<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
COMMISSION FILE # 1-13290
THE SPORTS CLUB COMPANY, INC.
A DELAWARE CORPORATION - I.R.S. NO. 95-4479735
11100 SANTA MONICA BLVD., SUITE 300, LOS ANGELES, CA 90025
(310) 479-5200
Indicate by check mark whether the company (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934, during the preceding 12 months (or for such shorter period that the
company was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Shares
Outstanding at
Class October 30, 1998
------------------------------ -----------------------
Common stock, $.01 par value 20,890,623
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND SEPTEMBER 30, 1998
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,581 $ 3,875
Accounts receivable, net of allowance for doubtful accounts
of $385 and $284 at December 31, 1997 and September 30, 1998 2,072 2,380
Inventories 813 1,440
Other current assets 354 696
Due from affiliates 106 66
--------- ---------
Total current assets 4,926 8,457
Property and equipment, at cost, net of accumulated depreciation and
amortization of $7,943 and $11,222 at December 31, 1997 and
September 30, 1998 106,791 125,701
Equity interest in unconsolidated subsidiary 862 1,035
Costs in excess of net assets acquired, less accumulated
amortization of $822 and $1,174 at December 31, 1997 and
September 30, 1998 15,917 15,563
Other assets, at cost, net 3,065 3,901
--------- ---------
$ 131,561 $ 154,657
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of notes payable and capitalized
lease obligations $ 2,975 $ 3,628
Notes payable to bank 5,000 --
Accounts payable 948 1,318
Accrued liabilities 7,985 5,122
Deferred membership revenues 9,936 10,659
--------- ---------
Total current liabilities 26,844 20,727
Notes payable and capitalized lease obligations,
less current installments 42,823 21,717
Notes payable to bank -- 3,640
Deferred lease obligations 2,817 5,007
Minority interest 600 600
--------- ---------
Total liabilities 73,084 51,691
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares authorized;
no shares issued or outstanding -- --
Common stock, $.01 par value, 40,000,000 shares authorized;
14,382,621 and 20,890,623 shares issued and outstanding at
December 31, 1997 and September 30, 1998 144 209
Additional paid-in capital 53,613 102,337
Retained earnings 5,674 8,049
Less: Treasury stock, at cost, 163,976 and 1,246,321 shares at
December 31, 1997 and September 30, 1998 (954) (7,629)
--------- ---------
Total shareholders' equity 58,477 102,966
--------- ---------
$ 131,561 $ 154,657
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 16,227 $ 20,682 $ 44,284 $ 60,645
Operating expenses:
Direct 11,414 14,251 31,671 42,266
Selling, general and administrative 1,789 2,082 4,877 6,170
Depreciation and amortization 1,025 1,381 2,859 3,820
-------- -------- -------- --------
Total operating expenses 14,228 17,714 39,407 52,256
-------- -------- -------- --------
Income from operations 1,999 2,968 4,877 8,389
Other income (expense):
Interest (768) (144) (2,368) (1,373)
Minority interests (37) (38) 16 (113)
Equity interest in net income of unconsolidated subsidiary 159 227 502 619
Litigation settlement -- -- (2,025) --
-------- -------- -------- --------
Income before income taxes and extraordinary item 1,353 3,013 1,002 7,522
Provision for income tax expense 513 1,207 380 2,975
-------- -------- -------- --------
Net income before extraordinary item 840 1,806 622 4,547
Extraordinary charge from early extinguishment of debt,
net of income tax benefit of $1,331 -- -- -- 2,173
-------- -------- -------- --------
Net income $ 840 $ 1,806 $ 622 $ 2,374
======== ======== ======== ========
Net income per share before extraordinary item:
Basic $ 0.06 $ 0.09 $ 0.05 $ 0.25
======== ======== ======== ========
Diluted $ 0.06 $ 0.09 $ 0.05 $ 0.25
======== ======== ======== ========
Per share effect of extraordinary item:
Basic $ -- $ -- $ -- $ (0.12)
======== ======== ======== ========
Diluted $ -- $ -- $ -- $ (0.12)
======== ======== ======== ========
Net income per share:
Basic $ 0.06 $ 0.09 $ 0.05 $ 0.13
======== ======== ======== ========
Diluted $ 0.06 $ 0.09 $ 0.05 $ 0.13
======== ======== ======== ========
Weighted average number of common shares outstanding:
Basic 13,568 20,036 12,162 18,255
======== ======== ======== ========
Diluted 13,714 20,209 12,308 18,494
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30,
1997 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 622 $ 2,374
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary charge from extinguishment of debt, net of tax -- 2,173
Depreciation and amortization 2,859 3,820
Equity interest in net income of unconsolidated subsidiary (502) (619)
Distributions from unconsolidated subsidiary 316 446
Minority interest in Reebok-Sports Club/NY (128) --
Increase in:
Accounts receivable, net (1,029) (308)
Inventories (228) (627)
Other assets (750) (497)
Increase (decrease) in:
Accounts payable (543) 370
