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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 333-40907
TOWN SPORTS INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEW YORK 13-2749906
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
888 SEVENTH AVENUE
NEW YORK, NEW YORK 10106
TELEPHONE: (212) 246-6700
(ADDRESS, ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANTS PRINCIPAL EXECUTIVE OFFICE.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 and 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. 1,028,698.
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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Condensed Consolidated Balance Sheets as of December
31, 2001 and September 30, 2002..................... 2
b) Condensed Consolidated Statements of Operations for
the three and nine months ended September 30, 2001
and 2002............................................ 3
c) Condensed Consolidated Statements of Cash Flows for
the nine months ended September 30, 2001 and 2002... 4
d) Notes to Condensed Consolidated Financial
Statements.......................................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............... 8
Item 3. Quantitative and Qualitative Disclosures About
Market Risk....................................... 13
Item 4. Controls and Procedures........................... 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................. 14
Item 2. Changes in Securities............................. 14
Item 3. Defaults upon Senior Securities................... 14
Item 4. Submission of Matters to a Vote of Security
Holders................................................ 14
Item 5. Other Information................................. 14
Item 6. Exhibits and Reports on Form 8-K.................. 14
SIGNATURES.................................................. 15
Sarbanes-Oxley Section 302(a) certification............... 16
1
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ALL FIGURES $'000, EXCEPT SHARE DATA
DECEMBER 31, 2001 AND SEPTEMBER 30, 2002
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 5,458 $ 5,063
Accounts receivable....................................... 1,355 664
Inventory................................................. 1,326 1,443
Prepaid expenses and other current assets................. 3,113 4,635
-------- --------
Total current assets............................... 11,252 11,805
Fixed assets, net of accumulated depreciation of $78,680 and
$98,013 at December 31, 2001 and September 30, 2002,
respectively.............................................. 200,120 208,358
Goodwill, net of accumulated amortization of $13,557 and
$12,988 at December 31, 2001 and September 30, 2002,
respectively.............................................. 42,145 41,457
Intangible assets, net of accumulated amortization of
$15,325 and $17,760 at December 31, 2001 and September 30,
2002, respectively........................................ 6,515 4,352
Deferred tax asset.......................................... 19,092 21,577
Deferred membership costs................................... 14,748 15,166
Other assets................................................ 2,133 1,846
-------- --------
Total assets....................................... $296,005 $304,561
======== ========
LIABILITIES, REDEEMABLE SENIOR PREFERRED STOCK AND
STOCKHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current portion of long-term debt and capital lease
obligations............................................. $ 4,015 $ 4,580
Accounts payable.......................................... 7,615 3,159
Accrued expenses.......................................... 18,474 24,783
Corporate income taxes payable............................ 444 182
Deferred revenue.......................................... 23,269 27,622
-------- --------
Total current liabilities.......................... 53,817 60,326
Long-term debt and capital lease obligations................ 159,964 148,929
Deferred lease liabilities.................................. 21,510 23,136
Deferred revenue............................................ 3,609 3,798
Other liabilities........................................... 4,783 7,755
-------- --------
Total liabilities.................................. 243,683 243,944
-------- --------
Redeemable senior preferred stock, $1.00 par value;
liquidation value $57,416 and $62,668 at December 31,
2001, and September 30, 2002, respectively; authorized
100,000 shares; 40,000 shares issued and outstanding at
December 31, 2001 and September 30, 2002.................. 54,687 60,194
-------- --------
Stockholders' (deficit) equity:
Series A preferred stock, at liquidation value............ 30,432 33,702
Series B preferred stock, at liquidation value............ 265 294
Class A voting common stock, $.001 par value; 1,028,698
shares issued and outstanding........................... 1 1
Paid-in capital........................................... 11,695 12,538
Unearned compensation..................................... (422) (364)
Foreign currency translation adjustment................... 21 163
Accumulated deficit....................................... (44,357) (45,911)
-------- --------
Total stockholders' (deficit) equity............... (2,365) 423
-------- --------
Total liabilities, redeemable senior preferred
stock and stockholders' (deficit) equity......... $296,005 $304,561
======== ========
See notes to the condensed consolidated financial statements.
