments................. 18,940 77,693
Deferred lease obligations............................................................. 7,675 7,699
Deferred revenues, less current portion................................................ 286 295
Minority interest...................................................................... 600 600
--------- ---------
Total liabilities............................................................. 228,519 107,667
Commitments and contingencies
Redeemable Convertible Preferred Stock, Series B, $.01 par value, 10,500 shares
authorized, issued and outstanding at December 31, 2005 and March 31, 2006 (liquidation
preference of $14,098 and $14,336 at December 31, 2005 and March 31, 2006,
respectively)...................................................................... 13,830 14,089
Redeemable Preferred Stock, Series E, $.01 par value, 20,000 shares authorized, issued
and outstanding at December 31, 2005 and March 31, 2006 (liquidation preference of
$2,295 and $2,351 at December 31, 2005 and March 31, 2006, respectively)............ 2,295 2,351
Stockholders' equity (deficit):
Preferred Stock, $.01 par value, 899,500 shares authorized at December 31,
2005 and March 31, 2006; no shares issued or outstanding......................... -- --
Convertible Preferred Stock, Series C, $.01 par value, 5,000 shares authorized,
issued and outstanding at December 31, 2005 and March 31, 2006 (liquidation preference
of $6,490 and $6,601 at December 31, 2005 and March 31, 2006, respectively)...... 6,490 6,601
Convertible Preferred Stock, Series D, $.01 par value, 65,000 shares authorized;
issued and outstanding at December 31, 2005 and March 31, 2006; (liquidation preference
of $7,556 and $7,701 at December 31, 2005 and March 31, 2006, respectively)......... 7,128 7,273
Common Stock, $.01 par value, 40,000,000 shares authorized;
21,074,717 shares issued and outstanding at December 31, 2005 and March 31, 2006. 211 211
Additional paid-in capital......................................................... 96,028 120,220
Accumulated deficit................................................................ (129,223) (131,895)
Note receivable from stockholder................................................... -- (7,849)
Treasury Stock, at cost, 1,668,999 shares at
December 31, 2005 and March 31, 2006............................................. (12,716) (12,716)
---------- ----------
Total Stockholders' equity (deficit).......................................... (32,082) (18,155)
---------- ----------
$ 212,562 $ 105,952
========= ==========
See accompanying notes to consolidated financial statements.
1
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2005 and 2006
(in thousands, except per share amounts)
(unaudited)
Three Months Ended
March 31,
2005 2006
---- ----
(Reclassified)
Revenues:
Membership revenues....................................... $ 9,166 $ 9,779
Products and services..................................... 4,473 4,784
----------- -----------
Total revenue........................................ 13,639 14,563
Operating expenses:
Club operating costs...................................... 6,495 6,786
Cost of products and services............................. 3,780 4,015
Selling and marketing..................................... 506 693
General and administrative................................ 2,048 2,248
Impairment charge......................................... -- 713
Depreciation and amortization............................. 1,224 1,137
----------- -----------
Total operating expenses............................. 14,053 15,592
----------- -----------
Loss from operations............................... (414) (1,029)
Other income (expense):
Interest, net............................................. (1,168) (2,280)
Other income.............................................. -- 628
Minority interests........................................ (37) (37)
------------ ------------
Loss from continuing operations before income
taxes and income from discontinued operations...... (1,619) (2,718)
Provision (benefit) for income taxes.......................... -- --
----------- ------------
Loss from continuing operations before income from
discontinued operations............................ (1,619) (2,718)
Income from discontinued operations....................... 375 47
------------- ------------
Net loss........................................... (1,244) (2,671)
Dividends on Preferred Stock.................................. 493 549
----------- -----------
Net loss attributable to common stockholders....... $ (1,737) $ (3,220)
============ ============
Net income (loss) per share attributable to common stockholders
- basic and diluted:
Discontinued operations................................. $ 0.02 $ 0.00
Continuing operations.................................... (0.11) (0.17)
------------- -------------
Net loss per share................................... $ (0.09) $ (0.17)
============= =============
Weighted average number of common shares outstanding:
Basic and diluted......................................... 19,131 19,406
=========== ============
See accompanying notes to consolidated financial statements.
2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2005 and 2006
(in thousands)
(unaudited)
Three Months Ended
March 31,
2005 2006
---- ----
(Reclassified)
Cash flows from operating activities:
Net loss............................................................. $ (1,244) $ (2,671)
Adjustments to reconcile net income (loss) to cash provided by (used
in)operating activities:
Income from discontinued operations............................. (375) (47)
Depreciation and amortization................................... 1,224 1,137
Related party costs settled with Common Stock................... 316 --
Impairment charge............................................... -- 713
Minority interests expense...................................... 37 37
Distributions to minority interests............................. (37) (37)
(Increase) decrease in:
Accounts receivable, net.................................... (50) (396)
Inventories................................................. 75 (35)
Other current assets........................................ 5 383
Other assets, net........................................... 284 (824)
Increase (decrease) in:
Accounts payable............................................ (388) (1,094)
Accrued liabilities......................................... (1,878) (5,283)
Deferred revenues........................................... 444 598
Accrued lease obligations................................... 286 24
--------- --------
Net cash used in operating activities.................... (1,301) (7,495)
Cash flows used in investing activities:
Capital expenditures............................................ (461) (3,093)
Marketable securities........................................... -- (14,972)
(Increase) decrease in restricted cash.......................... (15) (1,736)
---------- ---------
Net cash used in investing activities.................... (476) (19,801)
Cash flows from (used in) financing activities:
Net proceeds from notes payable and equipment financing loans... -- 60,000
Repayments of notes payable and equipment financing loans....... (124) (100,290)
---------- ---------
Net cash used in financing activities.................... (124) (40,290)
---------- ---------
Net cash used in continuing operations................... (1,901) (67,586)
Cash flows from (used in) discontinued operations:
Operating activities - Net cash provided by..................... 441 47
Investing activities:
Net proceeds from sale of Clubs.......................... -- 68,895
Capital expenditures..................................... (104) --
---------- --------
Net cash from discontinued operations................. 337 68,942
--------- --------
Net increase (decrease) in cash and cash equivalents.. (1,564) 1,356
---------- --------
Cash and cash equivalents at beginning of period......................... 7,559 10,287
--------- --------
Cash and cash equivalents at end of period............................... $ 5,995 $ 11,643
========= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest........................ $ 6,048 $ 5,398
========= ========
Cash paid during the period for income taxes.................... $ 195 $ 187
========= ========
Supplemental disclosure of non-cash investing activity:
Notes receivable related to sale of Clubs....................... $ -- $ 30,000
========= ========
See accompanying notes to consolidated financial statements.
3
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005 (Audited) and March 31, 2006 (Unaudited)
1. Basis of Presentation
The condensed consolidated balance sheet as of December 31, 2005
derived from audited financial statements and the unaudited condensed
consolidated financial statements for the interim periods ended March 31, 2006
and 2005, 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, 2005, consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K (SEC File Number
1-13290). Certain information and footnote disclosures, which are normally
included in financial statements prepared in accordance with United States
generally accepted accounting principles, have been condensed or omitted
pursuant to SEC rules and regulations for interim financial statements. The
Company believes that the disclosures made are adequate to make the information
presented not misleading. The information reflects all adjustments that, in the
opinion of management, are necessary for a fair presentation of the financial
position and results of operations for the interim periods set forth herein. All
such adjustments are of a normal and recurring nature. The results for the
three-month period ended March 31, 2006, are not necessarily indicative of the
results for the fiscal year ending December 31, 2006.
In accordance with Emerging Issues Task Force Issue No. 87-24,
Allocation of Interest to Discontinued Operations, interest was allocated to
discontinued operations based on the interest on debt that was required to be
repaid as a result of the disposal transactions. On January 13, 2006, the
Company sold five of its nine sports and fitness Clubs (see Note 4 to the
Company's condensed consolidated financial statements). The proceeds of $80.0
million from the sale were required to be used to repay a portion of the $100.0
million of Senior Secured Notes. Accordingly, the Company has allocated to
discontinued operations 80.0% of the interest associated with the Senior Secured
Notes. For the three-month period ended March 31, 2005, the amount of interest
allocated to discontinued operations was $2,476,000. Due to the relatively short
period that the Company owned the Clubs during 2006, no interest was allocated
to discontinued operations for the three-month period ended March 31, 2006.
2. Reclassification
2005 Reclassification
In December 2004, the Company committed to a plan and came to an
understanding to sell six of its nine sports and fitness Clubs to an affiliate
of Millennium Entertainment Partners (collectively with its affiliates
"Millennium") for $65.0 million. Accordingly, the Company reported the operating
results of these six Clubs as discontinued operations and their assets and
liabilities as held for sale in the consolidated financial statements included
in the Company's 2004 Form10-K and March 31, 2005 Form 10-Q.
The condensed consolidated financial statements for March 31, 2005
previously reported the assets and liabilities of The Sports Club/LA - New York
at Rockefeller Center as held for sale and reported the operations of this club
as part of discontinued operations. In November 2005, the Company decided to
retain ownership of this Club. Accordingly, the
4
condensed consolidated financial statements have been revised to include the
assets, liabilities and operating results of this club as part of continuing
operations in accordance with Statement of Financial Accounting Standards No.
144, Accounting for Impairment and Disposal of Long-Lived Assets.
A reclassified condensed consolidated statement of operations for the
three months ended March 31, 2005, reflecting the above reclassification is
presented below. The amounts are in thousands, except per share amounts.
5
Condensed Consolidated Statement of
Operations
Three Months Ended March 31, 2005
----------------------------------
As Retained As
Reported Operations Reclassified
-------- ---------- ------------
(unaudited) (unaudited) (unaudited)
Revenues:
Membership revenues............................... $ 7,837 $ 1,329 $ 9,166
Products and services............................. 3,814 659 4,473
----------- ------------ -----------
Total revenue................................ 11,651 1,988 13,639
Operating expenses:
Club operating costs.............................. 4,431 2,064 6,495
Cost of products and services..................... 3,218 562 3,780
Selling and marketing............................. 418 88 506
General and administrative........................ 2,048 -- 2,048
Depreciation and amortization..................... 1,224 -- 1,224
----------- ------------ -----------
Total operating expenses..................... 11,339 2,714 14,053
----------- ------------ -----------
Income (loss) from operations............ 312 (726) (414)
Other income (expense):
Interest, net..................................... (1,632) 464 (1,168)
Minority interests................................ (37) -- (37)
------------ ------------ ------------
Loss from continuing operations
before income taxes and income from
discontinued operations................... (1,357) (262) (1,619)
Provision (benefit) for income taxes................... -- -- --
----------- ------------ -----------
Loss from continuing operations
before income from discontinued
operations................................ (1,357) (262) (1,619)
Income from discontinued operations.................... 113 262 375
------------ ------------ ------------
Net loss.................................. (1,244) -- (1,244)
Dividends on Preferred Stock........................... 493 -- 493
------------ ------------ ------------
Net loss attributable to common
stockholders.............................. $ (1,737) $ -- $ (1,737)
============ ============ ============
Net income (loss) per share attributable to common stockholders
- basic and diluted:
Discontinued operations....................... $ 0.01 $ 0.01 $ 0.02
Continuing operations......................... (0.10) (0.01) (0.11)
------------- ------------ ------------
Net loss per share........................ $ (0.09) $ -- $ (0.09)
============= ============ ============
Weighted average number of common shares Outstanding:
Basic and diluted................................. 19,131 -- 19,131
============= ============ ===========
The condensed consolidated statement of cash flows for the three months
ended March 31, 2005 presented elsewhere in this Form 10-Q has also been
reclassified to reflect The Sports Club/LA - New York at Rockefeller Center as a
continuing operation.
6
3. Accounting for Stock-Based Compensation
Through the end of fiscal 2005, the Company measured compensation
expense for stock-based incentive programs utilizing the intrinsic value method
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." Under this method, the Company did not record
compensation expense when stock options were granted to eligible participants as
long as the exercise price was not less than the fair market value of the stock
when the option was granted. In accordance with Statement of Financial
Accounting Standards ("SFAS") 123R, the Company disclosed the pro forma net
income (loss) per share as if the fair value-based method had been applied in
measuring compensation expense for share-based incentive awards. No share-based
compensation cost was recognized in the Condensed Consolidated Statement of
Operations for the three months ended March 31, 2005 for options granted under
the Company's Stock Incentive Plans, as all unvested options granted had an
exercise price equal to the market value of the underlying common stock on the
date of grant.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123R. This statement requires that the cost resulting from all
share-based payment transactions be recognized in the Company's consolidated
financial statements. In addition, in March 2005 the Securities and Exchange
Commission ("SEC") released SEC Staff Accounting Bulletin No. 107, "Share-Based
Payment" ("SAB 107"). SAB 107 provides the SEC's staff's position regarding the
application of SFAS 123R and certain SEC rules and regulations, and also
provides the staff's views regarding the valuation of share-based payment
arrangements for public companies. Generally, the approach in SFAS 123R is
similar to the approach described in SFAS 123. However, SFAS 123R requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the statement of operations based on their fair values. Pro
forma disclosure of fair value recognition, as prescribed under SFAS 123, is no
longer an alternative.
In the first quarter of fiscal 2006, the Company adopted the fair value
recognition provisions of SFAS 123R utilizing the modified prospective
transition method, as prescribed by SFAS 123R. Under that transition method,
compensation cost recognized during the three months ended March 31, 2006
includes: (a) compensation cost for all share-based payments granted prior to,
but not yet vested as of December 31, 2005 based on the grant date fair value
estimated in accordance with SFAS 123, and (b) compensation cost for all
share-based payments granted subsequent to December 31, 2005, based on the
grant-date fair value estimated in accordance with the provisions of SFAS 123R.
Under the modified prospective transition method, results for the prior periods
have not been restated.
7
For the three months ended March 31, 2006, the Company recognized no
non-cash share-based compensation costs as a result of the adoption of SFAS
123R. The effect of the change in applying the original provisions of SFAS 123
resulted in no change in reported net loss or reported loss per share, as shown
below (in thousands, except per share amounts):
Prior to
Application of As per SFAS
SFAS 123R 123R
--------- ----
Net loss.................................. $ (3,220) $ (3,220)
Net loss per share - basic and diluted.... $ (0.17) $ (0.17)
The following table illustrates the effect on net loss and net loss per
share if the Company had applied the fair value recognition provisions of SFAS
123R to options granted under the Company's stock option plans in all periods
presented. The Company did not recognize any compensation expense related to the
issuance of stock options in 2005. The effect of applying SFAS 123R resulted in
no change in net loss and basic and diluted loss per share as shown below (in
thousands, except per share amounts):
Three Months Three Months
Ended Ended
March 31, 2005 March 31, 2006
-------------- --------------
Net loss, as reported........................................ $ (1,737) $ (3,220)
Deduct: Total share-based employee compensation expense
determined under fair value-based method for all awards,
net of related tax effects............................... -- N/A
---------------- -------------
Pro forma net loss...................................... $ (1,737) $ (3,220)
================= =============
Net loss per share-basic and diluted:
As reported............................................... $ (0.09) $ (0.17)
Pro forma................................................. $ (0.09) $ (0.17)
Shares used in computing net loss per share:
Basic and diluted......................................... 19,131 19,406
During the three months ended March 31, 2006, there were no shares
granted, exercised or cancelled under the Company's stock option plans. At
December 31, 2005 and March 31, 2006, there were no unvested options
outstanding.
4. Sale of Assets
In December 2004, the Company committed to a plan and came to an
understanding to sell six of its nine sports and fitness Clubs to an affiliate
of Millennium Entertainment Partners (collectively with its affiliates
"Millennium") for $65.0 million. Millennium is the Company's largest stockholder
and was the landlord at four of these Clubs. Accordingly, the Company reported
the operating results of these six Clubs as discontinued operations and their
assets and liabilities as held for sale in the condensed consolidated financial
statements included in the Company's March 31, 2005 Form 10-Q (see Note 2 to
8
the Company's condensed consolidated financial statements). In November 2005,the
Company decided to retain ownership of one Club and increase the sales price to
$80.0 million. The condensed consolidated financial statements included in the
Company's March 31, 2005 Form 10-Q have been reclassified to reflect the
decision to retain ownership of this Club (see Note 2 to the Company's condensed
consolidated financial statements). On January 13, 2006, the Company completed
the sale of five Clubs to Millennium for $80.0 million. The Clubs sold include
the Company's interest in Reebok Sports Club/NY and The Sports Club/LA in
Washington D.C., Boston, San Francisco and the Upper East Side in New York. The
Company's management agreement covering the Club in Miami was also terminated.
The Company received $50.0 million in cash upon closing the sale (before
transaction related costs) and received two Notes from Millennium. The first
Note of $22.2 million was due and was collected on January 31, 2006. The second
Note of $7.8 million is due in 2013 and is secured by a pledge of the Series C
and Series D Preferred Stock owned by Millennium and accordingly, the note
receivable has been presented as a contra-equity item on the Company's condensed
consolidated balance sheet. The Note is also guaranteed by an affiliate of
Millennium. The net proceeds from the sale exceeded the carrying value of the
net assets sold by approximately $24.8 million. Millennium has two directors on
the Company's board of directors, is a major stockholder of the Company and was
the landlord at four of the five Clubs that were sold. Millennium is a related
party, as defined by generally accepted accounting principles and by the United
States Securities and Exchange Commission. Accordingly, the amount by which the
net proceeds from the sale of the five Clubs to Millennium exceeded their
carrying value has been classified as a capital contribution in the accompanying
condensed consolidated financial statements.
