<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 JUNE 30, 1999
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 August 10, 1999
- ----------------------------------- -------------------------------------
Common Stock, 17,702,087
par value $.01 per share
<PAGE> 2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND JUNE 30, 1999
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, June 30,
ASSETS 1998 1999
---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,233 $ 56,886
Accounts receivable, net of allowance for doubtful accounts
of $215 and $254 at December 31, 1998 and June 30, 1999 2,480 1,992
Inventories 1,527 1,648
Other current assets 569 733
Due from affiliates 234 263
----------- -----------
Total current assets 7,043 61,522
Property and equipment, at cost, net of accumulated depreciation and
amortization of $12,520 and $15,053 at December 31, 1998 and June 30, 1999 138,485 149,336
Equity interest in unconsolidated subsidiary 1,295 1,130
Costs in excess of net assets acquired, less accumulated amortization
of $1,294 and $1,534 at December 31, 1998 and June 30, 1999 15,443 15,203
Other assets, at cost, net 1,491 8,577
----------- -----------
$ 163,757 $ 235,768
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of notes payable and capitalized
lease obligations $ 7,746 $ 4,813
Accounts payable 2,273 1,884
Accrued liabilities 6,227 8,984
Deferred membership revenues 9,953 11,072
----------- -----------
Total current liabilities 26,199 26,753
Notes payable and capitalized lease obligations,
less current installments 18,755 104,914
Notes payable to bank 10,940 3,080
Deferred lease obligations 2,724 3,236
Minority interest 600 600
----------- -----------
Total liabilities 59,218 138,583
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;
20,896,623 shares issued and outstanding at
December 31, 1998 and June 30, 1999 209 209
Additional paid-in capital 102,361 102,361
Retained earnings 9,656 10,506
Less: Treasury stock, at cost, 1,258,691 and 3,194,536 shares at
December 31, 1998 and June 30, 1999 (7,687) (15,891)
------------ ------------
Total shareholders' equity 104,539 97,185
----------- -----------
$ 163,757 $ 235,768
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 1998 AND 1999
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1999 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues $ 20,346 $ 22,203 $ 39,963 $ 44,037
Operating expenses:
Direct 14,127 15,222 28,015 30,366
Selling, general and administrative 2,057 2,416 4,089 4,658
Depreciation and amortization 1,236 1,558 2,439 3,088
Pre-opening expenses -- 460 -- 708
-------- ---------- ---------- ----------
Total operating expenses 17,420 19,656 34,543 38,820
-------- ---------- ---------- ----------
Income from operations 2,926 2,547 5,420 5,217
Other income (expense):
Net interest expense (296) (2,197) (1,228) (2,437)
Minority interests (38) (37) (75) (75)
Equity interest in net income of unconsolidated subsidiary 212 263 392 526
Non-recurring charge -- (17) -- (205)
-------- ---------- ---------- -----------
Income before income taxes, extraordinary charge and
cumulative effect of change in accounting principle 2,804 559 4,509 3,026
Income tax provision 1,093 260 1,768 1,277
-------- ---------- ---------- ----------
Income before extraordinary charge and cumulative
effect of change in accounting principle 1,711 299 2,741 1,749
Extraordinary charge, net of income tax benefit of $1,331 2,173 -- 2,173 --
Cumulative effect of change in accounting principle,
net of income tax benefit of $600 -- -- -- 899
Net income (loss) $ (462) $ 299 $ 568 $ 850
========= ========== ========== ==========
Income per share before extraordinary charge and cumulative effect of change in
accounting principle:
Basic $ 0.08 $ 0.02 $ 0.16 $ 0.09
======== ========== ========== ==========
Diluted $ 0.08 $ 0.02 $ 0.16 $ 0.09
======== ========== ========== ==========
Effect of extraordinary charge and cumulative effect of change in accounting
principle:
Basic $ (0.10) $ -- $ (0.13) $ (0.04)
========= ========== ========== ===========
Diluted $ (0.10) $ -- $ (0.13) $ (0.04)
========= ========== ========== ===========
Net income (loss) per share:
Basic $ (0.02) $ 0.02 $ 0.03 $ 0.05
========= ========== ========== ==========
Diluted $ (0.02) $ 0.02 $ 0.03 $ 0.05
========= ========== ========== ==========
Weighted average shares outstanding:
Basic 20,448 18,016 17,351 18,530
======== ========== ========== ==========
Diluted 20,448 18,180 17,641 18,696
======== ========== ========== ==========
</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
SIX MONTHS ENDED JUNE 30, 1998 AND 1999
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
June 30,
1998 1999
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 568 $ 850
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary charge from early extinguishment of debt 2,173 --
Cumulative effect of change in accounting principle -- 899
Depreciation and amortization 2,439 3,088
Equity interest in net income of unconsolidated subsidiary (392) (526)
Distributions from unconsolidated subsidiary 446 691
Stock issued for employee benefit plan 67 153
(Increase) decrease in:
Accounts receivable, net (370) 488
Inventories (502) (121)
Other current assets 990 (164)
Due from affiliates 21 (29)
Increase (decrease) in:
Accounts payable 1,039 (389)
Accrued liabilities (2,554) 3,357
Deferred membership revenues 1,190 1,119