2
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002
ALL FIGURES $'000
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2001 2002 2001 2002
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Revenues:
Club operations............................ $71,269 $80,678 $208,150 $236,598
Fees and other............................. 1,119 1,093 2,743 2,935
------- ------- -------- --------
72,388 81,771 210,893 239,533
------- ------- -------- --------
Operating expenses:
Payroll and related........................ 28,724 32,893 83,366 97,333
Club operating............................. 23,455 27,443 65,854 75,785
General and administrative................. 5,033 5,040 14,034 14,924
Depreciation and amortization.............. 8,047 7,824 23,802 23,768
------- ------- -------- --------
65,259 73,200 187,056 211,810
------- ------- -------- --------
Operating income........................... 7,129 8,571 23,837 27,723
Interest expense............................. 3,713 4,112 11,278 12,398
Interest income.............................. (84) (38) (347) (116)
------- ------- -------- --------
Income before provision for corporate
income tax and cumulative effect of
change in accounting principle.......... 3,500 4,497 12,906 15,441
Provision for corporate income tax........... 1,856 2,368 6,398 7,498
------- ------- -------- --------
Income before cumulative effect of a change
in accounting principle................. 1,644 2,129 6,508 7,943
Cumulative effect of a change in accounting
principle, net of income tax benefit of
$612.................................... -- -- -- 689
------- ------- -------- --------
Net income................................. 1,644 2,129 6,508 7,254
Accreted dividends on preferred stock........ (2,612) (2,958) (7,555) (8,552)
------- ------- -------- --------
Net loss attributable to common
stockholders............................ $ (968) $ (829) $ (1,047) $ (1,298)
======= ======= ======== ========
See notes to the condensed consolidated financial statements.
3
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002
ALL FIGURES $'000
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2001 2002
----------- -----------
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities:
Net income................................................ $ 6,508 $ 7,254
-------- --------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 23,802 23,768
Goodwill impairment write-off............................. -- 1,301
Club closure costs........................................ -- 1,095
Compensation expense in connection with stock options..... 898 901
Noncash rental expense, net of noncash rental income...... 2,330 1,278
Share of net income in affiliated companies............... (581) (523)
Amortization of debt issuance costs....................... 1,412 1,435
Change in certain working capital components.............. 10,295 9,804
Increase in deferred tax asset............................ (3,171) (2,485)
Increase in deferred membership costs..................... (1,797) (418)
Other..................................................... 96 136
-------- --------
Total adjustments....................................... 33,284 36,292
-------- --------
Net cash provided by operating activities............... 39,792 43,546
-------- --------
Cash flows from investing activities:
Capital expenditures, net of effects of acquired
businesses.............................................. (36,494) (34,324)
Acquisition of businesses................................. (1,201) (348)
Intangible and other assets............................... (245) 287
Landlord contributions.................................... 275 3,467
-------- --------
Net cash used in investing activities................... (37,665) (30,918)
-------- --------
Cash flows from financing activities:
Net line of credit (repayment)............................ (1,000) (12,000)
Subordinated credit borrowings, net of expenses........... -- 2,810
Repayments of notes for acquired businesses and capital
lease obligations borrowings............................ (2,332) (3,833)
-------- --------
Net cash used in financing activities................... (3,332) (13,023)
-------- --------
Net decrease in cash and cash equivalents............... (1,205) (395)
Cash and cash equivalents at beginning of period............ 3,365 5,458
-------- --------
Cash and cash equivalents at end of period.............. $ 2,160 $ 5,063
======== ========
Summary of change in certain working capital components, net
of effects of acquired businesses:
(Increase) decrease in accounts receivable................ $ (105) $ 384
Increase in inventory..................................... (350) (117)
Decrease (increase) in prepaid expenses, prepaid income
taxes and other current assets.......................... 1,303 (999)
Increase in accounts payable and accrued expenses......... 6,310 6,159
Increase in deferred revenue.............................. 3,137 4,377
-------- --------
Net changes in working capital.......................... $ 10,295 $ 9,804
======== ========
Supplemental disclosures of cash flow information:
Noncash investing and financing activities:
The Company assumed $445 of long-term debt in connection with a club
acquisition during the nine months ended September 30, 2002.
The Company acquired $1,889 and $1,565 of club equipment financed by
lessors during the nine months ended September 30, 2002 and September 30, 2001,
respectively.
See notes to the condensed consolidated financial statements.
4
TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND SEPTEMBER 30, 2002
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission ("SEC"). The condensed consolidated financial statements should be
read in conjunction with our December 31, 2001 consolidated financial statements
and notes thereto, included on Form 10-K. The year-end condensed balance sheet
data was derived from audited financial statements, but does not include all
disclosures required by accounting principles generally accepted in the United
States of America. Certain information and footnote disclosures which are
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to SEC
rules and regulations. We believe that the disclosures made are adequate to make
the information presented not misleading. The information reflects all
adjustments which, in the opinion of Management, are necessary for a fair
presentation of the financial position and results of operations for the interim
periods set forth herein. All such adjustments, except for the cumulative effect
of a change in accounting principle and the club closure costs, are of a normal
and recurring nature. The results for the three and the nine months ended
September 30, 2002 are not necessarily indicative of the results for the entire
fiscal year ending December 31, 2002.
2. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
DECEMBER 31, SEPTEMBER 30,
2001 2002
($'000) ($'000)
------------ -------------
Series B 9 3/4% Senior Notes, due 2004...................... $125,000 $125,000
Line of credit borrowings................................... 22,745 10,771
Subordinated credit borrowings.............................. 6,000 9,000
Notes payable for acquired businesses....................... 2,931 2,232
Capital lease obligations................................... 7,303 6,506
-------- --------
163,979 153,509
Less, Current portion due within one year................... 4,015 4,580
-------- --------
Long-term portion........................................... $159,964 $148,929
======== ========
We have a line of credit, with our principal banks for direct borrowings
and letters of credit of up to $25.0 million. The line of credit carries
interest at our option, based upon the Eurodollar borrowing rate plus 2.50% or
the bank's prime rate plus 1.50%, as defined. There were $10.8 million of
Eurodollar borrowings outstanding as of September 30, 2002 and outstanding
letters of credit issued totaled $1.9 million. As of September 30, 2002 the
interest rate charged on the outstanding Eurodollar borrowings was 4.38%. The
unutilized portion of the line of credit as of September 30, 2002 was $12.4
million. This line of credit expires on July 15, 2004.
The line of credit contains various covenants including interest coverage
and a leverage ratio as well as restrictions on the payment of dividends.
In November 2000, we entered into a Subordinated Credit Agreement (the
"Agreement") which provides for up to $20.0 million of principal borrowings and
expires December 31, 2004. The interest on principal borrowings accrues at the
greater of 12.75% or the bank's prime rate plus 3.0% per annum. On a monthly
basis, 9.75% is payable and the remaining 3.0% is accruable or payable at our
option. As of September 30, 2002 there were $9.0 million of outstanding
borrowings under the agreement and the rate in effect was 12.75%. The Agreement
contains similar, but less restrictive covenants than those of the line of
credit. The unutilized portion of this Agreement was $11.0 million as of
September 30, 2002.
5
3. SEPTEMBER 11 EVENTS
The terrorist attacks of September 11, 2001 ("the September 11 events"),
resulted in a tremendous loss of life and property. Secondarily, those events
interrupted the operations at four of our clubs located in downtown Manhattan.
Three of the effected four clubs and were back in operation by October 2001,
while the fourth club was reopened in September 2002.
We carry business interruption insurance to mitigate certain lost revenue
and profits experienced with the September 11 events. In this regard in the
third quarter of 2001 a $175,000 insurance receivable was recorded representing
our estimate of costs incurred in September 2001. Such costs include rent,
payroll, benefits, and other club operating costs incurred during periods of
club closure. In February 2002 we received an initial policy payment of $350,000
from our insurance carrier covering the receivable and a payment in
reimbursement of business interruption losses. In August 2002, a second policy
payment of $250,000 was received.
Although we have business interruption insurance to cover certain lost
profits at all four clubs, we cannot predict with any degree of certainty what
future amounts will actually be received from the insurance carrier. Furthermore
we cannot, at this time, determine whether the assets related to the fourth club
location have been permanently impaired. We will continue to gather information
to better assess whether or not the assets of this club have been permanently
impaired. We are communicating with our insurance carrier on an ongoing basis in
order to better assess the relief we could expect to receive for such coverage.
4. CLUB CLOSURE COSTS
In the quarter ended September 30, 2002 we recorded a $1.1 million net
write-off of fixed assets related to a club that has been scheduled for closure
November 30, 2002. This club has been operating under a short term lease and we
have not been able to extend the lease on acceptable economic terms. These club
closure costs have been included with club operating expenses.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In July, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement No. 146, ("SFAS 146") Accounting for Costs Associated with Exit or
Disposal Activities, which we are required to adopt on January 1, 2003. SFAS 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. We do not expect that adoption of the standard will have
a material adverse effect on our consolidated financial position or results of
operations.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." ("SFAS 145"). SFAS 145 rescinds SFAS No. 4, Reporting Gains and
Losses from Extinguishment of Debt, and SFAS No. 64, Extinguishment of Debt Made
to Satisfy Sinking-Fund Requirements. The provisions of this statement are
effective January 1, 2003. This Statement also amends SFAS No. 13, Accounting
for Leases, to require sale-leaseback accounting for certain lease modifications
that have economic impact similar to sale-leaseback transactions and amends
certain other authoritative pronouncements. These provisions of SFAS No. 145,
adopted in May 2002, had no impact on our consolidated financial position or
results of operations. In the event we extinguish our long-term debt obligations
prior to their original maturities, the related debt extinguishment costs will
be reported within operating income, rather than an extraordinary item.
In July 2001, the FASB issued Statement No. 141, Business Combinations
("SFAS 141") and Statement No. 142, Goodwill and Other Intangible Assets ("SFAS
142"). These statements significantly affect the financial accounting and the
reporting for business combinations, goodwill and intangible assets. SFAS 142
requires that goodwill be allocated to reporting units and that goodwill and
intangibles assets with indefinite useful lives not be amortized over their
useful lives, but rather be tested for impairment upon implementation of this
standard and at least annually thereafter. Amortizable intangible assets will be
subject to the impairment provisions of Statement No. 144 Accounting for the
Impairment or Disposal of Long-Lived Assets ("SFAS 144"). SFAS 142 required that
the useful lives of these amortizable intangible assets be
6
reassessed. These statements apply to all business combinations that are
initiated or completed after June 30, 2001 and the effective date of these
pronouncements is January 1, 2002.