Concurrent with the asset sale the Company entered into several
ancillary agreements with Millennium. These agreements provide Millennium
rights, subject to certain conditions, to use certain Proprietary Information
and Trademarks for perpetuity in connection with their operations of the
acquired Clubs. The Company also entered into a short-term Transitional Services
Agreement with Millennium to assist them in certain areas to ensure an orderly
transition in the operations of the Clubs. Both Millennium and the Company
entered into non-compete arrangements, that restricts each party's ability to
compete in the others primary territories. Millennium, as the owner of these
Clubs, remains responsible for general management of each Club and the Company
is not involved in the management of the sold Clubs.
The operating results of the five Clubs sold have been classified as
discontinued operations in the accompanying statements of operations. A
reclassified condensed consolidated statement of discontinued operations for the
three-month period ended March 31, 2005 and a listing of assets and liabilities
held for sale at December 31, 2005, follows:
9
The Sports Club Company, Inc.
Reclassified Condensed Consolidated Statement of Discontinued Operations
Three Months Ended March 31, 2005
(unaudited)
Revenues:
Membership revenues................................. $ 15,221
Products and services............................... 7,763
Management fees..................................... 92
Reimbursed costs.................................... 1,450
------------
Total revenue.................................... 24,526
Operating expenses:
Club operating costs................................ 12,858
Costs of products and services...................... 6,046
Selling and marketing............................... 785
General and administrative.......................... 58
Reimbursed costs.................................... 1,450
------------
Total operating expenses......................... 21,197
------------
Income from operations........................ 3,329
Other income (expense):
Interest, net....................................... (2,472)
Minority interests.................................. (331)
-------------
Income from operations of discontinued
operations before income taxes................ 526
Provision for income taxes.............................. 151
------------
Income from discontinued
operations.................................... $ 375
============
-------------
Note: Depreciation expense ceased effective January 1, 2005 upon classification
of the assets as "Held for Sale."
10
Assets and liabilities related to assets held for sale consist of the
following:
December 31,
2005
----
(in thousands)
Assets held for sale:
Cash and cash equivalents..................................... $ 2,105
Accounts receivable, net of allowance for doubtful accounts .. 1,316
Inventories................................................... 419
Prepaid expenses.............................................. 444
Property and equipment, net................................... 123,279
Other assets.................................................. 286
------------
Total assets held for sale................................ $ 127,849
============
Liabilities related to assets held for sale:
Accounts payable.............................................. $ 485
Accrued liabilities........................................... 1,897
Deferred revenues............................................. 15,469
Accrued lease obligations..................................... 58,796
Minority interest............................................. 1,723
------------
Total liabilities related to assets held for sale......... $ 78,370
============
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 March 31, 2006,
cash and cash equivalents were $11.6 million.
The Company considers cash, cash equivalents and other investments that
are required to be held as deposits to satisfy certain governmental regulatory
or Club security deposits as restricted cash. At March 31, 2006, the Company had
$3.1 million of both short-term and long-term restricted cash.
6. Marketable Securities
At March 31, 2006, the Company held $3.8 million and $11.2 million of
short-term and long-term marketable securities, respectively. All marketable
securities were classified as held-to-maturity and carried at amortized cost.
The marketable securities consisted entirely of Governmental Agency Notes and
Bank Certificates of Deposit. At March 31, 2006, the estimated fair value of
each investment approximated its amortized cost and therefore, there were no
significant unrealized gains or losses.
11
As of March 31, 2006, the Company's marketable securities were
classified as follows (in thousands):
Amortized Gross Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Short Term
----------
Bank Certificates of Deposit.......................... $ 600 $ -- $ -- $ 600
Federal Home Loan Bank Bonds.......................... 3,222 -- 6 3,216
------------ ----------- --------- -----------
Short-term total...................................... $ 3,822 $ -- $ 6 $ 3,816
------------ ----------- --------- -----------
Long Term
---------
Federal National Mortgage Association Notes........... $ 4,605 $ -- $ 6 $ 4,599
Federal Home Loan Mortgage Corporation................ 4,546 -- 7 4,539
Federal Home Loan Bank Bonds.......................... 1,999 -- 2 1,997
------------ ----------- --------- -----------
Long-term total....................................... $ 11,150 $ -- $ 15 $ 11,135
------------ ----------- --------- -----------
Total................................................. $ 14,972 $ -- $ 21 $ 14,951
============ =========== ========= ===========
7. Receivable From Stockholder/Related Party
Concurrent with the asset sale (see Note 4 to the Company's condensed
consolidated financial statements), the Company entered into a short-term
Transitional Services Agreement with Millennium to assist them in certain areas
to ensure an orderly transition in the operations of the Clubs. Millennium is
the Company's largest stockholder and was the landlord at four of the Clubs that
the Company sold. Income of $628,000 for the three months ended March 31, 2006
for such services are included as other income in the accompanying condensed
consolidated statement of operations. During this transitional services period
the Company paid and or incurred certain expenses for the sold Clubs on behalf
of Millennium for which Millennium is to reimburse the Company. At March 31,
2006, this receivable from stockholder/related party was $1,465,000.
12
8. Notes Payable and Equipment Financing Loans
Notes payable and equipment financing loans are summarized as follows:
December 31, March 31,
2005 2006
---- ----
(unaudited)
(in thousands)
Senior secured notes (a)......... $ 100,000 $ --
Mortgage note (b)................ 19,250 19,136
Mortgage note (c)................ -- 59,828
Equipment financing loans (d).... 63 59
-------------- --------------
119,313 79,023
Less current installments........ 100,373 1,330
-------------- --------------
$ 18,940 $ 77,693
============== ==============
---------
(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 were secured by
substantially all of the Company's assets, other than certain excluded
assets. The notes were repaid in January 2006 with a portion of the
funds received from the sale of five of the Company's Clubs (see Note 4
to the Company's condensed consolidated financial statements) and from
funds received from the new mortgage on The Sports Club/LA - Los
Angeles (See (c) below).
(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 March
31, 2006, 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) In January 2006, the Company secured a $60.0 million mortgage note
at The Sports Club/LA - Los Angeles. The note, which matures in January
2016, is secured by all the real estate and other assets at The Sports
Club/LA - Los Angeles, bears interest at 6.48% per annum and requires
monthly payments of $404,375 which amortizes the loan over a
twenty-five year period. Two of the Company's shareholders executed
limited guarantees under which the lender has recourse to them in
certain circumstances. The Company has agreed to indemnify these
shareholders under certain circumstances for losses under this
guarantee. In exchange for the guarantee, the Company pays each
guarantor a fee equal to .75% per annum of the average outstanding
principal balance of the loan. Such fees may be paid in Common Stock,
cash or a combination thereof at the Company's discretion.
(d) The equipment financing loans are secured by furniture, fixtures
and equipment. The amounts are generally repayable in monthly payments
over four or five years.
13
9. Consolidated Statements of Operations
Total revenue and total operating expenses consist of the following:
Three Months Ended
March 31,
--------
(in thousands)
2005 2006
---- ----
(unaudited) (unaudited)
Revenues:
Membership revenues:
Monthly dues........................... $ 8,468 $ 8,990
Initiation fees........................ 521 605
Other.................................. 177 184
----------- ---------
Total membership revenues............. 9,166 9,779
----------- ---------
Products and Services:
Private training....................... 2,376 2,684
Food and beverage...................... 1,088 1,149
Spa services........................... 492 552
Physical therapy....................... 314 267
Other.................................. 203 132
----------- ---------
Total products and services........... 4,473 4,784
----------- ---------
Total revenue................................. $ 13,639 $ 14,563
=========== =========
Operating expenses:
Club operating costs:
Payroll and benefits................... $ 2,718 $ 2,645
Rent................................... 1,329 1,329
Other operating costs.................. 2,448 2,812
----------- ---------
Total Club operating costs............ 6,495 6,786
----------- ---------
Costs of products and services:
Private training....................... 2,006 2,222
Food & beverage........................ 1,088 1,147
Spa services........................... 442 474
Physical therapy....................... 217 172
Other.................................. 27 --
----------- ---------
Total cost of products and services... 3,780 4,015
----------- ---------
Sales and marketing...................... 506 693
General and administrative............... 2,048 2,248
Depreciation and amortization............ 1,224 1,137
Impairment charge........................ -- 713
----------- ---------
Total operating expenses...................... $ 14,053 $ 15,592
=========== =========
14
10. Net Income (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 ended March 31, 2005 and 2006,
there were 3,332,465 and 4,042,300 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. At March 31, 2006, the Series B Preferred,
including accrued dividends of $3,836,000, was convertible into 4,965,536 shares
of Common Stock. The conversion price will be adjusted downward in the event the
Company issues additional shares of Common Stock at a price below $2.8871 per
share, subject to certain exceptions; and any such downward adjustment is
subject to the prior approval of the American Stock Exchange. In the event of
liquidation, the Series B Preferred holders are entitled to receive, prior and
in preference to any distribution to common shareholders and pari passu with
holders of the Series C Convertible Preferred Stock, an amount equal to $1,000
for each share of Series B Preferred then outstanding. Since this series of
Preferred Stock is conditionally redeemable it has been classified between
stockholders' equity and total liabilities in the accompanying balance sheet.