Deferred lease obligations 1,473 512
----------- ------------
Net cash provided by operating activities 6,588 9,928
Cash flows from investing activities:
Capital expenditures (15,769) (19,908)
Acquisition of membership base -- (902)
Proceeds from sale of Spectrum Club - Santa Ana -- 5,613
Stock re-purchase (2,023) (8,357)
------------ -------------
Net cash used in investing activities (17,792) (23,554)
Cash flows from financing activities:
Exercise of employee stock options 36 --
Proceeds from sale of Common Stock 48,774 --
Proceeds from Senior Secured Notes - net of costs and discount -- 93,713
Proceeds from notes payable and capital lease obligations -- 25,613
Repayments of notes payable and capital lease obligations (32,331) (51,047)
------------ --------------
Net cash provided by financing activities 16,479 68,279
----------- -------------
Net increase in cash and cash equivalents 5,275 54,653
Cash and cash equivalents at beginning of period 1,581 2,233
----------- -------------
Cash and cash equivalents at end of period $ 6,856 $ 56,886
=========== =============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 1,641 $ 1,033
=========== =============
Cash paid for income taxes $ 2,265 $ 1,512
=========== =============
Capital expenditures financed $ 3,950 $ 800
=========== =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 5
THE SPORTS CLUB COMPANY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND JUNE 30, 1999
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, 1998,
consolidated financial statements and notes thereto, included in the Company's
Annual Report on Form 10-K (SEC File Number 1-13290). Certain information and
footnote disclosures which are normally included in financial statements
prepared in accordance with 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 six-month
period ended June 30, 1999, are not necessarily indicative of the results for
the fiscal year ending December 31, 1999.
2. CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. On June 30, 1999, our
cash and cash equivalents balance was $56.9 million, of which $54.8 million has
been segregated into a disbursement escrow account and is specifically
designated for the development of new clubs.
3. NOTES PAYABLE AND CAPITALIZED LEASE OBLIGATIONS
On April 1, 1999, the Company issued in a private placement $100.0
million of Senior Secured Notes (the "Senior Secured Notes") with interest due
semi-annually beginning September 15, 1999. The Senior Secured Notes bear
interest at an annual rate of 11 3/8% and are due in March 2006. The Company
used $37.6 million of the proceeds to repay existing indebtedness. The balance
will be used to develop new Clubs and for general corporate purposes. In May
1999, the Company made an Exchange Offer to exchange the Senior Secured Notes
for registered Series B Senior Secured Notes. All Senior Secured Notes were
exchanged for the Series B Notes.
The Senior Secured Notes are secured by substantially all of the
Company's assets, other than certain excluded assets. In connection with the
issuance of the Senior Secured Notes, the Company entered into an indenture
dated as of April 1, 1999 (the "Indenture") which includes certain covenants
which limit the Company's ability, subject to certain exceptions, to: (i) incur
additional indebtedness; (ii) pay dividends or other distributions, repurchase
capital stock or other equity interest or subordinated indebtedness; (iii) enter
into transactions with affiliates; (iv) make investments; (v) create liens or
sell certain assets and (vi) enter into mergers and consolidations.
4
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Under the terms of the Indenture, after March 15, 2003, the Company
may, at its option, redeem all or some of the Senior Secured Notes at a
redemption price that will decrease over time from 105.688% to 100% of their
face amount, plus interest. Prior to March 15, 2002, if the Company publicly
offers certain equity securities the Company may, at its option, apply certain
of the net proceeds from those transactions to the redemption of up to 35% of
the principle amount of the Senior Secured Notes at 111.375% of their face
amount, plus interest. If the Company undergoes a change in control, as defined
in the Indenture, it must give holders of the Senior Secured Notes the
opportunity to sell their Senior Secured Notes to the Company at 101% of their
face amount, plus interest.
Notes payable and capitalized lease obligations are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
------------ ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Senior Secured Notes...................................... $ -- $ 100,000
The Sports Club/Irvine note (1)........................... 4,375 --
Note payable (2).......................................... 2,667 2,667
Spectrum Club-Agoura Hills note (1)....................... 2,506 --
Spectrum Clubs Fullerton and Santa Ana
lease obligations (1).................................. 9,745 --
Equipment financing and
capitalized lease obligations.......................... 7,208 7,060
------------ ------------
26,501 109,727
Less current installments................................. 7,746 4,813
------------ ------------
$ 18,755 $ 104,914
============ ============
</TABLE>
- ----------------------
(1) These obligations were repaid with the proceeds from the issuance of the
Company's Senior Secured Notes.