Effective January 1, 2002 we implemented SFAS 142. There were no changes to
the estimated useful lives of amortizable intangible assets due to the SFAS 142
implementation. In connection with the SFAS 142 transition impairment test we
recorded a $1.3 million write-off of goodwill. A deferred tax benefit of
$612,000 was recorded as a result of this goodwill write-off, resulting in a net
cumulative effect of change in accounting principle of $689,000, in the first
quarter of 2002. The write-off of goodwill related to four, remote
underperforming clubs. The impairment test was performed with discounted
estimated future cash flows as the criteria for determining fair market value.
Goodwill has been allocated to reporting units that closely reflect the regions
served by our four trade names; New York Sports Club, Boston Sports Club,
Washington Sports Club and Philadelphia Sports Club, with certain more remote
clubs that do not benefit from a regional cluster being considered single
reporting units.
A reconciliation of reported net income for the three and nine month
periods September 30, 2001 to net income adjusted for the impact of SFAS 142
over that same period is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
(000'S) (000'S)
------------------ ------------------
Net income as reported..................................... $1,644 $6,508
Goodwill amortization...................................... 1,080 3,247
Deferred tax benefit....................................... (328) (984)
------ ------
Net income as adjusted..................................... $2,396 $8,771
====== ======
A summary of our acquired amortizable intangible assets as of September 30,
2002 is as follows:
AS OF SEPTEMBER 30, 2002
(000'S)
------------------------------------------------------------------
GROSS CARRYING AMOUNT ACCUMULATED AMORTIZATION NET INTANGIBLES
ACQUIRED INTANGIBLE ASSETS --------------------- ------------------------ ---------------
Membership Lists...................... $ 9,834 $ (9,691) $143
Covenants-not-to-compete.............. 1,276 (1,067) 209
Beneficial Lease...................... 223 (160) 63
------- -------- ----
$11,333 $(10,918) $415
======= ======== ====
The amortization expense of the above acquired intangible assets for each
of the five years ending December 31, 2006 will be as follows:
AGGREGATE AMORTIZATION EXPENSE (000'S)
--------------------------------------
For the year ended 12/31/02(a).............................. $1,071
For the year ended 12/31/03................................. 265
For the year ended 12/31/04................................. 19
For the year ended 12/31/05................................. 11
For the year ended 12/31/06................................. 10
------
$1,376
======
- ---------------
(a) Amortization expense of acquired intangible assets for the three and nine
months ended September 30, 2002 amounted to $100 and $961, respectively.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
We are one of the two leading owners and operators of fitness clubs in the
Northeast and Mid-Atlantic regions of the United States. As of September 30,
2002, we operated 128 clubs that collectively served approximately 339,000
members. We develop clusters of clubs to serve densely populated major
metropolitan regions in which a high percentage of the population commutes to
work. We service such populations by clustering clubs near the highest
concentrations of our target customers' areas of both employment and residence.
Our target customer is college-educated, typically between the ages of 18 and 54
and earns an annual income in excess of fifty thousand dollars.
Our goal is to develop the premier health club network in each of the major
metropolitan regions we enter. We believe that clustering clubs allows us to
achieve strategic operating advantages that enhance our ability to achieve this
goal. In entering new regions, we develop these clusters by initially opening or
acquiring clubs located in the more central urban markets of the region and then
branching out from these urban centers to suburban commuter communities.
Capitalizing on this clustering of clubs, as of September 30, 2002,
approximately 45% of our members participated in a membership plan that allows
unlimited access to all of our clubs for a higher membership fee.
We have executed this strategy successfully in the New York region through
the network of clubs we operate under our New York Sports Club ("NYSC") brand
name. We are the largest fitness club operator in Manhattan with 36 locations
and operate a total of 83 clubs under the NYSC name within a defined radius of
New York City. We operate 20 clubs in the Boston region and 16 clubs in the
Washington, DC region under our Boston Sports Club ("BSC") and Washington Sports
Club ("WSC") trade names, respectively and have begun establishing a similar
cluster in the Philadelphia region with six clubs under our Philadelphia Sports
Club ("PSC") trade name. In addition we operate three clubs in Switzerland. We
employ localized trade names for our clubs to create an image and atmosphere
consistent with the local community, and to foster the recognition as a local
network of quality fitness clubs rather than a national chain.
Our operating and selling expenses are comprised of both fixed and variable
costs. The fixed costs include salary expense, rent, utilities, janitorial
expenses and depreciation. Variable costs are primarily related to sales
commissions, advertising and supplies. As clubs mature and increase their
membership base, fixed costs are typically spread over an increasing revenue
base and operating margins tend to improve.
HISTORICAL CLUB GROWTH
The following table sets forth our club growth during each of the quarters
in 2001 and each of the first three quarters in 2002.
