<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, 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.
<TABLE>
<CAPTION>
<S> <C>
Shares
Outstanding at
Class November 11, 1999
------------- ------------------
Common Stock, 17,703,753
par value $.01
</TABLE>
<PAGE> 2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND SEPTEMBER 30, 1999
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, September 30,
ASSETS 1998 1999
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,233 $ 55,373
Accounts receivable, net of allowance for doubtful accounts
of $215 and $183 at December 31, 1998 and September 30, 1999 2,480 2,239
Inventories 1,527 1,524
Other current assets 569 788
Due from affiliates 234 253
--------- ---------
Total current assets 7,043 60,177
Property and equipment, at cost, net of accumulated depreciation and
amortization of $12,520 and $16,527 at December 31, 1998 and September 30, 138,485 146,007
Equity interest in unconsolidated subsidiary 1,295 987
Costs in excess of net assets acquired, less accumulated amortization
of $1,294 and $1,655 at December 31, 1998 and September 30, 1999 15,443 15,082
Other assets, at cost, net 1,491 8,788
$ 163,757 $ 231,041
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of notes payable and capitalized
lease obligations $ 7,746 $ 4,857
Accounts payable 2,273 4,325
Accrued liabilities 6,227 5,990
Deferred membership revenues 9,953 10,429
--------- ---------
Total current liabilities 26,199 25,601
Notes payable and capitalized lease obligations,
less current installments 18,755 104,346
Notes payable to bank 10,940 -
Deferred lease obligations 2,724 3,155
Minority interest 600 600
--------- ---------
Total liabilities 59,218 133,702
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
Additional paid-in capital 102,361 102,361
Retained earnings 9,656 10,660
Less: Treasury stock, at cost, 1,258,691 and 3,194,536 shares at
December 31, 1998 and September 30, 1999 (7,687) (15,891)
--------- ---------
Total shareholders' equity 104,539 97,339
--------- ---------
$ 163,757 $ 231,041
========= =========
</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, 1998 AND 1999
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
1998 1999 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 20,682 $ 22,664 $ 60,645 $ 66,701
Operating expenses:
Direct 14,251 15,796 42,266 46,162
Selling, general and administrative 2,082 2,259 6,170 6,917
Depreciation and amortization 1,381 1,629 3,820 4,717
Pre-opening expenses -- 894 -- 1,602
-------- -------- -------- --------
Total operating expenses 17,714 20,578 52,256 59,398
-------- -------- -------- --------
Income from operations 2,968 2,086 8,389 7,303
Other income (expense):
Net interest expense (144) (1,998) (1,373) (4,435)
Minority interests (38) (38) (113) (113)
Equity interest in net income of unconsolidated subsidiary 227 260 619 786
Non-recurring charge -- -- -- (205)
-------- -------- -------- --------
Income before income taxes, extraordinary charge and
cumulative effect of change in accounting principle 3,013 310 7,522 3,336
Income tax provision 1,207 157 2,975 1,434
-------- -------- -------- --------
Income before extraordinary charge and cumulative
effect change in accounting principle, 1,806 153 4,547 1,902
Extraordinary charge, net of income tax benefit of $1,331 -- -- 2,173 --
Cumulative effect of change in accounting principle,
net of income tax benefit of $600 -- -- -- 899
-------- -------- -------- --------
Net income $ 1,806 $ 153 $ 2,374 $ 1,003
======== ======== ======== ========
Income per share before extraordinary charge and cumulative effect
Basic $ 0.09 $ 0.01 $ 0.25 $ 0.10
======== ======== ======== ========
Diluted $ 0.09 $ 0.01 $ 0.25 $ 0.10
======== ======== ======== ========
Effect of extraordinary charge and cumulative effect
Basic $ -- $ -- $ (0.12) $ (0.05)
======== ======== ======== ========
Diluted $ -- $ -- $ (0.12) $ (0.05)
======== ======== ======== ========
Net income per share:
Basic $ 0.09 $ 0.01 $ 0.13 $ 0.05
======== ======== ======== ========
Diluted $ 0.09 $ 0.01 $ 0.13 $ 0.05
======== ======== ======== ========
Weighted average shares outstanding:
Basic 20,036 17,702 18,255 18,251
======== ======== ======== ========
Diluted 20,209 17,912 18,494 18,431
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30,
----------------------
1998 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,374 $ 1,003
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 3,820 4,717
Equity interest in net income of unconsolidated subsidiary (619) (786)
Distributions from unconsolidated subsidiary 446 1,094
Stock issued for employee benefit plan -- 154
(Increase) decrease in:
Accounts receivable, net (308) 241
Inventories (627)
Other current assets (219)
Due from affiliates 40 (19)
Increase (decrease) in:
Accounts payable 370 2,052
Accrued liabilities (1,420) 363
Deferred membership revenues 723 476
Deferred lease obligations 2,190 431