The initial carrying value of the Series B Preferred was recorded at
its sale price less costs to issue on the date of issuance. The carrying value
of the Series B Preferred is periodically adjusted so that the carrying value
equals the redemption value on the redemption date. The carrying value of the
Series B Preferred will also be periodically adjusted for any accrued and unpaid
dividends. At December 31, 2005 and March 31, 2006, the Series B Preferred
carrying value consisted of the following ($ in thousands):
December 31, March 31,
2005 2006
---- ----
(unaudited)
Initial fair value, sale price of $10,500
less costs to issue of $592............$ 9,908 $ 9,908
Redemption value accretion.................. 324 345
Accrued and unpaid dividends accretion...... 3,598 3,836
--------------- -------------
Total carrying value....................$ 13,830 $ 14,089
=============== =============
15
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 accrue at an annual rate of $90.00 per share.
Dividends are payable when and as declared by the Board of Directors. Such
dividends are cumulative, but do not accrue interest and at the Company's
option, may be paid in cash or additional shares of Series C Convertible
Preferred. Dividends are paid pari passu with dividends on the Series B
Preferred. In addition, upon conversion any earned and unpaid dividends would
become payable. The Series C Convertible Preferred may, at the option of the
holder, be converted into shares of Common Stock at the rate of $2.8871 per
share, as adjusted for the issuance of Series D Preferred Stock in March 2004.
At March 31, 2006, the Series C Preferred, including accrued dividends of
$1,601,000, was convertible into 2,286,377 shares of Common Stock. Upon
conversion, any earned and unpaid dividends would become payable in cash or
additional shares of Series C Convertible Preferred, at the Company's option.
The conversion price will be adjusted downward in the event the Company issues
additional shares of Common Stock at a price below $2.8871 per share, subject to
certain exceptions; and any such downward adjustment is subject to the prior
approval of the American Stock Exchange. At the option of the Company, the
Series C Convertible Preferred may be redeemed in whole or in part by paying in
cash the sum of $1,000 per share plus any earned and unpaid dividends. In the
event of liquidation, the Series C Convertible Preferred holders are entitled to
receive, prior and in preference to any distribution to common shareholders, and
pari passu with holders of the Series B Preferred, an amount equal to $1,000 for
each share of Series C Convertible Preferred then outstanding, plus earned and
unpaid dividends.
The carrying value of the Series C Convertible Preferred is
periodically adjusted for any accrued and unpaid dividends. At December 31, 2005
and March 31, 2006, the Series C Convertible Preferred carrying value consisted
of the following (in thousands):
December 31, March 31,
2005 2006
---- ----
(unaudited)
Initial fair value............................$ 5,000 $ 5,000
Accrued and unpaid dividend accretion......... 1,490 1,601
-------------- --------------
Total carrying value..........................$ 6,490 $ 6,601
============== ==============
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 $428,000, and issued
65,000 shares of $.01 par value Series D Convertible Preferred Stock ("Series D
Convertible Preferred"), at a price of $100 per share. The Series D Convertible
Preferred was purchased by three of the Company's principal shareholders.
Dividends accrue at an annual rate of $9.00 per share and shall be paid prior
and in preference to any dividends earned on the Series B Preferred, Series C
Convertible Preferred, Common Stock or any other class of equity security that
is junior to the Series D Convertible Preferred. Dividends are payable when and
as declared by the Board of Directors. Such dividends are cumulative, but do not
accrue interest and at the Company's option, may be paid in cash or additional
shares of Series D Convertible Preferred. The Series D Convertible Preferred
may, at the option of the holder, be converted into shares of Common Stock at
the
16
rate of $2.00 per share. At March 31, 2006, the Series D Preferred,
including accrued dividends of $1,201,000, was convertible into 3,850,500 shares
of Common Stock. Each share of Series D Convertible Preferred shall
automatically be converted into shares of Common Stock upon the consummation of
a qualified public offering of Common Stock of at least $50.0 million or if the
closing price of the Common Stock for a period of thirty consecutive trading
days exceeds $6.00 per share and at least 150,000 shares of Common Stock have
been traded during such applicable thirty day period. Upon conversion, any
earned and unpaid dividends would become payable. The conversion price will be
adjusted equitably in the event of any combination, recapitalization, merger,
reclassification or similar transaction or issuance of Common Stock (or any
instrument convertible into or exercisable for Common Stock) at a price per
share less than $2.00. Commencing on the sixth anniversary of the issuance of
the Series D Convertible Preferred, the Company at its option may redeem the
Series D Convertible Preferred in whole or in part by paying in cash the sum of
$100 per share plus any earned and unpaid dividends. In the event of
liquidation, the Series D Convertible Preferred holders are entitled to receive,
prior and in preference to any distribution to common shareholders and holders
of the Series B Preferred and Series C Convertible Preferred, an amount equal to
$100 for each share of Series D Convertible Preferred then outstanding, plus any
earned and unpaid dividends. The holders of the Series D Convertible Preferred
are afforded protective rights that among other things restrict the Company's
ability to incur debt or lease obligations, make investments or acquisitions,
sell a Club leased from Millennium, issue any new class of equity securities,
repurchase or redeem any equity securities, hire or fire the Chief Executive
Officer, enter into any new line of business or change the primary line of
business and issue options under the Company's stock option plans. The Company
obtained all necessary approvals from the holders of the Series D Convertible
Preferred for the sale of the Clubs to Millennium and for the mortgage financing
of The Sports Club/LA - Los Angeles, on January 13, 2006 (see Note 4 to the
Company's condensed consolidated financial statements). In addition, Millennium
is entitled to designate two directors (at least one of whom must be
independent) and the other two holders are each entitled to designate one
director, to serve on the Company's Board of Directors.
The carrying value of the Series D Convertible Preferred is
periodically adjusted for any accrued and unpaid dividends. At December 31, 2005
and March 31, 2006, the Series D Convertible Preferred carrying value consisted
of the following (in thousands):
December 31, March 31,
2005 2006
---- ----
(unaudited)
Initial fair value...........................$ 6,500 $ 6,500
Issuance costs............................... (428) (428)
Accrued and unpaid dividend accretion........ 1,056 1,201
-------------- --------------
Total carrying value.........................$ 7,128 $ 7,273
============== ==============
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 Redeemable Preferred Stock. The Company
received $2.0 million in cash and issued 20,000 shares of $.01 par value Series
E Preferred Stock ("Series E Preferred") at a price of $100 per share. The
Series E Preferred was purchased by three of the Company's principal
shareholders consisting of Kayne Anderson Capital Advisors, Rex Licklider and D.
Michael Talla. Dividends accrue at an annual rate of $11.375 per share.
Dividends are cumulative, do not accrue interest and, at the Company's option,
may be paid in additional shares of Series E Preferred. The Series E Preferred
is not convertible into shares of the
17
Company's Common Stock and, except as required by law, does not entitle the
holder(s) to vote on matters brought before the Company's stockholders. At any
time after May 31, 2006, provided the Company is legally able to do so, (i) the
Company may, redeem all or part of the Series E Preferred for cash at the
redemption price of $100.00 per share, together with all accrued but unpaid
dividends or (ii) the holders of at least 50% of the Series E Preferred may
demand that the Company redeem all the shares of the Series E Preferred by
paying the redemption price in cash to each holder of the Series E Preferred.
Since this series of Preferred Stock is conditionally redeemable it has been
classified between stockholders' equity and total liabilities in the
accompanying balance sheet.
This initial carrying value of the Series E Preferred was recorded at
its sales price. The carrying value of the Series E Preferred is periodically
adjusted for any accrued and unpaid dividends. At December 31, 2005 and March
31, 2006, the Series E Preferred carrying value consisted of the following (in
thousands):
December 31, March 31,
2005 2006
---- ----
(unaudited)
Initial fair value.......................... $ 2,000 $ 2,000
Accrued and unpaid dividends accretion...... 295 351
------------- -------------
$ 2,295 $ 2,351
============= =============
In June 2006, as allowed under the terms of the Series E Preferred, the
Company redeemed all outstanding shares in cash for the redemption price of
$100.00 per share plus any accrued and unpaid dividends.
15. Note Receivable From Stockholder
On January 13, 2006, the Company completed the sale of five Clubs to
Millennium for $80.0 million (see Note 4 to the Company's condensed consolidated
financial statements). Millennium is the Company's largest stockholder and was
the landlord at four of these Clubs. The Company received $50.0 million in cash
upon closing the sale and received two Notes from Millennium. The first Note of
$22.2 million was due and was collected on January 31, 2006. The second Note of
$7.8 million is due on January 13, 2013, and is secured by a pledge of the
Series C and Series D Preferred Stock owned by Millennium. The Note is also
guaranteed by an affiliate of Millennium. The Note bears interest at the rate of
nine percent (9.0%) per annum and the interest shall accrue and be payable on
the Maturity Date.