2001 2002
--------------------------------- ------------------
Q1 Q2 Q3 Q4 TOTAL Q1 Q2 Q3
--- --- --- --- ----- ---- --- ---
Clubs at beginning of period....... 105 108 110 112 105 119 126 127
Greenfield clubs(a)................ 2 2 1 7 12 6 1 1
Acquired clubs..................... 1 -- 1 -- 2 1 -- --
--- --- --- --- --- ---- --- ---
Clubs at end of period(b).......... 108 110 112 119 119 126 127 128
=== === === === === ==== === ===
Number of partly owned clubs
included at the end of the
period........................... 2 2 2 2 2 2 2 2
- ---------------
(a) A "Greenfield club" is a new location constructed by the Company.
(b) As described in the September 11 Events discussion, a single club had been
temporarily closed due to its proximity to the World Trade Center. This club
is included in the total clubs at the end of period for all periods
presented.
Note: We include in the club count wholly and partly owned clubs. In addition to
the above count, as of December 31, 2001 and September 30, 2002 we managed
two additional clubs, in which we did not have an equity stake.
8
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
revenue for the periods indicated:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
2001 2002 2001 2002
----- ----- ----- -----
Revenue..................................................... 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Operating expenses
Payroll and related....................................... 39.7 40.2 39.5 40.6
Club operating............................................ 32.4 33.5 31.2 31.7
General and administrative................................ 7.0 6.2 6.7 6.2
Depreciation and amortization............................. 11.1 9.6 11.3 9.9
----- ----- ----- -----
Operating income.......................................... 9.8 10.5 11.3 11.6
Interest expense............................................ 5.1 5.0 5.3 5.2
Interest income............................................. (0.1) -- (0.2) --
----- ----- ----- -----
Income before provision for corporate income tax and
cumulative effect of change in accounting principle..... 4.8 5.5 6.2 6.4
Provision for corporate income tax.......................... 2.6 2.9 3.0 3.3
----- ----- ----- -----
Income before cumulative effect of change in accounting
principle................................................. 2.2 2.6 3.2 3.7
Cumulative effect of a change in accounting principle, net
of income tax benefit..................................... -- -- -- 0.3
----- ----- ----- -----
Net income................................................ 2.2 2.6 3.2 3.0
Accreted dividends on preferred stock....................... (3.6) (3.6) (3.6) (3.6)
----- ----- ----- -----
Net loss attributable to common stockholders.............. (1.4)% (1.0)% (0.4)% (0.6)%
===== ===== ===== =====
Three Months Ended September 30, 2002 Compared to Three Months Ended September
30, 2001
Revenues. Revenues increased approximately $9.4 million, or 13.0%, to
$81.8 million during the quarter ended September 30, 2002 from $72.4 million in
the quarter ended September 30, 2001. This increase resulted from the three
clubs opened or acquired the last quarter of 2000 (approximately $263,000), 14
opened or acquired during 2001 (approximately $4.4 million) and the nine clubs
opened or acquired in the first nine months of 2002 (approximately $2.5
million). In addition, revenues increased during the quarter by approximately
$2.2 million or 3.3%, at the Company's mature clubs (clubs owned and operated
for at least 24 months). The mature club revenue increase is due to three
factors: 1.1% due to an increase in membership, 1.8% from price increases and
0.4% from an increase in ancillary revenue. These increases were partially
offset by a decrease in revenue at our downtown Manhattan club that had been
temporarily closed through September 2002 because of the September 11, 2001
events.
Operating Expenses. Operating expenses increased $7.9 million, or 12.2%,
to $73.2 million in the quarter ended September 30, 2002, from $65.3 million in
the quarter ended September 30, 2001. The increase was primarily due to a 13.8%
increase in total months of club operations (the aggregate number of full months
of operation during a given period for the clubs open at the end of such period)
to 372 in the quarter ended September 30, 2002 from 327 in the quarter ended
September 30, 2001, in addition to the following factors:
Payroll and related increased by $4.2 million, or 14.5% to $32.9
million in the quarter ended September 30, 2002, from $28.7 million in the
quarter ended September 30, 2001. This increase was principally
attributable to the acquisition or opening of 14 clubs in 2001 and the nine
clubs opened or acquired in the first nine months of 2002. Payroll and
related also increased due to increases in health and workers' compensation
insurance, information technology staffing and payroll associated with
fee-for-service programs.
9
Club operating increased by $4.0 million or 17.0% to $27.4 million in
the quarter ended September 30, 2002, from $23.5 million in the quarter
ended September 30, 2001. This increase is primarily attributable to the
acquisition or opening of seven clubs in the last quarter of 2001 and nine
clubs opened or acquired in the first nine months of 2002. In the quarter
ended September 30, 2002 we recorded a $1.1 million net write off of fixed
assets related to a club that has been scheduled for closure November 30,
2002. This club has been operating under a short term lease, and we have
not been able to extend the lease on acceptable economic terms. These club
closure costs have been included within club operating expenses and
represent $1.1 million of the $4.0 million increase.