(2) This note was issued in connection with the acquisition of The Sports
Club/LA site at 61st and 1st Street in New York.
4. BANK CREDIT FACILITY
On April 1, 1999, concurrent with the offering of the Senior Secured
Notes, the Company restated and amended its bank credit facility and all loans
outstanding under the bank credit facility were repaid. The credit facility now
provides for revolving loans and letters of credit aggregating $20.0 million
($12.5 million pending the satisfaction of certain conditions). Borrowings under
the credit facility are secured by a first priority lien on substantially all of
the real and personal property assets of certain Sports Clubs and Spectrum Clubs
and bear interest at a variable rate of LIBOR plus 2 1/2% or the agent's prime
rate. The facility matures on May 31, 2001. The agreement also requires the
Company to maintain certain Tangible Net Worth, Debt Coverage Ratios and Senior
Liabilities to Tangible Net Worth Ratio requirements. At June 30, 1999, $3.1
million was outstanding under the credit facility and an additional $4.0 million
was utilized in the form of a letter of credit.
5
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5. NET INCOME PER SHARE
Basic earnings per share represents net earnings divided by the
weighted-average number of shares of Common Stock 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 six months ended June 30, 1998
and 1999, 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 stock options.
6. 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.
7. NEW ACCOUNTING PRONOUNCEMENTS
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. The Company adopted SOP 98-5 effective January 1, 1999 and
recorded a one-time cumulative effect of a change in accounting principle charge
of $899,000, net of tax. $460,000 of Club pre-opening expenses were incurred and
charged to operations in the three months ended June 30, 1999 and $708,000 was
charged to operations in the six months ended June 30, 1999.
The Company adopted Statement of Position 98-1 "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1")
effective January 1, 1999. SOP 98-1 provides guidance as to appropriate
treatment of internal use software costs that are acquired or internally
developed. The application of SOP 98-1 did not have a material impact on the
Company's financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with our
condensed consolidated financial statements and notes thereto appearing
elsewhere in this Form 10-Q. Our consolidated financial statements reflect the
operations of The Sports Clubs, the Spectrum Clubs and The SportsMed Company,
Inc. ("SportsMed"). We account for the Spectrum Club-Manhattan Beach under the
equity method of accounting.
RESULTS OF OPERATIONS
Comparison of Three Months Ended June 30, 1999 to Three Months Ended
June 30, 1998
Our revenues for the three months ended June 30, 1999, were $22.2
million, compared to $20.3 million in 1998, an increase of $1.9 million or 9.1%.
An increase of $1.2 million resulted from our opening of the Spectrum Club -
Thousand Oaks in February 1999 and a decrease of $500,000 resulted from the sale
of the Spectrum Club - Santa Ana in April 1999. Revenue growth of $1.2 million
occurred at our other Clubs and SportsMed.
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<PAGE> 8
Our direct operating expenses increased by $1.1 million to $15.2
million in the three months ended June 30, 1999, versus $14.1 million for the
same period in 1998. Direct expenses increased primarily due to our opening of
the Spectrum Club - Thousand Oaks in February 1999 and general cost increases at
other Clubs. Our direct operating expenses as a percentage of revenues decreased
to 68.6% for the three months ended June 30, 1999 compared to 69.4% in 1998,
primarily due to the positive effect of the operating margins at our Spectrum
Club - Thousand Oaks.
Our selling, general and administrative expenses were $2.4 million in
the three months ended June 30, 1999, versus $2.1 million for the same period in
1998. Selling costs increased approximately $162,000 primarily due to expenses
incurred at recently acquired or opened Clubs. Our general and administrative
costs increased by $197,000 primarily because we added additional corporate
overhead to support the development of new Clubs and our overall growth.
Our depreciation and amortization expenses were $1.6 million for the
three months ended June 30, 1999, versus $1.2 million for the same period in
1998. The increase is due primarily to additional depreciation and amortization
as a result of capital improvements made at Clubs acquired in 1997 and the
opening of the Spectrum Club - Thousand Oaks. Pre-opening expenses were $460,000
for the three months ended June 30, 1999. Effective January 1, 1999 we are
expensing pre-opening costs in the period they are incurred; previously these
costs were deferred until the opening of the related Club.
We incurred net interest expense of $2.2 million in the three months
ended June 30, 1999, versus $296,000 for the same period in 1998. Net interest
expense increased substantially as a result of the issuance of $100.0 million of
Senior Secured Notes on April 1, 1999 (See Note 3 to Condensed Consolidated
Financial Statements). The Notes bear interest at an annual rate of 11 3/8%.
Equity interest in net income of unconsolidated subsidiary was $263,000
for the three months ended June 30, 1999 versus $212,000 in 1998. These amounts
are associated with our investment in the Spectrum Club-Manhattan Beach
operations.
The non-recurring charge of $17,000 reflects additional expenses
associated with our sale of the Spectrum Club - Fountain Valley on February
15, 1999.