On June 14, 2006, the Company repurchased all of Millennium's Series C
and Series D Convertible Preferred Stock and concurrently, Millennium prepaid
the entire Note. Due to the terms and nature of the Note and to the Company's
relationship with Millennium, the Company has classified the Note as a reduction
of Stockholders Equity in the March 31, 2006 condensed consolidated balance
sheet.
16. Litigation
The Company is involved in various claims and lawsuits incidental to
its business, including claims arising from accidents. However, in the opinion
of management, the Company is adequately insured against such claims and
lawsuits involving personal injuries,
18
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.
19
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 currently the operator of four sports and fitness Clubs located
in the Los Angeles and New York metropolitan markets. Our Clubs are spacious,
modern facilities that typically include spas, restaurants, fitness centers,
swimming pools and basketball courts. Our Clubs, which are named The Sports
Club/LA, are recognized as among the finest sports and fitness facilities in the
United States.
Three of our four Clubs range in size from 90,000 to 140,000 square
feet. Due to the size of these facilities and the additional amenities included
in our Clubs, we spend significant amounts to construct a new facility. We
compare the results of our Clubs based upon how long the Clubs have been open at
the most recent measurement period. We categorize Clubs as either mature or
recently opened. Mature Clubs are those Clubs at which we believe the membership
levels have reached a stable level and based upon the amount of new membership
sales and attrition, or the size of the Club, we do not believe a significant
additional growth in the membership level will occur. Clubs are considered to be
recently opened while the membership level is increasing. Three of the Clubs
that we own are considered to be mature. The Sports Club/LA - Beverly Hills was
opened in October 2003 and is now nearing its optimum membership level. Newly
developed Clubs tend to achieve significant increases in revenues until a mature
membership level is reached. Recently opened Clubs that have not yet achieved
mature membership levels have operated at a loss or only a slight profit as a
result of fixed expenses that, together with variable operating expenses,
approximate or exceed membership fees and other revenues.
In 1999, we decided to expand The Sports Club/LA brand on a national
scale. We issued $100.0 million of Senior Secured Notes that were scheduled to
mature in March 2006 and used the proceeds to construct six new Clubs between
2000 and 2004. We invested significant amounts of cash in the construction and
operation of these new Clubs. Our operating performance and our liquidity were
negatively impacted due to the initial construction cost and start up costs and
the delay or failure of the Clubs to generate positive cash flows.
During 2005, the operations of these new Clubs increased to the level
where our operating cash flows were sufficient to cover our debt service and
capital expenditure obligations. However, we were faced with the maturity of the
$100.0 million of debt in March 2006, so in December 2004, we decided to sell
some of our Clubs and seek new financing of The Sports Club/LA - Los Angeles
property. On January 13, 2006, we completed the sale of five of our nine sports
and fitness Clubs for $80.0 million. Concurrent with the sale, we completed a
$60.0 million financing of The Sports Club/LA - Los Angeles. Proceeds from
20
these transactions were used to retire the $100.0 million Senior Secured Notes.
Following the sale, we continue to own and operate four Clubs: The Sports
Club/LA - Los Angeles, The Sports Club/LA - Beverly Hills, The Sports Club/LA -
Orange County and The Sports Club/LA - New York at Rockefeller Center. The
operating results from the five Clubs we sold and the fees and costs associated
with the Miami management agreement that has been terminated have been
classified as Discontinued Operations in the accompanying condensed consolidated
financial statements and in the other parts of this Form 10-Q.
We measure performance using key operating statistics such as
initiation fees, monthly dues and ancillary revenues per member. We closely
focus on new membership sales and the level of membership attrition at each
Club. We also closely evaluate our expenses with an emphasis on controlling
payroll costs. We use Club operating income, before depreciation expenses and
rent expense as a means to evaluate the overall performance of an individual
Club.
We have two primary sources of revenues. First, our largest source of
revenue is from membership dues and initiation fees. We recognize revenue from
dues in the month it is earned. Initiation fees are deferred and recognized as
revenue on a straight-line basis over the membership lives of each Club based on
each individual Club's respective average membership life. Secondly, we generate
ancillary revenue from our membership within each Club. The largest of these
revenues comes from individual private training. We also generate revenues from
our spas, restaurants, childcare, sports programs and guest fees. Our total
ancillary revenues for our continuing operations, represent 32.8% of total Club
revenue and we believe that percentage is among the highest in the industry. We
believe that membership levels are the primary indicator of a 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 at the Clubs we still own
of 28.9% is well below the norm in the industry.
Our direct expenses include costs to operate our Clubs. These consist
primarily of payroll and employee benefits, rent and other occupancy related
costs, supplies, repairs, costs of products sold and various other operating
costs. A significant amount of these costs are fixed in nature.
General and administrative expenses include costs related to our
centralized support functions such as accounting, information technology,
development and our executive management. Costs associated with being a publicly
owned company are also included in this category. Selling expenses include our
advertising, marketing department and promotional costs associated with the
generation of new memberships.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of the assets
and liabilities and disclosures of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. We base these estimates and assumptions upon
historical experience and existing known circumstances. Actual results could
differ from those estimates. Specifically, we must make estimates in the
following areas:
21
Revenue Recognition. We receive initiation fees and monthly membership
dues from our members. Substantially all of our members join on a month-to-month
basis and can therefore cancel their membership at any time. The transaction in
which we receive initiation fees may include free private training sessions.
Under Emerging Issues Task Force 00-21, Revenue Arrangement with Multiple
Elements, we determined that the initiation fees and private training sessions
did not represent separate units of accounting. Accordingly, initiation fees and
related direct expenses, primarily sales commissions, are deferred and
recognized, on a straight line basis, over the average membership life.
Effective in the second quarter of 2005, we started amortizing initiation fees
over the membership lives of each Club based on each individual Club's
respective average membership life. Dues that are received in advance are
recognized on a pro-rata basis over the periods in which services are to be
provided. In addition, payments of last months' dues are deferred. Revenues for
services including private training, spa treatments and physical therapy
sessions are recorded when such services are performed. Amounts received in
advance are recorded as deferred revenues. Revenues from our SportsMed
subsidiary are recognized when the services are rendered based upon the
estimated amount to be collected.
Allowance for doubtful accounts. We provide a reserve against our
receivables for estimated losses that may result from our members' inability to
pay. We determine the amount of the reserve by analyzing known uncollectible
accounts, economic conditions and historical losses and our members'
creditworthiness. The likelihood of a material loss from this area is minimal
due to our limited exposure to credit risk.
Lease Accounting. We record rent expense on facilities under operating
leases. The aggregate rental obligation is expensed on a straight line basis
over the lease term, commencing with the date when we take possession of the
property. If the lease imposes a significant economic penalty not to renew an
option period, we use the initial period plus the option period as the lease
term. Rent incurred before the facility is ready for use is capitalized as
leasehold improvements. Effective December 15, 2005, the Company adopted FASB
Staff Position 13-1 Accounting for Rental Costs Incurred During a Construction
Period, which requires rental costs incurred during construction be expensed.
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. Through 2005, we evaluated our three New York City Clubs as
a group since they were located in the same geographical area, were operated and
evaluated as a group and memberships allowed the members to use any of the New
York Clubs. Operating the Clubs as a group allowed us to compete more
effectively with the local competition which also have multiple locations. Due
to the sale of two New York Clubs, we now evaluate the remaining long-lived
asset in New York on a stand alone basis. 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. At
December 31, 2005, the evaluation of The Sports Club/LA - New York at
Rockefeller Center resulted in an impairment charge of $18.6 million. At March
31, 2006, the evaluating of The Sports Club/LA - New York at Rockefeller Center
resulted n an impairment charge of $713,000.
22
Valuation of goodwill. We recorded goodwill in connection with our
acquisitions of The Sports Club/LA in Los Angeles and Orange County, Reebok
Sports Club/NY and SportsMed. We are required to evaluate goodwill on an annual
basis or when certain events require us to reevaluate our goodwill. We performed
the analysis, as of December 31, 2003, 2004 and 2005, and determined that our
remaining goodwill was not impaired. No events occurred in the three months
ended March 31, 2006, that require the Company to re-evaluate its goodwill.
Marketable Securities. At March 31, 2006, the Company held $3.8 million
and $11.2 million of short-term and long-term marketable securities,
respectively. All marketable securities were classified as held-to-maturity and
carried at amortized cost. The marketable securities consisted entirely of
United States Treasury Notes and other Governmental Agency Notes. At March 31,
2006, the estimated fair value of each investment approximated its amortized
cost and therefore, there were no significant unrealized gains or losses.
Valuation of deferred income taxes. Valuation allowances are
established to reduce deferred tax assets to the amount expected to be realized.
The likelihood of material change in our expected realization of these assets
depends on future taxable income, our ability to deduct tax loss carry forwards
against future taxable income, the effectiveness of our tax planning and
strategies among the various tax jurisdictions in which we operate and any
significant changes in the tax laws.
