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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended May 31, 1998
/ / Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission file number: 333-40907
TOWN SPORTS INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
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NEW YORK 13-2749906
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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888 SEVENTH AVENUE
NEW YORK, NEW YORK 10106
(Address, including zip code and telephone number,
including area code, of registrant's principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
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 requirement for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K /X/.
The aggregate market value of Common Stock held by non-affiliates of the
registrant: Not applicable
As of August 12, 1998, there were 1,015,714 shares of Class A Common Stock
of the Company outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits filed with the Registrant's Registration Statements on Form
S-1 and Form S-4 (File Nos. 333-61439 and 333-40907, as amended) are
incorporated by reference into Part III of this Report on Form 10-K.
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TABLE OF CONTENTS
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ITEM PAGE
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PART I
1. Business.......................................................................................... 2
2. Properties........................................................................................ 5
3. Legal Proceedings................................................................................. 7
4. Submission of Matters to a Vote of Security Holders............................................... 7
PART II
5. Market for Registrant's Common Stock and Related Shareholder Matters.............................. 7
6. Selected Financial Data........................................................................... 8
7. Managements' Discussion and Analysis of Financial Condition and Results of Operations............. 10
7A. Quantitative and Qualitative Disclosures About Market Risks....................................... 16
8. Financial Statements and Supplementary Data....................................................... 17
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............. 17
PART III
10. Directors and Executive Officers of the Registrant................................................ 18
11. Executive Compensation............................................................................ 20
12. Security Ownership of Certain Beneficial Owners and Management.................................... 23
13. Certain Relationships and Related Transactions.................................................... 25
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................. 26
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TOWN SPORTS INTERNATIONAL, INC.
PART I
ITEM 1. BUSINESS
Town Sports International, Inc. (collectively with its subsidiaries, "Town
Sports" or the "Company") is one of the two leading owners and operators of
fitness clubs in the Northeast and Mid-Atlantic regions of the United States. As
of August 12, 1998, the Company operated 64 clubs that collectively served over
175,000 members. The Company develops clusters of clubs to serve densely
populated major metropolitan regions in which a high percentage of the
population commutes to work. The Company services such populations by clustering
clubs near the highest concentrations of its target customers' areas of both
employment and residence. The Company's target customer is college-educated,
typically between the ages of 20 and 44 and earns an annual income in excess of
$50,000.
The Company's goal is to develop the premier health club network in each of
the major metropolitan regions it enters. Management believes that clustering
clubs allows the Company to achieve strategic operating advantages that enhance
its ability to achieve this goal. When entering new regions, the Company
develops its clusters by initially opening or acquiring clubs located in the
more central urban markets of the region and then branching out from these urban
centers to suburbs and ancillary communities. Capitalizing on this clustering of
clubs, in fiscal 1998, approximately half of the Company's members participated
in a membership plan that allows unlimited access to all of the Company's clubs
for a higher membership fee.
The Company has executed this strategy successfully in the New York region
through the network of clubs it operates under its New York Sports Club ("NYSC")
brand name. The Company is the largest fitness club operator in Manhattan with
23 locations and operates a total of 52 clubs under the NYSC name within a
defined radius of New York City. The Company is in the process of more fully
developing clusters within a smaller radius surrounding Washington, DC under its
Washington Sports Club ("WSC") brand name and has begun establishing similar
clusters surrounding Boston and Philadelphia under its Boston Sports Club
("BSC") and Philadelphia Sports Club ("PSC") brand names, respectively. The
Company employs localized brand names for its clubs to create an image and
atmosphere consistent with the local community and to foster recognition as a
local network of quality fitness clubs rather than a national chain.
The Company has experienced significant growth over the past several years
through a combination of (i) acquiring existing, privately owned, single and
multi-club businesses, and (ii) developing and opening "greenfield" club
locations. From May 31, 1993 to August 12, 1998, the Company acquired 32
existing clubs, opened 14 greenfield clubs, sold one club and closed one club at
the expiration of its lease to increase its total clubs under operation from 20
to 64. The Company plans to acquire or open at least 25 clubs prior to December
31, 1999. The Company has achieved revenue growth over the past five fiscal
years at a compound annual rate of approximately 34.9% from $24.9 million in
fiscal 1994 to $82.4 million in fiscal 1998. This growth has been driven not
only by the addition of acquired and greenfield club locations, but also through
comparable club revenue growth, which has ranged from 10.9% to 27.3% for the
past five fiscal years and was 26.2% in fiscal 1998. Comparable club revenue
growth has enabled the Company to increase revenue per weighted average club in
each of the past five fiscal years. Revenue per weighted average club has risen
from $1.8 million in fiscal 1994 to $2.3 million in fiscal 1998. Based on the
Company's historical experience, a new club tends to achieve significant
increases in revenues during its first three years of operation as it reaches
maturity. Because clubs experience little incremental cost associated with such
revenue increases, the Company realizes a greater proportionate increase in
profitability. This operating leverage has allowed it to achieve EBITDA growth
over the past five years at a compound annual rate of approximately 44.8% from
$3.6 million in fiscal 1994 to $15.9 million in fiscal 1998. The Company's rate
of EBITDA growth from fiscal 1997 to fiscal 1998 accelerated
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to 89.6%. The Company reported net income of $277,000 in fiscal 1998 versus a
net loss of $936,000 in fiscal 1997.
The Company's model club ranges in size from approximately 15,000 to 25,000
square feet and averages approximately 20,000 square feet. Clubs typically have
an open space to accommodate cardiovascular and strength-training exercise, as
well as special purpose rooms to accommodate aerobic class instruction and other
exercise programs. Locker rooms generally include a sauna and steam room.
Management seeks to provide a broad array of high quality exercise programs and
equipment that is both popular and effective, while reinforcing the quality
exercise experience the Company strives to make available to its customers.
While the Company does not generally build locations with amenities such as
swimming pools or racquet and basketball courts, the Company does strive to
establish at least one flagship club that has such amenities in each of its
markets. Management believes that it is generally more economical to acquire
clubs with such amenities than to develop them as greenfield clubs.
Management engages in a detailed site analysis and selection process based
upon information provided by the Company's proprietary development software to
identify potential target areas for additional clubs based upon population
demographics, traffic and commuting patterns, availability of sites and
competitive market information. In addition to the Company's existing 64 clubs
under operation and the 12 sites for which the Company has entered into lease
commitments, management has identified approximately 125 target areas in which
it plans to add clubs under the brand names NYSC, WSC, BSC or PSC. Management
estimates that it will identify approximately 50 additional target areas in
which to add clubs under these brand names. Once the Company begins to approach
saturation of these regions, management will explore expansion opportunities in
contiguous regions along the East Coast and the Mid-Atlantic. Since its
inception, the Company has never closed a club prior to the expiration of a
lease and has closed only one club at the expiration of a lease.
The Company possesses an experienced management team, the top five
executives of which have been working together at the Company since 1990.
Management believes that it has the depth, experience and motivation to manage
the Company's internal and external growth, and that the Company has put in
place the infrastructure and systems to manage effectively the Company's planned
expansion for the next three years. Management believes that the presence of
such infrastructure will enable the Company over time to leverage certain fixed
cost aspects of overhead to realize increased EBITDA margins as the Company
continues to expand its club base. This operating leverage has already helped
the Company to more than double its EBITDA margin to approximately 19.3% in
fiscal 1998 compared to approximately 9.7% in fiscal 1997.
FORWARD-LOOKING STATEMENTS
The matters discussed or incorporated by reference in this Report on Form
10-K contain forward-looking statements, within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended. Actual results and events may
differ significantly from those discussed in such forward-looking statements. In
addition to other information discussed herein, factors that might cause or
contribute to such differences include the risks and uncertainties set forth
under the caption "Risk Factors" in the Prospectus relating to the Offering and
the Affiliate Stock Purchase, included in the Company's Registration Statement
on Form S-1 (File No. 333-61439).
THE LIFESTYLE ACQUISITION
On August 6, 1998, the Company acquired from Lifestyle Fitness of
Springfield, Inc. and its affiliates (collectively, "Lifestyle") substantially
all of the assets associated with Lifestyle's six fitness clubs located in New
Jersey in a series of related transactions (the "Lifestyle Acquisition"). In
addition, the Company assumed the obligations under a lease for a seventh club
to be constructed in the same market area. For
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the twelve months ended June 30, 1998, Lifestyle generated revenues of
approximately $7.9 million. The Company plans to operate these clubs under its
NYSC brand name.
THE OFFERING AND AFFILIATE STOCK PURCHASE
On August 13, 1998, the Company filed a Registration Statement on Form S-1
with the Securities and Exchange Commission covering shares of the Company's
common stock, par value $0.001 per share, (the "Common Stock") as part of an
initial public offering (the "Offering"). Concurrently with the consummation of
the Offering, certain affiliates (the "Purchasing Affiliates") of the Company
will purchase directly from the Company, shares of the Company's Common Stock,
at a price per share equal to the initial public offering price, less the
underwriting discount and commission.
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ITEM 2. PROPERTIES
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DATE OPENED OR
MANAGEMENT
LOCATION ADDRESS ASSUMED
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NEW YORK SPORTS CLUBS:
1. Manhattan 404 Fifth Avenue January, 1974
2. Manhattan 151 East 86th Street January, 1977
3. Manhattan 61 West 62nd Street July, 1983
4. Manhattan 614 Second Avenue July, 1986
5. Manhattan 30 Cliff Street January, 1990
6. Manhattan 380 Madison Avenue January, 1990
7. Manhattan 151 Reade Street January, 1990
8. Manhattan 1601 Broadway September, 1991
9. Manhattan 50 West 34th Street August, 1992
10. Manhattan 349 East 76th Street April, 1994
11. Manhattan 248 West 80th Street May, 1994
12. Manhattan 502 Park Avenue February, 1995
13. Manhattan 117 Seventh Avenue South March, 1995
14. Manhattan 303 Park Avenue South December, 1995
15. Manhattan 30 Wall Street May, 1996
16. Manhattan 1635 Third Avenue October, 1996
17. Manhattan 575 Lexington Avenue November, 1996
18. Manhattan 278 Eighth Avenue December, 1996
19. Manhattan 200 Madison Avenue February, 1997
20. Manhattan 131 East 31st Street February, 1997
21. Manhattan 2162 Broadway November, 1997
22. Manhattan 633 Third Avenue April, 1998
23. Manhattan 1657 Broadway July, 1998
24. Manhattan+ 217 Broadway Opening 1998
25. Manhattan* 300 West 125th Street Opening 2000
26. Brooklyn, NY 110 Boerum Place October, 1985
27. Brooklyn, NY 1736 Shore Parkway June, 1998
28. Forest Hills, NY 69-33 Austin Street April, 1997
29. Queens, NY 153-67 A Cross Island Parkway June, 1998
30. Staten Island, NY 300 West Service Road June, 1998
31. Great Neck, NY 15 Barstow Road July, 1989
32. Scarsdale, NY 696 White Plains Road October, 1995
33. Mamaroneck, NY 124 Palmer Avenue January, 1997
34. White Plains, NY 1 North Broadway September, 1997
35. Croton-on-Hudson, NY 420 South Riverside Drive January, 1998
36. Nanuet, NY 58 Demarest Mill Road May, 1998
37. Oceanside, NY* 2909 Lincoln Avenue Opening 1999
38. Stamford, CT 6 Landmark Square December, 1997
39. Stamford, CT 106 Commerce Road January, 1998
40. Danbury, CT 38 Mill Plain Road January, 1998
41. Stamford, CT+ 1063 Hope Street Opening 1998
42. Norwalk, CT* 250 Westport Avenue Opening 1999
43. East Brunswick, NJ 8 Cornwall Court January, 1990
44. Princeton, NJ 301 North Harrison Street May, 1997
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DATE OPENED OR
MANAGEMENT
LOCATION ADDRESS ASSUMED
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45. Freehold, NJ 200 Daniels Way April, 1998
46. Matawan, NJ 163 Route 34 April, 1998
47. Old Bridge, NJ Gaub Road and Route 516 April, 1998
48. Marlboro, NJ 34 Route 9 North April, 1998
49. Fort Lee, NJ 1355 15th Street June, 1998
50. Ramsey, NJ 1100 Route 17 North June, 1998
51. Mahwah, NJ 7 Leighton Place June, 1998
52. Parsippany, NJ 2651 Route 10 August, 1998
53. Springfield, NJ 215 Morris Avenue August, 1998
54. Colonia, NJ 1250 Route 27 August, 1998
55. Franklin Park, NJ 3911 Route 27 August, 1998
56. Plainsboro, NJ 10 Schalks Crossing August, 1998
57. Somerset, NJ 120 Cedar Grove Lane August, 1998
58. Hoboken, NJ+ 221 Washington Street Opening 1998
59. West Caldwell, NJ* Bloomfield Avenue Opening 1999
WASHINGTON SPORTS CLUBS:
60. Washington, DC 214 D Street, S.E. January, 1980
61. Washington, DC 1835 Connecticut Avenue, N.W. January, 1990
62. Washington, DC 1990 M Street, N.W. February, 1993
63. Washington, DC 2251 Wisconsin Avenue, N.W. May, 1994
64. Bethesda, MD 4903 Elm Street May, 1994
65. North Bethesda, MD 10400 Old Georgetown Road June, 1998
66. Germantown, MD 12623 Wisteria Drive July, 1998
67. Centreville, VA Old Centreville Crossing December, 1997
68. Alexandria, VA* 3654 King Street Opening 1999
BOSTON SPORTS CLUBS:
69. Boston, MA 561 Boylston Street November, 1991
70. Allston, MA 15 Gorham Street July, 1997
71. Weymouth, MA* 553 Washington Street Opening 1999
72. Boston, MA* 201 Brookline Avenue Opening 2000
PHILADELPHIA SPORTS CLUBS:
73. Philadelphia, PA+ 220 South 5th Street Opening 1998
74. Philadelphia, PA* 2000 Hamilton Street Opening 1999
SWISS SPORTS CLUBS:
75. Basel, Switzerland St. Johanns-Vorstadt 41 August, 1987
76. Zurich, Switzerland Glarnischstrasse 35 August, 1987
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+ Under construction, club in "pre-sales."
* Signed leases for greenfield club development.
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In addition to the club locations listed above, the Company owns the 151
East 86th Street location, which houses a Company club and a retail tenant that
generated approximately $500,000 of rental income for the Company during 1998.
All other clubs occupy leased space pursuant to long-term leases (generally 15
to 25 years, including options). In the next five fiscal years (ending
December31, 2004), only three of the Company's club leases will expire without
any renewal option.
The Company leases approximately 25,000 square feet of office space in New
York City, and 3,000 square feet of office space in Washington, DC, for
administrative, accounting and general corporate purposes. The Company also
leases warehouse and commercial space in Long Island City, New York, for storage
purposes and for the operation of a centralized laundry facility for certain New
York clubs.
As of May 31, 1998, 45 of the existing clubs were wholly-owned by the
Company and four were managed and/or partly-owned by the Company (the "Managed
Clubs"). The Managed Clubs are controlled by the Company, which acts as either
general partner or managing agent, and are operated by the Company in the same
manner as wholly owned clubs, subject to certain rights held by the Company's
partners or the club owners, according to the applicable partnership or
management agreements. As partner or manager, the Company receives a share of
club cash flow, which varies from club to club, but is typically 40.0%. These
amounts appear on the Company's income statements as management fees or as share
of net income in equity investments. However, the gross revenue generated by the
Managed Clubs (approximately $7.5 million per year) is not reflected in the
financial statements, because the Managed Clubs are not consolidated. The
Company acquired two Managed Clubs during fiscal 1995 and three Managed Clubs
during fiscal 1998 which were originally party to management agreements with the
Company. In the future, the Company may seek to acquire Managed Clubs, if such
opportunities arise.