Accrued liabilities 1,943 (1,420)
Deferred membership revenues 1,696 723
Deferred lease obligations 342 2,190
-------- --------
Net cash provided by operating activities 4,598 8,625
Cash flows from investing activities:
Capital expenditures (3,267) (19,107)
Business acquisitions (5,773) --
Stock re-purchase (979) (6,742)
-------- --------
Net cash used in investing activities (10,019) (25,849)
Cash flows from financing activities:
Exercise of employee stock options -- 39
Net proceeds from issuance of common stock 5,000 48,706
Decrease in due from affiliates 918 40
Proceeds from notes payable and capital lease obligations 500 3,640
Repayments of notes payable and capital lease obligations (2,573) (32,907)
-------- --------
Net cash provided by financing activities 3,845 19,518
-------- --------
Net increase (decrease) in cash and cash equivalents (1,576) 2,294
Cash and cash equivalents at beginning of period 4,146 1,581
-------- --------
Cash and cash equivalents at end of period $ 2,570 $ 3,875
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 2,635 $ 2,093
======== ========
Cash paid for income taxes $ 492 $ 2,012
======== ========
Capital expenditures financed $ 898 $ 3,950
======== ========
Stock issued in exchange for interest in Reebok-Sports Club/NY $ 5,000 $ --
======== ========
Stock issued as partial consideration for The Sports Club/Las Vegas $ 1,675 $ --
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). The condensed consolidated financial
statements should be read in conjunction with the Company's December 31, 1997,
consolidated financial statements and notes thereto, included on Form 10-K (SEC
File Number 1-13290). Certain information and footnote disclosures which are
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to SEC
rules and regulations. The Company believes that the disclosures made are
adequate to make the information presented not misleading. The information
reflects all adjustments which, in the opinion of management, are necessary for
a fair presentation of the financial position and results of operations for the
interim periods set forth herein. All such adjustments are of a normal and
recurring nature. The results for the nine-month period ended September 30,
1998, are not necessarily indicative of the results for the entire fiscal year
ending December 31, 1998.
2. NOTES PAYABLE AND CAPITALIZED LEASE OBLIGATIONS
Notes payable and capitalized lease obligations are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
The Sports Club/LA note (1) .............. $22,378 $ --
The Sports Club/Irvine note .............. 4,875 4,500
Vertical Club note (2) ................... -- 2,667
Spectrum Club-Agoura Hills note .......... 2,533 2,513
Spectrum Clubs Fullerton and Santa Ana
lease obligations ..................... 10,000 9,809
Equipment financing and
capitalized lease obligations ......... 5,602 5,856
Other notes payable ...................... 410 --
------- -------
45,798 25,345
Less current installments ................ 2,975 3,628
------- -------
$42,823 $21,717
======= =======
</TABLE>
- ------------
(1) This amount was repaid from the net proceeds of the sale of common stock in
April 1998 (See Note 6).
(2) This note was issued in connection with the acquisition of the Vertical
Club in New York in April 1998 and is payable in two equal installments in
April 1999 and 2000.
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3. BANK CREDIT FACILITY
In June 1998, the Company increased its bank credit facility ("Credit
Facility") to $30.0 million. The Credit Facility expires on May 31, 2000. The
Credit Facility is unsecured, however, the Company is prohibited from pledging
any of its assets except for normal furniture, fixture and equipment financing.
The agreement also requires the Company to maintain certain Tangible Net Worth,
Debt Coverage Ratios and Senior Liabilities to Tangible Net Worth Ratios. At
September 30, 1998, the Company was in compliance with its covenants and $7.6
million was outstanding under the Credit Facility represented by a $4.0 million
irrevocable standby letter of credit and $3.6 million in borrowings.
4. NET INCOME PER SHARE
Basic earnings per share represents net earnings divided by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share represents net earnings divided by the weighted-average
number of shares outstanding inclusive of the dilutive impact of common stock
equivalents. During the three and nine months ended September 30, 1997 and 1998,
there were no material differences between basic and diluted earnings per share.
The difference between the weighted average number of shares outstanding used in
the calculation of basic and diluted earnings per share was attributable to the
dilutive effect of common stock options.
5. INCOME TAXES
Income taxes are computed using the effective tax rate estimated to be
applicable for the full fiscal year, which is subject to ongoing review and
evaluation by management.
6. SALE OF COMMON STOCK
On April 7, 1998, the Company completed an offering of 6,000,000 shares
of common stock at a price of $8.00 per share. On April 27, 1998, the
underwriters exercised the over-allotment option granted as part of the
offering, pursuant to which an additional 500,000 shares were sold at a price of
$8.00 per share. Net proceeds from the offering of $48.7 million were used to
repay indebtedness and provide funds for developments and/or acquisitions and
for general corporate purposes.
7. ACQUISITIONS
On April 16, 1998, the Company acquired a 120,000 square foot fitness
and tennis club located in New York City. The lease rights and club operations
were acquired for approximately $4.0 million; however, a significant investment
is anticipated in connection with the development of this Club.
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for the 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. 130 is effective for fiscal years beginning after December 15, 1997.
Management has determined that there are no components of comprehensive income
that are not
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disclosed in the statements of operations. Accordingly, there is no difference
between net earnings and net comprehensive income.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131"). SFAS No. 131 establishes standards for public
business enterprises to report information about operating segments in annual
financial statements and selected information in the notes thereto. SFAS No. 131
is effective for financial statements for periods beginning after December 15,
1997. In the initial year of application, comparative information for earlier
years is to be restated. SFAS No. 131 need not be applied to interim financial
statements in the year of adoption, but comparative information is required in
the second year of application. The Company has not determined whether the
adoption of SFAS No. 131 will have a material impact upon the Company's
financial reporting.
In April 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-up
Activities." SOP 98-5 requires that costs of start-up activities, including
organization costs and Club openings, be expensed as incurred. SOP 98-5 is
applicable to financial statements for fiscal years beginning after December 15,
1998. Restatement of previously issued financial statements is not permitted. In
the fiscal year for which SOP 98-5 is first used, the application should be
reported as a cumulative effect of a change in accounting principle. The Company
has not yet determined whether the application of SOP 98-5 will have a material
impact upon the Company's financial position or results of operations.
9. YEAR 2000 DISCLOSURE
The Company recognizes the need to ensure its operations will not be
adversely impacted by Year 2000 software failures. Software failures due to
processing errors potentially arising from calculations using the Year 2000 date
are a known risk. The Company is in the process of replacing its membership
systems that are not Year 2000 compliant. The goal is to implement a new system
that is Year 2000 compliant with improved integrated functionality. With this
new system project, the Company is upgrading its information-system
infrastructure including wide and local-area networks and new personal computers
at all the Clubs.
In order to reduce exposure to Year 2000 risk, the Company is also
modifying the current membership system to be Year 2000 compliant. The
modifications are expected to be done by the second quarter of 1999. Therefore,
the Company's membership system Year 2000 compliance does not solely rely on the
completion of the new system project.
The financial accounting systems are also being upgraded to Year 2000
compliance, with completion expected in March 1999. The Company has upgrade and
replacement plans for other non-critical systems including personal computer
applications and retail point of sale systems. The Company is also investigating
the Year 2000 status on non-information technology systems including phone,
voice mail, security and building operations systems. The Company is not
currently aware of any Year 2000 compliance issues from third party vendors.
There is no assurance, however, that third party vendors' Year 2000
non-compliance issues or the Company's inability to complete its modifications
on the membership systems will not have an adverse effect on the Company.
6
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with the
condensed consolidated financial statements and notes thereto appearing
elsewhere in this Form 10-Q. The Company's consolidated financial statements
reflect the operations of The Sports Clubs, the Spectrum Clubs and The SportsMed
Company, Inc. ("SportsMed"). The Spectrum Club-Manhattan Beach is accounted for
under the equity method of accounting.
In July 1997, the Company opened the Spectrum Club-Valencia and, in
August 1997, acquired a Club located in Henderson, Nevada, which is operated as
The Sports Club/Las Vegas, in a transaction accounted for as a purchase. On
December 31, 1997, the Company acquired four Clubs formally known as Racquetball
World clubs in a transaction accounted for as a purchase; these Clubs are
located in Southern California and are now operated as Spectrum Clubs. As a
result of these transactions, the Company's results of operations in 1998 are
not directly comparable to its results in 1997. Seasonal factors have not had a
significant effect on the Company's operating results.
RESULTS OF OPERATIONS
Comparison of Three Months Ended September 30, 1998 to Three Months Ended
September 30, 1997
Revenues for the three months ended September 30, 1998, were $20.7
million, compared to $16.2 million in 1997, an increase of $4.5 million or
27.8%. An increase of $2.8 million resulted from increased revenues from the new
Clubs acquired during the last five months of 1997. Revenue growth of $1.7
million resulted from the other Clubs and SportsMed.
Direct operating expenses increased by $2.9 million to $14.3 million in
the three months ended September 30, 1998, versus $11.4 million for the same
period in 1997. The increase resulted primarily from the acquisition of Clubs
acquired in the last five months of 1997. Direct operating expenses as a
percentage of revenues decreased to 68.9% in 1998 compared to 70.3% in 1997.
Operating margins continued to improve at Reebok Sports Club/NY as this Club
continued to mature. Partially offsetting this increase were lower operating
margins at recently acquired Clubs.
Selling, general and administrative expenses were $2.1 million in the
three months ended September 30, 1998, versus $1.8 million for the same period
in 1997. Selling costs increased approximately $100,000 primarily due to the
additional six Clubs. General and administrative costs increased by
approximately $200,000 as additional corporate overhead was added to support the
six new Clubs and the growth of SportsMed. Selling, general and administrative
costs decreased as a percentage of revenue from 11.0% in 1997 to 10.1% in 1998.
The Company believes these costs should continue to decrease as a percentage of
future revenues as the Company expands and achieves economies of scale. There is
no assurance, however, that said expansion or economies of scale will be
achieved.
Depreciation and amortization expenses were $1.4 million for the three
months ended September 30, 1998, versus $1.0 million for the same period in
1997. The increase is due primarily to the addition of depreciation and
amortization at Clubs acquired in the last five months of 1997. Interest expense
was $144,000 in the three months ended September 30, 1998, versus
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$768,000 for the same period in 1997. Interest expense decreased due to the
payoff of the note secured by The Sports Club/LA in April 1998 with the proceeds
of a stock offering.
Equity interest in net income of unconsolidated subsidiary was $227,000
for the three months ended September 30, 1998 versus $159,000 in 1997. These
amounts are associated with the Spectrum Club-Manhattan Beach operations.
The Company's estimated income tax rate is 40% and 38% for the three
months ended September 30, 1998 and 1997, respectively, resulting in net income
of $1.8 million for the three months ended September 30, 1998, and $840,000 for
the same period in 1997.
Comparison of Nine Months Ended September 30, 1998 to Nine Months Ended
September 30, 1997
Revenues for the nine months ended September 30, 1998, were $60.6
million, compared to $44.3 million in 1997, an increase of $16.3 million or
36.8%. An increase of $11.6 million resulted from revenue at the new Clubs
acquired and/or opened during the last six months of 1997. Revenue growth of
$4.7 million from the remaining Clubs and SportsMed also contributed to the
overall increase.
Direct operating expenses increased by $10.6 million to $42.3 million in
the nine months ended September 30, 1998, versus $31.7 million for the same
period in 1997. The increase resulted primarily from the acquisition of Clubs
acquired and/or opened during the last six months of 1997. Direct operating
expenses as a percentage of revenues decreased to 69.7% in 1998 compared to
71.5% in 1997. Operating margins improved at Reebok Sports Club/NY as this Club
continued to mature. Partially offsetting these increases were lower operating
margins at recently acquired Clubs.
Selling, general and administrative expenses were $6.2 million in the
nine months ended September 30, 1998, versus $4.9 million for the same period in
1997. Selling costs increased approximately $492,000 primarily due to the
acquisition of Clubs acquired and/or opened during the last six months of 1997.
General and administrative costs increased by approximately $801,000 as
additional corporate overhead was added to support the six new clubs and the
growth of SportsMed. Selling, general and administrative costs decreased as a
percentage of revenue from 11.0% in 1997 to 10.2% in 1998. The Company believes
these costs should continue to decrease as a percentage of future revenues as
the Company expands and achieves economies of scale. There is no assurance,
however, that said expansion or economies of scale will be achieved.
Depreciation and amortization expenses were $3.8 million for the nine
months ended September 30, 1998, versus $2.9 million for the same period in
1997. The increase is due primarily to the addition of depreciation and
amortization at Clubs acquired and/or opened during the last six months of 1997.
Interest expense was $1.4 million in the nine months ended September 30, 1998,
versus $2.4 million in 1997. Interest expense decreased due to the payoff of the
note secured by The Sports Club/LA in April 1998 with the proceeds of a common
stock offering.
Equity interest in net income of unconsolidated subsidiary was $619,000
for the nine months ended September 30, 1998, versus $502,000 in 1997. These
amounts are associated with the Spectrum Club-Manhattan Beach operations.
The Company's income before income taxes, extraordinary item and a 1997
litigation settlement was $7.5 million for the nine months ended September 30,
1998, versus $3.0 million for
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the same period in 1997. In the period ended September 30, 1998, the Company
incurred a pre-tax loss from early extinguishment of debt, net of applicable
taxes, of $2.2 million, which was recorded as an extraordinary item. In the
period ended September 30, 1997, the Company incurred a pre-tax charge of $2.0
million to settle certain litigation. The Company's estimated income tax rate is
40% and 38% for the nine months ended September 30, 1998 and 1997, respectively,
resulting in net income of $2.4 million for the nine months ended September 30,
1998, compared to $622,000 for the same period in 1997.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended December 31, 1997, and the nine months ended
September 30, 1998, the Company generated $4.6 million and $8.6 million of cash
from operating activities, respectively.