Interest expense. In accordance with Emerging Issues Task Force
("EITF") Issue No. 87-24, Allocation of Interest to Discontinued Operations,
interest was allocated to discontinued operations based on the interest on debt
that was required to be repaid as a result of disposal transactions. On January
13, 2006, we completed the sale of five of our nine sports and fitness Clubs
(see Footnote Note 4 to our condensed consolidated financial statements
appearing elsewhere in this 10-Q). The proceeds of $80.0 million from the sale
were required to be used to repay a portion of our $100.0 million of Senior
Secured Notes. Accordingly we have allocated to discontinued operations 80.0% of
the interest expense associated with the Senior Secured Notes. For the
three-month period ended March 31, 2005, the amount of interest allocated to
discontinued operations was $2,476,000. Due to the relatively short period that
the Company owned the Clubs during 2006, no interest was allocated to
discontinued operations for the three-month period ended March 31, 2006.
Results of Operations
Several reclassifications have been made to the condensed consolidated
statement of operations for the three months ended March 31, 2005, primarily due
to our decision to retain The Sports Club/LA - New York at Rockefeller Center,
as discussed in Note 2 to the condensed consolidated financial statements, in
accordance with Statement of Financial Accounting Standards No. 144, Accounting
for Impairment and Disposal of Long-Lived Assets. The following discussion that
compares our results of operations is after consideration of such
reclassifications.
Comparison of Three Months Ended March 31, 2006 to Three Months Ended March 31,
2005.
Our total revenue from continuing operations for the three months ended
March 31, 2006, was $14.6 million, compared to $13.7 million for the same period
in 2005, an increase of $924,000 or 6.8%. Revenue increased by $549,000 at The
Sports Club/LA - Beverly Hills primarily as a result of an 11.9% increase in
membership between March 2005 and March
23
2006 and to annual rate increases for dues and other ancillary services. Revenue
increased by $226,000 at The Sports Club/LA - New York at Rockefeller Center
primarily as a result of a 7.9% increase in membership between March 2005 and
March 2006 and to annual rate increases for dues and other ancillary services.
Revenue increased by $196,000 at The Sports Club/LA - Los Angeles and The Sports
Club/LA - Orange County primarily as a result of dues increases and to higher
ancillary revenues, mostly private training revenues. There was a decrease in
revenue of approximately $47,000 at our two SportsMed locations primarily due to
decreased patient visits.
Our club operating costs and cost of products and services increased by
$526,000, or 5.1% to $10.8 million for the three months ended March 31, 2006,
versus $10.3 million for the same period in 2005. Club operating costs and cost
of products and services increased by approximately $199,000, as a result of the
increases in variable costs (mostly payroll, payroll related, supplies and other
operating expenses) associated with the increase in membership and revenues at
The Sports Club/LA-Beverly Hills. Club operating costs and cost of products and
services increased by approximately $348,000, as a result of the increases in
variable costs (mostly payroll, payroll related, supplies and other operating
expenses) associated with the increase in membership and revenues at The Sports
Club/LA- New York at Rockefeller Center. Club operating costs and cost of
products and services increased by approximately $24,000 at The Sports Club/LA -
Los Angeles and The Sports Club/LA - Orange County primarily due to increased
utility and supply costs. There was a decrease in cost of products and services
of approximately $45,000 at our two SportsMed facilities due to a decrease in
the number of patient visits.
Our selling and marketing expenses were $693,000 for the three months
ended March 31, 2006, versus $506,000 for the same period in 2005, an increase
of $187,000 or 37.0%. The increase in selling and marketing expenses is
primarily the result of not allocating various corporate level selling and
marketing costs to Clubs that were sold (see Note 4 to our condensed
consolidated financial statements). Prior to the sale we allocated certain
corporate level selling and marketing costs to all nine Clubs that we owned.
Once the five Clubs were sold we could no longer allocate these selling and
marketing costs to the sold Clubs. We have been able to reduce our corporate
level selling and marketing costs as a result of the reduced number of Clubs
that our corporate sales and marketing department now supports, but due to the
fixed nature of some of the expenses we have not been able to reduce our selling
and marketing cost in proportion to the number Clubs sold.
Our general and administrative expenses were $2.2 million for the three
months ended March 31, 2006, versus $2.0 million for the same period in 2005, an
increase of $200,000. Rent decreased by $155,000 as a result of relocating the
corporate office. Licenses and permits increased by $77,000 primarily as a
result of a City of Los Angeles business license required for the corporate
administrative offices. The remaining increase in general and administrative
expenses of approximately $278,000 is primarily the result of not allocating
various corporate level general and administrative expenses to Clubs that were
sold (see Note 4 to our condensed consolidated financial statements). Prior to
the sale we allocated certain corporate level general and administrative
expenses to all nine Clubs that we owned. Once the five Clubs were sold we could
no longer allocate these general and administrative expenses to the sold Clubs.
We have reduced our corporate level employee headcount and have been able to
eliminate other corporate level general and administrative expenses as a result
of the reduced number of Clubs that we now support, but due to the fixed nature
of some of the expenses we have not been able to reduce our general and
administrative expenses in proportion to the number of Clubs sold.
24
We incurred an impairment charge during the three months ended March
31, 2006, of $713,000. This impairment charge consisted of the write down of
fixed assets at The Sports Club/LA - New York at Rockefeller Center. The future
estimated cash flows from this Club were not adequate to recover the net book
value of its fixed assets. As a result, we were required to write down the fixed
assets to their estimated fair value.
Our depreciation and amortization expenses were $1.1 million for the
three months ended March 31, 2006, versus $1.2 million for the same period in
2005, a decrease of $87,000 or 7.1%. Depreciation and amortization expenses
increased by $27,000, primarily due to capital additions made at The Sports
Club/LA - Los Angeles and The Sports Club/LA - Orange County during 2005 and
2006. Depreciation and amortization expenses decreased by $114,000 at the
corporate office facility due to the relocation to a new smaller facility.
Net interest expense from continuing operations increased by $1.1
million to $2.3 million for the three months ended March 31, 2006, versus $1.2
million for the same period in 2005. Due to the sale of the discontinued Clubs
in January 2006, we stopped allocating interest costs on our $100.0 million of
Senior Secured Notes to our discontinued operations and this resulted in an
increase in net interest expense from continuing operations of $707,000.
Conditions attached to the Senior Secured Notes prevented us from paying them
off on the date we sold the discontinued Clubs and we did not pay them off until
late February 2006. In January 2006 we entered into a new mortgage for $60.0
million, secured by the assets of The Sports Club/LA - Los Angeles. Interest on
this mortgage increased net interest expense from continuing operations by
$842,000. Net interest expense from continuing operations increased by $156,000
due to guarantee fees incurred on the $60.0 million mortgage. Two of our largest
stockholders have personally guaranteed a portion of the mortgage and we pay
them each a guarantee fee for this personal guarantee. Net interest expense from
continuing operations decreased by $594,000 due to interest income earned on the
excess proceeds and notes receivable generated from the asset sale.
During the three months ended March 31, 2006, we recorded other income
of $628,000. This other income consists of transitional services fees charged
the new owner of the five Clubs we sold in January 2006 (see Note 4 to our
condensed consolidated financial statements).
We did not record any federal or state deferred tax benefit related to
our consolidated pre-tax losses from continuing operations for the three months
ended March 31, 2006 and March 31, 2005.
Our income from discontinued operations was $47,000 for the three
months ended March 31, 2006, versus income from discontinued operations of
$375,000 for the same period in 2005, a decrease of $328,000. We sold these
discontinued Clubs effective January 1, 2006, with a closing date of January 13,
2006. The income from discontinued operations of $47,000 for the three months
ended March 31, 2006 is the profit incurred during January 2006 related to these
sold Clubs.
After the income from discontinued operations and dividends on
preferred stock of $549,000 during the three months ended March 31, 2006 and
$493,000 during the three months ended March 31, 2005, our consolidated net loss
attributable to common stockholders was $3.2 million, or $0.17 per basic and
diluted share for the three months ended March 31, 2006, versus a loss of $1.7
million, or $0.09 per basic and diluted share for the three months ended March
31, 2005.