General and administrative was $5.0 million in the quarter ended
September 30, 2002, and the quarter ended September 30, 2001. Increases in
casualty insurance in the quarter ended September 30, 2002 when compared to
the quarter end September 30, 2001 were offset by decreases in charitable
contributions over the same periods. In the quarter ended September 30,
2001 approximately $286,000 of donations were made to the Red Cross in
response to the events of September 11, 2001.
Depreciation and amortization decreased by $223,000, or 2.8% to $7.8
million in the quarter ended September 30, 2002, from $8.0 million in the
quarter ended September 30, 2001. A $1.1 million decrease in goodwill
amortization was partially offset by a $0.9 million increase in
depreciation and amortization for fixed assets, additions, acquisitions or
club openings during 2001 and the increase of fixed assets arising out of
the acquisition or opening of nine new clubs during the first three
quarters of 2002.
Interest Expense. Interest expense increased $399,000 to $4.1 million
during the quarter ended September 30, 2002, from $3.7 million in the quarter
ended September 30, 2001. This increase was primarily due to increased line of
credit and subordinated debt borrowings associated with the Company's expansion.
Interest Income. Interest income decreased $46,000 to $38,000 during the
quarter ended September 30, 2002 from $84,000 in the quarter ended September 30,
2001. The decrease in interest income was primarily due to lower interest rates
in the quarter ended September 30, 2002 when compared to the same period of
2001.
Provision for Corporate Income Tax. The income tax provision for the
quarter ended September 30, 2002 was $2.4 million compared to $1.9 million for
the quarter ended September 30, 2001.
Accreted Dividends on Preferred Stock. Accreted dividends on the preferred
stock increased $346,000 to $3.0 million during the quarter ended September 30,
2002, from $2.6 million in the quarter ended September 30, 2001. This increase
is a result of the compounding of accreted dividends.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended September
30, 2001
Revenues. Revenues increased approximately $28.6 million, or 13.6%, to
$239.5 million for the nine months ended September 30, 2002, from $210.9 million
for the nine months ended September 30, 2001. This increase resulted from the
three clubs opened or acquired the last quarter of 2000 (approximately $1.2
million), 14 opened or acquired during 2001 (approximately $13.5 million) and
the nine clubs opened or acquired in the first nine months of 2002
(approximately $4.9 million). In addition, revenues increased during the nine
months by approximately $9.7 million or 4.8%, at the Company's mature clubs
(clubs owned and operated for at least 24 months). The mature club revenue
increase is due to three factors: 2.3% due to an increase in membership, 2.0%
from price increases and 0.4% from an increase in ancillary revenue. These
increases were partially offset by a decrease in revenue at our downtown
Manhattan club that has been temporarily closed through September 2002 because
of the September 11, 2001 events.
Operating Expenses. Operating expenses increased $24.8 million, or 13.2%
to $211.8 million for the nine months ended September 30, 2002, from $187.1
million for the nine months ended September 30, 2001. The increase was primarily
due to a 14.3% increase in total months of club operations to 1,100 for the nine
10
months ended September 30, 2002 from 962 for the nine months ended September 30,
2001, in addition to the following factors:
Payroll and related increased by $14.0 million, or 16.8% to $97.3
million for the nine months ended September 30, 2002, from $83.4 million
for the nine months ended September 30, 2001. This increase was principally
attributable to the acquisition or opening of 14 clubs in 2001 and the nine
opened or acquired clubs in the first nine months of 2002. Payroll and
related also increased due to increases in health and workers' compensation
insurance, information technology staffing and payroll associated with
fee-for-service programs.
Club operating increased by $9.9 million or 15.1% to $75.8 million for
the nine months ended September 30, 2002, from $65.9 million for the nine
months ended September 30, 2001. This increase is principally attributable
to the opening of seven clubs in the last quarter of 2001 and nine opened
or acquired clubs in the first nine months of 2002. In the quarter ended
September 30, 2002 we recorded a $1.1 million net write-off of fixed assets
related to a club that has been scheduled for closure November 30, 2002.
This club has been operating under a short term lease, and we have not been
able to extend the lease on acceptable economic terms. These club closure
costs have been included within club operating expenses and represent $1.1
million of the $9.9 million increase.
General and administrative increased by $890,000, or 6.3% to $14.9
million for the nine months ended September 30, 2002, from $14.0 million,
for the nine months ended September 30, 2001. This increase is principally
attributable to a $972,000 increase in casualty insurance partly offset by
decreases in charitable contributions.
Depreciation and amortization was $23.8 for the nine months ended
September 30, 2002, and 2001. A $3.2 decrease in goodwill amortization was
offset by increases in depreciation and amortization for fixed assets,
additions, acquisitions or club openings during 2001 and the increase of
fixed assets arising out of the acquisition or opening of nine new clubs
during the first nine months of 2002.