ITEM 3. LEGAL PROCEEDINGS
A claim has been filed against the Company related to alleged copyright
infringement from the unauthorized use of photographs in advertisements. The
case was brought originally in federal court in June 1996 and was dismissed in
February 1998 because the plaintiffs had not registered copyrights to the
photographs. The claim was refiled in New York State Supreme Court on April 15,
1998. The Company has filed a motion to dismiss the state lawsuit which is
presently pending. The plaintiffs seek an unspecified amount of damages,
including the Company's profits attributable to the use of the photographs.
Based on the advice of outside counsel, management believes that it is unlikely
that the outcome of this matter will have a materially adverse effect on the
business, results of operations or financial condition of the Company.
Management is vigorously contesting this claim.
The Company is a party to various other lawsuits arising in the normal
course of business. Management believes that the ultimate outcome of these
matters will not have a material adverse effect on the Company's business,
results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Not applicable
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND CLUB OPERATING DATA)
Set forth below are selected historical consolidated financial and other
operating data of the Company as of the dates and for the periods presented. The
selected historical consolidated statement of operations data for the years
ended May 31, 1996, 1997 and 1998 and the selected historical consolidated
balance sheet data as of May 31, 1997 and 1998 were derived from the audited
Consolidated Financial Statements of the Company, which are included herein. The
selected historical consolidated statement of operations data for the years
ended May 31, 1994 and 1995 and the selected historical consolidated balance
sheet data as of May 31, 1994, 1995 and 1996 were derived from the audited
consolidated financial statements of the Company, which are not included
therein. The information contained in this table and accompanying notes should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
and accompanying notes thereto appearing elsewhere in this Report on Form 10-K.
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YEAR ENDED MAY 31,
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1994 1995 1996 1997 1998
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STATEMENT OF OPERATIONS DATA:
Revenues............................................................... $ 24,890 $ 33,349 $ 43,755 $ 56,567 $ 82,350
Operating expenses:
Payroll and related.................................................. 10,799 16,105 18,626 23,321 33,309
Club operating....................................................... 8,115 11,740 14,542 18,044 25,858
General and administrative........................................... 2,359 3,321 3,562 3,774 5,825
Depreciation and amortization........................................ 1,514 2,168 2,929 4,219 7,736
Compensation expense in connection with stock options(1)............. -- 635 1,967 5,933 1,442
--------- --------- --------- --------- ----------
Operating income (loss)............................................ 2,103 (620) 2,129 1,276 8,180
Interest expense, net.................................................. 342 654 952 2,455 5,902
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Income (loss) before provision for income tax (benefit)............ 1,761 (1,274) 1,177 (1,179) 2,278
Provision for income tax (benefit)..................................... 824 (541) 628 (243) 1,131
Extraordinary item..................................................... -- -- -- -- (782)(2)
Cumulative effect of change in accounting policy....................... -- -- -- -- (88)(3)
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Net income (loss).................................................. 937 (733) 549 (936) 277
Accreted dividends on preferred stock.................................. -- (258) (400) (1,286) (2,387)
Net Income (loss) attributable to common stockholders.............. $ 937 $ (991) $ 149 $ (2,222) $ (2,110)
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OTHER OPERATING DATA:
EBITDA(4).............................................................. $ 3,617 $ 1,548 $ 5,058 $ 5,495 $ 15,916
EBITDA margin(4)....................................................... 14.5% 4.6% 11.6% 9.7% 19.3%
Deferred lease expense................................................. $ 1,017 $ 1,232 $ 1,277 $ 1,620 $ 2,671
Cash provided by (used in):
Operating activities................................................. 2,839 3,283 5,695 12,302 15,733
Investing activities................................................. (5,648) (7,674) (5,487) (13,571) (36,040)
Financing activities................................................. $ 2,910 $ 4,244 $ 144 $ 2,809 $ 40,836
New clubs opened(5).................................................... 4 2 2 3 1
Clubs acquired(5)...................................................... -- -- 1 5 13
Wholly owned clubs operated at end of period(5)........................ 16 20 23 28 45
Total clubs operated at end of period(6)............................... 23 25 28 35 49
Members at end of period(7)............................................ 38,300 48,300 54,800 78,600 125,100
Comparable club revenue increase(8).................................... 10.9% 14.7% 27.3% 17.7% 26.2%
Revenue per weighted average club(9)................................... $ 1,809 $ 1,794 $ 2,017 $ 2,267 $ 2,287
</TABLE>
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AS OF MAY 31,
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1994 1995 1996 1997 1998
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BALANCE SHEET DATA:
Working capital........................................................ $ (1,219) $ (2,329) $ (4,048) $ (8,436) $ 5,898
Total assets........................................................... 18,421 27,274 34,805 52,923 111,977
Long-term debt, including current installments......................... 10,205 10,430 10,453 41,071 88,289
Stockholders' equity (accumulated deficit)............................. 2,343 1,987 5,474 (6,951) (5,107)
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(1) Represents non-cash charges related to the vesting of certain stock options
issued to management and the accretion of preferred dividends related to
preferred stock underlying certain of such options.
(2) Reflects the write-off of previously capitalized fees and expenses of
$782,000, net of taxes of $624,000, related to the repayment of certain
indebtedness. See Note 15 to the Company's Consolidated Financial
Statements.
(3) Prior to fiscal 1998, the Company capitalized direct costs incurred to
obtain leases for new clubs to be constructed by the Company. During the
quarter ended May 31, 1998, the Company adopted the provisions of Statement
of Position 98-5 REPORTING ON THE COSTS OF START-UP ACTIVITIES ("SOP 98-5")
which requires that these costs be expensed as incurred. In connection with
the adoption of SOP 98-5 the Company, effective June 1, 1997, recorded a
pre-tax charge of $88,000 net of $70,000 in taxes, as the cumulative effect
of this accounting change. See Note 2(m) to the Company's Consolidated
Financial Statements.
(4) EBITDA is defined as earnings before interest, taxes, depreciation,
amortization, extraordinary charges and cumulative effect of changes in
accounting policy. EBITDA is presented because management believes it
provides useful information regarding the operating performance and
financial condition of the Company. EBITDA should not be considered in
isolation or as a substitute for net income, cash flows, or other
consolidated income (loss) or cash flow data prepared in accordance with
GAAP or as a measure of the Company's profitability or liquidity. EBITDA
Margin is defined as EBITDA as a percentage of revenues.
(5) During fiscal 1995, the Company acquired two formerly managed clubs. During
fiscal 1997, the Company opened or acquired six clubs and closed one club
upon the expiration of its lease. During fiscal 1998, the Company opened or
acquired 14 clubs and acquired three formerly managed clubs.
(6) Includes all clubs whether wholly-owned or managed.
(7) Represents members at wholly-owned clubs only.
(8) The Company defines comparable clubs as those clubs operated by the Company
for at least 13 full months.
(9) Revenue per weighted average club is calculated as club revenue divided by
the product of the total numbers of clubs and their weighted average months
in operation as a percentage of the total year.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The Company is one of the two leading owners and operators of fitness clubs
in the Northeast and Mid-Atlantic regions of the United States. As of August 12,
1998, the Company operated 64 clubs that collectively served over 175,000
members. The Company develops clusters of clubs to serve densely populated major
metropolitan regions in which a high percentage of the population commutes to
work. The Company services such populations by clustering clubs near the highest
concentrations of its target customers' areas of both employment and residence.
The Company's target customer is college-educated, typically between the ages of
20 and 44 and earns an annual income in excess of $50,000.
The Company's goal is to develop the premier health club network in each of
the major metropolitan regions it enters. Management believes that clustering
clubs allows the Company to achieve strategic operating advantages that enhance
its ability to achieve this goal. In entering new regions, the Company develops
these clusters by initially opening or acquiring clubs located in the more
central urban markets of the region and then branching out from these urban
centers to suburbs and ancillary communities. Capitalizing on this clustering of
clubs, in fiscal 1998, approximately half of the Company's members participated
in a membership plan that allows unlimited access to all of the Company's clubs
for a higher membership fee.
The Company has executed this strategy successfully in the New York region
through the network of clubs it operates under its NYSC brand name. The Company
is the largest fitness club operator in Manhattan with 23 locations and operates
a total of 52 clubs under the NYSC name within a defined radius of New York
City. The Company is in the process of more fully developing clusters within a
smaller radius surrounding Washington, DC under its WSC brand name and has begun
establishing similar clusters surrounding Boston and Philadelphia under its BSC
and PSC brand names, respectively. The Company employs localized brand names for
its clubs to create an image and atmosphere consistent with the local community,
and to foster the recognition as a local network of quality fitness clubs rather
than a national chain.
The Company's operating and selling expenses are comprised of both fixed and
variable costs. The fixed costs include salary expense, rent, utilities,
janitorial expenses and depreciation. Variable costs are primarily related to
sales commissions, advertising and supplies. As clubs mature and increase their
membership base, fixed costs are typically spread over an increasing revenue
base and operating margins tend to improve.
During the last several years, the Company has increased revenues and EBITDA
by expanding its club base in the New York, Washington, DC, Boston and other
metropolitan areas along the Northeast Corridor. As a result of the Company's
expanding club base and relatively fixed nature of the Company's operating
costs, the Company's EBITDA has increased from $1.5 million in fiscal 1995 to
$15.9 million in fiscal 1998, and EBITDA as a percentage of revenues has
increased from 4.6% to 19.3% over the same period. During the same period, the
Company's net income increased from a net loss of $733,000 for fiscal 1995 to
net income of $277,000 for fiscal 1998. Management expects the strong growth in
revenues, EBITDA and net income to continue as the 25 clubs opened or acquired
since the beginning of fiscal 1996 continue to mature. Based on the Company's
historical experience, a new club tends to experience significant increase in
revenues during its first three years of operation as it reaches maturity.
Because there is relatively little incremental cost associated with such
increasing revenue, there is a greater proportionate increase in profitability.
In the aggregate, the 25 clubs opened or acquired since the beginning of fiscal
1996 generated revenue, EBITDA (before corporate overhead), and operating income
(before corporate overhead) of $30.3 million, $5.8 million and $1.7 million,
respectively. The Company believes that the revenues, EBITDA (before corporate
overhead) and operating income (before
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corporate overhead) of these 25 clubs will increase significantly as they
mature. As a result of the Company's accelerated expansion program, however,
management expects EBITDA and operating income margins to be negatively impacted
in the near term.
COMPARABLE CLUB REVENUE
The Company defines comparable clubs as those clubs that were operated by
the Company for at least 13 full months. The Company's comparable club revenue
increased 26.2%, 17.7% and 27.3% in fiscal 1998, 1997 and 1996, respectively.
NET LOSSES
The Company incurred a net loss of $936,000 in fiscal 1997 and $733,000 in
fiscal 1995 and expects to incur a net loss during the seven months ended
December 31, 1998. Losses have resulted from a variety of costs, including, but
not limited to, amortization of goodwill and debt financing costs resulting from
the Company's acquisition strategy as well as compensation expense incurred in
connection with the vesting of certain stock options held by management.
Increased goodwill, amortization, depreciation and financing costs associated
with future acquisitions and greenfield club openings will impact profitability
and may result in net losses in the future.
CHANGE OF FINANCIAL REPORTING PERIOD
The Company intends to change its fiscal year end in order to report on a
calendar year basis. As a result, the Company will report a short financial
period for the seven months ended December 31, 1998, and thereafter on a
calendar year basis beginning with fiscal 1999.
RECENT DEVELOPMENTS
On August 6, 1998, the Company acquired from Lifestyle for approximately
$10.6 million substantially all of the assets associated with Lifestyle's six
fitness clubs located in New Jersey in a series of related transactions. In
addition, the Company assumed the obligations under a lease for a seventh club
to be constructed in the same market area. For the twelve months ended June 30,
1998, Lifestyle generated revenues of approximately $7.9 million. The Company
plans to operate these clubs under its NYSC brand name.
11
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
revenue for the periods indicated:
<TABLE>
<CAPTION>
FISCAL
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Revenue............................................................ 100.0% 100.0% 100.0%
--------- --------- ---------
Operating Expenses:
Payroll and related.............................................. 42.6 41.2 40.4
Club operating................................................... 33.2 31.9 31.4
General and administrative....................................... 8.1 6.7 7.1
Depreciation and amortization.................................... 6.7 7.5 9.4
Compensation expense in connection with stock options............ 4.5 10.5 1.8
--------- --------- ---------
Operating income............................................... 4.9 2.2 9.9
Interest expense, net.............................................. 2.2 4.3 7.2
--------- --------- ---------
Income (loss) before provision for income tax (benefit).......... 2.7 (2.1) 2.7
Provision for income tax (benefit)................................. 1.4 (0.4) 1.4
Extraordinary item................................................. -- -- (0.9)
Cumulative effect of change in accounting policy................... -- -- (0.1)
--------- --------- ---------
Net income (loss).............................................. 1.3 (1.7) 0.3
Accreted dividend on preferred stock............................... 0.9 2.2 2.9
Net income (loss) attributable to common stockholders.......... 0.4% (3.9)% (2.6)%
--------- --------- ---------
--------- --------- ---------
</TABLE>
FISCAL 1998 COMPARED TO FISCAL 1997
REVENUES. Revenues increased approximately $25.8 million, or 45.6%, to
$82.4 million during fiscal 1998 from $56.6 million in fiscal 1997. This
increase resulted primarily from the maturation of three clubs opened or
acquired during fiscal 1996 (approximately $3.0 million, of which $2.7 million
was related to membership growth); the six clubs opened or acquired during
fiscal 1997 (approximately $8.1 million, of which $7.0 million was related to
membership growth and $1.1 million was related to increase in ancillary revenue)
and 14 clubs opened or acquired during fiscal 1998 (approximately $10.1 million,
of which $8.7 million was related to membership growth and $1.4 million was
related to increase in ancillary revenue). In addition, revenues increased
during fiscal 1998 by $4.2 million at the Company's mature clubs of which $3.5
million was due to membership growth and $0.7 million was due to increased
ancillary revenue such as sales of personal training.
OPERATING EXPENSES. Operating expenses increased $18.9 million, or 34.1%,
to $74.2 million in fiscal 1998 from $55.3 million in fiscal 1997. This increase
was primarily due to a 40.4% increase in total club months to 417 in fiscal 1997
from 297 in fiscal 1996, in addition to the following factors:
Payroll and related increased by $10.0 million, or 42.8%, to $33.3
million in fiscal 1998, from $23.3 million in fiscal 1997. This increase was
attributable to the acquisition or opening of 14 clubs in fiscal 1998 and a
full year of operating the six clubs opened or acquired in fiscal 1997.
Club operating increased by $7.9 million, or 43.3%, to $25.9 million in
fiscal 1998, from $18.0 million in fiscal 1997. This increase is
attributable to the acquisition or opening of 14 clubs in fiscal 1998 and
the additional expenses attributable to operating the six clubs opened or
acquired by the Company in fiscal 1997.
12
<PAGE>
General and administrative increased by $2.0 million, or 54.3%, to $5.8
million in fiscal 1998, from $3.8 million. This increase is attributable to
associated expenses as a result of the Company's expansion, such as the
expansion of the Company's corporate office, the change in accounting policy
to expense certain Organizational Costs in the period in which they are
incurred rather than capitalizing them.
Depreciation and amortization increased by $3.5 million, or 83.4%, to
$7.7 million in fiscal 1998, from $4.2 million in fiscal 1997. This increase
is attributable primarily to increased fixed assets and intangible assets
arising out of new club acquisitions and openings during fiscal 1998, and a
full year of depreciation and amortization for fixed asset additions,
acquisitions or openings during fiscal 1997. Intangible assets acquired in
fiscal 1997 and 1998 totaled $1.7 million and $14.5 million, respectively.
Compensation expense in connection with stock options decreased by $4.5
million, or 75.7%, to $1.4 million in fiscal 1998, from $5.9 million in
fiscal 1997. In 1997, this expense was attributable to the adjustment of the
Company's stock options to fair market value in connection with the
Recapitalization.
INTEREST EXPENSE, NET. Interest expense increased $3.4 million to $5.9
million during fiscal 1998 from $2.5 million in fiscal 1997. The increased level
of interest expense was primarily due to the issuance of the Senior Notes. (See
Note 6 to the Consolidated Financial Statements.)
PROVISION FOR INCOME TAX (BENEFIT). The income tax provision for fiscal
1998 was $1.1 million compared to a tax benefit of $243,000 for fiscal 1997. For
fiscal 1998, the Company's effective tax rate was negatively impacted by high
state and local tax rates combined with a tax rate change. In fiscal 1997, the
income tax benefit was reduced by adjustments to expected tax refunds reduced in
part by the reversal of a valuation allowance on state net operating losses
carryforward, which was no longer needed.
EXTRAORDINARY ITEM. During fiscal 1998, the Company issued 9 3/4% Senior
Notes due 2004 pursuant to which the Company repaid its existing indebtedness.
Accordingly, previously capitalized fees and expenses of $1.4 million relating
to the former debt were written off, $782,000 net of a tax effect of $624,000.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY. In accordance with the
American Institute of Certified Public Accountants ("AICPA") recently issued
Statement of Position 98-5 (Accounting for the Costs of Start-up Activities),
the Company has expensed all Organizational Costs capitalized in previous fiscal
years. Accordingly, $158,000 was written off, $88,000 net of a tax effect of
$70,000.
ACCRETED DIVIDENDS ON PREFERRED STOCK. Accreted dividends on the Preferred
Stock increased $1.1 million to $2.4 million during fiscal 1998, from $1.3
million in fiscal 1997. This increase is the result of the Preferred Stock being
outstanding for a full year in 1998 and for only five months in 1997.
FISCAL 1997 COMPARED TO FISCAL 1996
REVENUES. Revenues increased $12.8 million, or 29.3%, to $56.6 million
during fiscal 1997 from $43.8 million in fiscal 1996. This increase resulted
primarily from the maturation of four clubs opened or acquired during fiscal
1995 (approximately $2.8 million, of which $2.4 million was related to
membership growth and $380,000 was related to dues and ancillary revenue
increases), the three clubs opened or acquired in fiscal 1996 (approximately
$4.3 million, of which $3.7 million was related to membership growth and
$557,000 was related to dues and ancillary revenue increases), and the six clubs
opened or acquired in fiscal 1997 (approximately $3.7 million, of which $3.1
million was related to membership growth and $596,000 was related to dues and
ancillary revenue increases). In addition, revenues increased during fiscal 1997
due to revenue growth at the Company's mature clubs resulting from
13
<PAGE>
membership growth (approximately $2.1 million) as well as increased sales of
personal services such as private training (approximately $560,000).
OPERATING EXPENSES. Operating expenses increased $13.7 million, or 32.8%,
to $55.3 million in fiscal 1997, from $41.6 million in fiscal 1996. This
increase was primarily due to a 16.5% increase in total club months to 297 in
fiscal 1996 from 255 in fiscal 1995, in addition to the following factors:
Payroll and related increased by $4.7 million, or 25.2%, to $23.3
million in fiscal 1997, from $18.6 million in fiscal 1996. This increase was
attributable to the acquisition or opening of six clubs in fiscal 1997 and a
full year of operating the three clubs opened or acquired in fiscal 1996.
Club operating increased by $3.5 million, or 24.1%, to $18.0 million in
fiscal 1997, from $14.5 million in fiscal 1996. This increase is
attributable to the acquisition or opening of six clubs in fiscal 1997 and
the additional expenses attributable to operating three clubs opened or
acquired by the Company in fiscal 1996.
General and administrative increased by $212,000, or 6.0%, to $3.8
million in fiscal 1997, from $3.6 million in fiscal 1996.
Depreciation and amortization increased by $1.3 million, or 44.0%, to
$4.2 million in fiscal 1997, from $2.9 million in fiscal 1996. This increase
is attributable to the increased fixed assets placed in service and
intangible assets acquired arising out of acquisition or opening of new
clubs.
Compensation expense in connection with stock options increased by $3.9
million, or 201.6%, to $5.9 million in fiscal 1997, from $2.0 million in
fiscal 1996. In 1997, this expense was attributable to the adjustment of the
Company's stock options to fair market value in connection with the
Recapitalization.
INTEREST EXPENSE, NET. Interest expense, net, increased $1.5 million to
$2.5 million in fiscal 1997 from $1.0 million in fiscal 1996, primarily as a
result of increased indebtedness due to the Recapitalization during this period.
PROVISION FOR INCOME TAX (BENEFIT). Provision for income tax (benefit)
changed by $871,000 to a benefit of $243,000 in fiscal 1997 from an expense of
$628,000 in fiscal 1996, as a result of the loss after interest expense in
fiscal 1997. The Company's effective tax rate in fiscal 1996 was negatively
impacted by losses at certain of the Company's clubs, incurred in states where
the net operating loss could not be currently utilized. In fiscal 1997, the
income tax benefit was reduced by adjustments to expected tax refunds partially
offset by a reduction in the valuation allowance for the deferred tax assets.
ACCRETED DIVIDENDS ON PREFERRED STOCK. Accreted dividends on the Preferred
Stock increased $886,000 to $1.3 million during fiscal 1997, from $400,000 in
fiscal 1996. This increase reflects the issuance of the Preferred Stock in
connection with the Recapitalization and redemption of formerly existing
preferred stock.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has satisfied its liquidity needs through cash
flows from operations and various borrowing arrangements. Principal liquidity
needs have included the acquisition and development of new clubs, debt service
requirements and other capital expenditures necessary to maintain existing
clubs.
OPERATING ACTIVITIES. Net cash provided by operating activities for fiscal
1998 was $15.7 million compared to $12.3 million and $5.7 million during fiscal
1997 and 1996, respectively. These increases were primarily due to the
maturation of recently opened or acquired clubs, as well as improved performance
in the Company's mature clubs. Excluding cash and cash equivalents, the Company
normally operates with a working capital deficit because it receives revenue
either (i) during the month
14
<PAGE>
services are rendered, or (ii) when paid-in-full 12 months in advance. As a
result, the Company has no material accounts receivable. In addition, because
initiation fees are received at enrollment and are recognized over the estimated
average term of membership, the Company records a deferred revenue liability.
Management believes that the Company's working capital deficit is an important
source of cash flow from operating activities that it believes will continue to
grow as the Company's revenues increase.
INVESTING ACTIVITIES. The Company invested $36.0 million, $13.6 million and
$5.5 million in capital expenditures and asset acquisitions during fiscal 1998,
1997 and 1996, respectively, primarily as a result of the Company's expansion
efforts. The Company estimates that, through the end of fiscal 1999, it will
invest a total of approximately $95.0 million in capital expenditures and asset
acquisitions, which includes $8.0 million that management intends to invest to
maintain and expand certain existing clubs and $2.5 million to further upgrade
its management information systems.
FINANCING ACTIVITIES. In October 1997, the Company issued the Senior Notes
and entered into the Credit Facility. After payment of fees and expenses of $3.3
million, the Company received net proceeds of $81.7 million, of which $41.5
million was used for the repayment of certain indebtedness. The Senior Notes
contain certain restrictive covenants and restrict the payment of dividends. The
Credit Facility contains certain restrictive covenants, including a leverage
ratio, an interest coverage ratio and dividend payment restrictions and is
collateralized by all the assets of the Company. As of May 31, 1998, the Company
had approximately $13.0 million available under the Credit Facility, which
matures in October 2002 and has no scheduled amortization requirements. The
Credit Facility was recently amended to allow for maximum borrowings of $25.0
million. As of August 12, 1998, the Company had approximately $17.0 million
available under the Credit Facility. Although management believes that the
Company will be able to obtain or generate sufficient funds to finance the
Company's current operating and growth plans through the end of fiscal 1999, any
material acceleration or expansion of that plan through additional greenfields
or acquisitions (to the extent such acquisitions include cash payments) may
require the Company to pursue additional sources of financing prior to the end
of fiscal 1999. There can be no assurance that such financing will be available
or that it will be available on acceptable terms. The inability to finance such
further or accelerated expansion on acceptable terms may negatively impact the
Company's competitive position and or materially adversely affect the Company's
business, results of operations or financial condition.
EFFECT OF RECENT CHANGES IN ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement No.
130 ("SFAS No. 130"), REPORTING COMPREHENSIVE INCOME AND STATEMENT NO. 131
("SFAS NO. 131"), DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION. SFAS No. 130, which is effective for fiscal years beginning after
December 15, 1997, establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. SFAS No. 131 establishes
standards for the way in which public companies report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes the standards for
related disclosure about products and services, geographic areas and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. Based on current estimates, management does
not believe that the adoption of SFAS No. 131 will have a material effect on the
Company's financial statements.
In February 1998, the Financial Accounting Standards Board issued Statement
No. 132 ("SFAS No. 132"), EMPLOYER DISCLOSURES ABOUT PENSIONS AND OTHER POST
RETIREMENT BENEFITS. This statement modifies financial statement disclosures
related to pension and other post retirement plans. In June 1998, the Financial
Accounting Standards Board issued Statement No. 133 ("SFAS No. 133"), ACCOUNTING
FOR
15
<PAGE>
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which standardizes the accounting
for derivative instruments by requiring that all derivatives be recognized as
assets and liabilities and measured at fair value. SFAS No. 133 is effective for
fiscal years beginning after June 15, 1999.
Based on current estimates, management does not believe that the adoption of
SFAS No. 130, SFAS No. 131 and SFAS No. 132, or the future adoption of SFAS No.
133, will have a material effect on the Company's financial statements.
INFLATION
The Company believes that inflation has not had a material impact on its
results of operations for the three years ended May 31, 1998.
YEAR 2000 COMPLIANCE
The Company is assessing its information systems to determine the effect of
the Year 2000 issue. The Company expects to implement the systems and
programming changes necessary to address Year 2000 issues with respect to its
internal systems and does not believe that the cost of such actions will have a
material adverse effect on its business, financial condition or results of
operations or cash flows. Although the Company is not aware of any material
operational issues or costs associated with preparing its internal systems for
the Year 2000, there can be no assurance that there will not be a delay in, or
increased costs associated with, the implementation of necessary systems and
changes to address the Year 2000 issues, and the Company's inability to
implement such systems and changes in a timely manner could have a material
adverse effect on the Company's business, results of operations or financial
condition.
The Company also relies directly and indirectly, on external systems of
business enterprises such as third party suppliers, members, creditors and
financial organizations, and of governmental entities for accurate exchange of
data. Even if the internal systems of the Company are not materially affected by
the Year 2000 issue, the Company could be affected by disruptions in the
operation of the enterprises with which the Company interacts. Despite the
Company's efforts to address the Year 2000 impact on its internal systems and
business operations, there can be no assurance that such impact will not result
in a material disruption of its business or have a material adverse effect on
the Company's business, results of operations or financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Not applicable
16
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Registrant's financial statements are included in this report beginning
on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
17
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names, ages and a brief account of the
business experience of each person who is currently a director or executive
officer of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Mark Smith........................................... 39 Chief Executive Officer and Director
Robert Giardina...................................... 40 President and Chief Operating Officer
Alexander Alimanestianu.............................. 39 Executive Vice President, Development
Richard Pyle......................................... 39 Executive Vice President and Chief Financial Officer
Deborah Smith........................................ 39 Senior Vice President, Operations
Leslie Kimerling..................................... 36 Senior Vice President, Information Management and
Planning
Keith Alessi......................................... 43 Director
Paul Arnold.......................................... 52 Director
Bruce Bruckmann...................................... 44 Director
Stephen Edwards...................................... 35 Director
Jason Fish........................................... 40 Director
</TABLE>
MARK SMITH joined the Company in 1985 and was appointed Chief Executive
Officer in 1995. Prior to this appointment, he held the position of Executive
Vice President of Development and International Operations. Mr. Smith has also
served as a director of the Company since September 1995. Mr. Smith has had
primary responsibility for the development and/or acquisition of the Company's
clubs since 1990, as well as responsibility for the Company's Managed Clubs in
Switzerland. Before joining the Company, Mr. Smith was a chartered accountant
with Coopers & Lybrand in New York City, London and New Zealand, and a
professional squash player.
ROBERT GIARDINA has served as President and Chief Operating Officer of the
Company since 1992. Mr. Giardina joined the Company in 1981 (when the Company
had four clubs) after six years of employment with other fitness club companies.
With over 20 years of experience in the club industry, Mr. Giardina has
expertise in virtually every aspect of facility management and club operations.
In addition to operations, Mr. Giardina has primary responsibility for sales and
marketing.
ALEXANDER ALIMANESTIANU joined the Company in 1990, and became Executive
Vice President, Development in 1995. From 1990 to 1995, Mr. Alimanestianu served
as Vice President and Senior Vice President. Before joining the Company, he
worked as a corporate attorney for six years with one of the Company's outside
law firms. Mr. Alimanestianu has been involved in the development or acquisition
of over 40 of the Company's clubs.
RICHARD PYLE, a British chartered accountant, joined the Company in 1987 and
has been chiefly responsible for the Company's financial matters since that
time, as a Vice President in 1988, Senior Vice President and Chief Financial
Officer in 1992 and Executive Vice President in 1995, successively. Before
joining the Company, Mr. Pyle worked in public accounting (in the United States,
Bermuda, Spain and in England) specializing in the hospitality industry, and as
the corporate controller for a British public company in the leisure industry.
DEBORAH SMITH joined the Company in 1987, and served as Vice President
before her appointment as a Senior Vice President of Operations in 1995. Ms.
Smith has been responsible for the startup and operation of Company clubs in New
York, Switzerland, Maryland and Washington, DC. She oversees club operations in
all U.S. geographic areas.
18
<PAGE>
LESLIE KIMERLING joined the Company in 1994 and became Senior Vice President
in 1995 with responsibility for the development of the Company's information
management and planning capabilities. Prior to joining the Company, Ms.
Kimerling was a management consultant for four years.
KEITH ALESSI has served as a director of the Company since April, 1997. Mr.
Alessi is President, Chief Executive Officer and a director of Telespectrum
Worldwide, Inc., a position he has held since March 1998. From May 1996 to March
1998, Mr. Alessi served as Chairman, President and Chief Executive Officer of
Jackson Hewitt, Inc. Prior to that, Mr. Alessi held various positions with Farm
Fresh, Inc. including Chief Financial Officer and President. Mr. Alessi is also
a director of Cort Business Services, Inc. and Shoppers Food Warehouse Corp.
PAUL ARNOLD has served as a director of the Company since April, 1997. Mr.
Arnold has served as President and Chief Executive Officer of Cort Business
Services, Inc., a leading national supplier of high end rental furniture since
1992.
BRUCE BRUCKMANN has served as a director of the Company since December,
1996. Since 1994, Mr. Bruckmann has served as a principal of BRS. From 1983
until 1994, Mr. Bruckmann served as an officer and subsequently a Managing
Director of Citicorp Venture Capital, Ltd. ("CVC"). Mr. Bruckmann is currently a
director of Mediq Inc., Penhall International, Inc., Jitney Jungle Stores of
America, Inc., Mohawk Industries, Inc., AmeriSource Distribution Corporation,
Chromcraft Revington Corporation, Cort Business Services, Inc. and Anvil
Knitwear, Inc. and a director of several private companies.
STEPHEN EDWARDS has served as a director of the Company since December,
1996. Since 1994, Mr. Edwards has served as a principal of BRS. From 1993 until
1994, Mr. Edwards served as an officer of CVC. From 1988 through 1991, he was an
associate of CVC. Prior to joining CVC, Mr. Edwards worked with
Citicorp/Citibank in various corporate finance positions. Mr. Edwards is
currently a director of Anvil Knitwear, Inc. and a director of several private
companies.
