<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 MARCH 31, 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>
Shares
Outstanding at
Class May 12, 1999
------------------------ -------------------------
<S> <C>
Common Stock, 17,773,470
par value $.01 per share
</TABLE>
<PAGE> 2
THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND MARCH 31, 1999
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, March 31,
ASSETS 1998 1999
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,233 $ 3,017
Accounts receivable, net of allowance for doubtful accounts
of $215 and $256 at December 31, 1998 and March 31, 1999 2,480 2,243
Inventories 1,527 1,578
Other current assets 569 657
Due from affiliates 234 346
--------- ---------
Total current assets 7,043 7,841
Property and equipment, at cost, net of accumulated depreciation and
amortization of $12,520 and $13,907 at December 31, 1998 and 135,269 142,042
March 31, 1999
Equity interest in unconsolidated subsidiary 1,295 1,098
Costs in excess of net assets acquired, less accumulated amortization
of $1,294 and $1,414 at December 31, 1998 and March 31, 1999 15,443 15,323
Other assets, at cost, net 4,707 7,079
--------- ---------
$ 163,757 $ 173,383
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of notes payable and capitalized
lease obligations $ 7,746 $ 7,602
Accounts payable 2,273 3,190
Accrued liabilities 6,227 6,579
Deferred membership revenues 9,953 11,336
--------- ---------
Total current liabilities 26,199 28,707
Notes payable and capitalized lease obligations,
less current installments 18,755 18,235
Notes payable to bank 10,940 21,153
Deferred lease obligations 2,724 3,363
Minority interest 600 600
--------- ---------
Total liabilities 59,218 72,058
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 March 31, 1999 209 209
Additional paid-in capital 102,361 102,361
Retained earnings 9,656 10,207
Less: Treasury stock, at cost, 1,258,691 and 2,169,191 shares at
December 31, 1998 and March 31, 1999 (7,687) (11,452)
--------- ---------
Total shareholders' equity 104,539 101,325
--------- ---------
$ 163,757 $ 173,383
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 AND 1999
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1999
-------- --------
<S> <C> <C>
Revenues $ 19,617 $ 21,834
Operating expenses:
Direct 13,875 15,144
Selling, general and administrative 2,045 2,242
Depreciation and amortization 1,203 1,530
Pre-opening expenses -- 248
-------- --------
Total operating expenses 17,123 19,164
-------- --------
Income from operations 2,494 2,670
Other income (expense):
Net interest expense (931) (240)
Minority interests (38) (38)
Equity interest in net income of unconsolidated
subsidiary 180 263
Non-recurring charge -- (188)
-------- --------
Income before income taxes and cumulative effect
of change in accounting principle 1,705 2,467
Income tax provision 675 1,017
-------- --------
Income before cumulative effect of change
in accounting principle 1,030 1,450
Cumulative effect of change in accounting principle,
net of income tax benefit of $600 -- 899
-------- --------
Net income $ 1,030 $ 551
======== ========
Income per share before cumulative effect of
change in accounting principle:
Basic $ 0.07 $ 0.08
======== ========
Diluted $ 0.07 $ 0.08
======== ========
Cumulative effect of change in accounting principle:
Basic $ -- $ 0.05
======== ========
Diluted $ -- $ 0.05
======== ========
Net income per share:
Basic $ 0.07 $ 0.03
======== ========
Diluted $ 0.07 $ 0.03
======== ========
Weighted average shares outstanding:
Basic 14,219 19,050
======== ========
Diluted 14,536 19,213
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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THE SPORTS CLUB COMPANY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998 AND 1999
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
March 31,
1998 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,030 $ 551
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of change in accounting principle -- 1,499
Depreciation and amortization 1,203 1,530
Equity interest in net income of unconsolidated subsidiary (180) (263)
Distributions from unconsolidated subsidiary 209 460
(Increase) decrease in:
Accounts receivable, net (390) 237
Inventories (332) (51)
Other current assets (628) (88)
Increase (decrease) in:
Accounts payable 1,546 917
Accrued liabilities (1,872) 352
Deferred membership revenues 896 1,383
Deferred lease obligations 740 639
-------- --------
Net cash provided by operating activities 2,222 7,166
Cash flows from investing activities:
Capital expenditures (7,372) (12,054)
Stock re-purchase -- (3,765)
-------- --------
Net cash used in investing activities (7,372) (15,819)
Cash flows from financing activities:
Exercise of employee stock options 14 --
Increase in due from affiliates (127) (112)
Proceeds from notes payable and capital lease obligations 6,400 15,713
Repayments of notes payable and capital lease obligations (704) (6,164)
-------- --------
Net cash provided by financing activities 5,583 9,437
-------- --------
Net increase in cash and cash equivalents 433 784
Cash and cash equivalents at beginning of period 1,581 2,233
-------- --------
Cash and cash equivalents at end of period $ 2,014 $ 3,017
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 1,080 $ 695
======== ========
Cash paid for income taxes $ 1,250 $ 857
======== ========
</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 MARCH 31, 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
three-month period ended March 31, 1999, are not necessarily indicative of the
results for the fiscal year ending December 31, 1999.