25
Liquidity and Capital Resources
Liquidity
In 1999, we decided to expand The Sports Club/LA brand on a national
scale. We issued $100.0 million of Senior Secured Notes that were scheduled to
mature in March 2006 and used the proceeds to construct six new Clubs between
2000 and 2004. We invested significant amounts of cash in the construction and
operations of these new Clubs. As typically happens when a new Club is open,
these Clubs operated at minimal or negative cash flows during their early stages
of operation as their membership levels were increasing. Because of this, we did
not have cash on hand to meet our interest obligations under the Senior Secured
Notes and therefore, between March 2002 and September 2004, we raised $24.0
million through four separate Preferred Stock issuances. During 2005, the
operations of these new Clubs increased to the level where our operating cash
flows were sufficient to cover our debt service and capital expenditure
requirements. However, we were faced with the maturity of the $100.0 million of
debt in March 2006, so in December 2004, we decided to sell some of our Clubs
and seek new financing of The Sports Club/LA - Los Angeles property. On January
13, 2006, we completed the sale of five of our nine sports and fitness Clubs for
$80.0 million. We received $50.0 million in cash upon closing the sale and
received two notes from Millennium. The first note of $22.2 million was paid in
cash in January 2006 and the second note of $7.8 million was satisfied by
redeeming Millennium's Preferred Stock in June 2006. The net proceeds from the
sale exceeded the carrying value of the net assets sold by approximately $24.8
million. Millennium has two directors on the Company's board of directors, is a
major stockholder of the Company and was the landlord at four of the five Clubs
that were sold. Millennium is a related party, as defined by generally accepted
accounting principles and by the United States Securities and Exchange
Commission. Accordingly, the amount by which the net proceeds from the sale of
the five Clubs to Millennium exceeded their carrying value has been classified
as a capital contribution in the accompanying condensed consolidated financial
statements. Concurrent with the sale, we completed a $60.0 million financing of
The Sports Club/LA - Los Angeles. Proceeds from these transactions were used to
retire the $100.0 million Senior Secured Notes.
Following the sale, we continue to own and operate four Clubs. We
believe our remaining consolidated operations will generate sufficient cash
flows to cover our operating costs and debt service obligation for the next
twelve months. At March 31, 2006, we have $26.6 million of cash and marketable
securities to fund our operations going forward.
We plan on spending more than the normal amount on capital
expenditures at three of our Clubs during 2006. Normally, we would expect to
spend between 3-4% of revenues on capital expenditures. This would approximate
$2.0 million per year. In 2006, we plan on replacing much of our cardio vascular
and weight training equipment, carpeting, audio-visual equipment and lockers at
these three Clubs as well as making other significant capital expenditures.
Therefore, we have budgeted $7.6 million for capital expenditures in 2006.
We retired our Series E Preferred Stock in June 2006. We used $2.4
million of cash to redeem the stock and pay the accrued dividends. At that time
we also paid all accrued dividends on the Series B, C and D Preferred Stock as
well as retired the Series C and D Preferred Stock owned by Millennium. This
resulted in the retirement of an additional $13.4 million of Preferred Stock and
accrued dividends. We were required to use $4.3 million of cash to make these
redemptions since the amounts due to Millennium were offset against a Note
receivable we had from them and a portion of the accrued dividends were paid by
issuing additional shares of Series C Preferred Stock.
26
Substantial funds are required to develop additional new Clubs. Our
current debt levels make it difficult for us to secure the financing to develop
additional new sites. Therefore we would expect any new Clubs to be structured
as joint ventures, partnership agreements or management arrangements. We are
currently pursuing several potential new Club developments that would be
structured in that manner. This structure would allow us to expand our brand and
receive an immediate earnings stream and cash flow, with the potential for
additional profits, without making the significant capital investment required
to develop a club without a partner.
Operating Activities
At December 31, 2005, our cash balance was $10.3 million. In January
2006, we completed the sale of five Clubs, financed The Sports Club/LA - Los
Angeles and retired our $100.0 million Senior Secured Notes leaving us with
$26.6 million of cash and marketable securities at March 31, 2006. We believe we
will generate positive cash flows from operating activities in the future.
Investing Activities
Investing activities consist of new Club development and expenditures
to maintain and update our existing Clubs. Our Clubs are upscale and capital
improvements are regularly needed to retain the upscale nature and presentation
of the Clubs. A deterioration of the quality of the Clubs can lead to reduction
in membership levels and lower revenues. In the first quarter of 2006, capital
expenditures to maintain and update our Clubs, were $3.1 million. We normally
estimate that expenditures of between 3% and 4% of revenues, depending on the
age of the Club, will be necessary to maintain the quality of the Clubs to our
satisfaction. However, in 2006 we plan on spending approximately $7.6 million in
capital expenditures at our four Clubs. We plan to replace most cardio vascular
and weight training equipment, carpeting, audio visual equipment and lockers at
our three established Clubs and upgrade our management information systems and
enhance our disaster recovery capabilities.
We currently have no definitive plans for new Club developments that
would require our own capital. However, we are in preliminary discussion with
several parties about the possibility of developing new Clubs under management
agreements.
Financing Activities
On April 1, 1999, we issued in a private placement $100.0 million of
11 3/8% Senior Secured Notes due in March 2006, with interest due semi-annually.
The Senior Secured Notes were issued pursuant to the terms of an indenture
agreement dated April 1, 1999 (the "Indenture"). The Senior Secured Notes were
secured by substantially all of our assets, other than certain excluded assets.
The Senior Secured Notes were repaid in January 2006 with the proceeds from the
sale of five of our Clubs and the financing of The Sports Club/LA - Los Angeles.
On June 12, 2003, we obtained financing in the form of a secured
five-year promissory loan in the amount of $20.0 million. The 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
27
guaranteed by two of our major stockholders. The note may be prepaid at any time
without penalty and requires a final payment of $18.3 million on July 1, 2008.
In March 2004, three of our principal shareholders purchased $6.5
million of a newly created class of Series D Convertible Preferred Stock in a
private placement offering. The proceeds were used to pay the March 15, 2004
interest payment on our Senior Secured Notes and to provide additional working
capital. In September 2004, three of our principal shareholders purchased $2.0
million of a newly created class of Series E Preferred Stock in another private
placement offering. The proceeds were used to pay the September 15, 2004
interest payment on our Senior Secured Notes. The Series E Preferred Stock may
be redeemed at any time after May 31, 2006.
In January 2006, we secured a $60.0 million mortgage note at The
Sports Club/LA - Los Angeles. The note, which matures in January 2016, is
secured by all the real estate and other assets at The Sports Club/LA - Los
Angeles, bears interest at 6.48% per annum and requires monthly payments of
$404,375 which amortizes the loan over a twenty-five year period. Two of our
shareholders executed limited guarantees under which the lender has recourse to
them in certain circumstances. We have agreed to indemnify these shareholders
under certain circumstances for losses under this guarantee. In exchange for the
guarantee, we agreed to pay each guarantor a fee equal to .75% per annum of the
average outstanding principal balance of the loan. At our discretion, such fees
may be paid in Common Stock, cash or a combination thereof.
Contractual Obligations
The following schedule lists known contractual obligations (amounts in
thousands) as of March 31, 2006:
Less Than More
1 3-5 Than 5
Contractual Obligations Total Year 1-3 Years Years Years
----------------------- ----- ---- --------- ----- -----
Mortgage note (1)..................... $ 59,828 $ 874 $ 2,074 $ 2,376 $ 54,504
Interest on mortgage note (1)......... 35,075 3,574 7,631 7,330 16,540
Mortgage note (2)..................... 19,136 357 18,779 -- --
Interest on mortgage note (2)......... 3,173 1,378 1,795 -- --
Equipment financing loans (3)......... 59 21 38 -- --
Interest on equipment financing
loans (3)........................ 9 6 3 -- --
Operating leases (4).................. 49,311 5,519 11,298 11,757 20,737
Minority interest (5)................. 1,013 150 863 -- --
Redeemable Preferred Stock (6)........ 16,126 2,296 13,830 -- --
----------- ----------- ----------- --------- -----------
Total $ 183,730 $ 14,175 $ 56,311 $ 21,463 $ 91,781
=========== =========== =========== ========= ===========
-------------
(1) In January 2006, we secured a $60.0 million mortgage note at The Sports
Club/LA - Los Angeles. The note, which matures in January 2016, is secured by
all the real estate and other assets at The Sports Club/LA - Los Angeles, bears
interest at 6.48% per annum and requires monthly payments of $404,375, which
amortizes the loan over a twenty-five year period. Two of our shareholders
executed limited guarantees under which the lender has recourse to them in
certain circumstances. We have agreed to indemnify these shareholders under
certain circumstances for losses under this guarantee. In exchange for the
guarantee, we agreed to pay each guarantor a fee equal to .75% per annum of the
average outstanding principal balance of the loan. At our discretion, such fees
may be paid in Common Stock, cash or a combination thereof.
(2) On June 12, 2003, we obtained financing in the form of a secured five-year
promissory loan in the amount of $20.0 million. The loan bears interest at a
fixed interest rate of 7.25%; requires monthly principal and interest payments
of $144,561; and requires a final principal payment of $18.3 million on July 1,
2008.
28
(3) Equipment financing loans are secured by our furniture, fixtures and
equipment. The amounts are generally repayable in monthly payments over four or
five years.
(4) We lease certain facilities pursuant to various operating lease agreements.
Club facility leases are generally long-term and non-cancelable triple-net
leases (requiring us to pay all real estate taxes, insurance and maintenance
expenses) and have an average remaining term of 19.47 years, including renewal
options which are included in the lease term, with the earliest lease expiration
date of January 31, 2013. We are also obligated under lease agreements for six
of our former Spectrum Club locations. We have subleased each of these
properties to the buyer of these Clubs under sublease agreements which provide
that all operating costs of these facilities be assumed by the new owners.