JASON FISH has been a director of the Company since December, 1996. Mr. Fish
has been a Managing Member of Farallon Capital Management, L.L.C. ("FCM") and
Farallon Partners, L.L.C., the Farallon's two management entities, since April
1996. Mr. Fish was a General Partner of the Farallon investment partnerships and
a Managing Director of FCM's predecessor, Farallon Capital Management, Inc.,
from 1990 to 1996.
19
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following summarizes, for the fiscal year indicated, the principal
components of compensation for the Company's Chief Executive Officer and the
four highest compensated executive officers (collectively, the "named executive
officers"). The compensation set forth below fully reflects compensation for
work performed on behalf of the Company.
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------------------------------
OTHER ANNUAL LONG-TERM COMPENSATION
FISCAL SALARY BONUS(1) COMPENSATION AWARDS COMMON STOCK
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) UNDERLYING OPTIONS/ SARS (#)
- ------------------------------- --------- ----------- ----------- ----------------- -------------------------------
<S> <C> <C> <C> <C> <C>
Mark Smith, Chief Executive
Officer...................... 1998 360,500 330,000 -- --
1997 350,000 176,000 -- 8,830
Robert Giardina, President and
Chief Operating Officer...... 1998 341,906 250,000 -- --
1997 331,948 118,000 -- 8,829
Richard Pyle, Executive Vice
President and Chief Financial
Officer...................... 1998 187,399 187,500 -- --
1997 181,941 85,000 -- 8,828
Alexander Alimanestianu,
Executive Vice President,
Development.................. 1998 187,399 187,500 -- --
1997 178,711 85,000 -- 8,828
Deborah Smith, Senior Vice
President, Operations........ 1998 141,100 125,000 -- 400
1997 136,990 63,475 -- 5,350
</TABLE>
- ------------------------
(1) Includes annual bonus payments under the Company's Annual Bonus Plan.
OPTION/SAR GRANTS DURING FISCAL 1998
The following discloses options on the Company's Common Stock granted during
fiscal 1998 to the named executive officer.
<TABLE>
<CAPTION>
INDIVIDUAL GRANT POTENTIAL REALIZABLE VALUE
---------------------------------------------------------------- AT ASSUMED ANNUAL RATES
NUMBER OF OF STOCK PRICE
SECURITIES % OF TOTAL APPRECIATION FOR
UNDERLYING OPTIONS/SARS OPTION TERM
OPTIONS/ GRANTED TO ----------------------------
SAR'S EMPLOYEES IN 5% ANNUAL 10% ANNUAL
GRANTED FISCAL YEAR EXERCISE OR BASE EXPIRATION GROWTH RATE GROWTH RATE
NAME (#)(1) (%) PRICE ($) DATE ($) ($)
- -------------------------------- --------------- --------------- ----------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Deborah Smith................... 400 2.72 17.50 4-3-08 11,402 18,156
</TABLE>
- ------------------------
(1) All of such options were granted under the Company's option plan. The
options granted under the option plan are subject to accelerated vesting
over five years subject to certain performance targets and repurchase
provisions upon termination of employment.
20
<PAGE>
AGGREGATED OPTION/SAR EXERCISES DURING 1998 AND 1998 YEAR-END OPTION/SAR VALUES
The following summarizes exercises of stock options (granted in prior years)
by the named executive officers during fiscal 1998, as well as the number and
value of all unexercised options held by the named executive officers at the end
of fiscal 1998.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
OPTIONS/SARS AT FY-END
(#) VALUE OF UNEXERCISED IN-THE-
UNDERLYING UNEXERCISED MONEY OPTIONS/SARS AT
SHARES ------------------------- FY-END($)(1)
ACQUIRED
ON VALUE EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
EXERCISE (#) REALIZED ------------------------- -------------------------------
NAME COMMON ($) COMMON COMMON PREFERRED COMMON PREFERRED
- --------------------- --------------- ----------------- ------------- ---------- ---------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Mark Smith........... -- -- 3,532/5,298 42,812/0 58,278/87,417 1,070,289/0
Robert Giardina...... -- -- 3,532/5,297 32,793/0 58,278/87,400 819,829/0
Richard Pyle......... -- -- 3,532/5,296 27,569/0 58,278/87,384 689,225/0
Alexander
Alimanestianu...... -- -- 3,532/5,296 27,199/0 58,278/87,384 679,983/0
Deborah Smith........ -- -- 2,220/3,530 9,530/0 35,310/52,965 238,257/0
</TABLE>
- ------------------------
(1) Value realized is based upon the fair market value of the stock at the
exercise date minus the exercise price. Fair market value was determined in
good faith by the Board of Directors and was based upon the historical and
projected financial performance of the Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Compensation Committee are Bruce Bruckmann,
Stephen Edwards and Mark Smith. Messrs. Bruckmann and Edwards are non-employee
directors of the Company.
MANAGEMENT EQUITY AGREEMENTS
Simultaneously with the Recapitalization, the Company entered into Executive
Stock Agreements with certain of the officers and other key employees of the
Company. Pursuant to the Executive Stock Agreements, the executives each have
purchased shares of Common Stock and/or shares of Series B Preferred of the
Company at a purchase price of $1.00 per share of Common Stock and $35.00 per
share of Series B Preferred Stock.
EQUITY INCENTIVE PLAN
The Company intends to adopt the Long-Term Equity Incentive Plan (the
"Equity Incentive Plan"), designed to provide incentives to present and future
executive, managerial, marketing, technical and other key employees, and
consultants and advisors of the Company and its subsidiaries ("Participants") as
may be selected in the sole discretion of the Company's Board of Directors. The
Equity Incentive Plan will provide for the granting to participants of the
following types of incentive awards: stock options, stock appreciation rights
("SARs"), restricted stock, performance units, performance grants and other
types of awards that the Compensation Committee of the Board (the "Committee")
deems to be consistent with the purposes of the Equity Incentive Plan. An
aggregate amount of shares of Common Stock (which amount represents
approximately 5.0% of the Company's authorized Common Stock) are reserved for
issuance under the Equity Incentive Plan. The Equity Incentive Plan affords the
Company latitude in tailoring incentive compensation for the retention of key
personnel, to support corporate and business objectives, and to anticipate and
respond to a changing business environment and competitive compensation
practices.
The Committee will have exclusive discretion to select the Participants and
to determine the type, size and terms of each award, to modify the terms of
awards, to determine when awards will be granted and paid, and to make all other
determinations which it deems necessary or desirable in the interpretation and
administration of the Equity Incentive Plan. The Equity Incentive Plan will
terminate ten years from the date that is approved and adopted by the
stockholders of the Company, unless extended for up
21
<PAGE>
to an additional five years by action of the Board of Directors. With limited
exceptions, including termination of employment as a result of death, disability
or retirement, or except as otherwise determined by the Committee, rights to
these forms of contingent compensation will be forfeited if a recipient's
employment or performance of services terminates within a specified period
following the award. Generally, a Participant's rights and interest under the
Equity Incentive Plan will not be transferable except by will or by the laws of
descent and distribution or pursuant to a qualified domestic relations order.
Options, which include nonqualified stock options and incentive stock
options, are rights to purchase a specified number of shares of Common Stock at
a price fixed by the Committee. The option price may be less than, equal to or
greater than the fair market value of the underlying shares of Common Stock, but
in no event shall the exercise price of an incentive stock option be less than
the fair market value on the date of grant. Options generally will expire no
later than ten years after the date on which they are granted. Options will
become exercisable at such times and in such installments as the Committee shall
determine. Payment of the option price must be made in full at the time of
exercise in such form (including, but not limited to, cash or Common Stock of
the Company) as the Committee may determine.
The Equity Incentive Plan will provide that an SAR may be granted alone, or
in connection with the grant of an option, either at the time of grant of the
related option or by amendment thereafter to an outstanding option. SARs granted
in connection with options shall be exercisable only when, to the extent and on
the condition that, any related option is exercisable. The exercise of an option
shall result in an immediate forfeiture of any related SAR to the extent the
option is exercised, and the exercise of an SAR shall cause an immediate
forfeiture of any related option to the extent the SAR is exercised.
Upon the exercise of an SAR, the Participant shall be entitled to a
distribution in an amount equal to the difference between the fair market value
of a share of Common Stock on the date of exercise and the exercise price of the
SAR or, in the case of SARs granted in tandem with options, any option to which
the SAR is related, multiplied by the number of shares of Common Stock as to
which the SAR is exercised. The Committee shall decide whether such distribution
shall be in cash, in shares of Common Stock having a fair market value equal to
such amount, in other securities having a fair market value equal to such amount
or in a combination thereof.
A restricted stock award will be an award of a given number of shares of
Common Stock which are subject to a restriction against transfer and to a risk
of forfeiture, during a period set by the Committee. During the restriction
period, the Participant generally will have the right to vote and receive
dividends on the shares. Dividends received while under restriction will be
treated as compensation.
The Equity Incentive Plan will provide that performance awards are those
whose final value, if any, is determined by the degree to which specified
performance objectives have been achieved during an award period set by the
Committee, subject to such adjustments as the Committee may approve based on
relevant factors. Performance objectives will be based on measures of Company,
unit or Participant performance, or any combination of these and other factors,
as the Committee may determine. The Committee will make such adjustments in the
computation of any performance measure as it deems appropriate. The Committee
shall determine the portion of each performance award that has been earned by a
participant on the basis of the Company's performance over the performance cycle
in relation to the performance goals for such cycle. The earned portion of a
performance award may be paid out in shares of Common Stock, cash, other
securities of the Company, or any combination thereof, as the Committee may
determine.
The Equity Incentive Plan will also provide that, upon the liquidation or
dissolution of the Company, all outstanding awards under the Equity Incentive
Plan shall terminate immediately prior to the consummation of such liquidation
or dissolution, unless otherwise provided by the Committee. In the event of a
reorganization, recapitalization, stock split, stock dividend, combination of
shares, merger, consolidation, distribution of assets, or any other change in
the corporate structure or shares of the Company, the Committee shall make such
adjustment as it deems appropriate in the number and kind of shares or
22
<PAGE>
other property reserved for issuance under the Equity Incentive Plan, in the
number and kind of shares or other property covered by grants previously made
under the Equity Incentive Plan, and in the exercise price of outstanding
options and SARs. In the event of any merger, consolidation or other
reorganization in which the Company is not the surviving or continuing entity or
in which a change in control is to occur, all of the Company's obligations
regarding options, SARs performance awards, and restricted stock that were
granted hereunder and that are outstanding on the date of such event shall, on
such terms as may be approved by the Committee prior to such event, be assumed
by the surviving or continuing entity or canceled in exchange for property
(including cash).
COMPANY BENEFIT PLANS
In April 1996, the Company implemented a 401(k) salary deferral plan (the
"401(k) Plan") which is available to eligible employees, as defined. The 401(k)
Plan provides for the Company to make discretionary contributions. The Company,
however, elected not to make contributions for either fiscal 1998, 1997 or 1996.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth (as of May 31, 1998) certain information with
respect to the beneficial ownership of the Common Stock and Preferred Stock by:
(i) each person or entity who owns of record or beneficially more than 5% or
more of any class of the Company's voting securities; (ii) each named executive
officer and director of the Company; and (iii) all directors and named executive
officers of the Company as a group.
<TABLE>
<CAPTION>
PERCENTAGE
COMMON STOCK OF COMMON SERIES A
NAME BENEFICIALLY OWNED(1) STOCK OUTSTANDING(1) PREFERRED STOCK
- ----------------------------------------------------- ---------------------- ----------------------- ----------------
<S> <C> <C> <C>
BRS (2)
126 East 56th Street, 29th Floor
New York, New York 10022........................... 504,456 49.7% 104,330
The Farallon Entities (3)
One Maritime Plaza, Suite 1325
San Francisco, California 94111.................... 198,461 19.5% 41,045
Canterbury Mezzanine Capital, L.P. (4)
600 Fifth Avenue, 23rd Floor
New York, New York 10020........................... 124,022 11.0% --
EXECUTIVE OFFICERS AND DIRECTORS:
Mark Smith (5)....................................... 74,955 7.3% --
Robert Giardina (5).................................. 59,480 5.8% --
Richard Pyle (5)..................................... 50,839 5.0% --
Alexander Alimanestianu (5).......................... 51,410 5.0% --
Deborah Smith (5).................................... 21,338 2.1% --
Bruce C. Bruckmann (6)............................... 517,642 51.0% 106,973
Stephen Edwards (7).................................. 504,456 49.7% 104,330
Jason Fish (8)....................................... 198,461 19.5% 41,045
Paul Arnold.......................................... * * 591
Keith Alessi......................................... * * 591
EXECUTIVE OFFICERS AND DIRECTORS AS A GROUP:
(10 persons)(9)...................................... 974,125 92.7% 153,637
<CAPTION>
SERIES B
NAME PREFERRED STOCK
- ----------------------------------------------------- ----------------
<S> <C>
BRS (2)
126 East 56th Street, 29th Floor
New York, New York 10022........................... --
The Farallon Entities (3)
One Maritime Plaza, Suite 1325
San Francisco, California 94111.................... --
Canterbury Mezzanine Capital, L.P. (4)
600 Fifth Avenue, 23rd Floor
New York, New York 10020........................... --
EXECUTIVE OFFICERS AND DIRECTORS:
Mark Smith (5)....................................... 42,812
Robert Giardina (5).................................. 32,793
Richard Pyle (5)..................................... 27,569
Alexander Alimanestianu (5).......................... 27,199
Deborah Smith (5).................................... 10,080
Bruce C. Bruckmann (6)............................... --
Stephen Edwards (7).................................. --
Jason Fish (8)....................................... --
Paul Arnold.......................................... --
Keith Alessi......................................... --
EXECUTIVE OFFICERS AND DIRECTORS AS A GROUP:
(10 persons)(9)...................................... 140,453
</TABLE>
- ------------------------
* Represents less than 1%.
23
<PAGE>
(1) Beneficial ownership is determined in accordance with Rule 13d-3 under the
Exchange Act. In computing the number of shares beneficially owned by a
person and the percentage ownership of that person, shares of Common Stock
subject to options held by that person that are currently exercisable or
exercisable within 60 days of August 12, 1998 are deemed outstanding. Such
shares, however, are not deemed outstanding for the purposes of computing
the percentage ownership of any other person.
(2) Excludes shares held individually by Mr. Bruckmann and other individuals
(and affiliates and family members thereof), each of whom are employed by
BRS.
(3) Includes shares held by each of Farallon Capital Partners, L.P., Farallon
Capital Institutional Partners, L.P., Farallon Capital Institutional
Partners II, L.P. and R.R. Capital Partners, L.P. (the "Farallon Entities").
Farallon Partners, L.L.C. is the general partner of each of the Farallon
Entities. Farallon Partners, L.L.C. disclaims beneficial ownership of such
shares.
(4) Includes a warrant to purchase 114,022 shares of Common Stock with an
exercise price of $.01 per share and an expiration date of December 10,
2006. See "Description of Capital Stock--Warrant."
(5) Includes options to acquire, exercisable within 60 days, Common Stock, and
Series B Preferred Stock options, exercisable within 60 days, pursuant to
the Old Option Plan and the Preferred Option Plan, respectively. Messrs.
Smith, Giardina, Pyle, Alimanestianu and Ms. Smith each hold such options on
8,830, 8,829, 8,828, 8,828 and 5,430 shares of Common Stock, respectively.
All shares of Series B Preferred Stock beneficially owned by such persons
are in the form of Series B Options, except with respect to Ms. Smith only,
9,530 shares are in the form of Series B Options. The address for each of
these named executive officers is the same as the address of the Company's
principal executive offices.
(6) Includes 504,456 shares held by BRS, and approximately 2,971 shares held by
certain other family members of Mr. Bruckmann. Mr. Bruckmann disclaims
beneficial ownership of such shares held by BRS.