-------- --------
Net cash provided by operating activities 8,665 10,409
Cash flows from investing activities:
Capital expenditures (19,107) (30,298)
Acquisition of membership base -- (902)
Proceeds from sale of Spectrum Clubs -- 17,613
Stock re-purchase (6,742) (8,357)
-------- --------
Net cash used in investing activities (25,849) (21,944)
Cash flows from financing activities:
Exercise of employee stock options 39 --
Proceeds from sale of Common Stock 48,706 --
Proceeds from Senior Secured Notes - net of costs and discount -- 93,713
Proceeds from notes payable and capital lease obligations 3,640 37,263
Repayments of notes payable and capital lease obligations (32,907) (66,301)
-------- --------
Net cash provided by financing activities 19,478 64,675
-------- --------
Net increase in cash and cash equivalents 2,294 53,140
Cash and cash equivalents at beginning of period 1,581 2,233
-------- --------
Cash and cash equivalents at end of period $ 3,875 $ 55,373
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 2,093 $ 6,266
======== ========
Cash paid for income taxes $ 2,012 $ 1,785
======== ========
Capital expenditures financed $ 3,950 $ 800
======== ========
</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, 1998 AND SEPTEMBER 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 nine-month
period ended September 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 September 30,
1999, cash and cash equivalents were $55.4 million, of which $44.4 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 exchanged the Senior Secured Notes for registered Series B
Senior Secured Notes.
The Senior Secured Notes are secured by substantially all of the
Company's assets, other than certain excluded assets. In connection with the
issuance of the Senior Secured Notes, the Company entered into an indenture
dated as of April 1, 1999 (the "Indenture") 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. The Company
was in compliance with the aforementioned covenants as of September 30, 1999.
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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, SEPTEMBER 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 6,536
------------ ------------
26,501 109,203
Less current installments................................. 7,746 4,857
------------ ------------
$ 18,755 $ 104,346
============ ============
</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.
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 September 30, 1999, $4.0 million was utilized in the form of a letter of
credit and no borrowings were outstanding. The Company was in compliance with
the aforementioned covenants as of September 30, 1999.
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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 nine months ended September
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. At September 30, 1999,
there were 494,000 anti-dilutive common stock equivalents.
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. Club pre-opening expenses incurred and charged to
operations were $894,000 and $1,602,000 in the three and nine months ended
September 30, 1999, respectively
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.
8. SALE OF SPECTRUM CLUBS
In September of 1999, the Company completed the sale and leaseback of
the real estate at the Spectrum Club - Thousand Oaks and realized $12.0 million
from that transaction.
On September 28, 1999, the Company announced it had reached an
agreement to sell the Spectrum Clubs, a group of ten sports and fitness clubs
located in Southern California, to investment group Brentwood Associates for
$48.4 million. The transaction is expected to close in November 1999.
The estimated gain on both transactions is anticipated to be between
$500,000 and $1.0 million.
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 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 September 30, 1999 to Three Months Ended
September 30, 1998
Our revenues for the three months ended September 30, 1999, were $22.7
million, compared to $20.7 million in 1998, an increase of $2.0 million or 9.6%.
An increase of $1.6 million resulted from our opening of the Spectrum Club -
Thousand Oaks and the Spectrum Club - Puente Hills in February 1999 and July
1999, respectively. A decrease of $748,000 resulted from the sale of the
Spectrum Club - Fountain Valley and the Spectrum Club - Santa Ana in January
1999 and April 1999 respectively. Revenue growth of $1.1 million occurred at our
other Clubs and SportsMed.
Our direct operating expenses increased by $1.5 million to $15.8
million in the three months ended September 30, 1999, versus $14.3 million for
the same period in 1998. Direct expenses increased primarily due to our opening
of the Spectrum Club - Thousand Oaks and the Spectrum Club - Puente Hills in
February 1999 and July 1999, respectively, and general cost increases at other
Clubs.
Our selling, general and administrative expenses were $2.3 million in
the three months ended September 30, 1999, versus $2.1 million for the same
period in 1998. Selling costs increased approximately $82,000 primarily due to
expenses incurred at recently acquired or opened Clubs. Our general and
administrative costs increased by $96,000 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 September 30, 1999, versus $1.4 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 and Spectrum Club - Puente
Hills in February and July 1999, respectively.
Pre-opening expenses were $894,000 for the three months ended September
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. Pre-opening expenses were $663,000 at new Sports Club/LA
developments and $231,000 at new Spectrum Club developments.
We incurred net interest expense of $2.0 million in the three months
ended September 30, 1999, versus $144,000 for the same period in 1998. Net
interest expense increased substantially as
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a result of the issuance of $100.0 million of Senior Secured Notes on April 1,
1999. The Notes bear interest at an annual rate of 11 3/8%.
Equity interest in net income of unconsolidated subsidiary was $260,000
for the three months ended September 30, 1999 versus $227,000 in 1998. These
amounts are associated with our investment in the Spectrum Club-Manhattan Beach
operations.
Our estimated federal and state income tax rate is 40% for the three
months ended September 30, 1999 and 1998, resulting in net income of $153,000
for the three months ended September 30, 1999, and a net income of $1,806,000
for the same period in 1998. The decrease in net income resulted primarily from
increased interest expense associated with the Senior Secured Notes, most of the
proceeds of which have been and will be invested in Clubs currently under
development. The overall income tax rate in 1999 is higher due to the New York
City income tax associated with Reebok Sports Club/NY.
Comparison of Nine Months Ended September 30, 1999 to Nine Months Ended
September 30, 1998
Our revenues for the nine months ended September 30, 1999, were $66.7
million, compared to $60.7 million in 1998, an increase of $6.0 million or
10.0%. An increase of $3.8 million resulted from our opening of the Spectrum
Club - Thousand Oaks and Spectrum Club - Puente Hills in February 1999 and July
1999, respectively. A decrease of $1.5 million resulted from our sale of the
Spectrum Club - Fountain Valley and the Spectrum Club -Santa Ana in January 1999
and April 1999 respectively. Revenue growth of $3.7 million occurred at our
other Clubs and SportsMed.
Our direct operating expenses increased by $3.9 million to $46.2
million in the nine months ended September 30, 1999, versus $42.3 million for
the same period in 1998. Direct expenses increased primarily due to our opening
of the Spectrum Club - Thousand Oaks and the Spectrum Club - Puente Hills in
February 1999 and July 1999, respectively, and to general cost increases at
other Clubs. Our direct operating expenses as a percentage of revenues decreased
to 69.2% for the nine months ended September 30, 1999 compared to 69.7% in 1998,
primarily due to the positive effect of the operating margins at our Spectrum
Club - Thousand Oaks and improved operating margins at Reebok Sports Club/NY.
Our selling, general and administrative expenses were $6.9 million in
the nine months ended September 30, 1999, versus $6.2 million for the same
period in 1998. Selling costs increased approximately $307,000 primarily due to
expenses incurred at recently acquired or opened Clubs. Our general and
administrative costs increased by $441,000 because we added additional corporate
overhead to support the development of new Clubs and our overall growth.
Our depreciation and amortization expenses were $4.7 million for the
nine months ended September 30, 1999, versus $3.8 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 and Spectrum Club - Puente Hills.
Pre-opening expenses were $1,602,000 for the nine months ended
September 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. Pre-opening expenses for the nine months ended
September 30, 1999 were $929,000 at new Sports Club/LA developments and $673,000
at new Spectrum Club developments.
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<PAGE> 10
We incurred net interest expense of $4.4 million in the nine months
ended September 30, 1999, versus $1.4 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. The Notes bear interest at an
annual rate of 11 3/8%.
Equity interest in net income of unconsolidated subsidiary was $786,000
for the nine months ended September 30, 1999 versus $619,000 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 nine
months ended September 30, 1999 and 1998, resulting in net income of $1,003,000
for the nine months ended September 30, 1999, and net income of $2,374,000 for
the same period in 1998. The overall income tax rate in 1999 is higher due to
the New York City income tax associated with Reebok Sports Club/NY. Net income
for the nine months ended September 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 nine months ended
September 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 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 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 September 30, 1999, no
borrowings were outstanding under the credit facility and $4.0 million was
utilized in the form of a letter of credit, leaving $16.0 million available for
future borrowings. Under the terms of the Indenture, we are also allowed to
incur an additional $3.5 million in equipment financing. We anticipate reducing
our bank credit facility to $15.0 million in November 1999 after completing the
sale of our Spectrum Clubs.