In April 1998, the Company completed the sale of 6,500,000 shares of
common stock ("Offering") and realized net proceeds of $48.7 million.
Approximately $36.9 million of the net proceeds have been used to repay
indebtedness, approximately $6.7 million has been used to repurchase the
Company's common stock and the balance is available to provide funds for future
development and/or acquisitions and for general corporate purposes.
The Company currently owns a 60% interest in the Reebok-Sports Club/NY
partnership. At September 30, 1998, the Reebok-Sports Club/NY partnership had
outstanding a $2.1 million equipment loan and a $3.0 million note payable to the
Company, which note is eliminated when presenting the Company's consolidated
balance sheet. The Reebok-Sports Club/NY partnership achieved a positive
operating cash flow in September 1995 and has improved its operations since that
date. The Club is expected to continue to improve its operating results in the
future as membership levels increase (although there can be no assurance when,
if ever, such increases may occur). The Reebok-Sports Club/NY partnership is
making monthly payments of $75,000 to repay the equipment loan and $167,000 to
Millennium Entertainment Partners, L.P. or one of its affiliates (collectively
"Millennium") as rent. Additional cash flows of the Reebok-Sports Club/NY
partnership will be applied as follows: (i) $3.0 million per year will be used
to pay to Millennium a priority distribution, which is accounted for by the
Company as additional rent expense; and (ii) remaining cash will be distributed
to the Company to satisfy accrued management fees, the note payable and certain
additional priority distributions, which at September 30, 1998, aggregated $16.6
million. After these amounts plus interest thereon are paid, the Company is
entitled to 60% of future cash distributions. The Company anticipates that the
Partnership cash balance on December 31, 1998, will allow for the $3.0 million
priority payment to Millennium for 1998 and that the Company will receive its
priority distributions to the extent additional funds are available.
In August 1997, the Company acquired a Club located in Henderson, Nevada
which is now operated as The Sports Club/Las Vegas. The Company expects to
invest approximately $250,000 over the next six months to complete improvements
to this Club.
In December 1997, the Company acquired four Clubs formally known as
Racquetball World clubs which are now operated as Spectrum Clubs. The purchase
agreement calls for up to 159,081 shares of common stock to be issued to the
Clubs' prior owners on December 31, 1998, subject to reduction if certain
liabilities of the Clubs exceed agreed-upon amounts. Millennium acquired
properties underlying two of the Clubs for $10.0 million and is leasing these
properties to the Company under a financing lease agreement which is reflected
as a capital lease obligation in the Company's consolidated balance sheet. The
lease has a term of twenty years and provides for monthly payments which
aggregate $1.0 million per year for the first ten years and $1.2 million
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per year thereafter. At any time during the first three years of the lease, the
Company may purchase the leased property from Millennium for a purchase price
(currently estimated to be approximately $10.2 million) equal to $10.0 million
plus all costs incurred by Millennium in connection with the acquisition of such
property, plus an amount sufficient to provide to Millennium a 12% compound
return on its total investment. Millennium has the right to require the Company
to acquire its interest in the property at such price if (i) the Company
receives private debt financing in excess of $95.0 million; (ii) the Company
receives public equity financing in excess of $20.0 million; (iii) a default (as
defined in the lease) occurs; or (iv) a major casualty occurs with respect to
either property. Millennium waived its right as related to the April 1998 equity
placement. The Company has instituted a capital improvement program at these
four Clubs and expects to spend approximately $1.0 million over the next six
months in order to complete renovations and equipment purchases at these Clubs.
In December 1997, the Company acquired real property and a vacant
building in Thousand Oaks, California which is being redeveloped as a Spectrum
Club. The Company expects to invest $2.5 million in development costs over the
next six months to complete construction of this Club which is scheduled to open
in January 1999. In 1998, the Company entered into lease agreements with respect
to Spectrum Clubs to be built in Puente Hills, Anaheim and Northridge,
California. The Company expects to expend approximately $3.0 million over the
next twelve months in connection with the development of these three Clubs.
In February 1998, the Company signed a lease with respect to the
development of a Sports Club at Rockefeller Center in New York City. The Company
will begin renovation of the existing space later this year and expects to
commence pre-sale activities in June 1999. The Company expects to spend
approximately $12.0 million over the next twelve months to complete development
of this Club.
In April 1998, the Company acquired the Vertical Club, a 120,000 square
foot fitness and tennis club in New York City. The Company paid the prior owner
$1.3 million in cash and issued a note for $2.7 million to be paid in two equal
annual installments. The Company currently anticipates incurring approximately
$14.0 million in costs to renovate the existing club over the next fifteen
months.
The Company has entered into lease agreements with respect to the
development of Sports Clubs in Washington, D.C. and San Francisco, California
and announced its intention to develop a Sports Club in Boston, Massachusetts.
These projects are scheduled to begin construction in late 1998. The Company's
portion of the development costs for these Clubs is currently estimated to be
approximately $15.0 million and is expected to be invested over a twelve-month
period beginning in late 1999.
In June 1998, the Company acquired undeveloped land in Houston, Texas,
for approximately $3.1 million, on which the Company intends to develop a Sports
Club. The total additional cost of developing this property is currently
estimated to be approximately $17.0 million. The Company will commence
development of this site upon securing adequate financing; however, there can be
no assurance that such financing will be available.
In addition to the items described above, the Company plans to spend
approximately $2.5 million to upgrade its management information systems.
$700,000 has already been spent and $1.4 million will be spent in the next
twelve months (see Note 9 to the financial statements). The Company generally
expects to spend approximately 4% of revenues on facility and equipment upgrades
and replacements. The Company has available lease finance commitments
aggregating
10
<PAGE> 12
approximately $4.3 million to finance new equipment. Equipping new Clubs will
require expenditures and financing above this level.
In May 1998, the Company's Board of Directors authorized the repurchase
of up to $3.8 million of its common stock. In August, the Board of Directors
increased the authorized amount by $3.0 million. The purchases have been made
from time to time in the open market or directly from shareholders at prevailing
market prices. As of October 20, 1998, the Company had repurchased the entire
amount authorized by the Board.
At September 30, 1998, the Company had a $30.0 million bank credit
facility ("Credit Facility"). Currently, $3.6 million has been advanced under
this facility and $4.0 million is utilized in the form of a irrevocable standby
letter of credit. Advances under the facility bear interest at a variable rate
equal to LIBOR plus 1 1/2% or the lender's prime rate.
The Company believes that the cash balance on hand plus operating cash
flows and available financings will be sufficient for the Company's working
capital, debt service and capital expenditure needs for the next twelve months.
The Company's long-term capital needs are to provide funds for the developments
described above, additional development and acquisition projects and general
corporate purposes. The Company estimates that its capital expenditures for the
next twelve months on the projects currently under development will be
approximately $31.0 million, substantially all of which the Company believes
could be financed through cash on hand, projected cash flows, the Company's
existing bank facility and additional financing alternatives which are not yet
in place. The Company's development activities beyond twelve months from the
date hereof, as well as the Company's strategy of opportunistically acquiring
and developing additional Clubs will require additional capital. The Company
believes there are a number of financing alternatives available, including
commercial credit facilities, equipment financing, mortgage financing, and
public and private debt and equity offerings. The Company will also consider
entering into joint venture and partnership agreements for the purpose of
developing new Clubs. However, there can be no assurance that financing will be
available on commercially reasonable terms, if at all. To the extent that the
Company is unable to obtain additional financing on acceptable terms, the
Company will be forced to delay or limit its development and acquisition plans.
The failure to timely develop projects could result in increased interest,
carrying and other costs, and could delay or prevent the Company from receiving
a return on its investments in such projects. The foregoing could have a
material adverse effect on the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for the 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. 130 is effective for fiscal years beginning after December 15, 1997.
Management has determined that there are no components of comprehensive income
that are not disclosed in the statements of operations, accordingly, there is no
difference between net earnings and net comprehensive income.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131"). SFAS No. 131 establishes standards for public
business enterprises to report information about operating segments in annual
financial statements and selected information in the notes thereto. SFAS No. 131
is effective for financial statements for periods beginning after December 15,
1997. In the initial year of application, comparative information for earlier
years is to be restated. SFAS No.
11
<PAGE> 13
131 need not be applied to interim financial statements in the year of adoption,
but comparative information is required in the second year of application. The
Company has not determined whether the adoption of SFAS No. 131 will have a
material impact upon the Company's financial reporting.
In April 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-up
Activities." SOP 98-5 requires that costs of start-up activities, including
organization costs and club openings, be expensed as incurred. SOP 98-5 is
effective for financial statements for fiscal years beginning after December 15,
1998. Restatement of previously issued financial statements is not permitted. In
the fiscal year SOP 98-5 is first adopted, the application should be reported as
a cumulative effect of a change in accounting principle. The Company has not yet
determined whether the application of SOP 98-5 will have a material impact upon
the Company's financial position or results of operations.