(7) Includes shares held by BRS. Mr. Edwards disclaims beneficial ownership of
such shares.
(8) Includes shares held by each of the Farallon Entities. Mr. Fish is a
managing member of Farallon Partners, L.L.C., which is the general partner
of each of the Farallon Entities. Mr. Fish disclaims beneficial ownership of
such shares.
(9) Includes (i) shares held by BRS, which may be deemed to be owned
beneficially by Messrs. Bruckmann and Edwards, and (ii) shares held by the
Farallon Entities, which may be deemed to be owned beneficially by Mr. Fish.
Excludes the shares beneficially owned by BRS and the Farallon Entities, the
directors and named executive offices as a group beneficially own (i)
276,922 shares of Common Stock (which represents approximately 26.2% of the
Common Stock on a fully diluted basis), (ii) 3,909 shares of Series A
Preferred Stock, and (iii) 140,453 shares of Series B Preferred Stock.
24
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
THE RECAPITALIZATION
In December 1996, the Company consummated the Recapitalization pursuant to
which, among other things: (i) all shares of the Company's preferred stock
outstanding prior to the Recapitalization were redeemed or converted into shares
of the Company's then authorized common stock ("Old Common Stock"); (ii) all
shares of Old Common Stock (other than shares held by certain members of the
Company's management team) were exchanged for cash; and (iii) BRS and the
Farallon Entities acquired shares of the Company's Common Stock and Series A
Preferred Stock, representing approximately 73.0% of the Company's voting equity
interests on a fully-diluted basis. In addition, certain members of the
Company's management acquired shares of the Company's Common Stock and Series B
Preferred Stock representing approximately 27.0% of the Company's voting equity
interests on a fully-diluted basis. In addition, pursuant to the
Recapitalization, the Company instituted the Old Option Plan and the Preferred
Option Plan, which granted certain members of the Company's management, options
to acquire the Company's Common Stock and Series B Options, respectively.
REGISTRATION RIGHTS AGREEMENT
In connection with the Recapitalization, the Company, BRS, the Farallon
Entities, Canterbury Mezzanine Capital, L.P. ("CMC"), certain members of
management and other shareholders of the Company entered into a Registration
Rights Agreement, dated December 10, 1996 (as amended, the "Registration Rights
Agreement"). Pursuant to the terms of the Registration Rights Agreement, BRS,
the Farallon Entities and CMC have the right to require the Company, at the
expense of the Company and subject to certain limitations, to register under the
Securities Act all or part of the shares of Common Stock (the "Registrable
Securities") held by them. BRS is entitled to demand up to three long-form
registrations at any time and unlimited short-form registrations. Farallon is
entitled to demand one long-form registration (but only one year after the
Company has consummated an initial registered public offering of its Common
Stock) and up to three short-form registrations. CMC is entitled to demand up to
two short-form registrations.
All holders of Registrable Securities are entitled to an unlimited number of
"piggyback" registrations, with the Company paying all expenses of the Offering,
whenever the Company proposes to register its Common Stock under the Securities
Act. Each such holder is subject to certain pro rata limitations on its ability
to participate in such a "piggyback" registration. In addition, pursuant to the
Registration Rights Agreement, the Company has agreed to indemnify all holders
of Registrable Securities against certain liabilities, including certain
liabilities under the Securities Act.
PROFESSIONAL SERVICES AGREEMENT AND TRANSACTION FEES
In connection with the Recapitalization, Bruckmann, Rosser, Sherrill & Co.,
Inc. ("BRS Co."), an affiliate of BRS, and the Company entered into a
Professional Services Agreement, whereby BRS Co. agreed to provide certain
advisory and consulting services to the Company. In exchange for such services,
BRS Co. receives an annual fee of $250,000 per calendar year while they own at
least 20.0% of the outstanding Common Stock of the Company. The Company also
paid BRS Co. and the Farallon Entities transaction fees of $584,000 and
$216,000, respectively for investment banking advisory services rendered to the
Company in connection with the Recapitalization.
25
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Document List
1. Financial Statements
The following consolidated financial statements of the Company are included
in Item 8:
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of independent accountants.......................................................................... F-2
Consolidated balance sheets at May 31, 1997 and 1998....................................................... F-3
Consolidated statements of operations for the years ended May 31, 1996, 1997 and 1998...................... F-4
Consolidated statements of stockholders' equity (deficit) for the years ended May 31, 1996, 1997 and
1998..................................................................................................... F-5
Consolidated statements of cash flows for the years ended May 31, 1996, 1997 and 1998...................... F-6
Notes to consolidated financial statements................................................................. F-7
2. Financial Statement Schedule includes:
Report of Independent Public Accountants................................................................... F-25
Schedule II, Valuation and Qualifying Accounts............................................................. F-26
</TABLE>
(b) Reports on Form 8-K
The Company filed reports on Form 8-K on April 15, 1998 and on August 12,
1998.
(c) Exhibits:
<TABLE>
<C> <S>
2.1 Agreement and Plan of Merger dated as of November 8, 1996 by and among the Company,
various Sellers and Option Holders and TSI Recapitalization Sub, Inc.+
2.2 Amendment to Agreement and Plan of Merger dated as of December 10, 1996 among TSI
Merger Sub, Inc., the Company and certain stockholders and option holders of the
Company.+
3.1 Amended and Restated Certificate of Incorporation of the Company.+
3.2 By-Laws of the Company.+
4.1 Indenture dated as of October 16, 1997 between the Company and United States Trust
Company of New York.+
4.2 Purchase Agreement dated as of October 9, 1997 among the Company and BT Alex. Brown
Incorporated.+
4.3 Registration Rights Agreement dated as of October 16, 1997 among the Company, and
BT Alex. Brown Incorporated.+
4.4 Registration Rights Agreement dated as of December 10, 1996 by and among the
Company, BRS and various investors, the Farallon Entities, CMC, and certain Town
Sports stockholders.+
10.1 Amended and Restated Credit Agreement among the Company, Various Lending
Institutions and Bankers Trust Company, as Administrative Agent dated as of October
16, 1997.+
10.2 First Amendment to the Amended and Restated Credit Agreement among the Company,
various Lending Institutions and Bankers Trust Company, as Administrative Agent
dated as of August 6, 1998.*
10.5 Shareholders Agreement dated as of December 10, 1996 by and among the Company, BRS,
the Farallon Entities, CMC and certain other stockholders of the Company.+
</TABLE>
26
<PAGE>
<TABLE>
<C> <S>
21.1 Subsidiaries of the Company*
27.1 Financial Data Schedule.*
</TABLE>
- ------------------------
+ Incorporated by reference to the Registrant's Registration Statement on Form
S-4, File No. 333-40907.
* Incorporated by reference to the Registrant's Registration Statement on Form
S-1, File No. 333-61439.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on August 17, 1998.
<TABLE>
<S> <C> <C>
TOWN SPORTS INTERNATIONAL, INC.
By: /s/ MARK SMITH
-----------------------------------------
Mark Smith
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
By: /s/ MARK SMITH
-----------------------------------------
Mark Smith
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
By: /s/ RICHARD PYLE
-----------------------------------------
Richard Pyle
EXECUTIVE VICE PRESIDENT AND CHIEF
FINANCIAL OFFICER (PRINCIPAL FINANCIAL
AND ACCOUNTING OFFICER)
By: /s/ KEITH ALESSI
-----------------------------------------
Keith Alessi
DIRECTOR
By: /s/ PAUL ARNOLD
-----------------------------------------
Paul Arnold
DIRECTOR
By: /s/ BRUCE BRUCKMANN
-----------------------------------------
Bruce Bruckmann
DIRECTOR
</TABLE>
28
<PAGE>
<TABLE>
<S> <C> <C>
By: /s/ STEPHEN EDWARDS
-----------------------------------------
Stephen Edwards
DIRECTOR
By: /s/ JASON FISH
-----------------------------------------
Jason Fish
DIRECTOR
</TABLE>
29
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
New York, New York
July 9, 1998, except for the last
paragraph of
Note 6 and Note 16, as to which the
date is August 6, 1998
To the Board of Directors and Shareholders
of Town Sports International, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of TOWN
SPORTS INTERNATIONAL, INC. and SUBSIDIARIES (the "Company") as of May 31, 1998
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended May 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2(m) to the consolidated financial statements, the
Company changed its method of accounting for organizational costs effective June
1, 1997.
PRICEWATERHOUSECOOPERS LLP
F-1
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MAY 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
--------- -----------
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents.............................................................. $ 2,468 $ 22,997
Accounts receivable.................................................................... 312 420
Inventory.............................................................................. 327 673
Prepaid expenses and other current assets.............................................. 493 677
Prepaid corporate income taxes......................................................... 202
--------- -----------
Total current assets................................................................. 3,802 24,767
Fixed assets, net........................................................................ 34,214 54,518
Intangible assets, net................................................................... 4,425 19,923
Deferred tax asset....................................................................... 5,972 7,159
Deferred membership costs................................................................ 3,530 4,933
Other assets............................................................................. 980 677
--------- -----------
Total assets......................................................................... $ 52,923 $ 111,977
--------- -----------
--------- -----------
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Current liabilities:
Current portion of long-term debt and capital lease obligations........................ $ 1,924 $ 2,036
Accounts payable....................................................................... 1,802 2,451
Accrued expenses....................................................................... 4,017 7,869
Corporate income taxes payable......................................................... 122
Deferred revenue....................................................................... 4,599 6,391
--------- -----------
Total current liabilities............................................................ 12,342 18,869
Long-term debt and capital lease obligations............................................. 39,147 86,253
Deferred lease liabilities............................................................... 6,625 9,298
Deferred revenue......................................................................... 1,036 1,890
Other liabilities........................................................................ 724 774
--------- -----------
Total liabilities.................................................................... 59,874 117,084
--------- -----------
Commitments and contingencies (Notes 6, 7, 8, and 13)
Stockholders' deficit :
Series A preferred stock, $1.00 par value; at liquidation value; authorized 200,000
shares; issued and outstanding 152,455 shares at May 31, 1997 and 153,637 shares at
May 31, 1998......................................................................... 16,250 18,736
Series B preferred stock, $1.00 par value; at liquidation value; authorized 200,000
shares; issued and outstanding 3,857 shares at May 31, 1997 and 1998................. 144 164
Class A voting common stock, $.001 par value; authorized 1,150,000 shares; issued and
outstanding 1,010,000 shares at May 31, 1997 and 1,015,714 shares at May 31, 1998.... 1 1
Paid-in capital.......................................................................... 3,994
Unearned compensation.................................................................... (2,546)
Accumulated deficit...................................................................... (23,346) (25,456)
--------- -----------
Total stockholders' deficit.......................................................... (6,951) (5,107)
--------- -----------
Total liabilities and stockholders' deficit.......................................... $ 52,923 $ 111,977
--------- -----------
--------- -----------
</TABLE>
See notes to consolidated financial statements.
F-2
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE YEARS ENDED MAY 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Revenues:
Club operations................................................................... $ 40,796 $ 54,164 $ 79,719
Management fees and other......................................................... 2,959 2,403 2,631
--------- --------- ---------
43,755 56,567 82,350
--------- --------- ---------
Operating expenses:
Payroll and related............................................................... 18,626 23,321 33,309
Club operating.................................................................... 14,542 18,044 25,858
General and administrative........................................................ 3,562 3,774 5,825
Depreciation and amortization..................................................... 2,929 4,219 7,736
Compensation expense in connection with stock options............................. 1,967 5,933 1,442
--------- --------- ---------
41,626 55,291 74,170
--------- --------- ---------
Operating income.............................................................. 2,129 1,276 8,180
Interest expense, net of interest income of $60, $115 and and $1,228,
respectively...................................................................... 952 2,455 5,902
--------- --------- ---------
Income (loss) before provision (benefit) for corporate income taxes........... 1,177 (1,179) 2,278
Provision (benefit) for corporate income taxes...................................... 628 (243) 1,131
--------- --------- ---------
Income (loss) before extraordinary item and cumulative effect of change in
accounting policy............................................................ 549 (936) 1,147
Extraordinary loss from early extinguishment of debt, net of income tax benefit of
$624.............................................................................. (782)
--------- --------- ---------
Income (loss) before cumulative effect of change in accounting policy......... 549 (936) 365
Cumulative effect on prior years of a change in accounting for club organizational
costs, net of income tax benefit of $70........................................... (88)
--------- --------- ---------
Net income (loss)............................................................. 549 (936) 277
Accreted dividends on preferred stock............................................... (400) (1,286) (2,387)
--------- --------- ---------
Net income (loss) attributable to common stockholders......................... $ 149 $ (2,222) $ (2,110)
--------- --------- ---------
--------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
TOWN SPORTS INTERNATIONAL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE DATA)
FOR THE YEARS ENDED MAY 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
PREFERRED STOCK
----------------------------------------------------------------------
SERIES A ($1.00 PAR) SERIES A ($.10 PAR) SERIES B ($1.00 PAR)
-------------------- ---------------------- ------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- ----------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at May 31, 1995............................... 496
Issuance of Class A Common Stock......................
Issuance of Class A and B Common Stock................
Accretion of Series B redeemable convertible preferred
stock dividends ($1.22 per share)...................
Compensation expense in connection with stock
options.............................................
Net Income............................................
----- ---------
Balance at May 31, 1996........................... 496
Liquidation of Series A Preferred Stock, for $1,000
per share, redemption Class A and B Common Stock for
a cash price of $35 per share and change in equity
related to exercise of stock options................ (496)
Issuance of Series A and B Preferred and Common Stock
at cash price of $100, $35 and $1, respectively..... 152,455 $ 15,245 3,857 $ 135
Warrant exercise at $.01 per share....................
Original issue discount in connection with the
issuance of warrants and subordinated debt..........
Compensation expense in connection with common stock
options.............................................
Compensation expense in connection with Series B
Preferred Stock options.............................
Accretion of Series A and Series B preferred stock
dividend ($6.59 and $2.32 per share,
respectively.)...................................... 1,005 9
Net loss..............................................
--------- --------- ----- --------- ----- -----
Balance at May 31, 1997........................... 152,455 16,250 -- -- 3,857 144
----- ---------
----- ---------
Issuance of Series A Preferred Stock and Class A
Common Stock........................................ 1,182 119
Unearned Compensation in connection with common stock
options.............................................
Amortization of unearned compensation.................
Compensation expense in connection with Series B
Preferred stock options.............................
Accretion of Series A and Series B preferred stock
dividend ($15.14 and $5.44 per share,
respectively)....................................... 2,367 20
Net income............................................
--------- --------- ----- -----
Balance at May 31, 1998........................... 153,637 $ 18,736 3,857 $ 164
--------- --------- ----- -----
--------- --------- ----- -----
<CAPTION>
COMMON STOCK
---------------------------------------------------------------------------
CLASS A ($.001 PAR) CLASS A ($.01 PAR) CLASS B CONVERTIBLE
-------------------------- ------------------------- --------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ------------- ---------- ------------- --------- ---------
<S> <C> <C> <C> <C>
Balance at May 31, 1995............................... 475,000 $ 5
Issuance of Class A Common Stock...................... 87,948 1
Issuance of Class A and B Common Stock................ 13,358 2,351
Accretion of Series B redeemable convertible preferred
stock dividends ($1.22 per share)...................
Compensation expense in connection with stock
options.............................................
Net Income............................................
--
---------- --------- ---------
Balance at May 31, 1996........................... 576,306 6 2,351
Liquidation of Series A Preferred Stock, for $1,000
per share, redemption Class A and B Common Stock for
a cash price of $35 per share and change in equity
related to exercise of stock options................ (576,306) (6) (2,351)
Issuance of Series A and B Preferred and Common Stock
at cash price of $100, $35 and $1, respectively..... 1,000,000 $ 1
Warrant exercise at $.01 per share.................... 10,000
Original issue discount in connection with the
issuance of warrants and subordinated debt..........