Amounts due for Spectrum Club leases are excluded from this table.
(5) We own a 50.1% interest in the partnership that owns The Sports Club/LA -
Los Angeles, and D. Michael Talla, our Chairman, beneficially owns the remaining
49.9%. We have the option to redeem Mr. Talla's preferred partnership interest
for $600,000, which expires on December 31, 2008. We have included the annual
preferred distribution of $149,700 to Mr. Talla in the above table for the next
2.75 years and the redemption amount is included in 2008 (Year 3).
(6) On March 18, 2002, we issued 10,500 shares of Series B Preferred Stock. The
stock is redeemable by the stockholders on March 18, 2009. On September 14,
2004, we issued 20,000 shares of Series E Preferred Stock. The stock is
redeemable by the stockholders after May 31, 2006. The amount of dividends
payable on the redemption date is included in the above table.
29
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 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 revenues during
the summer months at our New York 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 our mortgage
notes,
o our ability to attract and retain members, which depends on
competition, market acceptance of new and existing sports and fitness
clubs and services, demand for sports and fitness club services
generally and competitive pricing trends in the sports and fitness
market,
o our ability to successfully develop new sports and fitness clubs,
o disputes or other problems arising with development partners or
landlords,
o changes in economic, competitive, demographic and other conditions in
the geographic areas in which we operate, including business
interruptions resulting from earthquakes or other causes,
o competition,
o changes in personnel or compensation, and
o changes in statutes and regulations or legal proceedings and rulings.
We will not update forward-looking statements even though our situation
may change in the future.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our current financing bears interest at a fixed rate and is
not subject to interest rate risk. We are exposed to risk from a change in
interest rates to the extent we are required to refinance existing fixed rate
indebtedness at rates higher than those prevailing at the time the existing
indebtedness was incurred. As of March 31, 2006, we had two mortgages totaling
$79.0 million due in July 2008 and January 2016 bearing fixed interest rates. A
hypothetical increase in interest rates of 1% would increase our interest
expense by approximately $790,000 per year.
The fair value of our financial instruments as of March 31, 2006 is
estimated as follows (in thousands):
First Mortgage Note........................ $ 19,136
First Mortgage Note........................ 59,828
---------------
$ 78,964
===============
31
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, as amended, are recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's ("SEC") rules and forms, and that such information is accumulated
and communicated to management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosures. Our internal control system is designed to provide reasonable
assurance regarding the preparation and fair presentation of published financial
statements. All internal control systems are designed based in part upon certain
assumptions about the likelihood of future events, and, no matter how well
designed, have inherent limitations. Therefore, even those systems determined to
be effective can provide only reasonable assurance with respect to financial
statement preparation and presentation and may not prevent or detect all
misstatements. Our management, including our Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"), has evaluated the effectiveness of our
disclosure controls and procedures as of the end of the fiscal quarter covered
by this Quarterly Report on Form 10-Q. This evaluation included a review of the
steps management undertook in an effort to ensure that information required to
be disclosed in its Exchange Act filings is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC. In
light of certain material weaknesses in our controls and procedures described
below, the CEO and CFO concluded that, as of the end of such period, these
deficiencies have caused our disclosure controls and procedures not to be
effective to enable us to record, process, summarize, and report information
required to be included in our SEC filings within the required time period, and
to ensure that such information is accumulated and communicated to our
management, including our CEO and CFO, to allow timely decisions regarding
required disclosure. As described below, we are taking steps to remediate the
deficiencies in our control over the financial reporting process.
In performing its audit of our Consolidated Financial Statements for
the years ended December 31, 2004 and 2005, Stonefield Josephson, Inc.
("Stonefield") noted a matter involving our internal controls that it considered
to be a "reportable condition." A "reportable condition," which may or may not
be deemed a material weakness, involves matters relating to significant
deficiencies in the design or operation of internal controls that, in the
auditor's judgment, could adversely affect our ability to record, process,
summarize and report financial data consistent with the assertions of management
in the financial statements.
The reportable condition that Stonefield considered to be a material
weakness was that the Company was unable to process its financial information
and present financial statements within a timely fashion. Stonefield's
observation was summarized in its letters dated September 30, 2005 and May 5,
2006 to the Audit Committee of the Board of Directors.
In December 2004, the Company received a comment letter relating to
the Company's Form 10-K/A for the year ended December 31, 2003 and Form 10-Q for
the quarter ended September 30, 2004 from the staff of the SEC. One of the
issues dealt with accounting for initiation fees under the provision of Emerging
Issues Task Force ("EITF") No. 00-21. The eventual resolution of this issue
contributed to the untimely filing of the Company's financial statements for the
year ended December 31, 2004 and quarterly periods ended March 31, 2005 and June
30, 2005.
32
The Audit Committee has authorized and directed management to devise
and implement actions to address this deficiency and to enhance the reliability
and effectiveness of the Company's internal controls over financial reporting
and to provide reasonable assurance that our disclosure controls and procedures
allow for the accurate presentation and timely filing of our financial
statements. The Company's accounting personnel have reviewed their reporting and
certification obligations under the Exchange Act and the Sarbanes Oxley Act of
2002, and have consulted with the Company's outside counsel with respect to
those obligations. We have assigned a high priority to both the short-term and
long-term strengthening of these controls and have identified certain additional
measures, which we believe will address the conditions identified by our
auditors as a material weakness, including the following:
o engaging an accounting or financial consulting firm (other than the
Company's independent auditor) to consult with the Company on accounting issues,
including the interpretation of new accounting rules and releases promulgated by
the SEC, the Financial Accounting Standards Board and other organizations, and
the application of accounting principles to new transactions in which the
Company engages;
o reviewing the new FASB, EITF, SOP and other accounting rules and
pronouncements. The review will assess each new rule or pronouncement; whether
or not it amends or modifies an existing rule or pronouncement; its
applicability to the Company or any transactions in which the Company has
engaged, or proposes to engage; and the appropriate accounting ramifications of
the new rule or pronouncement;
o subscribing to selected professional publications that discuss new
accounting rules and regulations applicable to reporting companies, and sending
our senior accounting personnel to seminars and other presentations which focus
on new accounting and financial disclosure rules and pronouncements; and
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
condition identified as material weaknesses by Stonefield. We will continue to
monitor and evaluate the effectiveness of our disclosure controls and procedures
and our internal controls over financial reporting on an ongoing basis, and are
committed to taking further action and implementing additional enhancements or
improvements, as necessary. We believe that these measures are reasonably likely
to have a material impact on both our internal controls over financial reporting
and disclosure controls and procedures in future periods.
(b) Changes in internal controls over financial reporting.
During the quarter ended March 31, 2006, the following changes
occurred in the Company's internal controls over financial reporting (as those
terms are defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that
have materially affected, or are reasonably likely to materially affect, its
internal controls over financial reporting:
o the Company has worked with an accounting firm (other than Company's
independent auditor) to consult with on accounting issues;
33
o the Company has reviewed new accounting pronouncements to determine
the applicability to the Company;
o the Company has subscribed to professional publications that discuss
new accounting rules and regulations;
34
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 1A. Risk Factors
There have been no material changes from the information previously
reported under Item 1A of the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2005, which Item 1A is hereby incorporated by
reference.
Item 2. Changes in Securities
None
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
31.1 Certification of Rex A. Licklider pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Timothy O'Brien pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Rex A. Licklider pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Timothy O'Brien pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SPORTS CLUB COMPANY, INC.
Date: August 8, 2006 by /s/ Rex A. Licklider
------------------------------------
Rex A. Licklider
Chief Executive Officer
(Principal Executive Officer)
Date: August 8, 2006 by /s/ Timothy M. O'Brien
------------------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and Accounting
Officer)
36
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 third
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
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls over financial reporting.
Dated, August 8, 2006
/s/ Rex A. Licklider
--------------------------------------
Rex A. Licklider
Chief Executive Officer
37
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 third
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
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls over financial reporting.
Dated, August 8, 2006
/s/ Timothy O'Brien
--------------------------------------
Timothy O'Brien
Chief Financial Officer
38
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 ended March 31, 2006 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Rex A.
Licklider, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. (Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act
of 2002, that to my knowledge:
(i) The Report fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(ii) The information contained in the Report
fairly represents, in all material respects, the financial condition and result
of operations of the Company.
/s/ Rex A. Licklider
-------------------------------------------
The Sports Club Company, Inc.
Chief Executive Officer
August 8, 2006
39
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 ended March 31, 2006 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Timothy
O'Brien, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
(Section Mark) 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of
2002, that to my knowledge:
(i) The Report fully complies with the
requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(ii) The information contained in the Report
fairly represents, in all material respects, the financial condition and result
of operations of the Company.
/s/ Timothy O'Brien
----------------------------------------
The Sports Club Company, Inc.
Chief Financial Officer
August 8, 2006
40