Our estimated federal and state income tax rate is 40% for the three
months June 30, 1999 and 1998, resulting in net income of $299,000 for the three
months ended June 30, 1999, and a net loss of $462,000 for the same period in
1998. The overall income tax rate is higher due to the New York City income tax
associated with the Reebok Sports Club/NY. The net loss in the second quarter of
1998 included a $2.2 million charge on the early retirement of debt, which was
recorded net of the related income tax benefit of $1.3 million.
Comparison of Six Months Ended June 30, 1999 to Six Months Ended June 30, 1998
Our revenues for the six months ended June 30, 1999, were $44.0
million, compared to $40.0 million in 1998, an increase of $4.0 million or
10.2%. An increase of $2.4 million resulted from our opening of the Spectrum
Club - Thousand Oaks in February 1999 and a decrease of approximately $600,000
resulted from the sale of the Spectrum Club - Santa Ana in April 1999. Revenue
growth of $2.2 million occurred at our other Clubs and SportsMed.
Our direct operating expenses increased by $2.4 million to $30.4
million in the six months ended June 30, 1999, versus $28.0 million for the same
period in 1998. Direct expenses increased
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<PAGE> 9
primarily due to our opening of the Spectrum Club - Thousand Oaks in February
1999 and general cost increases at other Clubs. Our direct operating expenses as
a percentage of revenues decreased to 69.0% for the six months ended June 30,
1999 compared to 70.1% in 1998, primarily due to the positive effect of the
operating margins at our Spectrum Club - Thousand Oaks and Reebok Sports
Club/NY.
Our selling, general and administrative expenses were $4.7 million in
the six months ended June 30, 1999, versus $4.1 million for the same period in
1998. Selling costs increased approximately $225,000 primarily due to expenses
incurred at recently acquired or opened Clubs. Our general and administrative
costs increased by $345,000 because we added additional corporate overhead to
support the development of new Clubs and our overall growth.
Our depreciation and amortization expenses were $3.1 million for the
six months ended June 30, 1999, versus $2.4 million for the same period in 1998.
The increase is due primarily to additional depreciation and amortization as a
result of capital improvements made at Clubs acquired in 1997 and the opening of
the Spectrum Club - Thousand Oaks. Pre-opening expenses were $708,000 for the
six months ended June 30, 1999. Effective January 1, 1999 we are expensing
pre-opening costs in the period they are incurred; previously these costs were
deferred until the opening of the related Club.
We incurred net interest expense of $2.4 million in the six months
ended June 30, 1999, versus $1.2 million for the same period in 1998. Net
interest expense increased substantially as a result of the issuance of $100.0
million of Senior Secured Notes on April 1, 1999 (See Note 3 to Condensed
Consolidated Financial Statements). The Notes bear interest at an annual rate of
11 3/8%.
Equity interest in net income of unconsolidated subsidiary was $526,000
for the six months ended June 30, 1999 versus $392,000 in 1998. These amounts
are associated with our investment in the Spectrum Club-Manhattan Beach
operations.
The non-recurring charge of $205,000 reflects expenses associated with
our sale of the Spectrum Club - Fountain Valley on February 15, 1999.
Our estimated federal and state income tax rate is 40% for the six
months ended June 30, 1999 and 1998, resulting in net income of $850,000 for the
six months ended June 30, 1999, and net income of $568,000 for the same period
in 1998. The overall income tax rate is higher due to the New York City income
tax associated with Reebok Sports Club/NY. Net income for the six months ended
June 30, 1999 included an $899,000 cumulative effect of change in accounting
principle, recorded net of the related income tax benefit of $600,000, which
relates to the write-off of pre-opening and start up costs capitalized prior to
January 1, 1999. Net income for the six months ended June 30, 1998 included a
$2.2 million charge on the early retirement of debt, which was recorded net of
the related income tax benefit of $1.3 million.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Credit Availability
On April 1, 1999, we issued in a private placement $100.0 million of 11
3/8% Senior Secured Notes due in March 2006 (the "Senior Secured Notes") with
interest due semi-annually beginning September 15, 1999. We used $37.6 million
of the proceeds to repay existing indebtedness. The balance will be used to
develop new Clubs and for general corporate purposes. The Senior Secured Notes
are secured by substantially all of the Company's assets, other than
8
<PAGE> 10
certain excluded assets. In connection with the issuance of the Senior Secured
Notes, the Company entered into an indenture dated as of April 1, 1999 (the
"Indenture") which includes certain covenants which limit the Company's ability,
subject to certain exceptions, to: (i) incur additional indebtedness; (ii) pay
dividends or other distributions, repurchase capital stock or other equity
interest or subordinated indebtedness; (iii) enter into transactions with
affiliates; (iv) make investments; (v) create liens or sell certain assets and
(vi) enter into mergers and consolidations.
