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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission File Number 333-40907

TOWN SPORTS INTERNATIONAL, INC.

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.

Yes þ    No o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes o    No þ

     As of November 4, 2003 date there were 1,176,043 shares of Class A Common Stock of the Company outstanding.

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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003

INDEX

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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to the condensed consolidated financial statements.

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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 30, 2002 and 2003
All figures $’000
(Unaudited)

See notes to the condensed consolidated financial statements.

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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to the condensed consolidated financial statements.

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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and September 30, 2003
(Unaudited)

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, 2002 consolidated financial statements and notes thereto, included in 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. 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, except for the cumulative effect of a change in accounting principle, discontinued operations, and loss on extinguishment of debt are of a normal and recurring nature. The results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results for the entire fiscal year ending December 31, 2003.

2. Long-Term Debt and Capital Lease Obligations

     On April 16, 2003 the Company successfully completed a refinancing of its debt. This refinancing included an offering of $255.0 million of 9 5/8% Senior Notes (“Notes”) that will mature April 15, 2011, and the entering into of a new $50.0 million senior secured revolving credit facility (the “Senior Credit Facility”) that will expire April 15, 2008. The Notes accrue interest at 9 5/8% per annum and interest is payable semiannually on April 15, and October 15. The Company has effected a registration statement with the Securities and Exchange Commission for notes having substantially identical terms as the Notes as part of an offer to exchange freely tradable exchange notes for the Notes. In connection with this refinancing, the Company wrote-off $3.7 million of deferred financing costs related to extinguished debt, paid a call premium of $3.0 million and incurred $1.0 million of interest on the 9 3/4% Notes representing the interest incurred during the 30 day redemption notification period. The uses of proceeds from the 9 5/8% Note offering were as follows:

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     The Senior Credit Facility contains various covenants including limits on capital expenditures, the maintenance of a consolidated interest coverage ratio of not less than 2.25:1.00 during 2003, and a maximum permitted total leverage ratio of 4.00:1.00 during 2003. Loans under the Senior Credit Facility will, at our option, bear interest at either the bank’s prime rate plus 3.0% or the Eurodollar rate plus 4.0%, as defined. There were no borrowings outstanding at September 30, 2003 and outstanding letters of credit issued totaled $1.8 million. The unutilized portion of the Senior Credit Facility as of September 30, 2003 was $48.2 million.

3. September 11, 2001 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 clubs located in downtown Manhattan. Three of the affected four clubs were back in operation by October 2001, while the fourth club reopened in September 2002.

     The Company carries business interruption insurance to mitigate certain lost revenue and profits experienced with the September 11 events. In this regard, the Company received $350,000 in the first quarter of 2002, of which $175,000 represented reimbursement for costs incurred and $175,000 represented an on-account payment towards the interruption claim. In the third and fourth quarters of 2002, on-account payments of $250,000 and $600,000 were received. In the first quarter of 2003, an on-account payment of $1.3 million was received, and in July 2003, the Company entered into a settlement agreement with its insurer resulting in a final settlement payment of $1.5 million. These on-account and final payments have been classified with fees and other revenues when received.

4. Goodwill and Other Intangibles

     Effective January 1, 2002 the Company implemented the Financial Accounting Standards Board (“FASB”) Statement No. 141 Business Combinations and Statement No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). In connection with the SFAS 142 transition impairment test the Company recorded a $1.3 million write-off of goodwill in the quarter ended March 31, 2002. A deferred tax benefit of $612,000 was recorded with 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 the 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 each being considered a single reporting unit. The Company performed an impairment test in the quarter ended March 31, 2003 and determined that goodwill was not impaired.

     The change in the carrying amount of goodwill from December 31, 2002 through September 30, 2003 is as follows:

     Below is a summary of the Company’s acquired intangible assets as of December 31, 2002 and September 30, 2003.

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     The amortization expense of the above acquired intangible assets for each of the five years ended December 31, 2007 is as follows:

(a)

Amortization expense for the three and nine months ended September 30, 2003 amounted to $225,000 and $721,000 respectively.

5. Stock-Based Employee Compensation

     For financial reporting purposes, the Company accounts for stock-based compensation in accordance with the intrinsic value method (“APB No. 25”). In accordance with this method, no compensation expense is recognized in the accompanying financial statements in connection with the awarding of stock option grants to employees provided that, as of the grant date, all terms associated with the award are fixed and the fair value of the Company’s stock is not greater than the amount an employee must pay to acquire the stock as defined; however, to the extent that stock options are granted to employees with variable terms or if the fair value of the Company’s stock as of the measurement date is greater than the amount an employee must pay to acquire the stock, then the Company will recognize compensation expense. The fair value of warrants granted to nonemployees for the provision financing are recorded as deferred financing costs and amortized into interest expense using the interest method.