YEAR 2000 DISCLOSURE
The Company recognizes the need to ensure its operations will not be
adversely impacted by Year 2000 software failures. Software failures due to
processing errors potentially arising from calculations using the Year 2000 date
are a known risk. The Company is in the process of replacing its membership
systems that are not Year 2000 compliant. The goal is to implement a new system
that is Year 2000 compliant with improved integrated functionality. With this
new system project, the Company is upgrading its information-system
infrastructure including wide and local-area networks and new personal computers
at all the Clubs.
In order to reduce exposure to Year 2000 risk, the Company is also
modifying the current membership system to be Year 2000 compliant. The
modifications are expected to be done by the second quarter of 1999. Therefore,
the Company's membership system Year 2000 compliance does not solely rely on the
completion of the new system project.
The financial accounting systems are also being upgraded to Year 2000
compliance, with completion expected in March 1999. The Company has upgrade and
replacement plans for other non-critical systems including personal computer
applications and retail point of sale. The Company is also investigating the
Year 2000 status on non-information technology systems including phone, voice
mail, security and building operations systems. The Company is not currently
aware of any Year 2000 compliance issues from third party vendors. There is no
assurance, however, that third party vendors' Year 2000 non-compliance issues or
the Company's inability to complete its modifications on the membership systems
will not have an adverse effect on the Company.
FORWARD LOOKING STATEMENTS
The foregoing discussion contains forward-looking statements relating to
the future operations of the Company, including Reebok Sports Club/NY, estimated
development and acquisition costs for new and acquired clubs, the adequacy of
the Company's cash and financing facilities for its anticipated requirements,
and other matters. These forward-looking statements are based on a series of
projections and assumptions regarding the economy, other statements that are not
historical facts, the Company's operations and the sports and fitness industry
in general. These projections and assumptions involve certain risks and
uncertainties that could cause actual results to differ materially from those
included in the forward-looking statements. Furthermore, actual results may
differ from projected results due to unforeseen developments relating to demand
for the Company's services and competitive pricing trends in the health and
fitness market; increased expenses; the availability of financing; the success
of planned advertising, marketing and
12
<PAGE> 14
promotional campaigns; changes in personnel or compensation; business
interruptions resulting from earthquakes, landlord disputes or other causes;
general market acceptance of new and existing Clubs operated by the Company;
changes in membership growth patterns; the success of new products; and
regulatory or legal proceedings and rulings which might adversely affect the
Company. Investors are also directed to consider other risk and uncertainties
discussed in all documents filed by the Company with the SEC. The Company
expressly disclaims any obligation to update any forward-looking statements as a
result of developments after the date hereof.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 1, 1998, the Company agreed to pay ST Institute of California
("STI") approximately $660,000 to settle litigation relating to performance
payments under an asset purchase agreement with SportsMed. The settlement
relates to a suit filed by STI against the Company alleging damages for breach
of contract, conversion, fraud, negligent misrepresentation and civil
conspiracy. STI had claimed damages in excess of $4.0 million.
The settlement was completed with payment made on April 3, 1998.
On or about May 4, 1998, Bally Total Fitness Holding Corporation
("Bally") commenced an action against the Company in New York state court
seeking injunctive relief and damages in connection with the management
agreement between Bally and Hilton, the Company's predecessor as owner of the
Vertical Club in New York City. Shortly thereafter, the court entered an
injunction preventing the Company from terminating the management agreement or
acting pursuant to the management agreement. On May 22, the Company applied for
clarification of the injunction and the court issued an order providing that the
injunction was issued to maintain the status quo during the pendency of the
suit. Bally is seeking damages arising out of the assignment of the management
agreement from Hilton to the Company in connection with the purchase of the
Vertical Club. The Company has filed an appeal to the injunction ruling, which
was heard in October. A decision is expected in 4-6 weeks.
Discovery has just commenced in the action.
For information concerning other legal proceedings, see Item 3 of the
Company's annual report on Form 10-K for the year ended December 31, 1997 (SEC
File Number 1-13290).
ITEM 2. CHANGES IN SECURITIES
The Company's Registration Statement on Form S-2, File No. 333-46973
registering 6,900,000 shares of the Company's common stock under the Securities
Act was declared effective by the Securities and Exchange Commission on April 1,
1998, and a public offering of those shares commenced thereafter. 6,800,000
shares were registered on behalf of the Company and 100,000 shares were
registered on behalf of certain selling stockholders. The underwriters included
Schroder & Co. as lead manager and Prudential Securities Incorporated and Sutro
& Co. Incorporated as co-managers. The Company sold 6,500,000 shares of common
stock in the offering with an aggregate offering price of $52.0 million
including 500,000 shares of common stock sold upon the exercise of the
underwriters' over allotment option, and certain stockholders of the Company
sold 100,000 shares of common stock with an aggregate offering price of $800,000
upon exercise of the underwriter's over allotment option. The aggregate offering
price of all shares sold was $52.8 million. If all of the shares which were
registered were sold, the aggregate offering price would have been $55.2
million.