Upon completion of the Senior Secured Note Offering, our bank credit
facility was reduced to $20.0 million ($12.5 million pending the satisfaction of
certain conditions) and the maturity date was extended to May 31, 2001. Advances
under our credit facility bear interest at a variable rate of LIBOR plus 2 1/2%
or the agent's prime rate. At June 30, 1999, $3.1 million was outstanding under
the credit facility and $4.0 million was utilized in the form of a letter of
credit, leaving $5.4 million available for future borrowings. Under the terms of
the Indenture, we are also allowed to incur an additional $2.9 million in
equipment financing. We generated $9.9 million of cash from operating activities
in the first six months of 1999. In April 1999, we sold the Spectrum Club -
Santa Ana for $5.6 million in cash. In the first six months of 1999, we invested
$16.1 million on new Club development projects and $3.8 million for capital
expenditures at existing locations. In the first six months of 1999, we
purchased $8.4 million of our Common Stock at an average price of $4.23 per
share. On June 30, 1999 our cash balance was $56.9 million. Of this amount $54.8
million has been segregated into a disbursement escrow account and is
specifically earmarked for the development of new Clubs.
New Club Development
In February 1998, we signed a lease with respect to the development of
the Sports Club/LA at Rockefeller Center in New York City. We have begun to
renovate the space and expect to commence pre-sale activities in September 1999
and to open the Club in the first quarter of 2000. We delivered a $4.0 million
letter of credit to the landlord to secure our performance under the lease
agreement. Based on current estimates, we expect to spend approximately $11.9
million from the disbursement escrow account to complete development of this
Club.
In April 1998, we acquired rights to develop the Sports Club/LA at 61st
and 1st Streets on the Upper East Side in New York City. We issued a
non-interest bearing note for $2.7 million to the seller, and are required to
pay principal in two equal installments in 1999 and 2000. Based on current
estimates, we expect to spend approximately $20.7 million from the disbursement
escrow account to complete development of this Club, which is expected to
commence pre-sale activities in September 1999 and open in the second quarter of
2000.
We have entered into lease agreements with Millennium Entertainment
Partners ("Millennium") with respect to the development of Sports Club/LA's in
San Francisco and Washington, D.C. and are negotiating a lease with Millennium
for a Sports Club/LA in Boston. Millennium began construction on each of these
projects in 1998. Our portion of the aggregate development costs for these Clubs
is currently estimated to be approximately $16.5 million. The construction
disbursement account has $9.0 million reserved for the Boston and Washington,
D.C. sites. Millennium and its affiliates own approximately 27% of our
outstanding Common Stock.
In June 1998, we acquired undeveloped land in Houston, Texas, for
approximately $3.1 million, on which we intend to develop a Sports Club/LA.
Construction at this location is not scheduled to begin until after the two new
Sports Club/LA's in New York City are open. Based on preliminary estimates, we
expect to spend approximately $19.3 million to complete development of this
Club.
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<PAGE> 11
We are developing two Spectrum Clubs on leased sites in Southern
California one of which opened on July 1, 1999 and the other will open in early
2000. Based on current estimates, we expect to spend approximately $2.0 million
to complete development of these Clubs.
Future Capital Requirements
In addition to the development projects described above, we incur
capital expenditures for normal replacement of fitness equipment and remodeling
of Clubs. Equipment financing and operating cash flow have funded these
expenditures. Amounts borrowed pursuant to equipment financing arrangements are
generally repayable in monthly installments over five years, with effective
interest rates between 8% and 10% per annum. While capital expenditures may
fluctuate from time to time, we generally expect to spend approximately 4% of
revenues on facility and equipment upgrades and replacements. We also expect to
spend approximately $1.8 million during the next 12 months to upgrade our
management information systems. The terms of the Indenture allow us to borrow an
additional $2.9 million for equipment financing. Operating cash flow will be
utilized for the remaining capital expenditures.
Our long-term capital needs are to provide funds for the developments
described above, for additional development and acquisition projects, to pay
interest on the Senior Secured Notes and for general corporate purposes. We
estimate that the cash in the disbursement escrow account, operating cash flows,
and credit to be available under our credit facility will be sufficient to fund
our capital expenditures in fiscal 1999 and 2000 on the projects currently under
development. Future acquisitions and developments will require additional
capital. Pursuant to the terms of the Indenture, we may borrow up to $20.0
million under our credit facility and up to $10.0 million through equipment
financing. In addition, if certain conditions are met, the terms of the
Indenture and our credit facility may permit us to incur additional
indebtedness. We may also consider entering into joint venture and partnership
agreements for the purpose of developing new Clubs, subject to the terms of the
Indenture and our credit facility.
YEAR 2000 DISCLOSURE
Until recently, computer programs were written to store only two digits
of date-related information in order to more efficiently handle and store data,
and thus are unable to distinguish between the year 1900 and the year 2000. This
problem is frequently referred to as the "Year 2000 Problem." We have initiated
a Year 2000 Project to bring all of our information technology ("IT") systems
and non-IT systems into Year 2000 compliance. Utilizing internal resources, we
are in the process of defining, assessing and converting, or replacing, various
programs, hardware and instrumentation systems to make them Year 2000 compliant.