Interest Expense. Interest expense increased $1.1 million to $12.4 million
for the nine months ended September 30, 2002, from $11.3 million for the nine
months ended September 30, 2001. This increase was primarily due to increased
line of credit and subordinated debt borrowings associated with the Company's
expansion.
Interest Income. Interest income decreased $231,000 to $116,000 for the
nine months ended September 30, 2002, from $347,000 for the nine months ended
September 30, 2001. This decrease was primarily due to lower levels of cash on
hand earning lower interest rates in the nine months ended September 30, 2002
when compared to the same period of 2001.
Provision for Corporate Income Tax. The income tax provision for the nine
months ended September 30, 2002 was $7.5 million compared to a tax provision of
$6.4 million for the nine months ended September 30, 2001.
Cumulative Effect of Change in Accounting Principle. In connection with
the implementation of SFAS 142 the Company recorded a goodwill write-off of $1.3
million, in the first quarter of 2002. A deferred tax benefit of $612,000 was
recorded in connection with this goodwill write-off resulting in a net
cumulative effect of change in Accounting Principle of $689,000 during the nine
months ended September 30, 2002.
Accreted Dividends on Preferred Stock. Accreted dividends on the preferred
stock increased $997,000 to $8.6 million during the nine months ended September
30, 2002, from $7.6 million during the nine months ended September 30, 2001.
This increase is a result of the compounding of accreted dividends.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have satisfied our liquidity needs through cash from
operations and various borrowing arrangements. Principal liquidity needs have
included the acquisition and development of new clubs, debt service requirements
and other capital expenditures necessary to maintain existing clubs.
11
Operating Activities. Net cash provided by operating activities for the
nine months ended September 30, 2002 was $43.5 million compared to $39.8 million
for the nine months ended September 30, 2001, an increase of $3.7 million. Cash
flows from operations has improved as the profitability of the mature club base
and the clubs opened or acquired during the last quarter of 2000, continues to
improve. The balance of the increase is principally due to an increase in the
working capital deficit. We received a tax refund of approximately $1.2 million
during the first nine months of 2001. Excluding cash and cash equivalents, we
normally operate with a working capital deficit because we receive dues or fee
revenue either (i) during the month services are rendered, or (ii) when
paid-in-full, in advance. As a result, we have no material accounts receivable.
In addition, because initiation fees are received at enrollment and are
recognized over the estimated average term of membership, we record a deferred
revenue liability. We believe that our working capital deficit is an important
source of cash flow from operating activities that we believe will continue to
grow as membership revenues increase.
Investing Activities. We invested $30.9 million in capital expenditures
and a club acquisition net of landlord contributions during the nine months
ended September 30, 2002. We currently estimate total capital expenditure and
asset acquisition requirements for the remaining three months of 2002 to
approximate $13.8 million, which includes $4.6 million to renovate and expand
certain existing clubs, $1.5 million to maintain certain existing clubs and
$500,000 to further upgrade our management information systems. Total capital
expenditures and asset acquisition requirements for 2003 are currently estimated
at $40.0 million.
Financing Activities. As of September 30, 2002, we had $125.0 million of
Senior Notes outstanding. Under the provisions of the Senior Note Indenture, we
may not issue additional Senior Notes without modification of the indenture with
the bondholders' consent. Our line of credit with our principal bank provides
for direct borrowings and letters of credit of up to $25.0 million. As of
September 30, 2002, $10.8 million of Eurodollar borrowings are outstanding under
this line at an interest rate of 4.38%. As of September 30, 2002 outstanding
letters of credit totaled $1.9 million. As of September 30, 2002, we had
approximately $12.4 million available under the line of credit, which matures in
July 2004, and has no scheduled amortization requirements. We also have a $20.0
million subordinated credit facility which expires in December, 2004, under
which there are $9.0 million of outstanding borrowings as of September 30, 2002.
As of September 30, 2002 the interest rate charged on outstanding subordinated
debt was 12.75%. The line of credit contains restrictive covenants including a
leverage ratio and interest coverage ratio and dividend payment restrictions and
is collateralized by all the assets of the Company. The subordinated credit
facility contains similar, but less restrictive covenants than those of the line
of credit. As of September 30, 2002 the Company's Net Leverage Ratio, and Net
Interest Coverage Ratio as defined by the terms of the line of credit agreement
are 2.2 and 4.8 to 1.0, respectively. Our ability to incur additional debt is
limited by the terms of the line of credit facility in that the Net Leverage
Ratio, as defined, cannot exceed 3.0 to 1.0 and the Net Interest Coverage Ratio
must be greater than 3.0 to 1.0. In addition the Senior Note indenture limits
the incurrence of additional indebtedness unless the consolidated fixed charge
coverage ratio, as defined in the Indenture, is greater than 2.0 to 1.0 after
giving effect to such additional indebtedness. Our common stock is not publicly
traded and therefore our ability to raise equity financing is not as readily
available as for companies that have publicly traded common stock.