We generated $10.4 million of cash from operating activities in the
first nine months of 1999. In April 1999, we sold the Spectrum Club - Santa Ana
for $5.6 million in cash. In the first
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nine months of 1999, we invested $25.1 million on new Club development projects
and $5.2 million for capital expenditures at existing locations. In the first
nine months of 1999, we purchased $8.4 million of our Common Stock at an average
price of $4.23 per share. On September 30, 1999 our cash balance was $55.4
million. Of this amount $44.4 million has been segregated into a disbursement
escrow account and is specifically earmarked for the development of new Clubs.
Sale of Spectrum Clubs
We completed the sale and leaseback of the real estate at our Spectrum
Club - Thousand Oaks in September 1999 and realized $12.0 million from that
transaction. Of this amount, $2.0 million has been kept in escrow until we
complete construction of a parking structure. The remaining $10.0 million will
be placed in the disbursement escrow account and be earmarked for the
development of The Sports Club/LA projects.
As part of a strategy to focus on The Sports Club/LA line of Clubs, we
expect to complete our sale of the Spectrum Clubs in November 1999 for gross
proceeds of approximately $48.4 million. We will retire approximately $5.2
million of equipment financing obligations, complete various construction
projects at several of these Clubs and actively attempt to resolve any
litigation related to the Spectrum Clubs. We anticipate our net proceeds from
these transactions will be approximately $37.8 million. Under the terms of our
Indenture, the Company will be required, within 360 days of the Spectrum Club
sale, to make an offer to retire the Senior Secured Notes to the extent these
funds are not invested in assets related to our business.
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 are renovating the
space and commenced pre-sale activities in October 1999 and plan 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 $8.9 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 $25.6 million from the disbursement
escrow account to complete development of this Club, which commenced pre-sale
activities in September 1999. We currently expect to open this Club 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, Washington, D.C. and 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
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<PAGE> 12
preliminary estimates, we expect to spend approximately $19.3 million to
complete development of this Club.
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 $1.5 million during the next 12 months to upgrade our
management information systems. The terms of the Indenture currently allow us to
borrow an additional $3.5 million for equipment financing. If the sale of the
Spectrum Clubs is consummated as anticipated in November 1999, $8.7 million of
equipment financing will be available. 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. 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.
We estimate that the cash in the disbursement escrow account, proceeds
from the sale of our Spectrum Clubs, operating cash flows, and credit available
under our credit facility and equipment financing will be sufficient to fund our
capital expenditures in fiscal 1999 and 2000 on the projects currently under
development.
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 were not Year 2000 compliant. We are
installing a new system which is Year 2000 compliant, which we expect to be in
service late in the year 2000. Because the new membership system will
11
<PAGE> 13
not be installed prior to the year 2000, we have also modified our current
membership systems to be Year 2000 compliant. We have upgraded all membership
system computers, operating systems and program language to be year 2000
compliant. All major modifications to our current membership systems were
completed and installed at all our Clubs in the third quarter of 1999. We
continue to make various minor modifications to these systems. We expect all the
year 2000 programming and testing to be done during the fourth quarter of 1999.
Financial Accounting Systems. We recently installed a new version of
our financial accounting system. This new 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. A majority of our food and beverage, sports boutique
sales, private training and other services and products systems are Year 2000
compliant, and we expect to replace or modify the non-compliant systems to be
Year 2000 compliant by December 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, $1.4 million has been expended to date. 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. We plan to
develop and implement a contingency plan for dealing with an interruption of a
critical system in the fourth quarter of 1999.
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<PAGE> 14
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:
- the availability and adequacy of our cash flow and financing
facilities for our requirements, including payment of the Senior
Secured Notes,
- 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,
- our ability to successfully develop new sports and fitness clubs,
- disputes or other problems arising with our development partners
or landlords,
- 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,
- competition,
- changes in personnel or compensation,
13
<PAGE> 15
- changes in statutes and regulations or legal proceedings and
rulings, and
- Year 2000 uncertainties.
We will not update forward-looking statements even though our situation will
change in the future.