Our IT systems include our computer equipment and software relating to
membership, financial accounting and sales of products and services. Non-IT
systems include our communications systems, alarm and security systems,
elevators and fitness equipment. Our Year 2000 Project focuses on three IT
component systems as well as non-IT systems.
Membership Systems. The software programs we currently use to store
membership and fee collection data and to process electronic funds transfers
("EFT") and credit card transactions are not Year 2000 compliant. We are
installing a new system which is Year 2000 compliant, which we expect to be in
service in 2000. Because we do not anticipate installing the new membership
system prior to the year 2000, we are also modifying our current membership
systems to be Year 2000 compliant. All major modifications to our current
membership systems were completed in the second quarter of 1999. We expect these
modified systems to be operational during the third quarter of 1999.
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<PAGE> 12
Financial Accounting Systems. The supplier of the installed version of
our financial accounting system has orally represented to us that the system is
Year 2000 compliant. In addition, we have installed a new version of this system
and are currently using one modual of the system and plan to have the second
modual in place during August, 1999. This newer version is certified in writing
to be Year 2000 compliant.
Other IT Systems. We are currently reviewing all other IT systems for
Year 2000 compliance. Our food and beverage, sports boutique sales, private
training and most other services and products systems are not Year 2000
compliant, but we expect to replace or modify these systems to be Year 2000
compliant during the third quarter of 1999.
Non-IT Systems. We have requested vendors of our non-IT systems to
advise us if such systems are Year 2000 compliant where we believe such
assurance to be necessary. We have received such assurances from vendors of
certain systems, such as elevators, and we do not believe that the failure of
other non-IT systems would have a material impact on us. We believe that we will
be able to replace or modify all significant non-IT systems which are not Year
2000 compliant by December 1999.
Expense of Year 2000 Project. We currently estimate that we will expend
approximately $2.9 million to acquire new hardware and other equipment, acquire
new membership software, upgrade our existing membership software, update our
financial accounting software and make the other modifications to our IT systems
described above. Most of these expenses would be incurred in order to upgrade
our membership and accounting systems in the ordinary course of business. Of
this amount, $1.1 million has been expended to date. This expenditure will
include new hardware and other equipment and software programs. We have not
determined what amounts we will expend to replace non-IT systems, but we do not
expect such costs to be material.
Third Party Systems. We believe that the only third parties whose Year
2000 problems would be likely to have a material effect on us are financial
institutions that process our EFT and credit card transactions. We believe that
these institutions have completed, or will complete prior to Year 2000,
modifications to their systems to insure Year 2000 compliance; however, we are
unable to test third party systems.
Risks of Year 2000 Problems. The failure to correct a material Year
2000 problem could interrupt our normal business activities or operations. We
believe that failures in our membership, financial accounting and food and
beverage systems, or performance by third parties with respect to EFT and credit
card transactions, could materially and adversely affect us. While we intend to
test systems supplied by third parties, such testing may not reveal all Year
2000 problems. With the exception of certain critical non-IT systems which we
have been assured are Year 2000 compliant, we do not believe that a failure of
other systems would have a material impact on us. Due to the general uncertainty
inherent in the Year 2000 problem, resulting in part from the uncertainty of the
Year 2000 readiness of third parties and the performance of systems represented
to us by vendors to be Year 2000 compliant, we are unable to determine at this
time whether Year 2000 failures will have a material impact on us. Although our
Year 2000 Project is not expected to significantly reduce our level of
uncertainty about Year 2000 problems, including the Year 2000 readiness of third
parties, we believe that completion of the Year 2000 Project will reduce the
possibility of significant interruptions of normal operations. A contingency
plan has not yet been developed for dealing with an interruption of a critical
system. We plan to develop and implement such a plan in the fourth quarter of
1999.
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<PAGE> 13
The costs of our Year 2000 Project and the dates on which we believe we
will complete the various phases of our Year 2000 Project are based upon our
management's best estimates, which were derived using numerous assumptions
regarding future events, including the continued availability of certain
resources, third party remediation plans and other factors. There can be no
assurance that these estimates will prove to be accurate, and actual results
could differ materially from those currently anticipated. Specific factors that
could cause such material differences include, but are not limited to, the
availability and cost of personnel trained in Year 2000 issues, the ability to
identify, assess, remediate and test all relevant computer code and imbedded
technology, performance of new systems and equipment, the reduction of
productivity pending completion of employee training, the need to remediate
problems caused by failures in Year 2000 compliance by third parties and similar
uncertainties.