Although we believe that we will be able to obtain or generate sufficient
funds to finance our current operating and growth plans through the end of 2003,
any material acceleration or expansion of that plan through additional
greenfields or acquisitions (to the extent such acquisitions include cash
payments) may require us to pursue additional sources of financing prior to the
end of 2003. There can be no assurance that such financing will be available, or
that it will be available on acceptable terms. The inability to finance such
further or accelerated expansion on acceptable terms may negatively impact our
competitive position and/or materially adversely affect our business, results of
operations or financial condition. The line of credit accrues interest at
variable rates based on market conditions, accordingly, future increases in
interest rates could have a negative impact on net income.
The Senior Notes, the line of credit facility and the subordinated credit
facility expire in the second half of 2004. We intend to refinance the long-term
debt facilities prior to their expiration. We will explore a variety of
refinancing options including: new borrowing facilities, private equity
offerings, initial public equity
12
offerings, and strategic partnering, but at this time there are no definitive
plans in place. There can be no assurances that long-term financing will be
available to us on acceptable terms. Our inability to obtain acceptable
long-term financing may negatively impact our competitive position and or
materially adversely affect our business, results of operations or financial
condition.
SEPTEMBER 11 EVENTS
The terrorist attacks of September 11, 2001 ("the September 11 events"),
resulted in a tremendous loss of life and property. Secondarily, those events
have interrupted the operations at four of our clubs located in downtown
Manhattan. Three of the effected four clubs were back in operation by October
2001, while the fourth club, was reopened in September, 2002.
We carry business interruption insurance to mitigate certain lost revenue
and profits experienced with the September 11 events. In this regard in the
third quarter of 2001 a $175,000 insurance receivable was recorded representing
our estimate of costs incurred in September 2001. Such costs include rent,
payroll, benefits, and other club operating costs incurred during periods of
club closure. In February 2002 we received an initial policy payment of $350,000
from our insurance carrier covering the receivable and a payment in
reimbursement of business interruption losses. In August 2002, a second policy
payment of $250,000 was received.
Although we have business interruption insurance to cover certain lost
profits at all four clubs, we cannot predict with any degree of certainty what
future amounts will actually be received from the insurance carrier. Furthermore
we cannot, at this time, determine whether the assets related to the fourth club
location have been permanently impaired. We will continue to gather information
to better assess whether or not the assets of this club have been permanently
impaired. We are communicating with our insurance carrier on an ongoing basis in
order to better assess the relief we could expect to receive for such coverage.
FORWARD-LOOKING STATEMENTS
Certain statements in this report on Form 10-Q of the Company for the nine
month period ended September 30, 2002 are forward-looking statements, including,
without limitation, statements regarding future financial results and
performance, and potential sales revenue. These statements are subject to
various risks and uncertainties, many of which are outside the control of the
Company, including the level of market demand for the Company's services,
competitive pressures, the ability to achieve reductions in operating costs and
to continue to integrate acquisitions, the application of Federal and state tax
laws and regulations, and other specific factors discussed herein and in other
Securities and Exchange Commission filings by the Company. The information
contained herein represents management's best judgement as of the date hereof
based on information currently available; however, the Company does not intend
to update this information, except as required by law to reflect development or
information obtained after the date hereof and disclaims any legal obligation to
the contrary.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Within the 90 days prior to the date of filing this Form 10-Q, the
Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chairman and
Chief Executive Officer along with the Company's Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation,
the Company's Chief Executive Officer along with the Company's Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company (including its consolidated subsidiaries) required to be included in the
Company's periodic SEC filings.
(b) There have been no significant changes in the Company's internal
controls or in other factors which could significantly affect internal controls
subsequent to the date the Company carried out its evaluation.
13
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Not applicable.
ITEM 2. CHANGES IN SECURITIES.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits
Exhibit 99.1 Certification of Chief Executive Officer.
Exhibit 99.2 Certification of Chief Financial Officer.
b) Reports on Form 8-K
Not applicable
14
SIGNATURES
Pursuant to requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOWN SPORTS INTERNATIONAL, INC.
(Registrant)
DATE: November 4, 2002 By: /s/ RICHARD PYLE
--------------------------------------------------------
Richard Pyle
Chief Financial Officer, Office of the President
(principal financial, accounting officer)
DATE: November 4, 2002 By: /s/ ROBERT GIARDINA
--------------------------------------------------------
Robert Giardina
Chief Executive Officer
(principal executive officer)
15
I, Robert Giardina, Chief Executive Officer of Town Sports International, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Town Sports
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors:
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 4, 2002
By: /s/ ROBERT GIARDINA
----------------------------------
Robert Giardina
Chief Executive Officer
16
I, Richard Pyle, Chief Financial Officer of Town Sports International, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Town Sports
International, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors:
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 4, 2002
By: /s/ RICHARD PYLE
----------------------------------
Richard Pyle
Chief Financial Officer
17