2. NOTES PAYABLE AND CAPITALIZED LEASE OBLIGATIONS
Notes payable and capitalized lease obligations are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
The Sports Club/Irvine note (1) ................ $ 4,375 $ 4,250
Note payable (2) ............................... 2,667 2,667
Spectrum Club-Agoura Hills note (1) ............ 2,506 2,499
Spectrum Clubs Fullerton and Santa Ana
lease obligations (1) ....................... 9,745 9,682
Equipment financing and
capitalized lease obligations ............... 7,208 6,739
------- -------
26,501 25,837
Less current installments ...................... 7,746 7,602
------- -------
$18,755 $18,235
======= =======
</TABLE>
- ----------------------
(1) These obligations were repaid with the proceeds from the issuance of the
Company's Senior Secured Notes (See Note 6).
(2) This note was issued in connection with the acquisition of The Sports
Club/LA site at 61st and 1st Street in New York.
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3. BANK CREDIT FACILITY
At March 31, 1999, the Company had a $30.0 million bank credit facility.
At that date, $21.2 million was outstanding and an additional $4.0 million was
utilized in the form of a letter of credit. The loans were unsecured, however,
the Company was prohibited from pledging any of its assets except for furniture,
fixture and equipment financing.
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.
4. 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 months ended March 31, 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.
5. INCOME TAXES
Income taxes are computed using the effective tax rate estimated to be
applicable for the full fiscal year, which is subject to ongoing review and
evaluation by management.
6. SUBSEQUENT EVENTS
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 is
using the proceeds to repay existing indebtedness, 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.
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 premium 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
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proceeds from those transactions to the redemption of up to 35% of the principal
amount of the Senior Secured Notes at 111.375% of their face amount, plus
interest. If the Company goes through a change in control, 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.
A pro forma balance sheet as of March 31, 1999 after giving effect to
the Senior Secured Notes is presented below:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Cash .................... $ 58,776
Property and equipment .. 142,042
Other assets ............ 34,981
--------
$235,799
========
Notes payable and capital
lease obligations .... $109,406
Other liabilities ....... 25,068
Shareholders' equity .... 101,325
--------
$235,799
========
</TABLE>
In 1999, the Company approved the use of $8.4 million to repurchase
shares of Common Stock. At March 31, 1999, 910,500 shares had been purchased for
$3.8 million. As of May 11, 1999, an additional 992,700 shares have been
purchased for $4.3 million.
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. In addition, $248,000 of Club pre-opening expenses were
incurred and charged to operations in the first quarter of 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.
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<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 March 31, 1999 to Three Months Ended March 31,
1998
Our revenues for the three months ended March 31, 1999, were $21.8
million, compared to $19.6 million in 1998, an increase of $2.2 million or
11.3%. An increase of $1.2 million resulted from our opening of the Spectrum
Club - Thousand Oaks in February 1999. Revenue growth of $1.0 million occurred
at our other Clubs and SportsMed.
Our direct operating expenses increased by $1.2 million to $15.1 million
in the three months ended March 31, 1999, versus $13.9 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 69.4% for the three months ended March 31, 1999 compared to 70.7% in 1998,
primarily due to increased operating margins at Reebok Sports Club/NY.
Our selling, general and administrative expenses were $2.2 million in
the three months ended March 31, 1999, versus $2.0 million for the same period
in 1998. Selling costs increased approximately $63,000 primarily due to our
opening of the Spectrum Club - Thousand Oaks. Our general and administrative
costs increased by $134,000 because we added additional corporate overhead to
support the development of new Clubs and our overall growth. Our selling,
general and administrative costs decreased as a percentage of revenue from 10.4%
in 1998 to 10.3% in 1999. We believe these costs should continue to decrease as
a percentage of our future revenues as our Clubs under development open and
reach maturity resulting in economies of scale. There is no assurance, however,
that we will achieve this expansion or economies of scale.
Our depreciation and amortization expenses were $1.5 million for the
three months ended March 31, 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 five Clubs acquired in 1997 and the
opening of the Spectrum Club - Thousand Oaks. We incurred interest expense of
$240,000 in the three months ended March 31, 1999, versus $931,000 for the same
period in 1998. Interest expense decreased due to the payoff of a note secured
by The Sports Club/LA in April 1998 with the proceeds of our Common Stock
offering. The Company's interest expense will increase substantially in future
periods as a result of the issuance of $100.0 million aggregate principal amount
of Senior Secured Notes on April 1, 1999, which bear interest at an annual rate
of 11 3/8%.
Pre-opening expenses were $248,000 for the three months ended March 31,
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.