FORWARD LOOKING STATEMENTS
From time to time we make "forward-looking statements" within the
meaning of Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934. Forward-looking statements include the words "may,"
"will," "estimate," "continue," "believe," "expect" or "anticipate" and other
similar words. The forward-looking statements are generally located in the
material set forth under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations" but may be found in other
locations as well. Forward-looking statements may also be found in our other
reports filed with the Securities and Exchange Commission and in our press
releases and other statements. These forward-looking statements generally relate
to our plans and objectives for future operations and are based upon
management's reasonable estimates of future results or trends. Although we
believe that our plans and objectives reflected in or suggested by such
forward-looking statements are reasonable, such plans or objectives may not be
achieved. Actual results may differ from projected results due to unforeseen
developments including developments relating to the following:
o the availability and adequacy of our cash flow and financing
facilities for our requirements, including payment of the
Senior Secured Notes,
o our ability to attract and retain members, which depends on
competition, market acceptance of new and existing sports and
fitness clubs and services, demand for sports and fitness club
services generally and competitive pricing trends in the
sports and fitness market,
o our ability to successfully develop new sports and fitness
clubs,
o disputes or other problems arising with our development
partners or landlords,
o changes in economic, competitive, demographic and other
conditions in the geographic areas in which we operate,
including business interruptions resulting from earthquakes or
other causes,
o competition,
o changes in personnel or compensation,
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<PAGE> 14
o changes in statutes and regulations or legal proceedings and
rulings, and
o Year 2000 uncertainties.
We will not update forward-looking statements even though our situation will
change in the future.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
MKDG/Rhodes SC Partnership and Sports Club, Inc. vs. Agricultural
Insurance Company (Los Angeles Superior Court). At the time of the Northridge
earthquake on January 17, 1994, Agricultural Insurance Company ("Agricultural")
provided certain excess earthquake coverage for The Sports Club/LA which was
owned by a limited partnership in which MKDG/Rhodes SC Partnership ("MKDG") and
Sports Club, Inc. were general partners and D. Michael Talla and TTO Partners
were limited partners. Each of the partners in the limited partnership was named
as an insured under the policy issued by Agricultural (the "Policy"). The
Company's predecessors (the "SCLA Parties") assigned to MKDG all of their rights
to payment under the Policy and retained no interest in any amounts paid by
Agricultural.
A dispute between MKDG and Agricultural arose under the Policy
because Agricultural would not pay the approximate $2,000,000 unpaid balance of
the Policy. MKDG filed a complaint against Agricultural, and Agricultural filed
a cross-complaint against MKDG and the SCLA Parties, alleging intentional
misrepresentation (fraud), negligent misrepresentation, breach of contract,
tortuous breach of implied covenant of good faith and fair dealing, rescission,
money had and received, declaratory judgment and indemnity in which Agricultural
sought the return of amounts paid (approximately $3.0 million) plus punitive
damages and attorneys fees. A demurrer was sustained without leave to amend as
to all claims other than for breach of contract and declaratory relief.
Agricultural filed a Petition for Writ of Mandate, seeking to set
aside the trial court's ruling. In a decision which became final in May 1999,
the Court of Appeal has granted the Writ of Mandate in part and denied it in
part, holding that Agricultural has no cause of action for tortuous breach of
the covenant of good faith and fair dealing and, hence, no claim for attorneys'
fees. The Court of Appeal also held that Agricultural had no claim for negligent
misrepresentation which it noted would encompass the same damages as those
sought in Agricultural's breach of contract claim. However, the Court of Appeal
also held that Agricultural should be permitted to amend its cross-complaint to
specifically allege the fraud it claims was committed by the insured and any
damages it claims to have suffered as a result of the alleged fraud.
After receipt of the Writ of Mandate, the trial court sustained
demurrers to Agricultural's fraud cause of action and granted leave to
Agricultural to amend its cross-complaint. A First Amended Cross-Complaint was
received by counsel for the Company on July 29, 1999, alleging causes of action
for intentional misrepresentation (fraud), breach of contract, breach of implied
covenant of good faith and fair dealing, rescission, money had and received,
declaratory judgment and indemnify. No specific amount of damages is claimed;
however, damages "according to proof at the time of trial" are claimed against
each of the SCLA Parties as well as punitive damages, interest, attorneys' fees,
expert costs, adjusters' fees, and other costs. The indemnity claim does not
seek any damages from the SCLA Parties. Counsel has not had the opportunity to
analyze the legal sufficiency of the new pleading.
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<PAGE> 15
In the interim, an appraisal proceeding was held in which the referee
found that the loss suffered by the insured was less than the policy proceeds
but greater than the amount paid by Agricultural to date. Agricultural contends
that portions of the appraised loss are not covered by the policy, an issue
which will be determined by the trial court. A Trial Setting Conference has been
scheduled for October 5, 1999.
We will seek to be indemnified by MKDG for all damages and costs
incurred in this action, although no assurance can be made that MKDG will
indemnify us.
OTR v Spectrum Club Liquidation, Inc. and The Sports Club Company,
Inc. (Orange County Superior Court). OTR and Spectrum Club Liquidation, Inc.