Compensation expense in connection with common stock
options.............................................
Compensation expense in connection with Series B
Preferred Stock options.............................
Accretion of Series A and Series B preferred stock
dividend ($6.59 and $2.32 per share,
respectively.)......................................
Net loss..............................................
-- --
----------- ---------- --------- ---------
Balance at May 31, 1997........................... 1,010,000 1 -- -- -- --
--
--
---------- --------- ---------
---------- --------- ---------
Issuance of Series A Preferred Stock and Class A
Common Stock........................................ 5,714 0
Unearned Compensation in connection with common stock
options.............................................
Amortization of unearned compensation.................
Compensation expense in connection with Series B
Preferred stock options.............................
Accretion of Series A and Series B preferred stock
dividend ($15.14 and $5.44 per share,
respectively).......................................
Net income............................................
--
-----------
Balance at May 31, 1998........................... 1,015,714 $ 1
--
--
-----------
-----------
<CAPTION>
(ACCUMULATED TOTAL
DEFICIT) STOCKHOLDERS'
PAID-IN UNEARNED RETAINED EQUITY
CAPITAL COMPENSATION EARNINGS (DEFICIT)
---------- -------------- -------------- ---------------
Balance at May 31, 1995............................... $ 1,788 $ 193 $ 1,986
Issuance of Class A Common Stock...................... 1,371 1,372
Issuance of Class A and B Common Stock................ 144 144
Accretion of Series B redeemable convertible preferred
stock dividends ($1.22 per share)................... (400) (400)
Compensation expense in connection with stock
options............................................. 1,823 1,823
Net Income............................................ 549 549
---------- -------------- -------
Balance at May 31, 1996........................... 5,126 342 5,474
Liquidation of Series A Preferred Stock, for $1,000
per share, redemption Class A and B Common Stock for
a cash price of $35 per share and change in equity
related to exercise of stock options................ (11,228) (21,466) (32,700)
Issuance of Series A and B Preferred and Common Stock
at cash price of $100, $35 and $1, respectively..... (226) 15,155
Warrant exercise at $.01 per share....................
Original issue discount in connection with the
issuance of warrants and subordinated debt.......... 123 123
Compensation expense in connection with common stock
options............................................. 5,660 5,660
Compensation expense in connection with Series B
Preferred Stock options............................. 273 273
Accretion of Series A and Series B preferred stock
dividend ($6.59 and $2.32 per share,
respectively.)...................................... 272 (1,286)
Net loss.............................................. (936) (936)
---------- -------------- -------
Balance at May 31, 1997........................... (23,346) (6,951)
Issuance of Series A Preferred Stock and Class A
Common Stock........................................ 6 125
Unearned Compensation in connection with common stock
options............................................. 3,352 (3,352)
Amortization of unearned compensation................. 806 806
Compensation expense in connection with Series B
Preferred stock options............................. 636 636
Accretion of Series A and Series B preferred stock
dividend ($15.14 and $5.44 per share,
respectively)....................................... (2,387)
Net income............................................ 277 277
---------- ------- -------------- -------
Balance at May 31, 1998........................... $ 3,994 $ (2,546) $ (25,456) $ (5,107)
---------- ------- -------------- -------
---------- ------- -------------- -------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED MAY 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
1996 1997 1998
--------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income.......................................................... $ 549 $ (936) $ 277
--------- ---------- ----------
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Compensation expense in connection with stock options.................... 1,967 5,933 1,442
Depreciation and amortization............................................ 2,929 4,219 7,736
Amortization of debt issuance costs...................................... -- 156 412
Loss from early extinguishment of debt................................... -- -- 1,406
Write-off of organization costs.......................................... -- -- 158
Noncash rental expense, net of noncash rental income..................... 1,277 1,620 2,670
Change in certain working capital components............................. 1,216 4,389 4,316
Increase in deferred tax asset........................................... (1,539) (2,058) (1,187)
Increase in deferred membership costs.................................... (926) (847) (1,403)
Other.................................................................... 222 (174) (94)
--------- ---------- ----------
Total adjustments...................................................... 5,146 13,238 15,456
--------- ---------- ----------
Net cash provided by operating activities.............................. 5,695 12,302 15,733
--------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net of effect of acquired businesses................. (5,380) (11,403) (16,170)
Acquisition of businesses.................................................. (35) (1,888) (19,733)
Intangible and other assets................................................ (72) (280) (137)
--------- ---------- ----------
Net cash used in investing activities.................................. (5,487) (13,571) (36,040)
--------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of stock, net of expenses......................................... 2,000 15,155 125
Redemption and liquidation of stock, including expenses.................... -- (38,820) --
Proceeds from borrowings................................................... 5,365 42,092 89,372
Repayments of borrowings................................................... (7,221) (13,607) (45,130)
Debt issuance costs........................................................ -- (2,011) (3,531)
--------- ---------- ----------
Net cash provided by financing activities.............................. 144 2,809 40,836
--------- ---------- ----------
Net increase in cash and cash equivalents.............................. 352 1,540 20,529
Cash and cash equivalents at beginning of period............................. 576 928 2,468
--------- ---------- ----------
Cash and cash equivalents at end of period............................. $ 928 $ 2,468 $ 22,997
--------- ---------- ----------
--------- ---------- ----------
Summary of the change in certain working capital components, net of effects
of acquired businesses:
(Increase) decrease in accounts receivable................................. $ (19) $ 469 (108)
Increase in inventory...................................................... (135) (39) (343)
(Increase) decrease in prepaid expenses and other current assets........... (38) 631 30
Increase in accounts payable and accrued expenses.......................... 805 2,055 1,895
(Decrease) increase in prepaid corporate income taxes...................... (913) 156 324
Increase in deferred revenue............................................... 1,516 1,117 2,518
--------- ---------- ----------
Net change in certain working capital components....................... $ 1,216 $ 4,389 $ 4,316
--------- ---------- ----------
--------- ---------- ----------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
1. NATURE OF BUSINESS:
Town Sports International, Inc. and Subsidiaries (the "Company") owns,
operates or manages thirty-nine fitness clubs ("clubs") and a physical therapy
facility in the New York metropolitan market, six clubs in Washington, D.C., two
clubs in Boston, and two clubs in Switzerland. The Company's geographic
concentration in the New York metropolitan market may expose the Company to
adverse developments related to competition, demographic changes, real estate
costs and economic down turns.
On December 10, 1996, the Company completed a restructuring of its ownership
and debt capitalization. The restructuring was undertaken to increase
stockholder value by providing access to growth capital and financial advisory
skills thereby enabling the Company to optimize its competitive advantage in the
market place, and to present certain existing equity holders the opportunity to
diversify their respective equity interests in the Company. The restructuring
was accounted for as a leveraged recapitalization whereby new investors, on a
fully-diluted basis, effectively acquired 73% of the Company resulting in a
reduction of equity of $32,700. The reduction in equity included the liquidation
of Series A Preferred Stock of $496, and the redemption of stock and stock
options outstanding immediately prior to the recapitalization of $28,025 and
$4,179, respectively. In addition, 368,333 shares of Series B Redeemable
Preferred Stock, which had been accounted for as mezzanine financing, were
redeemed at a cost of $6,121. New and existing investors acquired newly
constituted preferred and common stock. Closing fees paid to certain new
investors totaled approximately $800. Senior and subordinated debt facilities
were obtained to finance the repayment of existing bank facilities and to
provide growth capital.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
A. PRINCIPLES OF CONSOLIDATION:
The accompanying consolidated financial statements include the accounts of
Town Sports International, Inc. and all wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
B. REVENUE RECOGNITION:
The Company receives a one-time non-refundable initiation fee and monthly
dues from its members. Substantially all of the Company's members join on a
month-to-month basis and can therefore cancel their membership at any time with
30 days notice.
Initiation fees and related direct expenses, primarily sales commissions
payable to membership consultants, are deferred and recognized, on a
straight-line basis, in operations over an estimated membership period of twenty
four (24) months. Dues that are received in advance are recognized on a pro-rata
basis over the periods in which services are to be provided.
In connection with advance receipts of fees or dues, the Company is required
to maintain surety bonds totaling $1,035, pursuant to various state consumer
protection laws.
Management fees earned for services rendered are recognized at the time the
related services are performed.
The Company recognizes revenue from merchandise sales upon delivery to the
member.
F-6
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
C. INVENTORY:
Inventory consists primarily of athletic equipment and supplies for sale to
members and club supplies. Inventories are valued at the lower of cost or market
by the first-in, first-out method.
D. FIXED ASSETS:
Fixed assets are recorded at cost and depreciated on a straight-line basis
over the estimated useful lives of the assets, which are thirty years for
building and improvements, five years for club equipment, furniture, fixtures
and computer equipment, and three years for proprietary computer software.
Leasehold improvements are amortized over the shorter of their estimated useful
lives or the remaining period of the lease. Expenditures for maintenance and
repairs are charged to operations as incurred. The cost and related accumulated
depreciation or amortization of assets retired or sold are removed from the
respective accounts and any gain or loss is recognized in operations.
E. ADVERTISING AND CLUB PREOPENING COSTS
Advertising costs and club preopening costs are charged to operations during
the period in which they are incurred. Total advertising costs incurred by the
Company during the years ended May 31, 1996, 1997 and 1998 totaled $1,291,
$1,627 and $2,147, respectively.
F. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates. The most
significant assumptions and estimates relate to the useful lives and
recoverability of fixed and intangible assets, deferred income tax valuation and
expense in connection with stock options and warrants.
G. CORPORATE INCOME TAXES:
Deferred tax liabilities and assets are recognized for the expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred tax liabilities and assets are
determined on the basis of the difference between the financial statement and
tax bases of assets and liabilities ("temporary differences") at enacted tax
rates in effect for the years in which the temporary differences are expected to
reverse. A valuation allowance is recorded if it is more likely than not that
all or part of a deferred tax asset will not be realized.
F-7
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
H. STATEMENTS OF CASH FLOWS:
Supplemental disclosure of cash flow information:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Cash paid during the year for:
Interest (net of amounts capitalized)........................ $ 1,118 $ 1,603 $ 6,798
Taxes........................................................ 3,080 1,655 1,300
Noncash investing and financing activities:
Acquisition of fixed assets included in accounts payable..... 293 850 2,496
Acquisition of equipment financed by suppliers or lessors.... 1,475 1,411 562
</TABLE>
See Notes 9 and 10 for additional noncash investing and financing
activities.
I. CASH AND CASH EQUIVALENTS:
The Company considers all highly liquid debt instruments which have
maturities of three months or less when acquired to be cash equivalents. The
carrying amounts reported in the balance sheets for cash and cash equivalents
approximate fair value.
J. DEFERRED LEASE LIABILITIES AND NONCASH RENTAL EXPENSE:
The Company recognizes rental expense for leases with scheduled rent
increases on the straight-line basis.
K. FOREIGN CURRENCY:
Transactions denominated in a foreign currency have been translated into
U.S. dollars at the rates of exchange at the transaction dates. Assets and
liabilities have been translated at the respective year-end exchange rates. For
the years ended May 31, 1996, 1997 and 1998, the Company recognized foreign
exchange gains (losses) of approximately $20, ($65) and ($3), respectively.
These gains (losses) relate to certain management fees earned in Switzerland.
L. INVESTMENTS IN AFFILIATED COMPANIES:
The Company has investments in Capitol Hill Squash Club Associates and
Kalorama Sports Management Associates (collectively referred to as the
"Affiliates"). The Affiliates have operations, which are similar, or related to,
those of the Company. The Company accounts for these Affiliates in accordance
with the equity method. The assets, liabilities, equity and operating results of
the Affiliates and the Company's pro rata share of the Affiliates' net assets
and operating results were not material for all periods presented.
F-8
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
M. INTANGIBLE ASSETS:
Intangible assets consist of acquired leasehold rights, membership lists,
debt issuance costs, goodwill and covenant-not-to compete. Such intangibles,
except debt issuance costs, are stated at amortized cost and are being amortized
by the straight-line method over their estimated lives. Debt issuance costs are
amortized as additional interest expense over life of the underlying debt using
the interest method. Effective June 1, 1997, the Company changed the estimated
useful lives of membership lists from three to two years. The effect on
operating results for the year ended May 31, 1998 of decreasing the useful life
was to increase amortization expense by $234, $117 net of taxes. Goodwill and
acquired leasehold rights are being amortized over the remaining lives of the
respective leases, five to fifteen years, and debt issuance costs are being
amortized over the term of the respective borrowings, five to seven years.
Prior to the year ended May 31, 1998, the Company capitalized direct costs
(legal fees and real-estate commissions) incurred to obtain leases for new clubs
to be constructed by the Company ("Organizational Costs"). Such amounts were
amortized over a five year period using the straight-line method. During the
quarter ended May 31, 1998, the Company adopted the provisions of Statement of
Position 98-5 REPORTING ON THE COSTS OF START-UP ACTIVITIES ("SOP 98-5") which
requires that Organizational Costs be expensed as incurred. In connection with
the adoption of SOP 98-5, the Company restated its first-quarter operating
results as if adoption had occurred on June 1, 1997 and recorded a pre-tax
charge of $158, $88 net of taxes, as the cumulative effect of this accounting
change.
N. ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS:
Long-lived assets, such as fixed assets and intangible assets, including
goodwill, are reviewed when events or circumstances indicate that their carrying
value may not be recoverable. Estimated undiscounted expected future cash flows
are used to determine if an asset is impaired in which case the asset's carrying
value would be reduced to fair value. For all periods presented, no impairment
losses were recorded.
O. CONCENTRATIONS OF CREDIT RISK:
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents. Such amounts are
held, primarily, in a single commercial bank. The Company holds no collateral
for these financial instruments.
P. STOCK-BASED EMPLOYEE COMPENSATION:
For financial reporting purposes, the Company accounts for stock-based
compensation in accordance with the intrinsic value method ("APB No. 25"). In
accordance with this method, no compensation expense is recognized in the
accompanying financial statements in connection with the awarding of stock
option grants to employees provided that, as of the grant date, all terms
associated with the award are fixed and the fair value of the Company's stock,
as of the grant date, is not greater than the amount an employee must pay to
acquire the stock as defined; however, to the extent that stock options are
granted to employees with variable terms or if the fair value of the Company's
stock as of the measurement date is greater than the amount an employee must pay
to acquire the stock, then the Company will recognize
F-9
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
compensation expense. However, the fair value of options or warrants granted to
nonemployees for financing, goods or services are included in operating results
as an expense.
Disclosures, including pro forma operating results had the Company prepared
its financial statements in accordance with the fair value based method of
accounting for stock-based compensation, have been included in Note 9.
Q. OTHER RECENT ACCOUNTING PRONOUNCEMENTS:
In June 1997, the Financial Accounting Standards Board issued Statement No.
130 ("SFAS No. 130"), REPORTING COMPREHENSIVE INCOME. This statement, which is
effective for fiscal years beginning after December 15, 1997, establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains, and losses) in a full set of general-purpose
financial statements. Based on current estimates, management does not believe
that the future adoption of SFAS No. 130 will have a material effect on the
Company's financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131 ("SFAS No. 131"), DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION. SFAS No. 131 establishes standards for the way in which public
companies report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes the standards for related disclosure about products and services,
geographic areas and major customers. SFAS No. 131 is effective for financial
statements for fiscal years beginning after December 15, 1997. Based on current
estimates, management does not believe that the future adoption of SFAS No. 131
will have a material effect on the Company's financial statements.
In February 1998, the Financial Accounting Standards Board issued Statement
No. 132 ("SFAS No. 132"), EMPLOYER DISCLOSURES ABOUT PENSIONS AND OTHER POST
RETIREMENT BENEFITS. This statement modifies financial statement disclosures
related to pension and other post retirement plans, and will not have an effect
on the Company's financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("SFAS No. 133"), ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES. SFAS No. 133 standardizes the accounting for derivative instruments
by requiring that all derivatives be recognized as assets and liabilities and
measured at fair value. This statement is effective for fiscal years beginning
after June 15, 1999. Based on current estimates, management does not believe
that the future adoption of SFAS No. 133 will have an effect on the Company's
financial statements.