The proceeds received by the Company from the offering were $48.7
million after deducting aggregate estimated expenses paid by the Company of $3.2
million consisting of $2.6
13
<PAGE> 15
million for underwriting discounts and commission and estimated expenses of
$600,000 for legal, accounting, printing and other filing related fees and
costs. Approximately $36.9 million of the net proceeds have been used to repay
indebtedness, approximately $6.7 million has been used to repurchase shares of
the Company's common stock and the balance was used to provide funds for
developments and for general corporate purposes. Of the net proceeds used for
business acquisitions, $1.0 million was paid to RM Sports Club, Inc., a
corporation owned and controlled by D. Michael Talla, Chairman and Chief
Executive Officer of the Company, and Rex Licklider, Vice Chairman of the
Company, which as of April 1, 1998, entered into an agreement to purchase the
Vertical Club in New York and had funded a $1.0 million deposit in connection
therewith. On April 15, 1998, RM Sports Club, Inc. transferred its rights under
such agreement to the Company for $1.0 million and the Company acquired the
Vertical Club. See "Management's Discussion and Analysis of Financial Condition
and Results of Operation -- Liquidity and Capital Resources."
On September 29, 1998, the Company declared a dividend distribution of
one right (a "Right") for each outstanding share of Common Stock, $.01 par value
(each, a "Common Share"), of the Company to stockholders of record at the close
of business on October 6, 1998. The Rights are designed to enable the Board of
Directors to act effectively on behalf of stockholders in response to any
takeover bid. Currently, the Rights trade with and are represented by the
certificates representing the Company's common stock, and may not be exercised.
In the event any person becomes, or commences a tender offer which would result
in such person becoming, the beneficial owner of 15% or more of the Company's
common stock, each Right (other than a Right held by the 15% stockholder) will
become exercisable, generally ten business days following such event, to
purchase common stock or other securities of the Company having a market value
equal to two times the then current exercise price (initially $20). Existing
shareholders holding more than 15% of the outstanding common stock will not
trigger the Rights unless such shareholders acquire beneficial ownership of
additional shares. The Rights expire on September 29, 2008 (unless previously
triggered), and are subject to redemption by the Board of Directors at $.001 per
Right at any time prior to the first date upon which they become exercisable.
The description and terms of the Rights are set forth in Rights Agreement (the
"Rights Agreement") between the Company and American Stock Transfer & Trust
Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1998 Annual Meeting of Stockholders of the Company was held on July
31, 1998. The following matters were submitted to stockholders for a vote:
1. Election of Andrew L. Turner as a Class I director to serve until
the 2001 annual meeting of stockholders or until his successor is
elected and has qualified.
<TABLE>
<CAPTION> Shares Voted
For Withheld authority
--- ------------------
<S> <C>
16,938,119 4,625
</TABLE>
Election of John M. Gibbons as a Class I director to serve until
the 2001 annual meeting of stockholders or until his successor is
elected and has qualified.
14
<PAGE> 16
<TABLE>
<CAPTION>
Shares Voted
For Withheld authority
--- ------------------
<S> <C>
16,938,119 4,625
</TABLE>
Election of Brian J. Collins as a Class I director to serve until
the 2001 annual meeting of stockholders or until his successor is
elected and has qualified.
<TABLE>
<CAPTION>
Shares Voted
For Withheld authority
--- ------------------
<S> <C>
16,710,150 232,594
</TABLE>
2. To amend and restate the Company's 1994 Incentive Stock Plan to
(i) increase the number of shares of common stock that may be
issued or sold under the Stock Option Plan from 1,000,000 to
1,800,000 and (ii) modify certain other provisions.
<TABLE>
<CAPTION>
Shares Voted
For Against Abstentions
--- ------- -----------
<S> <C> <C>
14,266,411 2,561,033 115,300
</TABLE>
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following reports on Form 8-K have been filed since July 1, 1998:
On September 29, 1998, the Company filed a Form 8-K relating to the
distribution of Rights described in Item 2.
15
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
<TABLE>
<S> <C>
THE SPORTS CLUB COMPANY, INC.
Date: November 12, 1998 by /s/ David Michael Talla
---------------------------------
David Michael Talla
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: November 12, 1998 by /s/ Timothy M. O'Brien
---------------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and
Accounting Officer)
</TABLE>
16
<TABLE> <S> <C>
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<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,875
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<INVENTORY> 1,440
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<PP&E> 136,923
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0
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<COMMON> 209
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<TOTAL-LIABILITY-AND-EQUITY> 154,657
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