("SCLI") entered into a lease (the "Lease") with respect to a proposed
development site in Anaheim Hills, California, and The Sports Club Company, Inc.
("TSCC") guaranteed SCLI's obligations under the Lease. SCLI sought to rescind
the Lease and OTR brought the subject action for damages against SCLI for breach
of the Lease and against TSCC on the guarantee. OTR is seeking damages of
between $4,616,000 and $6,147,000.
It is the position of SCLI that the Lease was entered into as a
result of fraud or mistake and there are witnesses who have testified to this
effect. There is also a defense based upon OTR's alleged failure to reasonably
mitigate its damages. SCLI's experts have testified at their depositions that,
if OTR had reasonably attempted to mitigate its alleged damages, it would not
have suffered any loss as a result of SCLI's failure to proceed with the Lease.
The trial of this case is scheduled to commence on October 12, 1999.
Discovery has not been completed. Liability and damages are contested and the
outcome cannot be predicted at this time.
R.W. Management Group, Inc. v. Sequoia Athletic Club & Racquetball
World, et al. (Los Angeles Superior Court): On January 20, 1998, R.W. Management
Group ("RWMG") filed an action against various Racquetball World-related
entities and individuals (the "RBW Defendants"), the Spectrum Club Company, Inc.
("SCC"), and the Company, alleging, among other things, breach of contract,
breach of fiduciary duty and interference with contract. The complaint seeks
equitable relief (including a temporary restraining order, preliminary and
permanent injunction), unspecified compensatory damages, punitive damages and
attorneys' fees. The contract which RWMG alleges was breached (the "RWMG
Contract") relates to the Racquetball World Club located in Canoga Park, which
facility (the "Canoga Park Club") was acquired by SCC in December 1997. In
connection with that acquisition, SCC acquired the assets thereof and assumed
only certain designated liabilities, none of which related to the RWMG Contract;
all other obligations and liabilities associated with the Canoga Park Club were
retained by the seller. The Company and SCC successfully demurred to the
complaint and it was dismissed as to them in September 1998.
In May 1999, Norcan, an RBW Defendant and the entity from whom SCC
acquired the Canoga Park Club, filed and served a cross-complaint for indemnity
against SCC. Because the RWMG complaint relates to pre-acquisition conduct by
the RBW Defendants and not to conduct by SCC, the Company and SCC believe
Norcan's cross-compliant lacks any merit whatsoever. SCC has filed a demurrer to
the cross-complaint, which is scheduled for hearing on September 1, 1999.
Lyudmirsky, and those similarly situated v. Sports Club, Inc. of
California; LA/Irvine Sports Clubs Ltd. (Los Angeles Superior Court): On June
25, 1999, Ilya Lyudmirsky filed an action on behalf of himself and those
similarly situated against Sports Club, Inc. of California and
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<PAGE> 16
L.A./Irvine Sports Clubs Ltd. (collectively, the "Company") alleging, among
other things, violations of California Civil Code section 1812.80 et seq,
claiming the Company's membership fee structure and membership contracts violate
the provisions of the Contracts for Health Studio Services Act. Plaintiff
further alleges violations of California Civil Code sections 51 and 52, claiming
the Company gives unlawful, preferential discounts to attractive women in
violation of the Unruh Civil Rights Act. The complaint seeks equitable relief,
including a temporary and permanent injunction, as well as unspecified
compensatory damages, punitive damages and attorneys' fees. The Company has not
yet conducted any discovery into this action and is in the process of evaluating
Plaintiff's claims.
Other Matters. We are also involved in various claims and lawsuits
incidental to our business including claims arising from accidents. However, in
the opinion of management, we are adequately insured against claims and lawsuits
involving personal injuries, and any ultimate liability arising out of any such
proceedings will not have a material adverse effect on our financial condition,
cash flow or operations.
ITEM 2. CHANGES IN SECURITIES
Our ability to pay dividends with respect to our Common Stock is
restricted by the terms of the Indenture dated April 1, 1999, relating to our
Senior Secured Notes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The following reports on Form 8-K have been filed since April 1, 1999:
On April 1, 1999 we filed a report on Form 8-K regarding a private
offering of $100.0 million principal amount of 11 3/8% Senior Secured Notes due
in March 2006.
On June 7, 1999, we filed a report on Form 8-K regarding the
appointment of John Gibbons, the Company's President, as Chief Executive Officer
effective July 21, 1999. Mr. Gibbons succeeded D. Michael Talla who remains as
the Chairman of the Board of Directors.
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<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.
THE SPORTS CLUB COMPANY, INC.
Date: August 10, 1999 by /s/ John M. Gibbons
-----------------------------
John M. Gibbons
President and
Chief Executive Officer
(Principal Executive Officer)
Date: August 10, 1999 by /s/ Timothy M. O'Brien
-----------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and
Accounting Officer)
16
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