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Equity interest in net income of unconsolidated subsidiary was $263,000
for the three months ended March 31, 1999 versus $180,000 in 1998. These amounts
are associated with our investment in the Spectrum Club-Manhattan Beach
operations.
The non-recurring charge of $188,000 reflects our sale of the Spectrum
Club Fountain Valley on February 15, 1999. The cumulative effect of change in
accounting principle relates to the write off of pre-opening and start up costs
capitalized prior to January 1, 1999.
Our estimated federal and state income tax rate is 40% for the three
months ended March 31, 1999 and 1998, resulting in net income of $551,000 for
the three months ended March 31, 1999, and $1.0 million for the same period in
1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Credit Availability
We generated $7.2 million of cash from operating activities in the first
quarter of 1999. During this period, we invested $9.1 million on new Club
development projects and $3.0 million for capital expenditures at existing
locations. In the first quarter 1999, we purchased $3.8 million of our Common
Stock at an average price of $4.14 per share. We increased our borrowings by
$9.5 million during this period to finance these expenditures.
On March 31, 1999, we had a cash balance of $3.0 million.
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 are using the
proceeds to repay $37.6 million of existing indebtedness, 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.
On March 31, 1999, our cash balance on a pro forma basis after giving
effect to the Senior Secured Notes was $58.8 million. Of this amount $54.4
million has been segregated into a disbursement escrow account and is
specifically earmarked for the development of new Sports Clubs. In April 1999,
we sold the Spectrum Club-Santa Ana. Net proceeds from this transaction of $5.9
million have also been placed into the disbursement escrow account. 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. As of May 12, 1999 we had outstanding a $4.0 million letter
of credit under the bank credit facility.
There were no loans outstanding as of that date.
New Club Development
In February 1998, we signed a lease with respect to the development of a
Sports Club 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 around December 31, 1999. We delivered a $4.0 million letter of
credit to the landlord to secure our performance under the
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lease agreement. Based on preliminary estimates, we expect to spend
approximately $14.5 million from the disbursement escrow account to complete
development of this Club.
In April 1998, we acquired rights to develop a Sports Club 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 preliminary estimates, we expect to
spend approximately $24.0 million from the disbursement escrow account to
complete development of this Club, which is expected to open in the later part
of the first quarter of 2000.
We have entered into lease agreements with Millennium Entertainment
Partners ("Millennium") with respect to the development of Sports Clubs in San
Francisco and Washington, D.C. and are negotiating a lease with Millennium for a
Sports Club 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.
Construction at this location is not scheduled to begin until after the two new
Sports Clubs in New York City are open. Based on preliminary estimates, we
expect to spend approximately $19.3 million to complete development of this
Club.
We are developing three Spectrum Clubs on leased sites in Southern
California which are expected to open in late 1999 and early 2000. Based on
preliminary estimates, we expect to spend approximately $3.5 million to complete
development of these Clubs.
Future Capital Requirements
In 1999, our Board of Directors approved the use of $8.4 million to
repurchase shares of our Common Stock. At March 31, 1999, 910,500 shares had
been purchased for $3.8 million. As of May 12, 1999, an additional 992,700
shares have been purchased for $4.3 million.
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 $2.1 million during the next 12 months to upgrade our
management information systems. The terms of the Indenture allow us to borrow an
additional $3.3 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. Acquiring and developing additional Clubs 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
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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. We expect these modified systems to be
operational during the third quarter of 1999.
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 are purchasing a newer version of this
system which we expect to have in place before the end of the third quarter of
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, $800,000 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.
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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 by the fourth quarter of
1999.
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:
11
<PAGE> 13
- 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 health and fitness club
services generally and competitive pricing trends in the
health 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,
- 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.
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,
tortious 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
12
<PAGE> 14
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 tortious 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.
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 status conference will be held in
the trial court on June 9, 1999. At that time, the parties will discuss
amendment of the pleadings and completion of discovery.
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 with respect to a proposed development site in Anaheim
Hills, California, and we guaranteed SCLI's obligations under the lease. SCLI
sought to rescind the lease, and OTR brought this action for damages against
SCLI for breach of the lease and against us on the guarantee, seeking specific
damages in excess of $1.0 million and unspecified general damages. We believe
the claim is without merit and have filed a cross-complaint seeking rescission
of the lease on the basis of fraud, mistake and negligent misrepresentation.
Other Matters. We are also involved in various claims and lawsuits
incidental to our business, including claims arising from accidents and disputes
with landlords. 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
13
<PAGE> 15
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 December 31,
1998:
On February 18, 1999 we filed a report on Form 8-K in regards to an
amendment to our stockholder rights plan adopted on September 29, 1998.
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.
14
<PAGE> 16
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: May 13, 1999 by /s/ D. Michael Talla
-------------------------------
D. Michael Talla
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: May 13, 1999 by /s/ Timothy M. O'Brien
-------------------------------
Timothy M. O'Brien
Chief Financial Officer
(Principal Financial and
Accounting Officer)
15
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