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<PAGE> 16
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. Certain of
our predecessors (the "SCLA Parties") were named insureds under the policy. The
Partners assigned to MKDG/Rhodes SC Partnership ("MKDG") all of their rights to
payment under the policy and retained no interest in any amounts paid by
Agricultural. A dispute arose under the policy, and MKDG filed a complaint
against Agricultural. Agricultural has filed a First Amended Cross-complaint
against MKDG and the SCLA Parties, alleging intentional misrepresentation
(fraud), breach of contract, breach of implied covenant of good faith and fair
dealing, rescission, money had and received, declaratory judgment and indemnity.
Agricultural seeks the return of amounts paid (approximately $3.0 million) plus
punitive damages and attorneys fees. A demurrer to the First Amended Complaint
will be heard on December 1, 1999. A trial setting conference is also scheduled
on that date.
An appraisal hearing found that the loss suffered 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 to be determined by the trial court. 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 $5,687,000 and $7,144,000.
In connection with the Company's contemplated transaction to sell all
its Spectrum Clubs, the Company will actively attempt to resolve this
litigation.
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
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<PAGE> 17
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-complaint lacks
any merit whatsoever. SCC has filed a demurrer to the cross-complaint, which was
sustained with leave to amend on September 1, 1999. Norcan filed a first amended
complaint, to which the Company again demurred. That demurrer is scheduled for
hearing on November 15, 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 a class action lawsuit against Sports Club, Inc.
of California and 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 certain provisions of the Health Studio Services Act.
Plaintiff further alleges violations of the Unruh Act and the Consumer Legal
Remedies Act, claiming the Company gives unlawful, preferential discounts to
attractive women and advertises membership fees which are higher than fees
actually charged to some members. The complaint seeks equitable relief,
including a temporary and permanent injunction, as well as unspecified
compensatory damages, punitive damages and attorneys' fees. On October 22, 1999,
the Court granted plaintiff's motion for summary adjudication on the first cause
of action, finding that the Company's membership contracts violate California
Civil Code section 1812.80 et seq., which is part of the Health Studio Services
Act. The Company intends to appeal this ruling and to challenge the plaintiff's
motion to obtain class certification. In addition, because the Company allows
all members to cancel their membership for any reason by giving 30 days written
notice, and to receive a full refund of prepaid fees, the Company does not
believe that any plaintiff has been materially damaged as a result of the
provisions of the membership agreement found to violate the Health Studio
Services Act. The company has not yet completed its analysis of potential
damages arising out of California Civil Code Sections 51 and 52, 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
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1999 Annual Meeting of Stockholders of the Company was held on July
21, 1999. The following matters were submitted to stockholders for a vote:
1. The election of Nanette Pattee Francini and Dennison T. Veru as
Class II directors to serve until the 2002 annual meeting of
stockholders.
Shares Voted
16
<PAGE> 18
<TABLE>
<CAPTION>
For Against Abstained
--- ------- ---------
<S> <C> <C> <C>
14,538,873 0 0
</TABLE>
2. An amendment to the Company's Bylaws to provide for a range of
between five and nine directors, with the exact number being
fixed from time to time by the Board of Directors.
<TABLE>
<CAPTION>
Shares Voted
For Against Abstained
--- ------- ---------
<S> <C> <C> <C>
14,511,723 46,635 1,900
</TABLE>
3. An amendment to the Company's 1994 Stock Compensation Plan to
increase from 1,000 to 2,000 the number of shares annually granted
to each non-employee Director.
<TABLE>
<CAPTION>
Shares Voted
For Against Abstained
--- ------- ---------
<S> <C> <C> <C>
13,451,623 177,035 931,600
</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, 1999:
On September 28, 1999 we filed a report on Form 8-K announcing that we
have reached an agreement to sell the Spectrum Clubs, a group of ten sports and
fitness clubs located in Southern California, to an affiliate of the investment
group Brentwood Associates for $48.4 million. The Company also entered into a
sale and leaseback of its Spectrum Club - Thousand Oaks property for net
proceeds of $12.0 million.
17
<PAGE> 19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
THE SPORTS CLUB COMPANY, INC.
Date: November 11, 1999 by /s/ John M. Gibbons
----------------------
John M. Gibbons
President and
Chief Executive Officer
(Principal Executive
Officer)
Date: November 11, 1999 by /s/ Timothy M. O'Brien
----------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial
and Accounting Officer)
18
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
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0
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<COMMON> 209
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