R. RECLASSIFICATIONS:
Certain reclassifications have been made to the 1996 and 1997 financial
statements to conform with the 1998 presentation.
F-10
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
3. FIXED ASSETS:
Fixed assets as of May 31, 1997 and 1998 are shown at cost, less accumulated
depreciation and amortization, and are summarized below:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Leasehold improvements................................................. $ 26,309 $ 39,029
Club equipment......................................................... 8,581 13,394
Furniture, fixtures and computer equipment............................. 5,171 6,841
Building and improvements.............................................. 4,995 4,995
Land................................................................... 986 986
Construction in progress............................................... 1,284 6,937
--------- ---------
47,326 72,182
Less, Accumulated depreciation and amortization........................ 13,112 17,664
--------- ---------
$ 34,214 $ 54,518
--------- ---------
--------- ---------
</TABLE>
Depreciation and leasehold amortization expense for the years ended May 31,
1996, 1997 and 1998 was approximately $2,813, $3,843 and $6,130, respectively.
4. INTANGIBLE ASSETS:
Intangible assets as of May 31, 1997 and 1998 are shown at cost, less
accumulated amortization, and are summarized below:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Goodwill arising on acquisition of businesses........................... $ 2,798 $ 14,755
Deferred financing costs................................................ 2,150 4,103
Membership lists........................................................ 176 3,154
Organizational expenses................................................. 158 --
Covenant-not-to compete................................................. -- 400
--------- ---------
5,282 22,412
Less, Accumulated amortization.......................................... 857 2,489
--------- ---------
$ 4,425 $ 19,923
--------- ---------
--------- ---------
</TABLE>
Amortization expense of intangible assets for the years ended May 31, 1996,
1997 and 1998 was approximately $116, $532 and $2,018, respectively. Such amount
includes amortization expense of deferred financing costs of $0, $156, and $412,
respectively, which has been classified as interest expense for financial
reporting purposes.
F-11
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
5. ACCRUED EXPENSES:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Accrued payroll......................................................... $ 1,882 $ 3,359
Accrued interest........................................................ 839 1,171
Accrued other........................................................... 1,296 2,089
Amounts payable under agreement to purchase a club...................... -- 1,250
--------- ---------
$ 4,017 $ 7,869
--------- ---------
--------- ---------
</TABLE>
6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS:
Long-term debt and capital lease obligations consist of the following:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Series B 9 3/4% Senior Notes, due 2004................................. $ 85,000
Term Loan.............................................................. $ 30,000
Subordinated note payable--face value of $7,500. Note shown net of
original issue discount arising out of issuance of warrants to buy
common stock......................................................... 7,384
Capital lease obligations.............................................. 2,317 1,463
Notes payable for acquired business.................................... 1,370 1,826
--------- ---------
41,071 88,289
Less, Current portion due within one year........................ 1,924 2,036
--------- ---------
Long-term portion................................................ $ 39,147 $ 86,253
--------- ---------
--------- ---------
</TABLE>
The aggregate long-term debt and capital lease obligations maturing during
the next five years is as follows:
<TABLE>
<CAPTION>
YEAR ENDING MAY 31, AMOUNT DUE
- ------------------------------------------------------------------------------- -------------
<S> <C>
1999........................................................................... $ 2,036
2000........................................................................... 568
2001........................................................................... 349
2002........................................................................... 291
2003........................................................................... 45
Thereafter..................................................................... 85,000
-------------
$ 88,289
-------------
-------------
</TABLE>
On October 16, 1997, the Company issued $85,000 of Series B 9 3/4% Senior
Notes ("Senior Notes"), due October 2004. The net proceeds from the Senior Notes
totaled approximately $81,700 of which $41,500 was used to repay the term loan,
the line of credit and the subordinated note payable. The transaction fees of
approximately $3,300, were accounted for as deferred financing costs. The Senior
Notes bear interest at an annual rate of 9 3/4%, payable semi-annually. The
notes are redeemable at the option of the Company on or after October 15, 2001.
The Senior Notes are non-collateralized and rank
F-12
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS: (CONTINUED)
"PARI PASSU" with all unsubordinated debt and senior in right of payment with
all subordinated indebtedness of the Company. The note indenture under which the
Senior Notes were issued contains certain covenants that, among other things,
limit the Company's ability to incur additional indebtedness, pay dividends or
make certain other restricted payments, engage in transactions with affiliates,
incur liens and engage in asset sales.
As of May 31, 1998, the Company has a line of credit with its principal bank
for direct borrowings and letters of credit of up to $15,000. The line of credit
carries interest at the Company's option based upon the Eurodollar borrowing
rate plus 2.50% or the bank's prime rate plus 1.50%, as defined and the Company
is required to pay a commitment commission of 0.38% per annum based upon the
daily unutilized amount. There were no outstanding borrowings against this line
of credit as of May 31, 1998; however the amount available for borrowing has
been reduced by outstanding letters of credit totaling $1,993 (see Note 8). This
line of credit expires on October 15, 2002. The line of credit contains various
covenants including interest coverage and a leverage ratio as well as
restrictions on the payment of dividends. The line of credit is collateralized
by a mortgage on land, building and equipment, which, as of May 31, 1998, had an
aggregate book value of approximately $3,585, and by all other assets of the
Company.
The Term Loan, prior to repayment, carried interest based upon Eurodollar
borrowing rate plus 3.25%, or the base prime rate plus 2.00% as determined by
the Company.
The Subordinated note, prior to repayment, carried interest of 11.5%.
Notes payable were incurred upon the acquisition of various fitness clubs
and are subject to the Company's right of offset for possible post acquisition
adjustments arising out of operations of the acquired clubs. These notes are
stated at a discount from face value at rates of between 6% and 7%, and are
non-collateralized.
The carrying value of long-term debt, other than the Senior Notes,
approximates fair market value as of May 31, 1997 and 1998 as the interest rate
charged on the debt is variable or are generally short term. The Senior Notes
have a fair value which approximates carrying value as of May 31, 1998, based on
the quoted market price.
The Company's interest expense and capitalized interest related to club
facilities under construction for the years ended May 31, 1996, 1997 and 1998
are as follows:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Interest costs expensed........................................ $ 1,012 $ 2,570 $ 7,130
Interest costs capitalized..................................... 46 28 526
--------- --------- ---------
$ 1,058 $ 2,598 $ 7,656
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-13
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS: (CONTINUED)
The Company leases equipment under noncancelable capital leases. The initial
lease terms range from three to five years, after which the Company is required
to purchase the equipment at amounts defined by the agreements.
As of May 31, 1998, minimum rental payments, under all capital leases,
including payments to acquire leased equipment, are as follows:
<TABLE>
<CAPTION>
MINIMUM
YEAR ENDING MAY 31, ANNUAL RENTAL
- ------------------------------------------------------------------------------ ---------------
<S> <C>
1999.......................................................................... $ 1,124
2000.......................................................................... 358
2001.......................................................................... 98
2002.......................................................................... 15
-------
1,595
Less, Amounts representing interest........................................... 132
-------
Present value of minimum capital lease payments............................... $ 1,463
-------
-------
</TABLE>
The cost of leased equipment included in club equipment was approximately
$4,190 and $5,033 at May 31, 1997 and 1998, respectively; related accumulated
depreciation was $1,283 and $2,234, respectively.
On August 6, 1998, the Company amended its line of credit with its principal
bank whereby the credit limit was increased to $25,000.
7. RELATED PARTY TRANSACTIONS:
a. The Company entered into a management agreement with Town Squash AG
("TSAG"). The Company, together with the shareholders of TSAG, is contingently
liable to fund shortfalls in operating cash flow of TSAG, as defined. The terms
of the agreement provide for the Company to fund a maximum amount of operating
cash flow of approximately $135 ("Advances"). As of May 31, 1997 and 1998, the
Company had no outstanding Advances to TSAG. Amounts due the Company at May 31,
1997 and 1998 of $84 and $36, respectively, represented earned management fees
payable after year-end. Such amounts have been included in accounts receivable.
Management fees earned during the years ended May 31, 1996, 1997 and 1998
amounted to approximately $695, $223 and $239, respectively.
b. The Company entered into a professional service agreement with Bruckmann,
Rosser, Sherrill & Co., Inc. ("BRS"), for strategic and financial advisory
services on December 10, 1996. Fees for such services are $250 per annum, and
are payable while BRS owns 20% or more of the outstanding Common stock of the
Company. Amounts due BRS on May 31, 1997 and 1998, which are included in
accounts payable, were $104.
c. Prior to May 1998, the Company was obligated by the terms of a management
agreement with Great Neck Fitness Club Ltd. ("GNFC") to fund defined shortfalls
in operating cash flows of GNFC. On April 1, 1998 the Company acquired the
assets of GNFC and the management agreement was cancelled.
F-14
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
7. RELATED PARTY TRANSACTIONS: (CONTINUED)
No management fees were recognized as income during the year ended May 31, 1997
and $75 and $130 was recognized in the year ended May 31, 1996 and 1998,
respectively.
8. LEASES:
The Company leases office, warehouse and multi-recreational facilities and
certain equipment under noncancelable operating leases. In addition to base
rent, the facility leases generally provide for additional rent based on
increases in real estate taxes and other costs. Certain leases give the Company
the right to acquire the leased facility at defined prices based on fair value
and provide for additional rent based upon defined formulas of revenue, cash
flow or operating results of the respective facilities. Under the provisions of
certain of these leases, the Company is required to maintain irrevocable letters
of credit, which total $1,993.
The leases expire at various times through May 31, 2019, and certain leases
may be extended at the Company's option.
Future minimum rental payments under noncancelable operating leases are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING MAY 31, MINIMUM ANNUAL RENTAL
- -------------------------------------------------------------------- ------------------------
<S> <C>
1999................................................................ $ 14,542
2000................................................................ 15,145
2001................................................................ 15,253
2002................................................................ 15,298
2003................................................................ 14,737
Aggregate thereafter................................................ 119,053
----------
$ 194,028
----------
----------
</TABLE>
Rent expense, including deferred lease liabilities, for the years ended May
31, 1996, 1997 and 1998 was approximately $8,653, $10,169 and $15,493,
respectively. Such amounts include additional rent of $1,863, $2,146 and $2,590,
respectively.
The Company, as landlord, leases space under noncancelable operating leases.
In addition to base rent, certain leases provide for additional rent based on
increases in real estate taxes, indexation, utilities and defined amounts based
on the operating results of the lessee. The leases expire at various times
through May 31, 2005. Future minimum rentals receivable under noncancelable
leases are as follows:
<TABLE>
<CAPTION>
YEAR ENDING MAY 31, MINIMUM ANNUAL RENTAL
- -------------------------------------------------------------------- -------------------------
<S> <C>
1999................................................................ $ 440
2000................................................................ 409
2001................................................................ 409
2002................................................................ 372
2003................................................................ 313
Aggregate thereafter................................................ 350
-------
$ 2,293
-------
-------
</TABLE>
F-15
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
8. LEASES: (CONTINUED)
Rental income, including noncash rental income, for the years ended May 31,
1996, 1997, and 1998, was approximately $882, $936 and $963, respectively. Such
amounts included additional rental charges above the base rent of $570, $620 and
$651, respectively.
9. STOCKHOLDERS' EQUITY:
A. CAPITALIZATION:
The Company's certificate of incorporation, as amended, provides for the
issuance of up to 2,050,000 shares of capital stock, consisting of 1,150,000
shares of Class A Voting Common Stock ("Class A"), par value $0.001 per share;
500,000 shares of Class B Non-voting Common Stock ("Class B"), par value of
$0.001 per share, (Class A and Class B are collectively referred to herein as
"Common Stock") and 200,000 shares of Series A Preferred Stock ("Series A"), par
value $1.00 per share, and 200,000 shares of Series B Preferred Stock ("Series
B"), par value $1.00 per share (collectively "Preferred Stock").
All stockholders have preemptive rights to purchase a pro-rata share of any
future sales of securities, as defined.
PREFERRED STOCK
The Preferred Stock has liquidation preferences over Common Stock. The
Company's Series A and Series B stock have no conversion features or voting
rights except as required by law, and rank "PARI PASSU".
Series A stock has a liquidation value of $100 per share plus cumulative
unpaid dividends of $3,372 as of May 31, 1998. Series A stockholders are
entitled to a cumulative 14% annual dividend based upon the per share price of
$100.
Series B stock has a liquidation value of $35 per share plus cumulative
unpaid dividends of $29 as of May 31, 1998. Series B stockholders are entitled
to a cumulative 14% annual dividend based upon the per share price of $35.
Cumulative unpaid dividends on Preferred Stock are payable upon certain
defined events which include: the dissolution; liquidation or winding up of the
Company; the redemption of such shares; or the sale of substantially all of the
assets of the Company.
COMMON STOCK
Class A stock and Class B stock each have identical terms with the exception
that Class A stock is entitled to one vote per share, while Class B stock has no
voting rights, except as required by law. In addition, Class B stock is
convertible into an equal number of Class A shares, at the option of the holder
of the majority of the Class B stock. To date, the Company has not issued Class
B stock.
F-16
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
9. STOCKHOLDERS' EQUITY: (CONTINUED)
B. STOCK OPTIONS AND WARRANTS:
The following table summarizes the stock option activity for the years ended
May 31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
CLASS A CLASS A
COMMON COMMON SERIES B
($0.01 PAR ($.001 PAR CLASS B REDEEMABLE SERIES B
STOCK OPTIONS VALUE) VALUE) COMMON PREFERRED PREFERRED
- ------------------------------------------ ----------- ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Number of shares under option:
Outstanding at June 1, 1995............. 150,000 121,000 21,251
Options exercised....................... (13,358) (2,351)
Options cancelled....................... (6,642) (349)
----------- ----------- -------------
Outstanding at May 31, 1996......... 130,000 118,300 21,251
Options granted......................... -- 57,142 20,000 -- 164,783
Options exercised....................... (130,000) -- (138,300) (21,251) --
----------- ----------- ----------- ------------- -----------
Outstanding at May 31, 1997......... -- 57,142 -- -- 164,783
----------- ----------- -------------
----------- ----------- -------------
Options granted......................... -- 14,700 --
----------- -----------
Outstanding at May 31, 1998......... 71,842 164,783
----------- -----------
----------- -----------
Exercise price:
Outstanding at June 1, 1995............. $ 3.40 $ 10.00 $ 3.00
Options exercised....................... 2.40 9.89 --
Options cancelled....................... 2.40 9.89
----------- ----------- -------------
Weighted average price of outstanding
options at May 31, 1996................. 3.55 10.06 3.00
Options granted......................... -- $ 1.00(i) 6.00(ii) -- $ 10.00(ii)
Options exercised....................... 3.55 -- 9.47 3.00 --
----------- ----------- ----------- ------------- -----------
Weighted average price of outstanding
options at May 31, 1997................. -- 1.00 -- -- 10.00
----------- ----------- -------------
----------- ----------- -------------
Options granted......................... 17.50(ii) --
----------- -----------
Weighted average price of outstanding
options at May 31, 1998................. $ 4.38 $ 10.00
----------- -----------
----------- -----------
</TABLE>
- ------------------------
(i) Option exercise price equal to market price on the grant date.
(ii) Option exercise price less than market price on the grant date.
As of May 31, 1996, all outstanding options were exercisable. As of May 31,
1997, all outstanding options for Series B Redeemable Preferred Stock were
exercisable and 11,428 options of Class A stock were exercisable.
F-17
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
9. STOCKHOLDERS' EQUITY: (CONTINUED)
The following table summarizes stock option information as of May 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- ------------------------
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
OUTSTANDING LIFE PRICE EXERCISABLE PRICE
------------ -------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Class A Common:
1997 Grants................................ 57,142 106 months $ 1.00 22,857 $ 1.00
1998 Grants................................ 14,700 106 months $ 17.50 2,940 $ 17.50
Series B Preferred:
Exercise price $10.00...................... 164,783 282 months $ 10.00 164,783 $ 10.00
</TABLE>
CLASS A COMMON STOCK ($.001 PAR VALUE) OPTIONS:
During the year ended May 31, 1997 the Company adopted the Town Sports
International Inc. 1997 Common Stock Option Plan (the "1997 Plan"). The
provisions of the 1997 Plan, as amended and restated, provide for the Company's
Board of Directors to grant to executives and key employees options to acquire
80,876 share of Class A stock.
The Company granted 57,142 options ("1997 Grants") with an exercise price of
$1.00 on December 10, 1996. The 1997 Grants have a term of 10 years and
originally vested based on the achievement of annual equity values as defined.
During the year ended May 31, 1998, the 1997 Grants were amended. The amendment
impacted 45,714 options, which had not previously vested (the "Amended Grants")
by adding a provision whereby unvested outstanding options would automatically
vest on December 10, 2005. Vesting will be accelerated in the event that certain
defined events occur including the achievement of certain equity values, the
sale of the Company, or an initial public offering of equity securities as
defined.
During the year ended May 31, 1998, the Company granted 14,700 options
("1998 Grants") with an exercise price of $17.50 and a term of 10 years. This
exercise price was below the estimated fair value of the Class A stock of $60.50
on the date of grant. The 1998 Grants vest in full on December 10, 2005;
however, vesting will be accelerated in the event that certain defined events
occur including the achievement of annual equity values or the sale of the
Company.
In accordance with APB No. 25, the Company recorded unearned compensation in
connection with the Amended Grants and the 1998 Grants. Such amount is included
within stockholders' deficit and represented the difference between the
estimated fair value of the Class A stock on the date of amendment or grant,
respectively, and the exercise price. Unearned compensation will be amortized as
compensation expense over the vesting period. During the year ended May 31,
1998, amortization of unearned compensation totaled $806.
As of May 31, 1998, shares reserved for future option awards totaled 9,034.
F-18
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
9. STOCKHOLDERS' EQUITY: (CONTINUED)
SERIES B PREFERRED STOCK OPTIONS:
During the year ended May 31, 1997, the Company granted 164,783 options
("Series B Options") to certain employees which entitle the holders to purchase
an equal number of shares of Series B stock at an exercise price of $10.00 per
share. The estimated fair value of the Series B Preferred Stock on the date of
grant was $35.00. Accordingly, the Company recognized an aggregate charge for
the difference between the Series B Options' exercise price and the estimated
fair value of the Series B Preferred Stock, which totaled $4,120. Series B
Options were fully vested on the date of grant and expire on December 31, 2021.
The terms of the Series B Options also contain provisions whereby the exercise
price will be reduced or in certain cases, the option holder will receive cash
in accordance with a formula as defined. The aggregate value of either a
reduction in exercise price or the distribution of cash will be deemed
compensatory and accordingly the Company will record compensation expense. For
the years ended May 31, 1997 and 1998, compensation expense recognized in
connection with Series B Options totaled $273 and $636 respectively. There are
no shares of Series B Preferred Stock reserved for future option grants.
CLASS A ($0.01 PAR VALUE) AND CLASS B CONVERTIBLE OPTIONS:
During the years ended May 31, 1996 and 1997, in connection with the
granting of Class A Common Stock ($0.01 par value) and Class B Convertible
Common Stock Options, the Company recognized a compensation charge of
approximately $1,967 and $5,933, respectively. Such charges represented the
difference between the exercise price of the respective options and the fair
market value of the underlying stock as determined by the Board of Directors.
PRO FORMA OPERATING RESULTS:
The following table summarizes the pro forma operating results of the
Company had compensation costs for the outstanding options been determined in
accordance with the fair value based method of accounting for stock-based
compensation. There were no options granted during the year ended May 31, 1996.
Since option grants vest over several years and additional grants are
expected in the future, the pro forma results noted below are not likely to be
representative of the effects on future years of the application of the fair
value based method.
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Pro forma amounts:
Net loss to common stockholder........................................ $ (1,826) $ (1,804)
--------- ---------
--------- ---------
</TABLE>
For the purposes of the above pro forma information, the fair value of each
option granted was estimated on the date of grant using the Black-Scholes option
pricing model. For the years ending May 31, 1997 and 1998, the weighted-average
fair value of the option grants was approximately $26.00 and $44.00,
respectively. The following weighted-average assumptions were used in computing
the fair value of options grants: expected volatility of 60% for both years;
risk-free interest rate of approximately 6.5% for 1997 and 5.5% for 1998;
expected lives of five years for 1997 and three to five years for 1998; and a
zero dividend yield for both years.
F-19
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
9. STOCKHOLDERS' EQUITY: (CONTINUED)
WARRANTS TO BUY COMMON STOCK:
In connection with the issuance of the Subordinated note payable on December
10, 1996, warrants to buy 124,022 Class A Common Shares were issued at an
exercise price of $0.01 per share. Original issue discount arising upon this
issue, totaled approximately $123. 10,000 warrants were exercised on December
10, 1996 with the remaining warrants outstanding and fully exercisable until
expiration on December 10, 2006. In the event that certain defined events occur,
the number of warrants exercisable may be reduced.
10. ASSET ACQUISITIONS:
During the years ended May 31, 1996, 1997 and 1998, the Company completed
the acquisition of twenty fitness clubs. With the exception of the Ultrafit,
Inc. and Affiliates acquisition, as discussed below, the individual acquisitions
were not material to the financial position or results of operations of the
Company. The table below summarizes the aggregate purchase price and the
purchase price allocation to assets acquired:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Number of clubs acquired........................................ 1 3 16
Purchase prices payable in cash at closing...................... $ 35 $ 1,888 $ 19,733
Issuance and assumption of notes payable........................ 269 2,250 4,110
--------- --------- ---------
Total purchase prices..................................... $ 304 $ 4,138 $ 23,843
--------- --------- ---------
--------- --------- ---------
Allocation of purchase prices:
Fixed assets.................................................... $ 299 $ 2,462 $ 9,011
Membership lists................................................ 177 2,978
Goodwill........................................................ 1,484 11,557
Other net assets acquired....................................... 5 15 297
--------- --------- ---------
Total allocation of purchase prices....................... $ 304 $ 4,138 $ 23,843
--------- --------- ---------
--------- --------- ---------
</TABLE>
For financial reporting purposes, these acquisitions have been accounted for
under the purchase method and, accordingly, the purchase prices have been
assigned to the assets and liabilities acquired on the basis of their respective
fair values on the date of acquisition. The excess of purchase prices over the
net tangible assets acquired has been allocated to membership listings acquired,
covenant-not-to compete and goodwill. Intangible assets are amortized by the
straight-line basis over the estimated life of the asset. Acquired membership
lists are amortized over a 2 year period and goodwill is amortized over
remaining lives of the leases of the acquired fitness club which range from 6 to
15 years. The results of operations of the clubs have been included in the
Company's consolidated financial statements from the respective dates of
acquisition and the impact of these acquisitions on the consolidated financial
statements of the Company was not material, with the exception of the following
acquisition.
On April 6, 1998, the Company acquired Ultrafit, Inc. and Affiliates
(collectively referred to herein as "Ovox"). Ovox's operations consisted of four
fitness clubs in New Jersey which were owned and operated by a common group of
investors. The purchase price totaled $8,177, which included $7,750 of cash and
notes payable of $236. Transaction costs amounted to $191. The excess of the
purchase price
F-20
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
10. ASSET ACQUISITIONS: (CONTINUED)
over the net fair value of the assets acquired was $6,589, and has been
allocated to the membership lists acquired and goodwill. The following unaudited
pro forma information has been prepared assuming the Ovox Acquisition had taken
place at the beginning of the respective periods. The pro forma adjustments give
effect to amortization of goodwill, interest expense on acquisition debt, and
related income tax effects:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
MAY 31,
--------------------------
<S> <C> <C>
1997 1998
(UNAUDITED) (UNAUDITED)
------------ ------------
Revenues......................................................... $ 60,898 $ 87,158
Operating income................................................. 1,436 8,425
Proforma net loss to common stockholders......................... (2,148) (1,982)
</TABLE>
This unaudited pro forma financial information is presented for
informational purposes only and may not be indicative of the results of
operations as they would have been if the Company and the acquired clubs had
been a single entity during 1997 and 1998, nor is it indicative of the results
of operations which may occur in the future. Anticipated efficiencies from the
consolidation of the acquired clubs and the Company have been excluded from the
amounts included in the pro forma summary presented above.
11. REVENUE FROM CLUB OPERATIONS:
Revenues from club operations for the years ended May 31, 1996, 1997 and
1998 are summarized below:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Membership dues............................................ $ 35,800 $ 45,916 $ 66,878
Initiation Fees............................................ 1,849 3,308 4,408
Other club revenues........................................ 3,147 4,940 8,433
--------- --------- ---------
$ 40,796 $ 54,164 $ 79,719
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-21
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
12. CORPORATE INCOME TAXES:
The (benefit) provision for income taxes for the years ended May 31, 1996,
1997 and 1998 consists of the following:
<TABLE>
<CAPTION>
1996
---------------------------------
STATE
FEDERAL AND LOCAL TOTAL
--------- ----------- ---------
<S> <C> <C> <C>
Current..................................................... $ 1,256 $ 911 $ 2,167
Deferred.................................................... (964) (575) (1,539)
--------- ----------- ---------
$ 292 $ 336 $ 628
--------- ----------- ---------
--------- ----------- ---------
<CAPTION>
1997
---------------------------------
STATE
FEDERAL AND LOCAL TOTAL
--------- ----------- ---------
<S> <C> <C> <C>
Current..................................................... $ 1,053 $ 762 $ 1,815
Deferred.................................................... (1,226) (832) (2,058)
--------- ----------- ---------
$ (173) $ (70) $ (243)
--------- ----------- ---------
--------- ----------- ---------
<CAPTION>
1998
---------------------------------
STATE
FEDERAL AND LOCAL TOTAL
--------- ----------- ---------
<S> <C> <C> <C>
Current..................................................... $ 1,383 $ 935 $ 2,318
Deferred.................................................... (751) (436) (1,187)
--------- ----------- ---------
$ 632 $ 499 $ 1,131
--------- ----------- ---------
--------- ----------- ---------
</TABLE>
F-22
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
12. CORPORATE INCOME TAXES: (CONTINUED)
The components of the net deferred tax asset as of May 31, 1997 and 1998 are
summarized below:
<TABLE>
<CAPTION>
1997 1998
--------- ---------
<S> <C> <C>
Deferred tax assets:
Deferred lease liabilities............................................ $ 2,966 $ 4,106
Compensation expense incurred in connection with stock options........ 1,846 2,445
Fixed assets.......................................................... 1,153 358
State net operating loss carry-forwards............................... 100 214
Deferred revenue...................................................... 1,835 2,349
Other................................................................. 33 56
--------- ---------
7,933 9,528
--------- ---------
Deferred tax liabilities:
Accrued expenses...................................................... (153) (150)
Deferred costs........................................................ (1,624) (2,035)
--------- ---------
(1,777) (2,185)
--------- ---------
Net deferred tax asset, prior to valuation allowance.................. 6,156 7,343
Valuation allowance................................................... (184) (184)
--------- ---------
Net deferred tax asset................................................ $ 5,972 $ 7,159
--------- ---------
--------- ---------
</TABLE>
As of May 31, 1998, the Company has state net operating loss carry-forwards
of approximately $1,000. Such amounts expire between May 31, 1999 and May 31,
2005.
The following table accounts for the differences between the actual
provision and the amounts obtained by applying the statutory U.S. Federal income
tax rate of 34% to the income (loss) before provision (benefit) for corporate
income taxes:
<TABLE>
<CAPTION>
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Federal statutory tax rate............................................. 34% (34)% 34%
State and local income taxes, net of federal tax benefit............... 19 (6) 13
Reduction in valuation allowance....................................... -- (8) --
Adjustment of prior year's tax refund.................................. -- 25 --
Change in state and local tax rates.................................... -- -- 2
Other.................................................................. -- 2 1
-- -- --
53% (21)% 50%
-- -- --
-- -- --
</TABLE>
13. CONTINGENCIES:
A claim has been filed against the Company related to alleged copyright
infringement from the unauthorized use of photographs in advertisements. The
case was brought originally in federal court in June, 1996 and was dismissed in
February, 1998 because the plaintiffs had not registered copyrights to the
photographs. The claim was refiled in New York State Supreme Court on April 15,
1998. The
F-23
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
13. CONTINGENCIES: (CONTINUED)
Company has filed a motion to dismiss the state lawsuit which is presently
pending. The plaintiffs seek an unspecified amount of damages, including the
Company's profits attributable to the use of the photographs. Based on the
advice of outside counsel, management believes that it is unlikely that the
outcome of this matter will have a materially adverse effect on the consolidated
financial position, results of operations or cash flows of the Company.
Management is vigorously contesting this claim.
The Company is a party to various other lawsuits arising in the normal
course of business. Management believes that the ultimate outcome of these
matters will not have a material effect on the Company's consolidated financial
position, results of operations or cash flows.
14. EMPLOYEE BENEFIT PLAN:
The Company maintains a 401(k) defined contribution plan (the "401(k) Plan")
and is subject to the provisions of the Employee Retirement Income Security Act
of 1974 ("ERISA"). The 401(k) Plan provides for the Company to make
discretionary contributions; however, the Company elected not to make
contributions for the years ended May 31, 1996, 1997 and 1998.
15. EXTRAORDINARY ITEM:
During the year ended May 31, 1998, the Company completed an $85,000
financing. As part of this financing, an existing term loan, a line of credit
and a subordinated note were repaid. Accordingly, previously capitalized fees
and expenses relating to obtaining such financing of $1,406 were written off,
net of taxes of $624.
16. SUBSEQUENT EVENTS:
Subsequent to May 31, 1998, the Company acquired thirteen fitness clubs,
including seven clubs from Lifestyle, one of which is under development. These
acquisitions will be accounted for in accordance with the purchase method. The
aggregate purchase price totaled $19,479 which included $18,435 payable at
closing and the issuance of notes payable totaling $1,044. In addition, the
Company has entered into noncancelable operating leases which expire at various
dates through May 31, 2013. Future minimum rental payables required under the
leases total approximately $51,518. Future minimum rental receivables on space
that the Company will sublease totals $1,275.
F-24
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
New York, New York
July 9, 1998
To the Board of Directors and Stockholders of
Town Sports International, Inc.:
Our report on the consolidated financial statements of Town Sports
International, Inc. and Subsidiaries is included on page F-2 of the Form 10-K.
In connection with our audits of such financial statements, we have also audited
the related financial statement schedule on page F-26 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as whole, present
fairly, in all material respects, the information required to be included
therein.
PRICEWATERHOUSECOOPERS LLP
F-25
<PAGE>
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE II, VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
FOR EACH OF THE YEARS ENDED MAY 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
COL. C
ADDITIONS
COL. B ---------------------------------------- COL. E
----------- (1) (2) -----------
COL. A BALANCE AT CHARGED TO CHARGED TO COL. D BALANCE AT
- --------------------------------------------- BEGINNING COSTS AND OTHER ------------ END
DESCRIPTION OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
- --------------------------------------------- ----------- ------------------- ------------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Deferred tax valuation allowance:
1996......................................... $ 284 $ 284
1997......................................... 284 $ (100 (1) 184
1998......................................... 184 184
</TABLE>
- ------------------------
(1) Reduction of valuation allowance from the utilization of state net operating
loss carryfoward which were no longer required.
F-26