     The following table illustrates the effect on net income (loss) attributed to common stockholders if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board issued Statement No. 123, (“SFAS 123”) Accounting for Stock-Based Compensation, to stock-based employee compensation.

     Since option grants vest over several years and additional grants are expected in the future, the pro forma results noted above are not likely to be representative of the effects on future years of the application of the fair value based method.

     In July 2003 44,400 common stock options were granted to certain employees under the Town Sports International Stock Option Plan. The options have an exercise price of $144.00, which has been determined by a third party appraiser to be in excess of the fair value of the underlying common stock on the grant date. The options fully vest in 10 years and vesting can be accelerated if certain financial targets, as defined are met.

     For the purposes of the above pro forma information, the fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model. For the years ended December 31, 2000, 2001, and the July 2003 grant, the weighted-average fair value of the option grants were approximately $47.11, $111.89, and $14.50, respectively. The following weighted-average assumptions were used in computing the fair value of options grants: expected volatility of 69% for the year ended December 31, 2000, 72% for the year ended December 31, 2001, and 55.2% for the July 2003 grants, risk-free interest rate of approximately 6.6%, 4.6%, and 3.8% for December 31, 2000, 2001 and the July 2003 grants respectively, expected lives of five years for December 31, 2000 and 2001, and six years for the July 2003 grant, and a zero divided yield for all periods.

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6. Discontinued Operations

     In the fourth quarter of 2002, the Company sold or closed two remote underperforming, wholly-owned clubs. The Company has accounted for these two clubs as discontinued operations and, accordingly, the results of their operations have been classified as discontinued in the condensed consolidated statement of operations, and prior periods have been reclassified in accordance with the Financial Accounting Standards Board issued Statement No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. Revenues and pre-tax losses for these discontinued clubs were $459,000 and $1.2 million respectively for the three months ended September 30, 2002 and $1.3 million and $1.4 million respectively for the nine months ended September 30, 2002. Included in the pre-tax losses are $1.1 million of fixed asset write-offs related to these club closures.

7. Exercise of Stock Options

     In January 2003, an executive officer of the Company exercised 9,530 Series B preferred stock options, and in turn these newly issues shares were repurchased by the Company for $540,000 and were retired. In addition, the same officer sold 548 previously held shares of Series B preferred stock back to the Company for $43,000 which were also retired. In February 2003, several executives of the Company exercised and converted 148,775 Series B preferred stock options into 106,267 shares of Series B preferred stock. The difference between the 148,775 options exercised and the 106,267 shares issued is due to the remittance of these shares to the Company to cover the purchase price of the stock. The remitted shares were subsequently retired by the Company. The executives sold all of Series B preferred stock issued in connection with these February exercises to an affiliate of Rosewood Capital L.P., a stockholder of the Company.

8. Contingencies

     On February 13, 2003, an individual filed suit against the Company in the Supreme Court, New York County, alleging that on January 14, 2003, he sustained an injury at one of the Company’s club locations resulting in serious bodily injury. His complaint seeks $250.0 million in damages for personal injuries, in addition to $250.0 million of punitive damages. The Company has in force $51.0 million of insurance coverage to cover claims of this nature. The Company intends to vigorously contest this lawsuit and presently anticipates that these matters will be covered by insurance.

     In addition, the Company is a party to various lawsuits arising in the normal course of business. Management believes that the ultimate outcome of these matters will not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

9. Recent Accounting Pronouncements

     In May 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liability and Equity (“SFAS 150”), which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As of September 30, 2003 the Company does not have financial instruments within the scope of this pronouncement.

     In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. Interpretation No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or is entitled to receive a majority of the entity’s residual return or both. Interpretation No. 46 also provides criteria for determining whether an entity is a variable interest entity subject to consolidation. Interpretation No.46 requires immediate consolidation of variable interest entities created after January 31, 2003. For variable interest entities created prior to February 1, 2003, consolidation is required on October 1, 2003. The Company does not believe the adoption of Interpretation No. 46 will have a material effect on the consolidated financial statements.

10. Guarantors

     The Company and all of its domestic subsidiaries have unconditionally guaranteed the $255.0 million 9 5/8% Senior Notes. However the Company’s foreign subsidiaries have not provided guarantees for these Senior Notes.

     The following schedules set forth condensed consolidating financial information as required by Rule 3-10 of Securities and Exchange Commission Regulation S-X for the three and nine month periods ending September 30, 2002 and 2003. The financial information illustrates the composition of the combined guarantors.

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TOWN SPORTS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET